Restricted cash and cash equivalent balances are those which meet the definition of cash and cash equivalents but are not available for use by the group. In practice, these balances may arise when a subsidiary in a group operates in a jurisdiction where there are legal restrictions or foreign exchange controls that restrict the group’s access to, and use of, the subsidiary’s cash balances. They can also arise from ‘pledged’ bank balances and amounts placed in escrow accounts. Disclosure of restrictions to cash and its equivalents
Although these types of restrictions do not affect the presentation of the statement of cash flows, IAS 7.48 requires an entity to disclose the existence of any significant restricted cash balances, together with narrative commentary. This is normally included as part of the notes to the financial statements, with a separate line item in the primary financial statements for ‘restricted cash and cash equivalents’. Disclosure of restrictions to cash and its equivalents
IAS 1 Presentation of Financial Statements paragraph 66(d) requires an entity to classify an asset as current when: Disclosure of restrictions to cash and its equivalents
‘… the asset is cash or a cash equivalent (as defined in IAS 7) unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period.’
Although most cash and cash equivalents will be classified as current, it is important to understand the effects of any restrictions that are placed over the timing of use of those assets.
Reasons for Restricting Cash
There are several reasons why cash can be restricted:
1. Bank loan requirements
When a company receives a bank loan, the bank may require that the company reserves (or maintain) a certain amount of cash that will be unavailable for spending.
2. Payment deposits
A company may receive cash from a customer prior to providing services or shipping goods. The customer may require, through a clause in the agreement, that the company cannot spend the cash until the service or order is fulfilled.
3. Collateral pledge
A company may be required by an insurance company to pledge a certain amount of cash as collateral against risk.
4. Paying off debt
A company may set aside a certain amount of cash each quarter to make payment for long-term debt.