Defining cash – we thought it would be easier!

The IFRIC has issued for comment a tentative agenda decision, Demand Deposits with Restrictions on Use

The fact pattern concerns an entity that holds a demand deposit whose terms and conditions don’t prevent the entity from accessing the amounts held in it, and that has a contractual obligation with a third party to keep a specified amount of cash in that separate demand deposit and to use the cash only for specified purposes. If the entity were to use the amounts held in the demand deposit for purposes other than those agreed with the third party, the entity would be in breach of its contractual obligation. The Committee received a request about whether an entity includes such a demand deposit as a component of cash and cash equivalents in its statements of cash flows and financial position.

The submission to the IFRIC laid out one way of looking at the issue:

  • IAS 7:7 is clear that “[c]ash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes.”
  • Had the cash been placed in a non-demand deposit, for example a time deposit, that deposit would not have met the definition of cash equivalents because it is not held to meet short-term cash commitments. The fact the entity places it in a demand deposit should not change the conclusion.
  • Indeed, it would be inconsistent to exclude time deposits (with a maturity of less than 90 days) from cash equivalents if that time deposit is not intended to be used for meeting short-term commitments, but include on-demand deposits in cash when the on-demand deposits are similarly not available for short-term commitments.
  • Accordingly, if an entity has committed, through the contractual terms of the bank account or via contractual commitments to third parties that are not part of the bank account, that it will not use the amount held in the bank account for meeting short-term commitments then that balance cannot be presented as cash and cash equivalents.

I mentioned the other week that it’s funny, at this advanced stage in the history of accounting, that issues relating to cash would still arise, and here’s another one, this time reflecting the limited commentary in IFRS about what actually constitutes “cash.” IAS 7.6 only states, somewhat circularly, that cash “comprises cash on hand and demand deposits.” It does specify that for an investment to qualify as a cash equivalent “it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value,” adding that “an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition.” But those concepts only apply to cash equivalents, not to cash itself. The staff paper addresses the view set out above as follows:

  • In the fact pattern described in the submission, the entity holds amounts in a demand deposit, which meets the definition of ‘cash’ in paragraph 6 of IAS 7. The entity has a contractual obligation to use the amounts held in that demand deposit only for the purpose of indemnifying the buyer for future potential warranty claims. That contractual obligation does not change the nature of the asset the entity holds: the asset is a demand deposit because there are no restrictions on the entity’s ability to access—on demand—amounts held in the deposit account. The contractual obligation restricts only the purpose for which the entity can use that asset. In our view, therefore, the entity would include the demand deposit as a component of ‘cash and cash equivalents’ in its statement of cash flows.

We looked a couple of years ago at an issue addressed by ESMA, relating to a fact pattern quite similar to this one: a financing agreement containing a provision that an entity maintains a CU 30 million minimum cash balance continuously until specified notes are fully redeemed, in which various punitive events would be triggered if the balance falls below that amount. In that case, ESMA disagreed with the issuer’s presentation of the amount within cash and cash equivalents, but the new staff paper seems to suggest that the issuer’s presentation was acceptable. The bigger problem in that instance though was that the issuer didn’t provide any disclosures regarding the restrictions associated with the minimum cash balance, a clear error.

Anyway, one of the initial comment letters received on the tentative agenda decision said it “moves at a superficial level rather than going into the granularity of the issue as to what is a demand deposit and whether presenting a deposit having restrictions on its use as cash would provide relevant information that faithfully represents the state of affairs of the entity.” So there may be more life in this issue yet…

The opinions expressed are solely those of the author

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