The presentation of cash in the balance sheet is largely an issue of appropriate classification and description. Because of its importance in evaluating an entity’s financial condition, cash must be stated as accurately as possible. This calls for careful analysis of each component of cash so that no items will improperly be included in, or excluded from, current assets. This post describes cash classification and its presentation on the balance sheet based on various authorities accounting standards resources related to this topic.
ARB No. 43, “Restatement and Revision of Accounting Research Bulletins” (Ch. 3, pars. 4–6), states, in part:
For accounting purposes, the term current assets is used to designate cash and other assets or resources commonly identified as those which are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business. Thus the term comprehends in general such resources as (a) cash available for current operations and items which are the equivalent of cash. . . .
This concept of the nature of current assets contemplates the exclusion from that classification of such resources as: (a) cash and claims to cash which are restricted as to withdrawal or use for other than current operations, are designated for expenditure in the acquisition or construction of noncurrent assets, or are segregated for the liquidation of long-term debts. . . .
As the one asset that is liquid, that is, expendable with no intermediary transactions or conversions, cash assumes the position of prime importance in the balance sheet and is generally presented as the first item among the assets of the enterprise. Four examples of presentation are:
- Cash and cash equivalents
- Cash and equivalents
- Cash includes certificates of deposit or time deposits
Generally, the form shown above is widely used, but the important point is that cash subject to withdrawal restrictions should not be combined with cash of immediate availability. In this regard, O’Reilly, et al state in Montgomery’s Auditing:
The cash caption on the balance sheet should include cash on hand and balances with financial institutions that are immediately available for any purpose and cash equivalents.
Statement of Financial Accounting Standards (SFAS) No. 95, “Statement of Cash Flows” (par. 8), states that cash equivalents are short-term highly liquid investments that are both:
- 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
Paragraph 8 also states that “generally only investments with original maturities of three months or less qualify under that definition”.
Original maturity is further defined as maturity to the entity holding the investment. The Statement clarifies that the maturity date must be three months from the date of its acquisition by the entity. Thus, a Treasury note purchased three years ago and held does not become a cash equivalent when its remaining maturity is three months. Cash equivalents include Treasury bills, commercial paper, and money market funds.
Definition of Cash
Cash exists both in physical and book entry forms:
- Physical in the form of coin and paper currency as well as other negotiable instruments of various kinds; and
- Book entry in various forms such as commercial bank deposits and savings deposits.
In addition to coin and paper currency, other kinds of physical cash instruments that are commonly reported as cash for financial accounting purposes include certificates of deposit, bank checks, demand bills of exchange (in some cases), travelers’ checks, post office or other money orders, bank drafts, cashier’s checks, and letters of credit.
All these forms of cash involve credit and depend for their ready acceptance on the integrity and liquidity of some person or institution other than those offering or accepting them as cash. This is true even for coin and paper currency which is, ultimately, dependent on the credit of the government issuing it. Given this integrity and liquidity, the book entry forms and other physical instruments are properly viewed as cash because of their immediate convertibility into cash in its currency form at the will of the holder.
Convertibility in the case of savings accounts, certificates of deposit, and other time deposits may be something less than immediate depending on stipulated conditions imposed by the depository, but the assurance of such convertibility makes these items a generally accepted form of cash. However, only investments with original maturities of three months or less qualify for presentation as cash equivalents, as described above.
Cash restricted as to use by agreement, such as amounts deposited in escrow or for a specified purpose subject to release only at the order of a person other than the depositor, should not be classified in the balance sheet as cash and, unless deposited to meet an existing current liability, should presumably be excluded from current assets.
Cash is sometimes received from customers in advance payment for work being performed under contract or under similar circumstances. Such cash is properly designated as cash in the balance sheet, but may be properly classified as a current asset only if the resulting customer’s deposit is classified as a current liability.
Cash restricted as to withdrawal because of inability of the depository to meet demands for withdrawal (such as deposits in banks in receivership) is not a current asset and should not be designated in the balance sheet as cash without an appropriate qualifying caption.
In regard to cash awaiting use for construction or other capital purposes or held for the payment of long-term debt, O’Reilly, et al. state:
Cash sometimes includes balances with trustees, such as sinking funds or other amounts not immediately available, for example, those restricted to uses other than current operations, designated for acquisition or construction of noncurrent assets, or segregated for the liquidation of long-term debt.
Restrictions are considered effective if the company clearly intends to observe them, even though the funds are not actually set aside in special bank accounts. The facts pertaining to those balances should be adequately disclosed, and the amounts should be properly classified as current or noncurrent.
Overdrafts may be of two kinds:
- an actual bank overdraft, resulting from payment by the bank of checks in an amount exceeding the balance available to cover such checks; and
- a book overdraft, arising from issuance of checks in an amount in excess of the balance in the account on which drawn, although such checks have not cleared through the bank in an amount sufficient to exhaust the account.
Actual bank overdrafts represent the total of checks honored by the bank without sufficient funds in the account to cover them; such an overdraft is the bank’s way of temporarily loaning funds to its customer. Accordingly, bank overdrafts (other than those that arise in connection with a “zero-balance” or similar arrangement with a bank) represent short-term loans and should be classified as liabilities if the right of offset does not exist.
Book overdrafts representing outstanding checks in excess of funds on deposit should generally be classified as liabilities and cash reinstated at the balance sheet date. Such credit book balances should not be viewed as offsets to other cash accounts except where the legal right of setoff exists within the same bank due to the existence of other positive balances in that bank.
FASB Interpretation (FIN) No. 39, “Offsetting of Amounts Related to Certain Contracts”, provides guidance on whether the right of offset has been met. Where right of setoff does not exist, the credit balance can be viewed as a reinstatement of the liabilities that were cleared in the bookkeeping process.
When outstanding checks in excess of funds on deposit are reclassified, it is preferable that they be separately classified; if they are included in accounts payable, the amounts so included should be disclosed, if material. Reclassifying as a liability all outstanding checks (including those covered by funds on deposit in the bank account concerned) is generally not considered acceptable.
Cash Balance in Foreign Countries
Cash in foreign countries may properly be included in the balance sheet as cash if stated at its equivalent in U.S. currency at the prevailing rate of exchange and if no exchange restrictions exist to prevent the transfer of such monies to the domicile of the owner. Depending on circumstances and the extent to which such cash balances may be subject to exchange control or other restrictions, the amount of cash so included should be considered for disclosure, either by being stated separately, parenthetically, or otherwise.
The question of exchange restrictions (or economic conditions) preventing transfer of cash across national boundaries is of prime importance, and cash in foreign countries should be classified as a current asset only if appropriate review establishes that no significant restrictions or conditions exist with respect to the amounts involved. If restrictions exist but ultimate transfer seems probable, the cash may be included in the balance sheet in a noncurrent classification.
Difficulty in stating foreign cash balances at their equivalent in U.S. currency occurs when more than one rate of exchange exists. In this situation, the use of an exchange rate related to earnings received from the foreign subsidiary for the purpose of translating foreign currency accounts is recommended.
SFAS No. 52, “Foreign Currency Translation”, (pars. 26–28) provides guidance on the selection of exchange rates.
Compensating Cash Balances
It is not uncommon for banks to require that a current or prospective borrower maintain a compensating balance on deposit with the bank. Frequently, the required compensating balance is based on the average outstanding loan balance. A compensating deposit balance may also be required to assure future credit availability (including maintenance of an unused line of credit). The compensating balance requirement may be:
- written into a loan or line of credit agreement;
- the subject of a supplementary written agreement; or
- based on an oral understanding.
In some instances, a fee is paid on an unused line of credit (or commitment) to ensure credit availability.
The Securities and Exchange Commission (SEC) originally defined compensating balances in ASR No. 148 as follows:
A compensating balance is defined as that portion of any demand deposit (or any time deposit or certificate of deposit) maintained by a corporation (or by any other person on behalf of the corporation) which constitutes support for existing borrowing arrangements of the corporation (or any other person) with a lending institution. Such arrangements would include both outstanding borrowings and the assurance of future credit availability.
For SEC registrants, requirements for the disclosure of restrictions on the withdrawal or use of cash and cash items, such as compensating balance arrangements, are set forth in Rule 5-02.1 of Regulation S-X as follows:
Cash and Cash Items
Separate disclosure shall be made of the cash and cash items which are restricted as to withdrawal or usage. The provisions of any restrictions shall 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 shall be disclosed in the notes to the financial statements along with the amount and terms of such agreement.
Guidelines and interpretations for disclosure are in FRR No. 203 and Staff Accounting Bulletin (SAB) Topic 6H. These provide useful information in evaluating the need for segregation and disclosure of compensating balance arrangements, including determination of the amount to be disclosed. Cash float and other factors should be considered.
Although no other authoritative literature requires compensating balance disclosures in the financial statements of non-SEC registrants, disclosure of material compensating balances will usually be necessary for fair presentation of the financial statements in accordance with generally accepted accounting principles (GAAP). Consequently, the disclosure of material compensating balance arrangements in financial statements of non-SEC reporting companies, whether maintained under a written agreement or under an informal agreement confirmed by the bank, is usually considered necessary as an “informative disclosure” under the third standard of reporting. It should be noted that compensating balances may also relate to an agreement or an understanding relative to future credit availability (including unused lines of credit).
Compensating balances related to future credit availability should be disclosed as well as those related to outstanding borrowings:
- Disclosure. In circumstances where compensating balances relative to outstanding loans and future credit availability are not legally restricted as to withdrawal, note disclosure is appropriate.
- Segregation in the Balance Sheet. Cash that is not subject to withdrawal should be classified as a noncurrent asset to the extent such cash relates to the noncurrent portion of the debt that causes its restriction. To the extent legally restricted cash relates to short-term borrowings, it may be included with unrestricted amounts on one line in financial statements of non-SEC reporting companies provided the caption is appropriate and there is disclosure of the restricted amounts in the notes, for example, “Cash and restricted cash (Note 3).” Rule 5-02.1 of Regulation S-X requires SEC-reporting companies to disclose separately funds legally restricted as to withdrawal, but FRR No. 203.02.b is more specific in its requirement to segregate all legally restricted cash in the balance sheet.
No single example is appropriate for the disclosure of all compensating balance arrangements and future credit availability (including unused lines of credit) because the terms of loan agreements vary greatly.