6Cash and Cash Equivalents – Audit and Accounting Guide Depository and Lending Institutions, 2nd Edition

Chapter 6
Cash and Cash Equivalents

Introduction

6.01 Cash and cash equivalents include cash items in the process of collection (CIPC), deposits with other financial institutions, including corporate credit unions, balances with the Federal Reserve Banks and the Federal Home Loan Banks (FHLBs), federal funds sold, and cash and cash equivalents on hand. Instruments that meet the definition of cash and cash equivalents, as defined in the FASB Accounting Standards Codification (ASC) glossary, are discussed in this chapter. Investments in debt and equity securities that are accounted for under FASB ASC 320, Investments—Debt and Equity Securities, are discussed in chapter 7, “Investments in Debt and Equity Securities,” of this guide. Other investments are discussed in chapter 12, “Other Assets, Other Liabilities, and Other Investments,” of this guide. The fair value option for financial assets and liabilities under FASB ASC 825, Financial Instruments, is addressed in chapter 20, “Fair Value,” of this guide.

CIPC and Cash Equivalents

6.02 CIPC includes customer deposits drawn on other depository institutions that have not yet cleared, matured instruments (such as coupons and bonds), and other matured items temporarily held pending their liquidation. Such assets are received with deposits and other customer transactions. CIPC are eventually cleared through local clearinghouses, correspondent institutions (correspondents), or a Federal Reserve Bank. Collection of these items generally takes between one to five business days. A discussion of cash equivalents can be found in paragraph 6.09.

Deposits With Other Financial Institutions

6.03 Correspondents are depository institutions that hold the account balances of other financial institutions and provide services to those institutions, such as check collection and item processing. Such accounts with balances due from other institutions are generally called "due from banks" and are maintained by depository institutions as a means of more efficient check clearing or to compensate the correspondent for other services provided to the depositor. Institutions that engage in international banking may maintain deposits with foreign depository institutions for the same reasons.

6.04 Many institutions also invest in nonnegotiable or negotiable certificates of deposit (CDs) of other depository institutions. These balances are generally interest bearing and insured up to $250,0001 and have a range of maturity options.

6.05 Many credit unions hold funds in corporate credit unions. Corporate credit unions, which are regulated by the National Credit Union Administration, provide investment, liquidity, and payment services to natural-person credit unions. These corporate credit unions aggregate funds acquired from natural-person credit unions in order to facilitate the purchase of overnight and term investments. Overnight investments include cash management accounts and overnight certificates. Term investments, with maturities from two days to five years or longer, include fixed-rate and variable-rate shares and certificates.

Balances With Federal Reserve Banks and FHLBs

6.06 Federal regulations require depository institutions to set aside specified amounts of cash as reserves against transaction accounts and time deposits. These reserves may be held as vault cash, in a noninterest-bearing account with a district Federal Reserve Bank or FHLB, or as deposits with correspondents. Though one objective of reserve requirements is to safeguard liquidity in the banking system, institutions do not look to their reserves as a primary source of liquidity because regulations permit their depletion for only short periods and in limited circumstances. Rather, reserves are a primary tool of the Board of Governors of the Federal Reserve System (Federal Reserve) to effect monetary policy; by increasing or decreasing reserve requirements, the Federal Reserve can expand or contract the money supply. Depository institutions also may lend excess balances overnight and for short periods in the federal funds market.

Federal Funds Sold

6.07 Chapter 14, “Federal Funds and Repurchase Agreements,” of this guide discusses federal funds and repurchase agreements, which can be either assets or liabilities, depending on which side of the transaction the institution participates.

Cash on Hand

6.08 Cash on hand consists primarily of coin and currency in vaults, in the institution’s automated teller machines (ATMs), and maintained by tellers to meet customers' requests. Cash on hand generally represents a small percentage of a depository institution's total of cash and cash equivalent items.

Accounting and Financial Reporting

Definition of Cash and Cash Equivalents

6.09 The FASB ASC glossary defines cash as currency on hand, demand deposits with banks or other financial institutions, and other kinds of accounts that have the general characteristics of demand deposits in that the customer may deposit additional funds at any time and also effectively may withdraw funds at any time without prior notice or penalty. Cash equivalents are defined in the FASB ASC glossary as short term, highly liquid investments that have both of the following characteristics:

  1. a. Readily convertible to known amounts of cash
  2. b. So near their maturity that they present insignificant risk of changes in value because of changes in interest rates

Generally, only investments with original maturities of three months or fewer qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a three-month U.S. Treasury bill (T-bill) and a three-year U.S. Treasury note (T-note) purchased three months from maturity qualify as cash equivalents. However, a T-note purchased three years ago does not become a cash equivalent when its remaining maturity is three months. Examples of items commonly considered to be cash equivalents are T-bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations). Other examples may include CDs.

6.10 Only instruments that meet both of the previously mentioned criteria and are used as part of an institution's cash-management activities ordinarily would be included in cash equivalents. For example, T-bills purchased for an investment account would be part of the institution's investing activities (not cash-management activities) and would therefore be excluded from cash equivalents. The carrying amount of items classified as cash and cash equivalents generally approximates fair value because of the relatively short period of time between the origination of the instruments and their expected realization.

6.11 Investments, such as negotiable CDs and mutual funds that meet the definition of a security in the FASB ASC glossary are subject to the reporting, classification, and other provisions of FASB ASC 320. Investments subject to FASB ASC 320 are discussed in chapter 7 of this guide.

Classification of Cash Flows

6.12 FASB ASC 230, Statement of Cash Flows, presents standards for reporting cash flows in general-purpose financial statements. FASB ASC 230-10-45-4 states the total amounts of cash and cash equivalents at the beginning and end of the period shown in the statement of cash flows should be the same amounts as similarly titled line items or subtotals shown in the statements of financial position as of those dates.

6.13 FASB ASC 230-10-50-1 requires an entity to disclose its policy for determining which items are treated as cash equivalents. Any change to that policy is a change in accounting principle that should be effected by restating financial statements for earlier years presented for comparative purposes.

6.14 The cash equivalents policy is generally disclosed in the accounting policy footnote.

6.15 Specific guidance for applying the direct method and the indirect method of reporting cash flows is provided in FASB ASC 230-10. In reporting cash flows from operating activities, FASB ASC 230-10-45-25 states that entities are encouraged to report major classes of gross cash receipts and gross cash payments and their arithmetic sum—the net cash flow from operating activities (the direct method). If the direct method of reporting net cash flow from operating activities is used, the reconciliation of net income of a business entity to net cash flow from operating activities should be provided in a separate schedule, as stated in FASB ASC 230-10-45-30. Paragraphs 1–5 of FASB ASC 942-230-55 provide implementation guidance and illustrations regarding the statement of cash flows under the direct method for financial institutions.

6.16 Examples of major classes of gross cash receipts reported in operating activities may include interest received and service charges collected. Examples of gross cash disbursements may include interest paid and operating expenses paid.

6.17 Entities that choose not to provide information about major classes of operating cash receipts and payments by the direct method should determine and report the same amount for net cash flow from operating activities indirectly by adjusting net income of a business entity to reconcile it to net cash flow from operating activities (the indirect or reconciliation method), as stated in FASB ASC 230-10-45-28. If the indirect method is used, amounts of interest paid (net of amounts capitalized) and income taxes paid during the period should be disclosed, according to FASB ASC 230-10-50-2.

6.18 According to FASB ASC 230-10-45-10, a statement of cash flows should classify cash receipts and cash payments as resulting from investing, financing, or operating activities. The FASB ASC glossary defines operating activities as all transactions and other events that are not defined as investing or financing activities (see paragraphs 12–15 of FASB ASC 230-10-45). Operating activities generally involve producing and delivering goods and providing services. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income.

6.19 Paragraphs 11–12 of FASB ASC 230-10-45 state that cash flows from the purchases, sales, and maturities of available-for-sale securities should be classified as cash flows from investing activities and reported gross in the statement of cash flows. Receipts from sales of loans that were not specifically acquired for resale are cash inflows from investing activities. That is, if loans were acquired as investments, cash receipts from sales of those loans should be classified as investing cash inflows regardless of a change in the purpose for holding those loans.

6.20 Summarized in the following are some typical investing and financing cash flows that may be reported for a financial institution.

Investing Activities

Cash Inflows Cash Outflows
Loan principal payments Loan originations
Portfolio loan sale proceeds Loan purchases
Security sale and maturity proceeds (disclose separately for held-to-maturity securities and available-for-sale securities)* Security purchases (disclose separately for held-to-maturity securities and available-for-sale securities)*
Real estate sale proceeds Investment in real estate held for development
Net deposits withdrawn from other financial institutions Net deposits placed with other financial institutions
Sales of loan servicing rights Purchases of loan servicing rights
Net decrease in reverse repurchase agreements** (repos) Net increase in repos*
Decrease in National Credit Union Share Insurance Fund (NCUSIF) deposit Increase in NCUSIF deposit
* See footnote 1.
** Repos are addressed in chapter 14, “Federal Funds and Repurchase Agreements,” of this guide.

Financing Activities

Cash Inflows Cash Outflows
Net increase in mortgage escrow deposits Net decrease in mortgage escrow deposits
Net certificates of deposit (CDs) issued Net CDs matured
Net increase in other deposit accounts Net decrease in other deposit accounts
Proceeds from Federal Home Loan Banks (FHLB) advances and other borrowings Repayment of FHLB advances and other borrowings
Net increase in short term borrowings (original maturity of three months or fewer) Net decrease in short term borrowings (original maturity of three months or fewer)
Proceeds from the issuance of common stock or other equity instruments Reacquisition of equity instruments (for example, purchase of treasury stock)
Net increase in repurchase agreements (repos) and dollar-roll repos Net decrease in repos and dollar-roll repos
Dividends and other cash distributions to stockholders

6.21 Noncash investing and financing activities. According to paragraphs 3–4 of FASB ASC 230-10-50, information about all investing and financing activities of an entity during a period that affect recognized assets or liabilities but that do not result in cash receipts or cash payments in the period should be disclosed. Those disclosures may be either narrative or summarized in a schedule, and they should clearly relate the cash and noncash aspects of transactions involving similar items. Examples of noncash investing and financing activities are converting debt to equity; acquiring assets by assuming directly related liabilities, such as purchasing a building by incurring a mortgage to the seller; obtaining an asset by entering into a capital lease; obtaining a building or investment asset by receiving a gift; and exchanging noncash assets or liabilities for other noncash assets or liabilities.

6.22 Other examples of noncash investing and financing activities for financial institutions may include

  • originating a mortgage loan to finance the sale of foreclosed real estate or real estate held for development;
  • acquiring a real estate property through, or in lieu of, foreclosure of the related loan;
  • converting mortgage or other loans into mortgage-backed or other asset-backed securities (commonly referred to as securitizing loans); and
  • selling or purchasing branch offices when the buyer assumes deposit liabilities in exchange for loans and other assets received from the seller, in which case only the cash paid, net of cash acquired or received, ordinarily should be reported as a cash outflow or inflow.

Acquisition and Sales of Certain Securities and Loans

6.23 Banks, brokers and dealers in securities, and other entities may carry securities and other assets in a trading account, as stated in paragraphs 18–21 of FASB ASC 230-10-45. Cash receipts and cash payments resulting from purchases and sales of securities classified as trading securities as discussed in FASB ASC 320 should be classified pursuant to FASB ASC 230 based on the nature and purpose for which the securities were acquired. Cash receipts and cash payments resulting from purchases and sales of other securities and other assets should be classified as operating cash flows if those assets are acquired specifically for resale and are carried at fair value in a trading account. Cash receipts and cash payments resulting from acquisitions and sales of loans also should be classified as operating cash flows if those loans are acquired specifically for resale and are carried at fair value or at the lower of cost or fair value in accordance with FASB ASC 948, Financial Services—Mortgage Banking.

6.24 In applying the guidance stated in the previous paragraph, for the direct method, gross cash receipts and cash payments from these sources should be reported separately as operating cash flows consistent with FASB ASC 230-10-45-25. If the indirect method is used, only the net increases or decreases in loans and securities may be reported in reconciling net income to the net cash flow from operating activities consistent with FASB ASC 230-10-45-28.

Gross and Net Cash Flows

6.25 Paragraphs 7–9 of FASB ASC 230-10-45 state that, generally, information about the gross amounts of cash receipts and cash payments during a period is more relevant than information about the net amounts of cash receipts and payments. However, the net amount of related receipts and payments provides sufficient information for the following:

  • Cash equivalents
  • Certain items for which turnover is quick, amounts are large, and maturity is short
  • Cash receipts and payments pertaining to any of the following providing that the original maturity of the asset or liability is three months or less:

—  Investments (other than cash equivalents)

—  Loans receivable

—  Debt

6.26 According to FASB ASC 230-10-45-8, for certain other items, such as demand deposits of a bank and customer accounts payable of a broker-dealer, the entity is substantively holding or disbursing cash on behalf of its customers. Only the net changes during the period in assets and liabilities with those characteristics need be reported because knowledge of the gross cash receipts and payments related to them may not be necessary to understand the entity's operating, investing, and financing activities.

6.27 Other items for which the institution is substantively holding, receiving, or disbursing cash on behalf of its customers, may include

  • negotiable order of withdrawal (NOW) and super NOW accounts,
  • savings deposits,
  • money market deposit accounts,
  • mortgage escrow funds, and
  • collections and remittances on loans serviced for others.

6.28 FASB ASC 942, Financial Services—Depository and Lending, provides industry-specific accounting and reporting guidance for depository and lending financial institutions. Paragraphs 1–2 of FASB ASC 942-230-45 state that banks, savings institutions, and credit unions are not required to report gross amounts of cash receipts and cash payments for (a) deposits placed with other financial institutions and withdrawals of those deposits, (b) time deposits accepted and the repayments of deposits, and (c) loans made to customers and principal collections of loans. When those entities constitute part of a consolidated entity, net amounts of cash receipts and cash payments for deposit or lending activities of those entities should be reported separate from gross amounts of cash receipts and cash payments for other investing and financing activities of the consolidated entity, including those of a subsidiary of a bank, savings institution, or credit union that is not itself a bank, savings institution, or credit union.

Cash Receipts and Payments Related to Hedging Activities

6.29 FASB ASC 230-10-45-27 explains that cash flows from derivative instruments that are accounted for as fair value hedges or cash flow hedges may be classified in the same category as the cash flows from the items being hedged provided that the derivative instrument does not include an other-than-insignificant financing element at inception, other than a financing element inherently included in an at-the-market derivative instrument with no prepayments (that is, the forward points in an at-the-money forward contract) and that the accounting policy is disclosed. If the derivative instrument includes an other-than-insignificant financing element at inception, all cash inflows and outflows of the derivative instrument should be considered cash flows from financing activities by the borrower. If for any reason hedge accounting for an instrument that hedges an identifiable transaction or event is discontinued, then any cash flows after the date of discontinuance should be classified consistent with the nature of the instrument.

Financial Statement Presentation and Disclosure

6.30 FASB ASC 942-305-50-1 states that restrictions on the use or availability of certain cash balances, such as deposits with a Federal Reserve Bank, FHLB, or correspondent financial institutions to meet reserve requirements or deposits under formal compensating balance agreements, should be disclosed in the notes to the financial statements.

6.31 FASB ASC 942-305-05-2 states that a financial institution that accepts deposits may have balances due from the same financial institution from which it has accepted a deposit, also called reciprocal balances. Reciprocal account balances, as explained in FASB ASC 942-305-45-1, should be offset if they will be offset in the process of collection or payment. Overdrafts of such accounts should be reclassified as liabilities, unless the financial institution has other accounts at the same financial institution against which such overdrafts can be offset.

6.32 The presentation of deposits in other depository institutions in the balance sheet varies among financial institutions. For example, if all or some portion of such deposits meet the definition of cash equivalent, as defined in the FASB ASC glossary, some institutions may combine all or the applicable portion of deposits in other institutions with cash and cash equivalents as the first line item in the balance sheet. Any portion of deposits not meeting the definition of cash equivalent may then be shown separately in the balance sheet, or it may be combined with other short term investments or other investments (if interest bearing); in either case, presented after cash and cash equivalents in the statement of financial condition. Alternatively, some institutions may segregate interest-bearing and noninterest-bearing deposits. Noninterest-bearing deposits that meet the definition of cash equivalent are typically combined with cash equivalents. Interest-bearing deposits in other institutions are presented separately in the balance sheet after cash and cash equivalents, or combined with other short term investments or other investments, regardless of whether all or some portion of such deposits meet the definition of cash equivalent. These practices are considered acceptable, provided that cash and cash equivalents in the balance sheet include only those instruments meeting the definition of cash equivalents, and as discussed further in paragraph 6.09, herein, the institution discloses its policy used to classify items as cash equivalents.

6.33 If deposits in other institutions are material, then deposits should be presented as a separate amount in the balance sheet, as stated in FASB ASC 942-210-45-4.

Auditing2

Objectives

6.34 The primary audit objectives for cash are to obtain sufficient appropriate evidence that

  1. a. recorded balances exist and are owned by the institution;
  2. b. recorded balances are complete and stated at realizable amounts;
  3. c. balances are properly presented in the financial statements;
  4. d. restrictions on the availability or use of cash are appropriately identified and disclosed; and
  5. e. cash receipts, disbursements, and transfers between accounts are recorded in the proper period.

Planning

6.35 In accordance with AU-C section 315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement (AICPA, Professional Standards), the objective of the auditor is to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and relevant assertion levels through understanding the entity and its environment, including the entity’s internal control, thereby providing a basis for designing and implementing responses to the assessed risks of material misstatement (as described in chapter 5, “Audit Considerations and Certain Financial Reporting Matters,” of this guide). Factors related to cash and cash equivalents that could influence the risks of material misstatement may include (a) cash and cash equivalents are generally negotiable, (b) involve large volumes of transactions, and (c) affect a large number of financial statement accounts.

Internal Control Over Financial Reporting and Possible Tests of Controls

6.36 AU-C section 315 addresses the auditor’s responsibility to identify and assess the risks of material misstatement in the financial statements through understanding the entity and its environment, including the entity’s internal control. Paragraphs .13–.14 of AU-C section 315 state that the auditor should obtain an understanding of internal control relevant to the audit and, in doing so, should evaluate the design of those controls and determine whether they have been implemented by performing procedures in addition to inquiry of the entity’s personnel. (See chapter 5 of this guide for further discussion of the components of internal control.) To provide a basis for designing and performing further audit procedures, paragraph .26 of AU-C section 315 states that the auditor should identify and assess the risks of material misstatement at the financial statement level and the relevant assertion level for classes of transactions, account balances, and disclosures.

6.37 Because of the negotiability of the items included in cash, the large volume of activity in cash accounts, and the large number of accounts affected by cash transactions, the effectiveness of internal control in this area is an important factor in audit planning. Internal control over financial reporting and possible tests of controls related to the payments function, including wire transfers, are discussed in chapter 13, “Deposits,” of this guide. Examples of control activities for cash balances include the following:

  • Currency and coins are periodically counted and are reconciled to recorded amounts on a timely basis.
  • Surprise counts of teller cash funds, vault cash, and cash items are performed periodically by persons other than those with related day-to-day responsibility.
  • Tellers have exclusive access to and custody of their respective cash on hand.
  • Access to night depositories (including ATM depositories) is under dual control (the control of more than one person), and at least two persons are present when the contents of depositories are removed, counted, listed, or otherwise processed.
  • Cash transaction items are reviewed daily for propriety by an officer or a supervisory employee other than the custodian of the items.
  • Each of the functions of draft issuance, register maintenance, and reconciliation is performed by a different employee.
  • Confirmation requests received from depository institutions, supervisory examiners, and other parties are processed by an employee who does not also reconcile the subject account.
  • Controls exist over access to and execution of official and certified checks.
  • Controls exist over consignment items, such as traveler’s checks or money orders that could easily be converted into cash.
  • Cash and coin-counting equipment are periodically tested for accuracy.
  • Currency that is mutilated or identified as counterfeit is segregated and reported.
  • The replenishment of teller’s cash is documented and reviewed by another employee.
  • Vault cash is under the control of more than one person.
  • Procedures exist for the credit evaluation of correspondent banking relationships.
  • Records of ATM transactions are reconciled to their recording in books of entry on a daily basis.

6.38 AU-C section 330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained (AICPA, Professional Standards), addresses the auditor’s responsibility to design and implement responses to the risks of material misstatement identified and assessed by the auditor in accordance with AU-C section 315 and to evaluate the audit evidence obtained in an audit of financial statements.

6.39 In accordance with paragraph .08 of AU-C section 330, the auditor should design and perform tests of controls to obtain sufficient appropriate audit evidence about the operating effectiveness of relevant controls if (a) the auditor’s assessment of risks of material misstatement at the relevant assertion level includes an expectation that the controls are operating effectively or (b) substantive procedures alone do not provide sufficient appropriate audit evidence at the relevant assertion level. The following are examples of tests of controls to be considered:

  • Observing that the existing segregation of duties is adequate with respect to the handling and reconciliation of cash
  • Reading the documentation of surprise cash counts of teller, vault, ATM, and other cash on hand to determine whether documentation supports management’s assertion that the surprise cash counts are performed periodically and in accordance with the institution's policies
  • Observing maintenance of control over mail receipts and supplies of consigned items
  • Inspecting and testing reconciliations to determine that they are performed and reviewed in a timely manner

6.40 Possible tests of controls related to electronic funds transfers are discussed in chapter 13 of this guide.

Substantive Tests

6.41 Irrespective of the assessed risks of material misstatement, paragraph .18 of AU-C section 330 states that the auditor should design and perform substantive procedures for all relevant assertions related to each material class of transactions, account balance, and disclosure, which for a financial institution would include cash and cash equivalents. In accordance with paragraph .A45 of AU-C section 330, this requirement reflects the facts that (a) the auditor’s assessment of risk is judgmental and may not identify all risks of material misstatement and (b) inherent limitations to internal control exist, including management override.

6.42 Substantive procedures that the auditor may consider include, but are not limited to, the following:

  • Counting cash and comparing the balances with tellers' records
  • Testing tellers' records for mathematical accuracy
  • Testing the reconciliations between recorded balances of cash due from correspondents and statements received from correspondents
  • Reviewing the cutoff of interbank transfers
  • Testing the reconciliations of subsidiary ledgers to the general ledger
  • Testing the propriety of authorized accounts and signatures
  • Reviewing the composition of suspense accounts, especially noting the recurring use and aging of reconciling items and any failure or inability to reconcile the cash account
  • Confirming account balances with and reviewing the creditworthiness of correspondents
  • Confirming consigned items with consignors
  • Reviewing cash records for unusual transactions or adjustments
  • Testing the propriety of due to and due from accounts set off in the balance sheet
  • Testing fair value disclosures

Notes

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