cash and cash equivalents in balance sheet and restricted cash

Cash and cash equivalents are held to meet short-term payment commitments and not for investment or similar aspects.

Two requirements are necessary for an asset to meet the definition of a cash equivalent.

On the one hand, it must be easily convertible into a certain amount of cash.

In addition, the asset must be subject to an insignificant risk of changes in its value.

Let’s analyze the following scheme to easily understand the concept of cash and cash equivalents.

Cash and cash equivalent

Schema analysis

Cash and cash equivalent

Thus, a financial asset must be a short-term investment with a maturity of less than 3 months from the date of acquisition and easily convertible into cash.

For example, in January of year 1, an entity deposits $500,000 in a profitable account that provides an annual return of 7%.

If the entity withdraws the money before 12 months, it will cancel the right to receive the interest accrued during the current period.

This example does not represent cash and cash equivalents because the money deposited in the account is not readily convertible to a specific amount of cash.

As we see, the entity can only convert the investment into cash or its equivalent after 12 months.

In other words, the company must recognize this asset as a short-term investment.

Cash and cash equivalent

Cash and equivalents are also financial assets subject to an insignificant change in value or held to pay short-term obligations.

For example, an entity has a foreign currency bank account.

The account bank’s objective is to obtain a profit in the next 6 months due to the exchange rate fluctuation.

The example above does not represent cash or cash equivalents for two reasons.

The first reason is that the financial asset is not held for the payment of short-term obligations but to obtain a profit due to the increase in the exchange rate.

And the other reason is that cash is subject to important changes in value.

Before continuing to read the post, put your knowledge into practice.

Cash and equivalents - questions

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¿ What is restricted cash?

Now that we are clear about the cash and equivalents concept, let’s talk about restricted cash.

Restricted cash is cash that has certain limitations on its availability and, therefore, the company cannot use it to pay short-term liabilities.

Restricted cash is conditional on certain legal or contractual events.

Let’s look at some examples of elements that are considered restricted cash.

Funds to cover pensions or other benefits to employees long-term in a separate account.

Bank accounts with embargoes.

Funds for projects that will begin to be executed in the future.

Let’s look at an example:

A construction company receives an advance payment from a client for constructing a project.

The construction duration is five years.

The agreement between the parties stipulates that the advance must be kept in a bank account until the project’s progress exceeds 40%.

The company estimates that the project progress  will be reached in two years.

As we can see, there is a restriction for using this cash stipulated in a contract.

It is important to say that this asset must be reclassified in an account called long-term restricted cash and equivalents in the balance sheet.

Restricted cash - questions

We want to introduce you to our IFRS course, which has a new methodology based on answers and questions using videos and training tests.

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