Reminder: Cash and cash equivalents

For Tier 1 and Tier 2 For-profit and Public Benefit Entities (PBEs) the principles for classifying cash and cash equivalents in the statement of cash flows have not changed in two decades. While there have been minor tweaks to IAS 7 Statement of Cash Flows (or for PBEs – PBE IPSAS 2 Statement of Cash Flows), the basic requirements remain the same. Many entities still make common errors when deciding whether items similar to cash (such as deposit accounts) are considered ‘cash equivalents’.

What is ‘cash’?

Cash comprises cash on hand and demand deposits. Many entities no longer use cash or have petty cash on hand, so the bigger question is ‘What are demand deposits?’.

Demand deposits are not defined in IFRS® Accounting Standards. Nevertheless, according to their ordinary meaning, they are bank accounts from which funds can be withdrawn at any time, without advance notice, and without penalty. Essentially, they are as liquid as cash and are sometimes referred to as being ‘at call’. A seven or fourteen-day call deposit is, therefore, not cash because it cannot be withdrawn at any time. It may, however, be a cash equivalent.

What are cash equivalents?

Cash equivalents are:

• Short-term, highly liquid investments
• Readily convertible to known amounts of cash
• Subject to an insignificant risk of changes in value, and
• Held for the purpose of meeting short-term cash commitments rather than for investment or other purposes.

This means that an investment would only be a cash equivalent if it has a short maturity of three months or less from the origination date to the maturity date. A longer term is likely to result in it:

• Not being readily convertible into a known amount of cash
• Being subject to changes in value that are not insignificant (i.e. the longer the term to maturity, the greater the amount of termination penalties), and/or
• Not being held for meeting short-term commitments (cash management purposes).

Equity investments are not usually treated as cash equivalents unless they are, in substance, cash equivalents. This could be the case, for example, where preferred shares are acquired within a short period of their maturity, with a specified redemption date, for a known amount of cash. They would also need to meet the purpose test (that is, being held to meet short-term cash commitments).

Examples – Term deposits

Example 1	Example 2	Example 3	Example 4
Entity A is a profitable business and has surplus cash balances which it places in a three-month term deposit.	Entity B is a profitable business and has surplus cash balances which it places in a six-month term deposit.	Entity C is a profitable business and has surplus cash balances which it places in a six-month term deposit. At the reporting date, there are only two months remaining until the maturity date of the term deposit.	Entity D recently raised $10 million through a share placement. It invests this in a six-month term deposit. The funds will be used for long-term capital projects.
Will be used for cash management purposes.	Will be subject to the risk of changes in value. Due to the extended period, it is unlikely to be used for cash management purposes.	At its origination date, it was subject to the risk of changes in value. Due to the extended period, it was unlikely to be used for cash management purposes.	Will be subject to the risk of changes in value. Due to the extended period, it is unlikely to be used for cash management purposes. Will be used for investment, rather than cash management, purposes.
Cash equivalent	Not cash equivalents. Present as part of financial assets (other current receivables or term deposits) in the statement of financial position.	Not cash equivalents. Present as part of financial assets (other current receivables or term deposits) in the statement of financial position. Note: Deposits are not reclassified simply because they are within three months of maturity.	Not cash equivalents. Present as part of financial assets (other current receivables or term deposits) in the statement of financial position.

Examples – Bonds

Example 5	Example 6	Example 7	Example 8
Entity E is a profitable business and has surplus cash balances. It purchases a two-year government bond.	Entity F is a profitable business and has surplus cash balances. It purchases a two-year government bond, two months before the bond matures.	Entity G is a profitable business with surplus cash balances. Two months before the bond matures, it purchases a two-year government bond.	Entity H is a profitable business and has surplus cash balances. It purchases a two-year government bond, four months before the bond matures.
The bond is held for investment purposes.	The bond is held for investment purposes.	The bond is held to meet short-term cash commitments.	At its origination date, it was subject to the risk of changes in value. Due to the extended period, it was unlikely to be used for cash management purposes.
Not cash equivalents. Present as part of financial assets (other non-current receivables or term deposits) in the statement of financial position.	Not cash equivalents. Present as part of financial assets (other current receivables or term deposits) in the statement of financial position.	Cash equivalent. Note: For Entity G, there is only a two-month period from Entity G purchasing the bond (origination) to maturity.	Not cash equivalents. Present as part of financial assets (other current receivables or term deposits) in the statement of financial position.

Are bank overdrafts part of cash equivalents?

Bank overdrafts, which are repayable on demand, and form an integral part of an entity’s cash management processes, are included as cash equivalents. A characteristic of such arrangements is that the balance often fluctuates from positive to being overdrawn. The IFRIC agenda decision contains more analysis on this.

In the statement of financial position, overdrafts should only be offset against the positive cash and cash equivalent balances if they meet the offsetting criteria in paragraphs 42-50 of IAS 32 Financial Instruments: Presentation. Otherwise, they should be shown separately under current liabilities.

Are bank borrowings part of cash equivalents?

Bank borrowings are generally considered to be financing activities, and not part of cash equivalents. This is because they are not usually repayable on demand, and are not integral to an entity’s cash management processes. Also, their balance does not tend to fluctuate from being positive to overdrawn. The IFRIC agenda decision contains more analysis on this.
Similarly, short-term loans and credit facilities are also not considered cash equivalents.

We are here to help

Classifying cash and other bank accounts is not as simple as one might think, and it can involve significant judgement. Please contact our Financial Reporting Advisory team for help.

For more on the above, please contact your local BDO representative.

This article has been based on an article that originally appeared on BDO Australia, read the original article here.