Cash equivalents sit on the same balance sheet line as cash, so what counts matters to every liquidity measure a reader computes.
Two conditions. The investment must be readily convertible to a known amount of cash. It must also be so near maturity that a rate change would not meaningfully move its value. In practice the second condition is applied as a maturity of three months or less. The three months runs from when the entity acquired the instrument, not from the reporting date.
That acquisition-date rule catches people. A five-year Treasury bond bought four years and ten months ago has two months left to run and is not a cash equivalent. It was bought with five years of interest rate risk, and holding it is an investing decision. A three-month Treasury bill bought last week is a cash equivalent even though it also has interest rate exposure, because over three months that exposure is small.
Equity securities are never cash equivalents; they have no maturity, so the second condition cannot be met. A bank overdraft is not a negative cash equivalent either. It is a liability, unless the entity has a right of offset against another account at the same bank.
ASC 230-10-45-6 also requires an entity to establish which qualifying investments its policy treats as cash equivalents. Apply the complete definition and the policy; a short term alone is insufficient. The Linden Peak cash close joins a qualifying bill to a reconciled demand deposit.
Put the concept to work
Understand this concept
- State both conditions an investment must meet to be a cash equivalent, and explain why the maturity test runs from the acquisition date rather than from the reporting date.
Apply this concept
- Decide for each of a set of instruments whether it is cash, a cash equivalent, a short-term investment, or none of these, and state the condition that decided it.
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- Cash equivalent — Understand
To apply this concept: Required. Classifying requires the test.
- Cash — Understand
To understand this concept: Required. A cash equivalent is reported together with cash.
- Cash-equivalent original-maturity test — Apply
To apply this concept: Required. Most classifications turn on the original maturity.
Show 1 more prerequisites
- Cash-equivalent original-maturity test — Understand
To understand this concept: Required. The maturity condition is the operative half of the test.
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Show 2 more related concepts
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- Cash equivalent — Apply
Required level here: understand. Required. Classifying requires the test.