Chapter 4 — Cash and Cash Equivalents
Chapter 4 — Cash and Cash Equivalents
This chapter provides guidance on the determination and
presentation of cash and cash equivalents in the statement of cash
flows. In accordance with ASC 230-10-45-4, when the total amounts of
cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents are presented in more
than one line item within the statement of financial position, an
entity must provide additional disclosures to reconcile (1) the
amounts disaggregated by line item, as reported in the statement of
financial position, to (2) what is shown in the statement of cash
flows.
4.1 Definition of Cash and Cash Equivalents
ASC Master 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.
While the definition of cash is fairly straightforward, the determination of
cash equivalents may not be as clear. The ASC master glossary defines cash
equivalents as follows:
ASC Master 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).
Maturity is a critical component in the determination of whether short-term investments, such as certificates of deposit, time deposits, and other temporary investments, can be combined with cash and classified as cash equivalents or presented separately as short-term investments in an entity’s balance sheet and statement of cash flows.
Example 4-1
Entity A invests excess funds in short-term (less than three months) bank repurchase agreements. The underlying securities in the transaction may have maturities greater than three months. Entity A may classify these repurchase agreements as cash equivalents in its balance sheet and statement of cash flows. The investment (the repurchase agreement), in substance, meets the criteria in ASC 230. The critical factor is the maturity of the repurchase agreement itself, not the underlying securities that serve to secure the investment.
ASC 230-10
45-6 Not all investments that qualify are required to be treated as cash equivalents. An entity shall establish a policy concerning which short-term, highly liquid investments that satisfy the definition of cash equivalents are treated as cash equivalents. For example, an entity having banking operations might decide that all investments that qualify except for those purchased for its trading account will be treated as cash equivalents, while an entity whose operations consist largely of investing in short-term, highly liquid investments might decide that all those items will be treated as investments rather than cash equivalents.
In accordance with ASC 230-10-50-1, an entity should disclose its policy for
determining which items are treated as cash equivalents. Changes to an entity’s policy
represent changes in accounting principle for which preferability must be established in
accordance with ASC 250.
4.1.1 Restricted Cash
4.1.1.1 Balance Sheet Presentation of Restricted Cash
Cash available for general operations is distinguishable from cash restricted in accordance with third-party special-purpose agreements. When a cash account is restricted, the ability of the account’s owner to withdraw funds at any time is contractually or legally restricted. Since an entity cannot withdraw restricted cash without prior notice or penalty, the entity should not present such cash in cash and cash equivalents. While the terms “restricted cash” and “restricted cash equivalents” are not defined in U.S. GAAP, SEC Regulation S-X, Rule 5-02(1), requires registrants to separately disclose account balances whose withdrawal or usage is restricted. As a result, registrants typically present restricted cash and restricted cash equivalents separately from cash and cash equivalents on their balance sheet, and many nonpublic entities elect similar balance sheet presentation. However, entities may include restricted cash and restricted cash equivalents in other balance sheet line items. Accordingly, an entity’s definition of restricted cash and restricted cash equivalents is typically an accounting policy matter. Such a policy should be applied consistently and will need to take into account the nature of both the financial instruments and the restrictions.
Paragraph BC9 of ASU 2016-18 indicates that the Board’s clarifications related to presenting restricted cash and restricted cash equivalents in the statement of cash flows were not intended to change an entity’s practice for identifying and reporting restricted cash or restricted cash equivalents. Specifically, paragraph BC9 states:
Although the Master Glossary does not include specific definitions of restricted cash or restricted cash equivalents, some Task Force members believe that 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 beginning-of-period and end-of-period reconciliation of the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents on the statement of cash flows. Other Task Force members believe that the nature of the restrictions on cash or cash equivalents should be considered and that in certain cases the restrictions could be so severe that the financial instrument would not meet the definition of cash or cash equivalents, thereby preventing those balances from being included in the beginning-of-period and end-of-period reconciliation of total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents on the statement of cash flows. The Task Force considered defining restricted cash; however, it ultimately decided that the issue resulting in diversity in practice is the presentation of changes in restricted cash on the statement of cash flows. The Task Force’s intent is not to change practice for what an entity reports as restricted cash or restricted cash equivalents.
Further, paragraph BC19 of ASU 2016-18 notes that (1) an entity should apply the
guidance on a change in an accounting principle in ASC 250 “if [the] entity is
considering changing its accounting policy for determining restricted cash and
restricted cash equivalents” and (2) “[s]uch evaluation would be separate from adoption
of the amendments in this Update [ASU 2016-18].”
In addition, in accordance with ASC 230-10-50-7, an entity should “disclose
information about the nature of restrictions on its cash, cash equivalents, and amounts
generally described as restricted cash or restricted cash equivalents.” Further, when
cash, cash equivalents, and amounts generally described as restricted cash or restricted
cash equivalents are presented in more than one line item in the statement of financial
position, an entity should also apply the requirements in ASC 230-10-50-8, as discussed
below.
4.1.1.2 Presentation of Restricted Cash in the Statement of Cash Flows
ASC 230-10
45-4 A statement of cash
flows shall explain the change during the period
in the total of cash, cash equivalents, and
amounts generally described as restricted cash or
restricted cash equivalents. The statement shall
use descriptive terms such as cash or cash and
cash equivalents rather than ambiguous terms such
as funds. When cash, cash equivalents, and amounts
generally described as restricted cash or
restricted cash equivalents are presented in more
than one line item within the statement of
financial position, an entity shall provide the
disclosures required in paragraph 230-10-50-8.
45-5 Cash purchases and sales of items commonly
considered to be cash equivalents generally are part of the entity’s cash
management activities rather than part of its operating, investing, and
financing activities, and details of those transactions need not be reported
in a statement of cash flows. In addition, transfers between cash, cash
equivalents, and amounts generally described as restricted cash or
restricted cash equivalents are not part of the entity’s operating,
investing, and financing activities, and details of those transfers are not
reported as cash flow activities in the statement of cash flows.
50-8 When cash, cash equivalents, and amounts
generally described as restricted cash or restricted cash equivalents are
presented in more than one line item within the statement of financial
position, an entity shall, for each period that a statement of financial
position is presented, present on the face of the statement of cash flows or
disclose in the notes to the financial statements, the line items and
amounts of cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents reported within the statement
of financial position. The amounts, disaggregated by the line item in which
they appear within the statement of financial position, shall sum to the
total amount of cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents at the end of the
corresponding period shown in the statement of cash flows. This disclosure
may be provided in either a narrative or a tabular format. . . .
In a manner consistent with the guidance in ASC
230-10-45-4, an entity should include in the beginning and ending cash and
cash-equivalent balances of the statement of cash flows those amounts that
are generally described as restricted cash and restricted cash equivalents,
regardless of where such amounts may be included on an entity’s balance
sheet (e.g., cash, restricted cash, other assets, collections from
servicing). The concept of reconciling “total cash” in the statement of cash
flows is discussed in paragraph BC5 of ASU 2016-18, which states:
The Task Force reached a consensus that a statement of
cash flows should explain the change during the period in the total of cash, cash equivalents, and amounts generally
described as restricted cash or restricted cash equivalents. That
is, amounts generally described as restricted cash and restricted cash
equivalents should be included with cash and cash equivalents when
reconciling the beginning-of-period and end-of-period total amounts shown
on the statement of cash flows under the amendments in this Update. The
Task Force recognizes that some entities present cash and cash equivalents
with restrictions in multiple line items on the statement of financial
position and that in some cases those line items are titled something
other than restricted cash or restricted cash equivalents; therefore, the
phrase amounts generally described as restricted cash or restricted
cash equivalents is used throughout this Update. This consensus
requires that those amounts also be included in the beginning-of-period
and end-of-period total amounts shown on the statement of cash flows.
[Emphasis added] |
Example 4-2
Entity A is a mortgage servicer that collects mortgage payments from
debtors and remits the mortgage payments (net of authorized service fees) to
a creditor. Before remitting net mortgage payments to the creditor, A
classifies cash, which it has control over, under the caption “collections
from servicing” on its balance sheet. Because the amounts included in the
balance sheet under this caption represent cash, A presents these amounts in
the beginning-of-period and end-of-period cash, cash equivalents, and
restricted cash in the statement of cash flows rather than as part of the
cash flow activities reported for the period.
Changes in restricted cash and restricted cash equivalents that result from
transfers between cash, cash equivalents, and restricted cash and restricted cash
equivalents should not be presented as cash flow activities in an entity’s statement of
cash flows. This stipulation is consistent with paragraph BC8 of ASU 2016-18, which
states, in part:
The Task Force believes that internal transfers
between cash, cash equivalents, and amounts generally described as restricted cash or
restricted cash equivalents do not represent a cash inflow or outflow of the entity
because there is no cash receipt or cash payment with a source outside of the entity
that affects the sum of cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents.
Example 4-3
Company A enters into an agreement with Company B under which A will operate and maintain a desalination
plant owned by B. In accordance with the contract:
- Company B will transfer a fixed amount of cash into an account in A’s name at the beginning of every month to fund the cost of repairing and maintaining the plant.
- The account is segregated from A’s general operating account.
- Company A obtains approval from B before performing any repair and maintenance work, and available account funds cannot be withdrawn without B’s approval.
- Any funds remaining upon the expiration or termination of the agreement will be returned to B.
Because of the contractual restrictions associated with the use of the cash deposited into A’s account,
whenever B funds the account, A immediately recognizes restricted cash and a contract liability (i.e., deferred
revenue).
In accordance with ASC 230-10-45-4, A includes the restricted cash balance with cash and cash equivalents
in the reconciliation of beginning and ending cash, cash equivalents, restricted cash, and restricted cash
equivalents, instead of separate cash flows (for each period for which the cash amounts are restricted).
4.1.1.3 Reconciliation of Cash, Cash Equivalents, and Amounts Generally Described as Restricted Cash or Restricted Cash Equivalents for an Interim Reporting Period
ASC 230 requires the
reconciliation of (1) the ending cash, cash equivalents, and amounts generally described
as restricted cash or the restricted cash equivalents balance presented in the statement
of cash flows to (2) the statement of financial position when such amounts are presented
in more than one line item in the statement of financial position. Such information must
be provided on the face of the statement of cash flows or disclosed in the notes to the
financial statements and can be in narrative or tabular form. However, ASC 230 does not
specify how to apply this requirement to comparative periods when interim periods
presented in the statement of cash flows do not correspond to the periods presented in
the statement of financial position. Specifically, while ASC 230-10-50-8 states, in
part, that the reconciliation is required for “each period that a statement of financial position is presented” (e.g., as of March 31, 20X1, and
December 31, 20X0), ASC 230-10-50-8 then goes on to indicate that those amounts “shall
sum to the total amount of cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents at the end of the corresponding period
shown in the statement of cash flows” (e.g., March 31, 20X1, and
March 31, 20X0). [Emphasis added]
The lack of specific guidance
on this matter has led to diversity in how entities have applied this reporting
requirement for interim reporting periods. We believe that it is acceptable for an
entity to use one of the following alternatives to meet ASC 230’s reconciliation
requirement for interim reporting periods (for illustrative purposes, we have assumed
that in the interim financial statements, the statements of financial position are as of
March 31, 20X1, and December 31, 20X0, and the three months ended March 31, 20X1, and
March 31, 20X0, for the statement of cash flows):
- Provide the reconciliation for each period presented in the statement of financial position (e.g., March 31, 20X1, and December 31, 20X0).
- Provide the reconciliation for each period presented in the statement of cash flows (e.g., March 31, 20X1, and March 31, 20X0).
- Provide the reconciliation for each period presented in the statement of financial position as well as each period presented in the statement of cash flows (e.g., March 31, 20X1; December 31, 20X0; and March 31, 20X0).
See Appendix D for other SEC interim reporting
considerations related to the statement of cash flows.
4.1.2 Classification of Interest Earned on Restricted Funds
As noted in Section 4.1.1, entities must include in their cash and cash-equivalent balances in the statement of cash flows those amounts that are generally described as restricted cash and restricted cash equivalents. Entities must also provide certain disclosures about the amounts and nature of restricted cash included in their cash and cash-equivalent balances. Under ASC 230, an entity should classify interest earned on restricted funds in the statement of cash flows in a manner consistent with cash and cash equivalents that are not restricted and should also include such amounts in disclosures about restricted cash.
4.1.3 Funds Held for Others
In certain situations, an entity may arrange for the transfer of cash on behalf of others
(e.g., an entity that provides payroll tax filing, payment processing services, or
escrow-related activities). Questions have arisen regarding when such an entity should
report — as its asset on the balance sheet and the associated cash flows in the cash flows
statement — the cash and cash equivalents or restricted cash and restricted cash
equivalents held with financial institutions for the benefit of its clients (the
“Funds”).
We believe that the entity’s determination of whether to report the
Funds held on behalf of others as its own cash, or restricted cash in its balance sheet,
should be based on whether the entity controls the Funds. This stipulation is consistent
with the nonauthoritative guidance in Section 1100.08 of the AICPA’s Technical Q&As,
which states, in part, that “[t]he balance sheet caption ‘cash’ should represent an amount
that is within the control of the reporting enterprise.”
The determination of whether the entity controls the Funds held on the behalf of others
can be complex. Criteria an entity should consider in making this determination may
include, but are not limited to, the following:
- Whether the entity has legal ownership over or title to the Funds.
- Whether the entity has the right to use the Funds before performing under the terms of the arrangement (e.g., whether the entity has the right to invest the Funds before disbursement).
- In the event of bankruptcy, whether the Funds would be considered part of the bankruptcy state of the entity, the client, or both.
- What happens if the entity fails to perform (e.g., whether the entity would be obligated to make payments using its own cash if it failed to make payroll-related payments to a client’s employees).
If the entity determines that it controls the Funds held on behalf of
others, it should report the Funds as cash in its balance sheet. Further, the changes in
those Funds held for others generally should be classified as financing activities in a
manner consistent with our understanding of the SEC staff’s view that the holding of Funds
on behalf of others is analogous to proceeds received from borrowings. According to this
view, the borrowings are considered outstanding until the custodial entity delivers the
Funds to satisfy its client obligations and such delivery is deemed a repayment of the
borrowing. However, if an entity concludes that it does not control the Funds, it should
not present the Funds as assets on the balance sheet or present those transactions in the
statement of cash flows. We believe that an operating classification may also be
acceptable. Entities that plan on presenting the cash flow activity from this type of
arrangement within operating activities should consider consulting with their accounting
and financial advisers.
We believe that entities that participate in such arrangements should
consider disclosing the criteria and judgments they used when determining whether they
control the Funds held on behalf of others.
4.2 Book and Bank Overdrafts
4.2.1 Balance Sheet Considerations
4.2.1.1 Book Overdrafts
A book overdraft represents the amount of outstanding checks in excess of funds on deposit for a particular bank account, resulting in a credit cash balance reported on an entity’s balance sheet as of a reporting date. For financial reporting purposes, an entity should reinstate a liability (e.g., accounts payable) to the extent of the book overdraft in such a way that the cash balance is reported as a zero balance.
When an entity maintains separate funding and disbursement accounts with the same bank, it may not be as easy to determine the amount of the book overdraft. For example, an entity may have a cash management arrangement with a bank in which checks written are issued from a dedicated disbursement account that is funded from a separate deposit account as the checks are presented for payment to the bank. In such a scenario, the disbursement account may be designed to maintain a zero balance. Further, it is not uncommon for a bank to have the contractual right and ability to automatically sweep cash from the funding account to cover checks presented for payment from the disbursement account. Because of timing differences between when checks are written by an entity and when they are funded by the bank, the disbursement account may reflect a book overdraft as of a reporting date, which by design would represent the entire population of outstanding checks.
In practice, questions have arisen regarding how an entity should determine the book overdraft in such an arrangement to reinstate accounts payable. Two alternative approaches to making this determination have emerged:
- The single account approach ― The deposit and disbursement accounts with the same bank would be viewed as a single account in the determination of the book overdraft.
- The liability extinguishment approach ― The book overdraft with the same bank would be determined independently from any funds held in the deposit account, resulting in the reinstatement of the entire population of outstanding checks.
4.2.1.1.1 The Single Account Approach
The balance sheet offsetting guidance in ASC 210-20 focuses on whether a “right of setoff” exists. A right of setoff is defined as “a debtor’s legal right . . . to discharge all or a portion of the debt owed to another party by applying against the debt an amount that the other party owes to the debtor.” However, ASC 210-20-55-18A states that “[c]ash on deposit at a financial institution shall be considered by the depositor as cash rather than as an amount owed to the depositor.” Because cash on deposit is held by the bank for the entity in a fiduciary capacity, the cash on deposit would not be considered an “amount owed” to the entity. Although the offsetting guidance in ASC 210-20 would not apply to the separate deposit and disbursement accounts in the above scenario, we nonetheless believe that it would be acceptable — to the extent that the following conditions are met — for entities to analogize to the offsetting guidance in deciding whether to view the disbursement and deposit accounts as a single bank account in the determination of the book overdraft:
- Under the terms of the depositor relationship, the financial institution has the right, ability, and intent to offset a positive balance in one account against an overdrawn amount in the other.
- Amounts in each of the accounts are unencumbered and unrestricted with respect to use.
Further, we believe that the single account
approach is also consistent with the nonauthoritative guidance in AICPA
Technical Q&As Section 1100.08, which states:
Inquiry — Should the amount of checks that have been issued and are out of the control of the payor but which have not cleared the bank by the balance sheet date be reported as a reduction of cash?
Reply — Yes. A check is out of the payor’s control after it has been mailed or delivered to the payee. The balance sheet caption “cash” should represent an amount that is within the control of the reporting enterprise, namely, the amount of cash in banks plus the amount of cash and checks on hand and deposits in transit minus the amount of outstanding checks. Cash is misrepresented if outstanding checks are classified as liabilities rather than a reduction of cash.
Under the single account approach, a book overdraft would not exist to the extent that the funding account has sufficient funds to cover the amount of outstanding checks. Therefore, to the extent that outstanding checks exceed the amount in the deposit account, this excess would be considered the book overdraft and should be presented as a liability for financial reporting purposes.
4.2.1.1.2 The Liability Extinguishment Approach
Under the liability extinguishment approach, the disbursement account is viewed independently from the deposit account in the determination of the amount of the book overdraft. The accounting basis for this approach is that the liability (e.g., accounts payable) that will be settled through the issuance of the outstanding checks has not been legally extinguished as of the reporting date in accordance with ASC 405-20. Therefore, under the liability extinguishment approach, a book overdraft represents what is, in substance, a payable to the original creditor.
Accordingly, the existence of a deposit account with the same financial institution is not relevant to the accounting analysis. Specifically, ASC 405-20 indicates that a liability is not extinguished until a creditor is paid. Under this view, payment to the creditor occurs when the counterparty presents the check to the bank for payment rather than when the entity issues the check from the disbursement account. In addition, proponents of the liability extinguishment approach note that even if one were to support the view that book overdrafts are within the scope of ASC 210-20, offsetting is not required when the right of setoff exits. Instead, as noted in ASC 210-20-45-2, offsetting is permitted, but not required, provided that the right of setoff exists.
Consequently, under the liability extinguishment approach, the entire population of outstanding checks (i.e., all checks written from the disbursement account) would represent the book overdraft as of the end of the reporting period. Therefore, although there may be funds in the deposit account, accounts payable would be reinstated for such an amount. Further, while the liability extinguishment approach is based on a situation in which the separate disbursement and funding accounts are maintained with a bank, we believe that an entity would reach the same view when it uses one bank account for deposits and disbursements. That is, if an entity’s policy is that the liability derecognition guidance in ASC 405-20 does not apply until the counterparty presents the check to the bank for payment, we think that such a policy should be neutral regarding whether there are separate accounts (that are linked) or whether a single account is used for both funding and disbursements.
Regardless of whether an entity elects the single account approach or the liability extinguishment approach, we believe that the entity should consistently apply and transparently disclose the approach it uses.
4.2.1.2 Bank Overdrafts
A bank overdraft represents the amount by which funds disbursed by a bank exceed funds held on deposit for a given bank account. Therefore, a bank overdraft represents a loan from the bank to an entity and, for financial reporting purposes, the bank overdraft should be classified as a liability. There may be situations in which an entity maintains several bank accounts held by its subsidiaries at the same financial institution. Such subsidiary bank accounts are contractually linked, and the bank will allow the subsidiary cash accounts to be in a bank overdraft position, as long as sufficient funds are held on deposit at other subsidiary bank accounts that are part of the linked arrangement. Although the offsetting guidance in ASC 210-20 would not apply to such an arrangement (for the same reasons noted in Section 4.2.1.1), we nonetheless believe that for financial reporting purposes at the consolidated/parent level, the parent would be permitted but not required to offset bank overdraft balances in subsidiary bank accounts against positive cash account balances maintained in other subsidiary bank accounts with the same bank that are part of the contractual arrangement. For such offsetting to be acceptable, however, the following conditions would need to be met:
- Under the terms of the depositor relationship, the financial institution has the right and ability to offset a positive balance in one account against an overdrawn amount in the other.
- Amounts in each of the accounts are unencumbered and unrestricted with respect to use.
In addition, when a subsidiary prepares financial statements on a stand-alone basis, the presentation of the subsidiary’s bank accounts in the stand-alone financial statements should reflect the individual subsidiary’s facts and circumstances (i.e., in presenting bank accounts with the same financial institution, the subsidiary should not consider how the bank accounts are presented in the parent company’s consolidated financial statements).
4.2.2 Considerations Related to the Statement of Cash Flows
The nonauthoritative guidance in AICPA Technical Q&As Section 1300.15
stipulates that a net change in overdrafts should
be classified as a financing activity in the
statement of cash flows. Because this guidance
appears to address only bank overdrafts, an entity
that is in a bank overdraft position must show the
net change in liability related to the bank
overdraft as a financing activity.
However, we believe that if an entity is in a book overdraft position, it is acceptable for the entity to show the net change in the liability related to the book overdraft as either an operating activity or a financing activity in the statement of cash flows. This position is supported by the fact that at the time of the book overdraft, the entity has no financing activity with the bank (i.e., the bank has not extended credit, as would be the case if the bank account were overdrawn). The presentation of book overdrafts as either operating or financing activities is an accounting policy decision that the entity should apply consistently.
4.3 Centralized Cash Management Arrangements (“Cash Pools”)
A parent company and its subsidiaries may have centralized cash management arrangements in which excess cash is invested in a cash pool. Subsidiary cash requirements are met through withdrawals or borrowings from the pool. The pool is invested in assets (e.g., deposits at banks) that are in the parent company’s name. Under this type of arrangement, the parent company and its subsidiaries have sweep arrangements with their respective banks in which cash is transferred between the parent’s and subsidiaries’ bank accounts daily. This arrangement reduces lending costs and yields higher rates of return on investments (by allowing an entity to invest larger “blocks” of cash).
Generally, funds deposited by a subsidiary in its parent company’s cash account under a centralized cash management arrangement should not be classified as cash or a cash equivalent in the subsidiary’s separate financial statements if the subsidiary does not have legal title to the cash on deposit. For a subsidiary to classify funds on deposit with its parent as cash and cash equivalents in the balance sheet, the deposit in the cash pool would need to meet the definition of cash or a cash equivalent.
Because the deposit in the cash pool is not a demand deposit in a bank or other financial institution, it would not meet the definition of cash. Generally, legal title in a cash account is demonstrated by the deposit of the cash or cash equivalent in a demand deposit account at a bank or other financial institution in the subsidiary’s name.
A deposit in the cash pool would also not be considered a cash equivalent under ASC 230. As defined in
ASC 230-10-20, cash equivalents are “short-term, highly liquid investments.” Such investments are made available to a broad group of independent investors and are commonly recognized in markets as vehicles for investing funds for future benefit. Accordingly, the deposit in the affiliate cash management pool is generally a receivable from an affiliate and not an investment as contemplated in ASC 230.
Receivables from an affiliate resulting from a cash pooling arrangement are
generally considered loans and, correspondingly, changes resulting from such
deposits should be presented as investing activities in the statement of cash flows.
ASC 230-10-45-12 and 45-13 state that cash flows from investing activities include
payments and receipts related to making and collecting loans. Payables due to an
affiliate in these situations are considered borrowings and, correspondingly,
changes should be presented as financing activities in the statement of cash flows.
ASC 230-10-45-14 and 45-15 state that cash flows from financing activities include
proceeds and payments related to borrowings and repayments of amounts borrowed.
Example 4-4
Parent A maintains a centralized cash management program in which Subsidiary B participates. Subsidiary B issues stand-alone financial statements that reflect a $100 receivable from A as of December 31, 20X6, in connection with cash deposited by B into the centralized cash management program. During 20X7, B withdraws $200 from A as part of the centralized cash management program, resulting in a $100 payable to A as of December 31, 20X7. The statement of cash flows in the stand-alone financial statements of B for the 12 months ended 20X7 would report a $100 investing cash inflow and a $100 financing cash inflow related to the activity associated with the centralized cash management program.
ASC 230-10-45-8 and 45-9 indicate that payments and receipts in these situations
should be presented in the statement of cash flows on a gross basis, except when
“the turnover is quick, the amounts are large, and the maturities are short.” In
addition, if the receivable from or payable to affiliates is due on demand, net
presentation of payments and receipts is acceptable. In most centralized cash
management arrangements in which funds are due on demand, the parent acts as a bank
to the subsidiary in that it holds and disburses cash on the subsidiary’s behalf;
correspondingly, such related transactions may be presented net in the statement of
cash flows. See Section
3.2 for further discussion of reporting cash flows on a gross or net
basis.
The principles above also apply to condensed consolidating information for guarantor subsidiaries under SEC Regulation S-X, Rule 3-10. In a manner consistent with cash pooling arrangements, intercompany transactions settled on a net basis between entities with cash flow information reported in different columns in the condensed consolidating information in a guarantor footnote should be recorded separately in each entity’s column as if the columns were reported on a stand-alone basis. Therefore, the classification of intercompany funding activity between entities whose cash flow information is separately reported in each column should reflect cash payments and receipts in investing and financing activities.
4.4 Money Market Funds
Money market funds (MMFs) are investment funds that maintain a constant per-share net asset value (NAV) by adjusting the periodic interest rates paid to investors. The NAV is usually set at $1 per share. Generally, investors can make withdrawals from MMFs on short notice without incurring a penalty. However, as a result of the most recent credit crisis, certain money market mutual funds incurred losses on their investments, causing some of the funds to “break the buck” when the NAV fell below the constant per-share amount. As the fair values of MMFs declined as a result of deterioration in the creditworthiness of their assets and general illiquidity conditions, redemptions by investors increased. Accordingly, some funds were forced to impose limits on redemptions, liquidate their assets, or obtain support from related entities.
In July 2014, the SEC issued a final
rule that amends the rules governing MMFs under the Investment
Company Act of 1940. The final rule requires certain MMFs to “sell and redeem shares
based on the current market-based value of the securities in their underlying
portfolios rounded to the fourth decimal place (e.g., $1.0000), i.e., transact at a
’floating’ NAV.”1 In addition, the final rule gives the boards of directors of MMFs the
“discretion to impose a liquidity fee [or] suspend redemptions temporarily” (i.e.,
gate) if a fund’s weekly liquidity falls below the required regulatory threshold.
Further, the rules require nongovernmental MMFs to impose a liquidity fee or gate if
a fund’s weekly liquidity deteriorates below a designated threshold.
The definition of “cash equivalents” in the ASC master glossary indicates that
MMFs are often included within its scope. Under normal circumstances, an investment
in an MMF that has the ability to impose a fee or gate does not prevent the MMF from
being classified as a cash equivalent. Further, the requirement for certain MMFs to
transact at a floating NAV does not prevent an investment from being classified as a
cash equivalent. However, if events occur that give rise to credit and liquidity
issues for an investment and result in the imposition of redemption restrictions
(e.g., liquidity fees or gates) or a planned liquidation, it would generally not be
appropriate to continue to classify the investment as a cash equivalent.
Example 4-5
An MMF imposes a restriction on redemption before the balance sheet date to prevent an investor from converting its investment into cash as of the balance sheet date. It would not be appropriate to classify the fund as a cash equivalent since it is no longer “[r]eadily convertible to known amounts of cash” in accordance with the definition of “cash equivalents” in ASC 230.
Implicit in the definition of a cash equivalent is the assertion that an MMF is, in substance, cash or near cash. Therefore, a restriction on an MMF would contradict the definition of cash and therefore the intent of classification as a cash equivalent. Further, when an MMF has imposed redemption restrictions or is liquidating its investments over a period and is distributing the proceeds, an investor should not record any portion of its investment as a cash equivalent unless the entire investment is considered a cash equivalent in accordance with ASC 230. It would not be appropriate to look through the investment to the underlying securities and classify a portion of the investment as a cash equivalent.
Example 4-6
An MMF imposes an “insignificant” penalty on redemption, and an investor concludes that the imposition of this penalty causes the fund’s fair value to fall below the investor’s cost/par. Therefore, the MMF no longer qualifies as a cash equivalent.
Example 4-7
A redemption restriction is imposed on an MMF on or before the balance sheet date but is lifted after the balance sheet date and before the financial statements are issued or available to be issued. As a result, an investor is able to withdraw funds from the MMF without prior notice or penalty. The subsequent change to lift the redemption restriction should be accounted for as a nonrecognized subsequent event.
If a redemption restriction is imposed on January 15 for a calendar-year-end entity, we would expect the entity to reconsider the classification of the MMF and evaluate whether credit and liquidity issues existed as of the balance sheet date. Even if the redemption restriction is not imposed until after the balance sheet date, it may be appropriate to reclassify the MMF in the prior period depending on whether such conditions existed as of the balance sheet date.
Footnotes
1
The requirement to transact at a floating NAV applies to
institutional prime MMFs but not to government or retail MMFs.
4.5 Variable-Rate Demand Notes
Variable-rate demand notes (VRDNs), also called “low floaters” or “seven-day
floaters,” generally are municipal securities that
have long-term stated maturities. However, they
also have certain economic characteristics of
short-term investments, such as their rate-setting
mechanism and their liquidity provisions. These
notes are normally secured by a letter of credit.
The rates on VRDNs are reset periodically (e.g.,
daily, weekly, monthly) through an auction
process. If there is a failed auction, the VRDNs
can be tendered (i.e., put) by the investor for
par plus accrued interest. The counterparty to the
put is typically the third party that provided a
letter of credit. However, in certain cases in
which no letter of credit is involved, the
counterparty may be the original issuer of the
VRDN itself (e.g., a state, municipality, county,
or other governmental entity).
In determining whether VRDNs may be classified as cash equivalents in an
entity’s balance sheet and statement of cash
flows, an entity should consider whether the
instruments are puttable back to the original
issuer (or to the issuer through the issuer’s
agent) within three months throughout the term of
the instrument. An entity should also consider the
creditworthiness of the issuer. In the limited
circumstances in which VRDNs are puttable back to
the original issuer within three months throughout
the term of the instrument and there is no
concern about the issuer’s creditworthiness (e.g.,
in the case of a highly rated state government),
an entity may classify VRDNs as cash
equivalents.
VRDNs that are puttable to parties other than the original issuer (e.g.,
insurer, remarketing agent, bank, dealer, or other
third party) should be accounted for under ASC
815-10-15-6, which states, in part, that a “put or
call option that is added or attached to a debt
instrument by a third party contemporaneously with
or after the issuance of the debt instrument shall
be separately accounted for as a derivative
instrument under this Subtopic by the investor
(that is, by the creditor).”
Therefore, if a VRDN is puttable to a party other than the original issuer, the put option should be accounted for separately from the note in accordance with ASC 815. The note would not be considered a cash equivalent unless it is acquired within three months of its maturity and there is no concern about the issuer’s creditworthiness.
4.6 Auction Rate Securities
Auction rate securities (ARSs) are distinct from other, more traditional securities. ARSs generally have long-term stated maturities; the issuer is not required to redeem the security until 20 to 30 years after issuance. However, for the investor, these securities have certain economic characteristics of short-term investments because of their rate-setting mechanism. The return on these securities is designed to track short-term interest rates through a “Dutch” auction process, which resets the coupon rate (or dividend rate).
Generally, ARSs cannot be classified as cash equivalents in an investor’s statement of cash flows. Because ARSs have stated maturities of more than three months, investments in ARSs do not meet the definition of a cash equivalent in ASC 230-10-20 unless the ARSs are purchased very near their contractual maturity (i.e., three months or less). This conclusion is consistent with the views expressed in Section II.H.3 of the SEC’s Current Accounting and Disclosure Issues in the Division of Corporation Finance (updated November 30, 2006).
4.7 Credit and Debit Card Receivables
We have observed diversity in practice in how entities classify
credit and debit card receivables on their balance sheets. Depending on their
specific facts and circumstances (see discussion below), some entities classify
these receivables as cash and cash equivalents while others classify them as
receivables. This balance sheet diversity affects the statement of cash flows. If
these items are classified as cash and cash equivalents, they are included in the
beginning and ending balances of cash and cash equivalents (i.e., recognition of the
receivable is the equivalent of collecting the cash). Otherwise, they are included
in the change in net assets in the reconciliation from net income to cash flows from
operating activities, provided that entities are using the indirect method of
presenting operating cash flows (i.e., they are presented as operating cash inflows
when the entity receives the cash in its bank account).
Entities may have established a policy of classifying credit and
debit card receivables as cash equivalents if they consider them to be cash
equivalents as defined in the ASC master glossary. That is, credit and debit card
receivables are viewed as akin to short-term, highly liquid investments that are
both readily convertible to known amounts of cash and are so near their maturity
that they pose an insignificant risk of changes in value because of changes in
interest rates. (See Section
4.1 for additional discussion of cash equivalents.) These entities
consider how quickly the receivables are due (e.g., if they are due within five days
or less, and are thus subject to insignificant interest rate risk, the receivables
could be considered a cash equivalent).
Other entities may classify credit and debit card receivables within
trade accounts receivable because they are subject to the credit risk of the owing
financial institution and are not a significant part of the entities’ cash
management strategy (e.g., they are non-interest-bearing, and an entity does not
consider them when making decisions regarding dividends and share purchases).
After an entity establishes an appropriate policy, any change in
policy would represent a change in accounting principle for which preferability must
be established in accordance with ASC 250.