Restricted cash – basically just the same as all the other cash?

Here’s another of the issues arising from extracts of enforcement decisions issued in the past by the European Securities and Markets Authority (ESMA) (for more background see here); this is from their 22nd edition:

  • Subsidiary A of the issuer issued perpetual notes. The issuer faced liquidity issues. One of the provisions of the financing agreement was that the subsidiary maintains a CU 30 million minimum cash balance continuously until the perpetual notes are fully redeemed. This minimum cash balance has to be deposited with an authorised deposit taking institution. If the balance on the relevant bank account falls below CU 30 million, subsidiary A is obliged to notify a breach of contract, which triggers certain penalties (e.g. that it is prevented from issuing further notes and separate enforcement actions including indemnities and claims). Moreover, if, at the end of any given month, the issuer is not in compliance with the minimum cash balance clause, this constitutes an early redemption event, except where the issuer remedies the situation within 7 days.
  • In its consolidated statement of financial position, the issuer presented the minimum cash balance within the line item ‘cash and cash equivalents’. Moreover, the issuer did not provide any disclosures regarding the restrictions associated with the minimum cash balance.

The enforcer (as ESMA likes to term it) disagreed with this treatment, concluding that “the issuer has to provide disclosures about the obligation to maintain a minimum cash balance” and that “the minimum cash balance is ineligible for inclusion in the line item ‘cash and cash equivalents’ and should either be presented on a separate line or within another line of similar nature (e.g. other financial assets).”

It’s perhaps surprising that IAS 7 doesn’t deal with this issue more directly than it does. IAS 7.7 states that “cash equivalents are held for the purposes of meeting short-term cash commitments rather than for investment or other purposes.” From this one can conclude, as the enforcer does, that cash held for something other than a short-term cash commitment should be excluded, but it seems to leave significant room for interpretation regarding the meaning of a “short-term cash commitment” and of the excluded “other purposes”. For instance, are these “other purposes” solely investment- and finance-related, or do they include cash held for purposes that will ultimately be reflected in the operating section of the cash flow statement, except just not in the short term?

Ironically, for all its minimalism, old Canadian GAAP addressed this particular matter more directly than IFRS does. This is the entire text of old section 3000, Cash:

  • The following should be excluded from current assets:
  • cash subject to restrictions that prevent its use for current purposes;
  • cash appropriated for other than current purposes unless such cash offsets a current liability.

Of course, interpretation questions would arise on that too, but on the whole it seemed clearer to practitioners that if a particular amount of cash was restricted for any defined purpose whatsoever, then it should be excluded from the general balance of cash and cash equivalents. I actually recall, during the changeover to IFRS, a few issuers concluding that a cash amount previously presented separately on the balance sheet under old GAAP could be amalgamated with other cash under IFRS, subject to disclosing the associated restrictions in the note: this at least was probably a backward step in presentation.

The issue has flashed on the IASB’s agenda in the past, including as part of a December 2014 exposure draft. The May 2016 IASB update reported: “the Board tentatively decided to develop, as part of a narrow scope project, its proposals for the disclosure of restrictions that affect the decisions of an entity to use cash and cash equivalents.” By December of that year though, the Board had “decided not to continue with the work on the cash restrictions proposals (liquidity).” It reported at that time: “the work carried out on these proposals will inform the Post-implementation Review of IFRS 12 Disclosure of Interests in Other Entities.” I couldn’t readily identify whether anything else happened since then.

Anyway, against that background, ESMA seems to have a fair point in concluding in this instance that the CU 30 million account is held for something other than “meeting short-term cash commitments” and should be shown separately, and – at least from the information provided – the failure to disclose anything at all about the workings of those restrictions seems reckless indeed. ESMA cites at least two sources relevant to making that determination:

  • According to paragraph 48 of IAS 7, an entity must disclose the amount of significant cash and cash equivalents that are not available for use by the group. Furthermore, regardless of whether or not the minimum cash balance can be classified as cash and cash equivalents, in line with paragraph 31 of IFRS 7, the entity has to disclose information that enables users of its financial statements to evaluate the nature and extent of risks arising from financial instruments.

Again, neither of the cited paragraphs is as directly on point as one might like, but the underlying principles should surely have been clear enough…

The opinions expressed are solely those of the author

2 thoughts on “Restricted cash – basically just the same as all the other cash?

  1. Hi John. Thanks for this relevant blog. Yes, indeed IAS 7 lack clarity in the area of restricted cash and cash equivalent. This discussion is also relevant for cases whereby entities are prevented by law from utilizing funds received from counterparties as security money and have to place in a separate bank account. Further, at times, entities are required to place funds in bank accounts which are labeled as ‘let pass’ account whereby government entities deduct their dues and require entities to maintain minimum balances therein. In such cases, I believe that such amounts be excluded from cash and cash equivalent and presented as a separate line item on the balance sheet under restricted cash. Also, the movement in such balances should be presented separately in cash flow statements. What is your view of such cases?

    • Hi Muhammad – thanks. Yes I agree with you – I would generally advise presenting such amounts separately in both the balance sheet and cash flow statement. For the reasons noted though, this might be hard to impose. It might be particularly ambiguous when the separate bank accounts are still used for some kind of operating purpose, albeit a specified application that means they are not generally available for anything else…

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