Which statement best describes cash and cash equivalents on the balance sheet?

• A. Cash includes currency and demand deposits; cash equivalents are short-term, highly liquid investments readily convertible to known amounts of cash.
• B. Cash includes currency and demand deposits; cash equivalents are long-term investments.
• C. Cash equivalents are cash on hand.
• D. Cash includes only physical currency.

Answer: (A)

Cash and cash equivalents measure the most liquid assets on the balance sheet. Cash includes currency and demand deposits, such as money in checking and savings accounts. Cash equivalents are short-term, highly liquid investments that can be readily converted to a known amount of cash and are subject to insignificant risk of changes in value; they typically have original maturities of three months or less. This combination reflects liquidity, not long-term investment risk. Items like long-term investments aren’t considered cash equivalents, and cash equivalents aren’t just cash on hand or physical currency. So the statement that correctly describes this is that cash includes currency and demand deposits, while cash equivalents are short-term, highly liquid investments readily convertible to known cash amounts.