Cash and cash equivalents subject to restrictions
Cash and cash equivalents subject to restrictions
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 NZ IAS 7 Statement of Cash Flows, the basic requirements remain the same. Many Tier 1 and Tier 2 entities still make common errors when deciding whether items similar to cash (such as deposit accounts) are considered cash equivalents under NZ IAS 7 or the equivalent PBE IPSAS 2 Statement of Cash Flows for Public Benefit Entities (PBEs).
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 Nevertheless, according to their ordinary meaning, they are bank accounts from which funds can be withdrawn at any time, without advance notice, and without penalty.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 A seven or fourteen-day call deposit is, therefore, not cash because it cannot be withdrawn at any time.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.
- 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).
Restrictions on the use of cash
Sometimes funds may meet the definition of cash (i.e. cash in hand and demand deposits) but be subject to restrictions on how and when the funds may be used. For this reason, NZ IAS 7 (PBEs: PBE IPSAS 2) requires disclosure of the amount of significant cash held by the entity that is not available for use by the entity. This disclosure must be accompanied by management commentary explaining the circumstances of the restriction.
Example 1 – Cash for a construction project
A subsidiary obtains loan funding for a construction project. The funds are placed in demand deposits but can only be used for the subsidiary’s construction project which is currently underway. The funds cannot be used for working capital of the subsidiary, or by other group entities.
These demand deposits are classified as cash in the financial statements of both the subsidiary and the consolidated group. However, both the subsidiary’s financial statements and that of the consolidated group must include additional disclosure explaining the amount of cash that is ‘ring-fenced’ to the subsidiary’s construction project.
Example 2 – Foreign exchange controls
A parent entity has a subsidiary that operates in Country X and is subject to foreign exchange controls. The subsidiary has substantial amounts of cash in demand deposits, which it uses for cash management purposes in Country X. There are strict limits on the amounts of funds (cash) that can be repatriated by the subsidiary to the parent entity.These amounts are classified as cash in the financial statements of both the subsidiary and the consolidated group. However, the consolidated financial statements must include additional disclosure explaining how much of the subsidiary’s cash is not available for use by the rest of the group, and why.
Example 3 – Restricted cash is classified as cash
Entity X holds funds in a demand deposit account with Bank Y. There are no restrictions on the demand deposit account, and Entity X can withdraw funds at any time, without notice or penalty.However, Entity X has a contractual agreement with Entity Y to keep a specified amount of funds in the demand deposit account and to only use it for specific purposes. If Entity X fails to keep the stated amount in the demand deposit account, or uses it for other purposes, Entity X is in breach of its contractual obligations.
Entity X classifies the demand deposit as cash in its financial statements. This is because IFRIC’s agenda decision concluded that:
- The demand deposit still meets the definition of cash
- Restrictions in a contract on how a demand deposit can be used do not result in it no longer being cash. This applies unless those restrictions change the nature of the deposit so that it no longer meets the definition of cash in NZ IAS 7.
| In this fact pattern, the contractual restrictions do not change the nature of the deposit – Entity X can access those amounts on demand. However, if the restrictions on the use of cash were part of the terms and conditions of the deposit account with Bank Y, it is likely that it would not meet the definition of cash as it cannot be withdrawn on demand. |
Entity X must disclose the nature of the contractual restrictions on this demand deposit account and the related amount.
Restrictions on the use of cash equivalents
NZ IAS 7 (PBEs: PBE IPSAS 2) similarly requires disclosure of the amount of significant cash equivalents held by the entity that are not available for use by the entity.To meet the requirements for cash equivalents, the funds invested must be:
- 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.
When restrictions are imposed on accounts that are not ‘cash’, it is more likely they will not meet the definition of cash equivalents because they are held for a longer period in a term deposit, and/or the restriction has the effect that the funds cannot be used to meet short-term cash commitments.
An example of this could be a set amount of funds placed on a three-month term deposit as security for a two-year borrowing or a five-year commercial lease. As this deposit account is not held to meet short-term commitments, the last limb of the requirements above is not met, and the balance is not classified as cash equivalents. Rather, it is presented as a receivable in the statement of financial position and classified as a non-current asset. While it would ordinarily have been classified as a cash equivalent (except for the fact that it is not held for meeting short-term commitments) it is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period.
Significant judgements
Users of financial statements are particularly interested in how much cash and cash equivalents an entity has at reporting date, and how much it generated during the year. These are key metrics, so good disclosure about any significant judgements involved is vital.
Entities must carefully analyse any contractual terms that restrict when and how funds in their bank accounts, demand deposits and term deposits can be used. Significant judgement may be required to assess whether such restrictions result in amounts being presented in the balance sheet and cash flow statement as cash and cash equivalents, or as another type of receivable. Details of key judgements must be disclosed in accordance with paragraphs 122-124 of NZ IAS 1 Presentation of Financial Statements (PBEs: paragraphs 137-139 of PBE IPSAS 1 Presentation of Financial Statements). These are in addition to the disclosures noted above about restrictions on the way cash and cash equivalents can be used.
More information
Our previous article provides a reminder of common errors many entities continue to make when deciding whether items similar to cash (such as deposit accounts) are considered cash equivalents. You can also find extensive guidance in our publication.
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.