Recently, I got a question from Lotte who works in a construction company. Because this is a very common practice, let me answer and comment on that.

The question goes:

“We are a constructing company and we received an advance payment from our customer for the construction of the specialized production hall amounting to 5% of the total sales price. This is very significant for our financial statements.

The issue is that we have to keep this money on a separate bank account and we cannot use it until the hall is handed over to our customer. In fact, we cannot put our hands on that deposit without the third party agreeing. We assume the delivery of the hall 2 years after the construction started.

Can we still present this amount on our bank account as cash and cash equivalents?

If not, how shall we present it in our balance sheet and the statement of cash flows?”

This is a very good question – by the way, you, my readers and followers, ask me great questions anyway.

Answer: It depends.

The simple answer to this particular case is NO, this is NOT the cash and cash equivalents.

Let’s explain it.

Cash and cash equivalents under IAS 7

The standard IAS 7 Statement of cash flows defines cash as cash on hand and demand deposits.

When you have some money on the bank account that you can’t touch for 2 years, it is neither cash on hand (because you can’t use it) nor demand deposits.

Cash equivalents are short-term, highly liquid investments that are readily convertible to cash without the significant risk of changes in value.
IAS 7 specifies that in order to meet this definition, these investments must be convertible within 3 months or less.

Cash and cash equivalents IFRS

So, the deposit on your account is NOT the cash equivalent, because it’s not convertible within 3 months, you just can’t touch it.

This is so-called restricted cash.

Word of warning: The answer relates to this particular case only and you need to assess your specific circumstance. For example, you might be required to keep that cash on a separate account, but nothing prevents you from demanding that cash and getting it – then it is a demand deposit. Please read the discussion from IFRIC meeting held in March 2022 here.

Anyway, this is not the focus of this article. We are examining how to present restricted cash once you identify you have one.

Examples of restricted cash

Let me tell you some other examples of restricted cash:

  1. Amounts pledged as collaterals to insurance companies – sometimes, when insurance companies cover just a portion of some risk, they require some cash to be pledged as collateral and often, this cash needs to be held at separate escrow account.
  2. Mandatory deposits held in central banks – this is very common in many countries that every bank needs to deposit certain amount of cash to the central bank and this amount is simply not available to use.
  3. Contributions to cover pensions on a separate account – some companies create funds to cover some employee benefits, like pensions, to be paid after many years.
  4. Cash held under exchange controls – you can have a subsidiary that operates in some country with some restrictions or exchange controls that could prevent the use of cash.

So you get the point.

How to present restricted cash

In all above examples there was restricted cash and you need to assess whether you can still present it as a cash equivalent or not.

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The main factor to assess is the character of the restriction.

Let’s say that some conditions specify that you need to maintain specified amount of cash as a minimum balance, but you do not have to keep it at the separate bank account.

In this case, it is still restricted cash, but you could present it as cash and cash equivalents.

Now, how is restricted cash presented in the financial statements?

  1. The statement of financial position of the balance sheetIf you have restricted cash, then you should present it within other financial assets in most cases.Then also, you should be very careful with current and non-current distinction.If your restricted cash will stay there for more than 12 months after the end of the reporting period, then it’s non-current asset.
  2. Statement of cash flowsNormally, you present the change in cash and cash equivalent in the final reconciliation, because that’s the purpose of the statement of cash flows – to explain how and why the balance of cash moved.When you have the restricted cash not presented as cash in the balance sheet, you cannot present it as such in the statement of cash flows.Instead, this would be presented either in the investing activities, operating activities or in the financing activities, depending on what it is.
    For example, changes in restricted cash related to the repayments of borrowings are financing activities.

    Changes in these deposits taken from clients to build an asset for them are related to the main revenue generating activity, and therefore they are operating activity.

    You can learn more about it in my IFRS Kit – I will teach you to prepare the statement of cash flows in an easy and fail-proof method.

Here’s the video summing up the issue:

Do you have your own experience or question related to the restricted cash?

Please share it below in the comments. Thanks!