Restricted Cash

Restricted Cash is identified by the entity as the cash that is held for a specific purpose and is not available for the company to freely use. Often the restriction of the cash is part of a collateral or other type of agreement with a third party. For all restricted cash, the entity must disclose the nature of the restriction. Frequently, restricted cash is reported on separate line item on the statement of financial position.

Cash restricted in use should be reported separately on the balance sheet as restricted cash. If the company expects to use the restricted cash within the next year, it reports the amount as a current asset. When this is not the case, it reports the restricted funds as a noncurrent asset.

A company may have restricted cash, cash that is not available for general use but rather is restricted for a special purpose. For example, landfill companies are often required to maintain a fund of restricted cash to ensure they will have adequate resources to cover closing and clean-up costs at the end of a landfill site's useful life.

Types of reporting cash

There are three types of reporting cash :

• Cash equivalents are short-term, highly liquid investments that can be converted into a specific amount of cash. At the time of purchase, they typically have maturities of three months or less. They include money market funds, bank certificates of deposit, and US treasury bills and notes.
• Restricted cash a company may have cash that is restricted for a special purpose. An example is a payroll bank account for paying salaries and wages. Another would be a plant expansion cash fund for financing new construction. If company expects to use the restricted cash within the next year, the amount should be reported as a current asset.
• Compensating balances is the minimum balances, provide the bank with support for the loans. When making loans to depositors, banks commonly require borrowers to maintain minimum cash balances. They are a restriction on the use of cash that may affect a company's liquidity. Thus, companies should disclose compensating balances in the notes to the financial statements.

Restricted cash or equivalents cash

Company with restricted cash or restricted cash equivalents or both would include those amounts in cash and cash equivalents for reconciliation purposes. For public and private companies, the consensus opinion concluded the following:

• transfer between restricted cash and cash or cash equivalents are not part of operating, investing or financing activities
• the required reconciliation in the statement of cash flows should be for cash, cash equivalents and restricted cash, and restricted cash equivalents
• FASB chose not to define restricted cash with the ASU and left it up to the firms to determine when there were significant cash or cash equivalent restrictions

Examples of Restricted Cash

• Security deposits: Security deposits are cash deposits held to ensure that the associated party will meet certain obligations. For instance, a landlord may require a security deposit when entering into a rental agreement to ensure that the tenant pays their rent on time.
• Funds held in escrow: Funds held in escrow are cash deposits held by a third-party, such as a bank or an attorney, to ensure that parties fulfill certain obligations. For example, when a property is being sold, the buyer and seller may place the purchase funds in escrow until the property is transferred to the buyer.
• Funds held for loan repayment: Funds held for loan repayment are cash deposits set aside to make sure that a borrower can repay a loan. For example, a borrower may place funds in an escrow account to ensure that they have the money to pay back their loan if they are unable to make their payments.
• Restricted funds held by a government: Restricted funds held by a government are cash deposits set aside for specific purposes. For example, the U.S. government may place funds in a restricted account to pay for a certain program or initiative.
• Funds held for a specific purpose: Funds held for a specific purpose are cash deposits that are used for a specific purpose and are not available for general use. For example, a company may place funds in a restricted account to pay for a specific project or to cover the costs of a specific event.

Advantages of Restricted Cash

Restricted cash can offer a number of advantages to businesses, including:

• Improved cash flow forecasting: Restricting cash allows businesses to better plan and predict their cash flow, as it can provide more accurate information on the amount of liquidity they have available.
• Increased financial flexibility: By setting aside restricted cash, companies can have greater control over their cash flow and have access to funds when needed.
• Improved financial security: By keeping restricted cash separate from operating funds, businesses can protect themselves against unexpected expenses or losses.
• Improved financial transparency: By keeping restricted cash separate, businesses can better track and report on their financials, increasing transparency for stakeholders.

Limitations of Restricted Cash

Restricted cash has certain limitations that must be considered when assessing the financial position of a company. These limitations include:

• Difficult to Access: Restricted cash is not available for the company to use freely and must be accessed in accordance with the terms of the agreement that established the restriction. This can make it difficult to access the cash in a timely manner when needed.
• Uncertainty: The company may not always be certain of the exact amount of restricted cash they have or what the restrictions will be. This can lead to uncertainty and can make it difficult to plan for the future.
• Opportunity Cost: The restrictions on the use of the cash mean that the company may be unable to access the cash when it would be most beneficial or beneficial to the company. This means that the company may miss out on potential opportunities that could have been beneficial.
• Investment Risk: Restricted cash can be subject to investment risk, which can cause the value of the cash to fluctuate over time. This can lead to unexpected losses if the value declines.
• Legal Risk: The restrictions on the use of the cash can also create legal risks for the company. If the company does not comply with the restrictions, they may face legal consequences.

Other approaches related to Restricted Cash

Other than reporting Restricted Cash on a separate line item on the statement of financial position, there are several other approaches to reporting Restricted Cash.

• One approach is to include the restricted cash within the total cash balance. In this case, the entity should disclose the amount of restricted cash within the notes to the financial statements.
• A second approach is to set up a separate account for the restricted cash, which is then included in the total cash balance. This approach provides more transparency as the restricted cash is separately disclosed.
• A third approach is to set up a separate account for the restricted cash and include a disclosure of the amount in the notes to the financial statements. This approach gives the reader greater insight into the company's financial position.

Summary: Overall, there are several approaches to reporting Restricted Cash, such as including the restricted cash in the total cash balance, setting up a separate account for the restricted cash, or disclosing the amount of restricted cash in the notes to the financial statements. Each approach provides a different level of transparency and insight into the company's financial position.

Footnotes

Restricted Cash — recommended articles

Non current liability — Collateral management — Debenture Redemption Reserve — Current portion of long-term debt — Quick assets — General reserve — Fictitious asset — Bank reference — Credit Review

References

• Bain C., Davis Ch.J., (2018), Wiley CPAexcel Exam Review 2018 Study Guide: Financial Accounting and Reporting, John Wiley & Sons, New Jersey.
• Kimmel P.D., Weygandt J.J., Kieso D.E., (2009), Accounting: Tools for Business Decision Making, John Wiley & Sons, Canada.
• Kimmel P.D., Weygandt J.J., Kieso D.E., (2010), Financial Accounting: IFRS, John Wiley & Sons, New Jersey.
• Klammer T., (2018), Statement of Cash Flows, John Wiley & Son, London.

Author: Małgorzata Oleksińska