ACCA Strategic Business Reporting (SBR) Practice Exam

Which of the following best defines 'cash and cash equivalents'?

1. Assets that are highly volatile and illiquid

2. Cash on hand and short-term investments convertible into cash

3. Only cash that is held for future investments

4. Long-term investments with low liquidity risk

The correct answer is: Cash on hand and short-term investments convertible into cash

The concept of 'cash and cash equivalents' is crucial in accounting and financial reporting as it encompasses the most liquid assets that a company holds. The correct definition captures two key components: cash itself and short-term investments that can readily be converted into cash. Cash includes not only physical currency but also demand deposits that are readily available for use. Short-term investments classified as cash equivalents typically have a maturity of three months or less from the date of acquisition. They are easily convertible to a known amount of cash and are subject to an insignificant risk of changes in value. This means that they provide an immediate source of cash and can be used without significant time lag or liquidity concerns. Understanding this definition is essential for analyzing a company's liquidity position, as cash and cash equivalents are foundational in assessing the ability to meet short-term obligations. Other definitions that suggest high volatility or illiquidity misunderstand the fundamental nature of these assets. Similarly, focusing solely on cash for future investments or including long-term investments does not align with the clear, immediate availability that defines cash and cash equivalents.