Cash equivalents would include: Multiple Choice
Accounts receivable from customers.
Highly liquid Investments that can be quickly converted to cash.
Prepaid expenses that were purchased with cash.
Cash restricted for special purposes such as to repay debt in the future.
The Correct Answer and Explanation is :
The correct answer is: Highly liquid investments that can be quickly converted to cash.
Explanation:
Cash equivalents are defined as short-term, highly liquid investments that are easily convertible into a known amount of cash, with an insignificant risk of changes in value due to fluctuations in interest rates or other factors. These investments typically have original maturities of three months or less from the date of purchase. Examples of cash equivalents include Treasury bills, commercial paper, and money market funds.
Breakdown of Other Options:
- Accounts receivable from customers: Accounts receivable represent amounts owed by customers for goods or services already provided on credit. While this is an asset, it is not classified as a cash equivalent. Receivables may take time to collect, and there is uncertainty in the timing of cash inflow, making them not immediately liquid.
- Prepaid expenses purchased with cash: Prepaid expenses, such as prepaid insurance or rent, represent payments made in advance for goods or services to be received in the future. While these expenses were paid in cash, they are not liquid assets. Prepaid expenses are classified as current assets but do not have the same characteristics as cash or cash equivalents because they cannot be readily converted back into cash.
- Cash restricted for special purposes: Cash that is restricted for specific purposes (such as repayment of debt) is not classified as a cash equivalent. While it is still considered a form of cash, its restriction means it cannot be used freely, and thus, it doesn’t meet the liquidity requirements to be classified as a cash equivalent.
Conclusion:
To be considered a cash equivalent, an asset must be highly liquid, easy to convert into cash, and have minimal risk of value fluctuation. This is why highly liquid investments, such as Treasury bills, qualify as cash equivalents, whereas accounts receivable, prepaid expenses, and restricted cash do not.