to "The Ultimate Professor" Only

• LO21–2

Skilled cash managers will invest temporarily idle cash in short-term investments to earn interest on those funds, rather than maintain an unnecessarily large balance in a checking account. The FASB views short-term, highly liquid investments that can be readily converted to cash, with little risk of loss, as cash equivalents. Amounts held as investments of this type are essentially equivalent to cash because they are quickly available for use as cash. Therefore, on the statement of cash flows there is no differentiation between amounts held as cash (e.g., currency and checking accounts) and amounts held in cash equivalent investments. So, when we refer in this chapter to cash, we are referring to the total of cash and cash equivalents.

There is no differentiation between amounts held as cash and amounts held in cash equivalent investments.

Page 1262

Examples of cash equivalents are money market funds, Treasury bills, and commercial paper. To be classified as cash equivalents, these investments must have a maturity date not longer than three months from the date of purchase. Flexibility is permitted in designating cash equivalents. Each company must establish a policy regarding which short-term, highly liquid investments it classifies as cash equivalents. The policy should be consistent with the company's customary motivation for acquiring various investments and should be disclosed in the notes to the statement.3 A recent annual report of ExxonMobil Corporation provides this description of its cash equivalents (Illustration 21-3):

Each firm's policy regarding which short-term, highly liquid investments it classifies as cash equivalents should be disclosed in the notes to the financial statements.

Transactions that involve merely transfers from cash to cash equivalents (such as the purchase of a three-month Treasury bill), or from cash equivalents to cash (such as the sale of a Treasury bill), should not be reported on the statement of cash flows. The total of cash and cash equivalents is not altered by such transactions.4 The cash balance reported in the balance sheet also represents the total of cash and cash equivalents, which allows us to compare the change in that balance with the net increase or decrease in the cash flows reported on the statement of cash flows.

Primary Elements of the Statement of Cash Flows

This section describes the three primary activity classifications: (1) operating activities, (2) investing activities, and (3) financing activities; and two other requirements of the statement of cash flows: (4) the reconciliation of the net increase or decrease in cash with the change in the balance of the cash account and (5) noncash investing and financing activities.