Cash and cash equivalents

As per Para 54 of Ind. AS 1 on ‘Presentation of Financial Statements’, the statement of financial position shall include a minimum line items mentioned therein. One such point as per the line item (i) is ‘cash and cash equivalents’

 As per Para 7 of Ind.AS. 7 on Statement of Cash Flows, ‘Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition. Equity investments are excluded from cash equivalents unless they are, in substance, cash equivalents, for example in the case of preferred shares acquired within a short period of their maturity and with a specified redemption date.

Further as per Para 8 of Ind.AS.7, Bank borrowings are generally considered to be financing activities. However, where bank overdrafts which are repayable on demand form an integral part of an entity's cash management. In these circumstances, bank overdrafts are included as a component of cash and cash equivalents. A characteristic of such banking arrangements is that the bank balance often fluctuates from being positive to overdrawn.

In other words and to be precise, cash equivalents are financial assets that are not restricted in use and which are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. Therefore, an investment normally qualifies as a cash equivalent only when it has a maturity of 3 months or less from the date of acquisition (vide Para 7 of Ind. AS.7). Equity securities are therefore excluded from cash equivalents.

According to Para 6 of Ind.AS.7, cash and cash equivalents comprise:

· Cash comprises cash on hand and demand deposits.

· Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.

The following items are regarded as cash and cash equivalents:

· Cash at bank 

· Cash on hand in the form of notes or coins

· Traveler’s Cheques, bank Cheques etc.

· Post Office and other stamps recognized by the local authorities

· Short-term deposits due within 3 months from acquisition

· Short-term highly liquid debt instruments due within 3 months from acquisition

· Time deposits due within 3 months from acquisition

· Money market instruments due within 3 months from acquisition

 Bank overdrafts (not bank borrowings) are included, if a characteristic of such a banking arrangement is that the bank balance often fluctuates from being positive to negative 

However, it should be noted that bank borrowings (including bank overdrafts) are to be included separately in liabilities from short-term financing and should not be netted with bank deposits unless the right of legal set-off applies.

Under Para 66 (d) of Ind.AS.1, ‘An entity shall classify an asset as current when  the  asset  is  cash  or  a  cash  equivalent  (as  defined  in  Ind. AS. 7) unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period.

What is ‘restricted use’ in relation to Cash and cash equivalents? The dictionary meaning of the word ‘restricted’ is controlled or constrained- in other words, money can not be used suo motto. . For example,

Foreign exchange regulations that forbid the immediate transfer of funds, cash or bank balances may be subject to significant restrictions which may preclude their being classified as either cash and cash equivalents or current assets.

Similarly, bank accounts opened under legal requirements especially for payment of unpaid dividends under section124 of the Companies Act 2013 cannot be used except for the indented purpose and in fact shall be credited to the Investor Education and Protection Fund, if the dividends remained unclaimed and unpaid for a period of seven years. Therefore, to be fair and in fitness of things, it is not cash equivalent for the entity by any stretch of imagination.

Again, if they are any court order on any other restriction is placed on the operation of bank accounts that may preclude the said accounts from classifying as cash equivalents.

What about Bank Overdraft repayable on demand?

In Cash Flow Statement, Bank Overdraft to be netted against cash and cash equivalents if it forms an integral part of the entities cash management.

But, in Statement of Financial Position (SFP), this is not permitted on the face of SFP unless both the offsetting criteria are met that are:

• There is legally enforceable right to set off the recognized amounts.
• There is intention to settle on a net basis or to realize the asset and settle the liabilities simultaneously.

In case of difference between the above said two, reconciliation should be included in the notes.

For an item to qualify as a cash equivalent it must be readily convertible into a known amount of cash and be subject to an insignificant risk of changes in value. As a result, cash and cash equivalents are normally measured at carrying value. In other words, its

- Carrying value (book value) will be the fair value in most of the scenario, as normally no impairment/ derecognition envisaged

Cash and cash equivalents include cash in hand and at bank, and short–term deposits with an original maturity period of three months or less. Bank overdrafts that are an integral part of cash management and where there is a legal right of set– off against positive cash balances are included in cash and cash equivalents. Otherwise bank overdrafts are classified as borrowings.

But, if we visit Note-No 2.1 of Infosys consolidated quarterly Report for June 2015 on Cash and cash equivalents, it runs as follows:

‘Cash and cash equivalents consist of the following:                                                                             

                                                                                 As of                                    (In ` crore)

                                                                 30th June 2015 31st march 2015

Cash and bank deposits                                   24,711           26,195

Deposits with corporation                                  3,431            4,172

                                                                       28,142          30,367

Cash and cash equivalents as of June 30, 2015 and March 31, 2015 include restricted cash and bank balances of `375 crore and `364 crore, respectively. The restrictions are primarily on account of cash and bank balances held by irrevocable trusts controlled by

- the Company, bank balances held as margin money deposits against guarantees and balances held in unpaid dividend bank accounts.

The deposits maintained by the Group with banks and corporations comprise of time deposits, which can be withdrawn by the Group at any point without prior notice or penalty on the principal’.

We may notice two things as spelt out underneath that appear to speak in different voices

A disclosure is made as to the inclusion of the restricted cash balance in the cash equivalents. The one plausible reason could be a matter of judgment on the materiality. Materiality consideration for recognition and measurement are an accepted axiom. But, for groping, at times, it may hint altogether a different species.

The other disclosure as to the inclusion of deposits of more than 3 months in cash equivalents on the score that can be withdrawn by the Group at any point without prior notice or penalty on the principal. But, what about is the loss of interest?  Possible, the interest may be paid at the prevailing rate for the period up to, when en cashed and what will be lost is only the incremental higher interest for the period held to maturity, lest it is a likely bone of contention ,since may be apprehended  running against the ethos, purpose and objective of the classification. On this premise, most of the deposits will be only cash equivalent since, by and large, there is penalty only on interest for pre closure and not on principal.

But, alas, different entities are taking different stands on this- one going religiously by three month norm from inception, apparently relying on the intention to hold beyond three months by the entity, lest, it would not have gone for the period; and the other on the liberal stand applied that deposits can be broken, if need be, without loss of value to principal, though interest will get a hit to the extent of the incremental interest for the balance period to maturity..

If the intention of the Standard is otherwise, it would not have expressed so unequivocally in Para 7 of Ind. AS.7, to quote the other sentence it runs as follows:

 ‘An investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition’.  The word ‘only’ used in the midst in the quote  speaks volume to the extent of emphasizing that only those deposits of short maturity of, say, three months or less from the date of acquisition would qualify for cash equivalents. The only relieving factor is the word ‘normally’ interjected in the above quotes that can extent some comfort for the liberal interpretation.

If we refer Para 6.4 of the GN on Revised Schedule VI to the Companies Act 1956 on General Instructions to the Revised schedule VI is referred

"Further, bank balances held as margin money or security against borrowings are neither in the nature of demand deposits, nor readily available for use by the company, and accordingly, do not meet the aforesaid definition of cash equivalents. Thus, this is an apparent conflict between the requirements of the Revised Schedule VI and the Accounting Standards with respect to which items should form part of Cash and cash equivalents. As laid down in the General  Instructions, Para 1 of Revised Schedule VI, requirements of the Accounting  Standards would prevail over the Revised Schedule VI and the company  should make necessary modifications in the Financial Statements which may include addition, amendment, substitution or deletion in the head/sub-head or  any other changes inter se. Accordingly, the conflict should be resolved by changing the caption “Cash and cash equivalents” to “Cash and bank  balances,” which may have two sub-headings, viz., “Cash and cash  equivalents” and “Other bank balances.” The former should include only the items that constitute Cash and cash equivalents defined in accordance with  AS 3 (and not the Revised Schedule VI), while the remaining line-items may be included under the latter heading”.

Though the above quote is relation to AS. 3 Vis a Vis Revised Schedule VI, it is unequivocal as to content and tenor of to Cash and Cash Equivalent.  Therefore, there is an urgent and deserved need for level play here. A clarity will sane the situation and calm the contention.