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Wiley l FRS: Practicallmplementation Guide and Workb ook
(a) A better insight into the financial structure of an entity, including its liquidity and sol–
vency, and its ability to affect the amounts and timing of cash flows in order to adapt to
changing circumstances and opportunities; and
(b) Enhanced information for the purposes of evaluation of changes in assets, liabilities, and
equity of an entity.
4,2 Furthermore, a cash flow stateme nt also
(c) Enhances the comparability of reporting operating performance by different entities be–
cause it eliminates the effects of using different accounting treatments for similar transac–
tions; and
(d) Serves as an indicator of the amount, timing, and certa inty of future cash flows.
5. CASH AND CASH EQUIVALENTS
5.1 True Significance of the Term "Cash Equivalents"
Cash equivalents are held by the entity for meeting short-term commitments. The true meaning of
cash equivalents can be best understood by analyzing the definition given by the Standard. Ac–
cording to the definition, cash equivalents are required to possess these two attributes:
(a) They should be "short term" in nature; that is, they are held for meeting short-term cash
commitments. In other words, an investment normally qualifies as cash equivalent only if it
has a short maturity , say, three months or less, from the date of acquisition.
Example
A
time deposit with a bank (or a fixed deposit, as is referred to in some countries) with an
original maturity ofsix months would not qualify as cash equiva lent.
(b) They should be "highly liquid investments" that are "readily convertible to known amounts
of cash and are subject to an insignificant risk of changes in value."
Example
Investments in equity shares of another entity would not qualify as cash equivalents be–
cause they are subject to risk of changes in values that could be
"significant "
depending
on how their market values flu ctuate in reacting to economic conditions or other fa ctors.
However, investments in redeemable preference shares acquired within a short period of
their maturity and with a specified redempti on date qualify as cash
equivalents.
5.2 Bank Borrowings as Ca sh Equivalents
Amounts due to a bank are generally considered to be financing activities . However, in certain
countries, bank overdrafts that are repayable on demand and form an integral part of an entity' s
cash management may be included as a component of cash equivalents. In order for a bank over–
draft to be thus included in cash equivalents (in other words,
offset
other cash equivalents being a
negative cash equivalent ), an important characteristic of such banking arrangements is that the
bank balance should fluctuate from being positive to overdrawn (i.e., negative) during the
period/year for which the cash flow statement is being prepared.
Practical Insight
In certain countries, banks offer to their long-standing customers a service (sometimes referred
to as bounce protection) wherein the banks cover up to a certain amount of overdrawn balance
in a customer's current account with the bank by way of an accommodation to the customer.
This is a temporary accommodation, and the bank ' s customer whose account is overdrawn is
usually allowed a limit for this facility. Some banks charge the customer a fee for this kind of
a service.
Let us examine how this operates in practice. Sayan entity issues checks to its creditors in the
expectation that collections from checks deposited with the bank would clear in time and be
enough to cover the funds needed to pay the checks issued to its creditors. For reasons beyond
the control of the entity, the checks deposited are not cleared in time. The bank has to step in