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6.5 Cash, cash equivalents, and restricted cash
Publication date: 30 Nov 2020
us Financial statement presentation guide 6.5
The statement of cash flows must detail changes in the total of cash, cash equivalents, restricted cash, and restricted cash equivalents and any other segregated cash and cash equivalents for the period. The beginning and ending balance of cash, cash equivalents, restricted cash, and restricted cash equivalents and any other segregated cash and cash equivalents shown on the statement of cash flows should agree to the total of similarly titled line items on the balance sheet.
6.5.1 Definition of cash
Cash includes cash on hand (e.g., petty cash), demand deposits with financial institutions, money orders, certified checks and cashier’s checks.
ASC 230 defines cash as follows:
ASC 230-10-20 Glossary
Cash: Consistent with common usage, cash includes not only currency on hand but demand deposits with banks or other financial institutions. Cash also includes other kinds of accounts that have the general characteristics of demand deposits in that the customer may deposit additional funds at any time and also effectively may withdraw funds at any time without prior notice or penalty. All charges and credits to those accounts are cash receipts or payments to both the entity owning the account and the bank holding it. For example, a bank's granting of a loan by crediting the proceeds to a customer's demand deposit account is a cash payment by the bank and a cash receipt of the customer when the entry is made.
6.5.1.1 Bank overdrafts
Bank overdrafts occur when a bank honors disbursements in excess of funds on deposit in a reporting entity's account. Such a feature is commonly referred to as overdraft protection. Accordingly, bank overdrafts represent short-term loans from the bank and should be classified as debt on the balance sheet and financing cash flows in the statement of cash flows, as discussed in the non-authoritative guidance included in section 1300.15 of the AICPA Technical Questions and Answers.
Some reporting entities have executed contractual agreements that link numerous bank accounts within the same bank, or a group of banks. For example, multinational entities that maintain cash balances in numerous consolidated subsidiaries, in multiple currencies, in multiple countries sometimes enter into notional pooling arrangements to facilitate their worldwide treasury activities. Under a notional pooling arrangement, the balances of all bank accounts subject to the arrangement are combined into a single unit of account for purposes of determining the balance on deposit under the terms of the agreement. Accordingly, the bank accounts of certain subsidiaries in the notional pooling arrangement are allowed to be in an overdraft position if the bank accounts of other subsidiaries in the notional arrangement have aggregated deposit positions in excess of the aggregated overdraft accounts.
ASC 210, Balance Sheet, indicates that a reporting entity's cash account at a bank is not considered an amount owed to the reporting entity for purposes of determining whether a right of offset exists. Accordingly, the ASC 210 offset model cannot be utilized to offset a bank account in a deposit position against another bank account with the same bank that is in an overdraft position. Notwithstanding the guidance in ASC 210, some reporting entities have concluded that the contractual terms of their notional pooling arrangements preclude individual bank accounts within the arrangement from being considered separate accounts because contractually it functions as one account. In such circumstances, the reporting entity should aggregate all bank accounts that are subject to the notional pooling arrangement into a single balance on its balance sheet and to combine these balances when assessing if there is a bank overdraft. However, when a subsidiary that participates in the notional pooling arrangement prepares its financial statements on a standalone basis, the presentation of the subsidiary’s bank accounts should reflect the facts and circumstances of the individual subsidiary without consideration of its parent’s conclusions regarding the notional pooling arrangement at the consolidated level.
6.5.1.2 Book overdrafts
Book overdrafts are created when the sum of outstanding checks related to a specific bank account are in excess of funds on deposit (including deposits in transit) for that bank account. Unlike a bank overdraft, there is no cash flow impact from a book overdraft. Book overdrafts related to a specific bank account should not be offset against other cash or cash equivalent accounts (including time deposits, certificates of deposit, money market funds, and similar temporary investments).
Non-authoritative guidance included in section 1100.08 of the AICPA Technical Questions and Answers indicates that outstanding checks should be accounted for as a reduction of cash. As a result, in practice, most preparers reflect book overdrafts as a liability on the balance sheet and disclose that such liability is a reinstatement of liabilities cleared in the bookkeeping process.
However, a reporting entity may have a contractual banking arrangement whereby the unit of account is the contractual arrangement, not the individual bank accounts subject to the arrangement (see FSP 6.5.1.1). In such circumstances, the reporting entity should assess the combined balance on deposit for presentation within its balance sheet.
Question FSP 6-2 addresses the presentation of changes in book overdrafts within the statement of cash flows.
Question FSP 6-2
How should changes in book overdrafts be reflected in the statement of cash flows?
PwC response
A book overdraft is not reflected in the statement of cash flows because it only represents the reinstatement of accounts payable and does not result in cash changing hands or credit being extended by a financial institution. Thus, this activity does not represent “proceeds from short-term borrowings” as described in ASC 230-10-45-14 and is not a financing activity.
However, assuming that cash has been reduced for outstanding checks based on the non-authoritative AICPA guidance discussed above, if a zero balance account is linked to a bank overdraft credit facility and checks presented for payment are immediately payable under the credit facility, the “book” overdraft would be, in substance, a “bank” overdraft. This is because the bank can turn presented checks into legal liabilities without further action by the payor. In that case, changes in the overdraft would be classified as financing activities in the statement of cash flows and the overdraft would be presented as debt on the balance sheet.
6.5.1.3 Checks written but not released
Checks that have not been released by the end of the accounting period (e.g., not mailed) should not be reflected in the financial statements (i.e., the related balances should still be reflected as cash and the related account payable due).
6.5.2 Definition of cash equivalents
While the definition of cash is generally understood, what constitutes a cash equivalent is not as straightforward. ASC 230 defines cash equivalents.
ASC 230-10-20 Glossary
Cash Equivalents: Cash equivalents are short-term, highly liquid investments that have both of the following characteristics:
- Readily convertible to known amounts of cash
- So near their maturity that they present insignificant risk of changes in value because of changes in interest rates.
Generally, only investments with original maturities of three months or less qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a three-month U.S. Treasury bill and a three-year U.S. Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining maturity is three months. Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations).
The definition presumes that all cash equivalents have two attributes: they must be (1) short-term and (2) highly liquid. The definition then provides two characteristics that elaborate on the required attributes. In practice, reporting entities sometimes place undue focus on the maturity characteristic (short-term), while overlooking the readily convertible characteristic (highly liquid). While the FASB’s definition seems to focus more on the maturity characteristic, this does not diminish the requirement for a cash equivalent to be readily convertible to known amounts of cash. The definition of "readily convertible to cash" is included in the FASB Codification Master Glossary. To be considered "readily convertible to cash," an instrument must have both interchangeable units and quoted prices that are available in an active market. The active market must be able to handle a reporting entity's conversion of an instrument to cash quickly and without significantly affecting the quoted price.
Both characteristics included in the definition of cash equivalents must be met for an investment to be considered a cash equivalent. Accordingly, an investment with a maturity of less than three months that is not readily convertible to known amounts of cash is not a cash equivalent. Similarly, an investment that is readily convertible into a known amount of cash, but that has a maturity greater than three months, is also not a cash equivalent.
In its deliberations of ASU 2016-18, the EITF considered whether restricted cash could be a cash equivalent. Although they did not conclude, the Basis for Conclusions provides a helpful way to think about the interaction between restricted cash and the definition of cash equivalents.
Excerpt from BC9 in ASU 2016-18
… only those financial instruments that first meet the definition of cash or cash equivalents before considering the restrictions that exist in a separate provision outside those financial instruments should be included in the … total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents on the statement of cash flows.
For an example of how slight degradations to liquidity can impact the ability to classify an investment as a cash equivalent, see FSP 6.5.2.2 regarding an SEC rule that impacts the classification of certain money market funds as cash equivalents.
6.5.2.1 Credit card and debit card payments in transit
Some reporting entities include cash in transit from credit and debit payment processors in cash equivalents while others include these amounts in accounts receivable. There is diversity in practice over the classification of payments from credit card and debit card processors which settle shortly after the reporting date. Reporting entities should consistently apply and disclose the treatment of such payments.
6.5.2.2 Money market funds
Items commonly considered cash equivalents include treasury bills, commercial paper, and money market funds. Although what constitutes a money market fund is not defined in ASC 230, we believe it is appropriate for a fund to be classified as a cash equivalent if it meets all of the qualifying criteria for a money market fund under the 1940 Act.
Reporting entities must assess whether it is appropriate to classify funds as cash equivalents if they do not meet all of the qualifying criteria for a money market fund under the 1940 Act. We believe it would be appropriate for a reporting entity’s investment in a fund to be classified as a cash equivalent if all of the following attributes are present:
- A fund’s policies include a provision that requires the weighted average maturity of the fund’s securities holdings not to exceed 90 days
- The investor has the ability to redeem the fund’s shares daily in accordance with its cash management policy
- The fund’s investment attributes are consistent with the investment attributes of an SEC-registered money market fund
In July 2014, the SEC issued a final rule that mandates the use of a floating net asset value (NAV) for institutional prime money market funds. While the rule is not focused on the financial reporting of entities that have investments in money market funds, the changes could impact whether investments in money market funds are considered cash equivalents. The SEC noted that under normal circumstances, qualifying money market funds with floating NAVs will continue to be reported as cash equivalents. However, if credit or liquidity issues arise, including the increased potential for enactment of liquidity fees or redemption gates, investors will need to assess the validity of continuing to account for such money market funds as cash equivalents.
6.5.2.3 Reassessment of money market funds as cash equivalents
If there are increased credit and liquidity concerns associated with the money market fund, especially if there is a significant decline in net asset value, a money market fund may no longer have the attributes to be considered a cash equivalent. This analysis should be performed at each reporting period. If a money market fund no longer qualifies as a cash equivalent due to such analysis, we believe the corresponding outflow of cash equivalents within the statement of cash flows should be reflected as an investing activity.
Question FSP 6-3 addresses the presentation of a change in the classification of a money market fund.
Question FSP 6-3
In the current year, classification of a money market fund was changed from a cash equivalent to a short-term investment as a result of a periodic evaluation. Should the prior period be reclassified to conform to this new classification?
In the current year, classification of a money market fund was changed from a cash equivalent to a short-term investment as a result of a periodic evaluation. Should the prior period be reclassified to conform to this new classification?
PwC response
No, the prior period should not be reclassified. The evaluation of the classification is based upon the facts and circumstances at each individual reporting period.
6.5.2.4 Auction rate securities and variable rate demand notes
ASC 230-10-20 limits a cash equivalent’s maturity (to the reporting entity holding the investment) to three months. The maturity is determined by reference to the stated term of the security or the timeframe for exercising any put features to the issuer, not by reference to the frequency with which liquidity may be available through an auction, a put feature to a third party, or otherwise. Accordingly, auction rate securities and variable rate demand notes that do not mature, or are not puttable to the issuer, within three months from the date of acquisition do not demonstrate the maturity characteristic of a cash equivalent. Instead, they should be accounted for as investments in accordance with ASC 320-10.
When auction rate securities are subject to an auction, resetting the interest rate on the securities is not considered equivalent to a sale and a purchase of such securities when reporting cash flows. Therefore, cash flows should not be reflected when the interest rate is reset. An actual purchase and sale of a security through the auction process should be reflected as an investing activity in the statement of cash flows.
6.5.2.5 Accounting policy defining cash equivalents
As discussed in ASC 230-10-45-6, not all investments that qualify as cash equivalents are required to be classified as such. For example, a reporting entity with banking operations may choose to present certain cash equivalents within investments.
Pursuant to ASC 230-10-50-1, a reporting entity must disclose its definition of cash equivalents. Any subsequent change in the definition is a change in accounting principle, requiring retrospective presentation in prior years and a determination that such change is preferable.
Question FSP 6-4 addresses whether overnight repurchase agreements are considered cash equivalents.
Question FSP 6-4
Are overnight repurchase (lending) agreements cash equivalents?
PwC response
Yes. An overnight reverse repurchase transaction matures the next day; therefore, it is readily convertible to cash, similar to a demand deposit bank account or a treasury bill that trades with one-day settlement (both of which are regularly considered cash equivalents).
6.5.3 Restricted cash
ASC 230 does not define restricted cash. However, ASC 210-10-45 contains some limited guidance on the balance sheet classification of items that are restricted as to withdrawal or usage. Further, the SEC has some limited guidance on restricted cash (see FSP 6.5.3.4).
In its deliberations of ASU 2016-18, the EITF noted that the definition of restricted cash has not been a significant source of diversity in practice. As a result, due to the breadth of potential restrictions, it decided not to provide a formal definition, and instead, allow a reporting entity to continue to use its own definition.
While not defined, we believe restricted cash should generally include any cash that is legally restricted as to withdrawal or usage. Classification of additional amounts as restricted beyond those that are legally restricted should be subject to a reporting entity's accounting policy. Consistent with the views of most EITF members, we generally do not think that self-imposed designations should be presented as restricted cash unless an entity has an existing policy to do so.
6.5.3.1 Legal restrictions on cash
Generally, the fact that a reporting entity maintains a separate bank account for funds it owes to a third party does not require the cash to be restricted on the balance sheet. For example, if the reporting entity is named as the party that has the legal right to deposit into and withdraw from the deposit account (as opposed to being the entity for which the cash is held), the separate bank account is a matter of internal recordkeeping and is not a legally-segregated cash balance.
If the reporting entity can access the cash without any legal or contractual consequence (i.e., there is no requirement that the specific cash be set aside for remittance), the cash is likely not legally restricted. Even if the entity has a liability for the amount of cash it needs to remit to a customer, it is possible that the entity could raise cash to pay its customer in another way. For example, assuming an entity collects $100 to be remitted to a customer, it may be able to deploy that $100 for its other operations and then draw $100 from a line of credit and repay the customer, without regard for where the cash was sourced.
6.5.3.2 Compensating balances
Some borrowing arrangements contain compensating balance requirements. Given the lack of definitive guidance related to compensating balances and restricted cash, determining when compensating balances are restricted cash can be challenging. If a compensating balance arrangement legally restricts the use of cash, such amounts should be considered restricted cash. See FSP 6.5.3 for further discussion of this general principle.
Cash that cannot be withdrawn due to compensating balance arrangements should be classified as a noncurrent asset if it relates to the noncurrent portion of the debt that causes its restriction.
Compensating balance arrangements that do not legally restrict the use of cash should be disclosed in the footnotes.
Regardless of whether the reporting entity has met the compensating balance requirement, there should be disclosure of the sanctions for noncompliance under a compensating balance arrangement. An example of such disclosure may be as simple as stating, "Compensating balance deficiencies are subject to interest charges at the average rate for 91-day Treasury Bills."
As indicated in SEC FRP 203.02.b, when a reporting entity is not in compliance with a compensating balance requirement at the balance sheet date, that fact should be disclosed, together with stated or possible sanctions. SEC FRP 203 provides the following additional guidance:
Excerpt from SEC FRP 203.02.b
An arrangement where the [compensating] balance required is expressed as an average over time would ordinarily lead to additional footnote disclosure of the average amount required to be maintained for arrangements in existence at the reporting date since the amount held at the close of the reporting period might vary significantly from the average balance held during the period and bear little relationship to the amount required to be maintained over time. If arrangements requiring maintenance of compensating balances during the year were materially greater than those at year end, that fact should be disclosed. Disclosure may also include a statement, if appropriate, that the amounts are legally subject to withdrawal with or without sanctions, as applicable. If many banks are involved, the disclosure should summarize the most common arrangements and aggregate the compensating balances involved.
When a company is not in compliance with a compensating balance requirement, that fact generally should be disclosed along with stated or possible sanctions whenever such possible sanctions may be immediate (not vague or unpredictable) and material.
In determining whether compensating balance arrangements are sufficiently material to require segregation or disclosure, various factors should be considered. Among these may be the relationship of the amount of the balances to total cash, total liquid assets and net working capital, and the impact of the balances on the effective cost of financing. In the usual case, reportable compensating balances which in the aggregate amount to more than 15 percent of liquid assets (current cash balances, restricted and unrestricted, plus marketable securities) would be considered to be material. Lesser amounts may be material if they have a significant impact on the cost of financing.
Compensating balances related to future credit availability
Some borrowing arrangements do not prohibit the withdrawal of compensating balances, but as a practical matter; future credit availability may be dependent on the maintenance of such balances. Accordingly, reporting entities should disclose this fact. Sample wording might be "the compensating balances may be withdrawn, but the availability of short-term lines of credit is dependent upon maintenance of such compensating balances." If the borrower is not prohibited from withdrawing the compensating balance and using such funds in current operations, it could be appropriate to include such amounts in the cash and cash equivalent caption depending on the reporting entity's policy for defining restricted cash.
Related parties
Finally, compensating balances maintained by a reporting entity for the benefit of affiliates, officers, directors, principal stockholders, or other related parties should be disclosed as related party transactions. Similarly, compensating balances maintained by related parties for the reporting entity’s benefit should be disclosed in the footnotes.
6.5.3.3 Change in accounting policy on restricted cash
Any change to a reporting entity’s policy for determining restricted cash must be evaluated as a change in accounting principle subject to a conclusion that the new principle is preferable.
6.5.3.4 Balance sheet presentation of restricted cash
GAAP does not require restricted cash to be presented separately on the balance sheet. S-X 5-02(1) requires separate disclosure of the cash and cash items which are restricted as to withdrawal or usage. The provisions of any restrictions should be described in a note to the financial statements. Restrictions may include legally restricted deposits held as compensating balances against short-term borrowing arrangements, contracts entered into with others, or company statements of intention with regard to particular deposits; however, time deposits and short-term certificates of deposit are not generally included in legally restricted deposits. In cases where compensating balance arrangements exist but are not agreements which legally restrict the use of cash amounts shown on the balance sheet, describe in the notes to the financial statements these arrangements and the amount involved, if determinable, for the most recent audited balance sheet required and for any subsequent unaudited balance sheet required in the notes to the financial statements. Compensating balances that are maintained under an agreement to assure future credit availability should be disclosed in the notes to the financial statements along with the amount and terms of such agreement. Many private companies present restricted cash on the balance sheet.
6.5.3.5 Cash flow presentation of restricted cash
ASC 230 does not specify how to classify changes in restricted cash in the statement of cash flows. Reporting entities are required to explain the change in the cash, cash equivalents, and restricted cash balances during the period in the statement of cash flows. As a result, the statement of cash flows will reconcile the beginning and ending balances of cash, cash equivalents, and restricted cash and restricted cash equivalents and any other segregated cash and cash equivalents.
ASC 230 does not define restricted cash; instead, it refers to “amounts generally described as” restricted cash or restricted cash equivalents. By referring to restricted cash more broadly, the FASB intended it to encompass all restricted cash accounts, regardless of their classification on the balance sheet.
In other words, amounts generally described as restricted cash will be included with cash and cash equivalents on the statement of cash flows. As a result, a transfer between restricted and unrestricted cash accounts will not be reported as a cash flow. All cash receipts/payments with third parties directly to/from restricted cash accounts will need to be reported as an operating, investing, or financing cash flow based on the nature of the transaction.
The EITF considered concerns raised by some comment letter respondents that including restricted and unrestricted cash balances together in the statement of cash flows could mislead financial statement users about how much cash is available for an entity’s operations. The respondents noted that restricted cash is fundamentally different from unrestricted cash and may not be available to satisfy general obligations. However, the EITF thought that information about the liquidity of the amounts included in the statement of cash flows is best obtained from the balance sheet, and that the additional required disclosures about the nature of restrictions on cash should mitigate those concerns.
Example FSP 6-2 illustrates how a reporting entity should reflect the proceeds of a debt offering held in escrow by a bank in the statement of cash flows.
EXAMPLE FSP 6-2
Restricted use financing
Restricted use financing
FSP Corp issues debt in a $100 million bond offering, and, per the bond agreement, the proceeds are distributed to an escrow account that FSP Corp records as restricted cash. The proceeds from the offering are directly transferred from the investor to the trustee-controlled escrow account and FSP Corp never receives the cash from the bond offering in its general cash account. Per the bond agreement, the trustee is instructed to use $40 million of the proceeds to repay FSP Corp’s existing debt, while the remaining $60 million will be held in the restricted escrow account until FSP Corp incurs qualifying construction expenditures. At that time, the trustee will make distributions to FSP Corp’s general cash account for reimbursement of these incurred costs.
How should this arrangement be reflected in FSP Corp’s statement of cash flows?
Analysis
The cash flow statement should reflect a financing inflow of $100 million. Although it is restricted cash, it is part of the change in cash, cash equivalents, and restricted cash. Repayment of the $40 million existing debt is a $40 million financing outflow. When the $60 million is used for construction expenditures, it will be reflected as an investing outflow if it is for the payment of infrastructure, such as PP&E. When the $100 million bond is ultimately repaid, it will be reflected as a financing outflow.
6.5.3.6 Disclosure of restricted cash
Reporting entities are required to disclose (1) the nature of restrictions on cash balances and (2) how the statement of cash flows reconciles to the balance sheet when the balance sheet includes more than one line item of cash, cash equivalents, and restricted cash. A reporting entity should also consider the significance of its restricted cash balances and whether its definition should be disclosed as a significant accounting policy pursuant to ASC 235-10-50.
Nature of restrictions
ASC 230-10-50-7 requires a reporting entity to disclose information about the nature of restrictions on its cash and cash equivalents, but does not provide additional detail on what is required to be included in the disclosure. This disclosure could be similar to those already required by S-X 5-02(1) for public companies. While the guidance does not detail what is meant by the “nature of restrictions,” it includes sample disclosures that discuss the expected duration of the restriction, its purpose and terms, and the amount of cash subject to the restriction. The sample disclosures should not be considered a checklist of items to be disclosed. Reporting entities have flexibility to disclose relevant information about the nature of the restrictions based on their facts.
Reconciliation of the statement of cash flows to the balance sheet
If cash, cash equivalents, restricted cash, and restricted and other segregated cash and cash equivalents are presented in multiple line items on the balance sheet, reporting entities are required to present on the face of the statement of cash flows or disclose in the footnotes (in either a narrative or tabular format) a reconciliation of the total amount in the cash flow statement to the amounts presented in the balance sheet. The total should sum to the end-of-period total amount of cash, cash equivalents, restricted cash, and restricted and other segregated cash and cash equivalents shown on the statement of cash flows. This is consistent with the requirement in ASC 230-10-50-8 for cash and cash equivalents to agree to similarly-titled line items on the balance sheet.PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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