Bank overdrafts and cash and cash equivalents

Bank overdrafts and cash and cash equivalents – IAS 7 8 notes that although bank borrowings are generally considered to be financing activities, in some countries bank overdrafts form an integral part of an entity’s cash management. In such cases, bank overdrafts are included as a component of cash and cash equivalents meaning that bank overdraft balances would be offset against any positive cash and cash equivalent balances for the purposes of the statement of cash flows.

However, care is required when presenting bank overdrafts, and cash and cash equivalents, in the statement of financial position. This is because, even though IAS 7 permits offset of balances in the statement of cash flows, this may not be permitted by IAS 32 Financial Instruments: Presentation.

The IAS 32 requirements mean that balances are only offset when an entity: Bank overdrafts and cash and cash equivalents

  • Currently has a legally enforceable right to set off the recognised amounts; and Bank overdrafts and cash and cash equivalents
  • Intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. Bank overdrafts and cash and cash equivalents

Consequently, some balances may be offset in the statement of cash flows, but not in the statement of financial position.

Bank overdrafts and cash and cash equivalents It may be appropriate for entities to include narrative in their accounting policies, highlighting the distinction between cash flows that are offset in the statement of cash flows, and cash and cash equivalent balances that are offset in the statement of financial position.

Short-term credit lending and cash and cash equivalent classification

In some circumstances, short-term loans and credit facilities may meet the definition of a cash and cash equivalent, and would therefore be presented within cash and cash equivalents, rather than financing cash flows. Bank overdrafts and cash and cash equivalents

At its June 2018 meeting, the IFRS Interpretations Committee (the Committee) discussed the circumstances in which short-term loans and credit facilities may be presented as a component of cash and cash equivalents. Bank overdrafts and cash and cash equivalents

In the fact pattern: Bank overdrafts and cash and cash equivalents

  1. The entity has short-term loans and credit facilities that have a short contractual notice period (e.g. 14 days);
  2. The entity says it uses the short-term arrangements for cash management; and Bank overdrafts and cash and cash equivalents
  3. The balance of the short-term arrangements does not often fluctuate from being negative to positive. Bank overdrafts and cash and cash equivalents

The Committee observed that an entity generally considers bank borrowings to be financing activities, not a component of cash and cash equivalents. The Committee observed that bank borrowings are a component of cash and cash equivalent only in the particular circumstances noted in IAS 7 8: the arrangement is a bank overdraft that is payable on demand and forms an integral part of the entity’s cash management. Therefore, a short-term financing arrangement cannot form a component of cash and cash equivalents unless it is due on demand.

The Committee observed that for a facility to form an integral part of the entity’s cash management, it must use the facility in order to meet short-term cash commitments rather than for investing or other purposes. The Committee also noted that if the balance of a banking arrangement does not often fluctuate from being negative to positive, then the arrangement would generally not form an integral part of the entity’s cash management. If the facility is consistently in a negative position, then it is a form of financing.

Therefore, based on the fact pattern provided, the Committee concluded that such an arrangement would not be a component of cash and cash equivalents because these facilities are not repayable on demand and the balance does not often fluctuate from being negative to positive (i.e. it is consistently in a negative position where the entity owes the lender). The facilities are a form of financing and their cash flows should be classified as financing cash flows. Bank overdrafts and cash and cash equivalents

Book Overdrafts (US GAAP)

A book overdraft represents the amount of outstanding checks in excess of funds on deposit for a particular bank account, resulting in a credit cash balance reported on an entity’s balance sheet as of a reporting date. For financial reporting purposes, an entity should reinstate a liability (e.g., accounts payable) to the extent of the book overdraft in such a way that the cash balance is reported as a zero balance. Bank overdrafts and cash and cash equivalents

When an entity maintains separate funding and disbursement accounts with the same bank, it may not be as easy to determine the amount of the book overdraft. For example, an entity may have a cash management arrangement with a bank in which checks written are issued from a dedicated disbursement account that is funded from a separate deposit account as the checks are presented for payment to the bank. Bank overdrafts and cash and cash equivalents

In such a scenario, the disbursement account may be designed to maintain a zero  balance. Further, it is not uncommon for a bank to have the contractual right and ability to automatically sweep cash from the funding account to cover checks presented for payment from the disbursement account. Because of timing differences between when checks are written by an entity and when they are funded by the bank, the disbursement account may reflect a book overdraft as of a reporting date, which by design would represent the entire population of outstanding checks.

In practice, questions have arisen regarding how an entity should determine the book overdraft in such an arrangement to reinstate accounts payable. Two alternative approaches to making this determination have emerged: Bank overdrafts and cash and cash equivalents

  • The single account approach ― The deposit and disbursement accounts with the same bank would be viewed as a single account in the determination of the book overdraft.
  • The liability extinguishment approach ― The book overdraft with the same bank would be determined independently from any funds held in the deposit account, resulting in the reinstatement of the entire population of outstanding checks.

The Single Account Approach Bank overdrafts and cash and cash equivalents
The balance sheet offsetting guidance in ASC 210-20 focuses on whether a “right of setoff” exists. A right of setoff is defined as “a debtor’s legal right . . . to discharge all or a portion of the debt owed to another party by applying against the debt an amount that the other party owes to the debtor.” However, ASC 210-20-55-18A states that “[c]ash on deposit at a financial institution shall be considered by the depositor as cash rather than as an amount owed to the depositor.” Bank overdrafts and cash and cash equivalents

Because cash on deposit is held by the bank for the entity in a fiduciary capacity, the cash on deposit would not be considered an “amount owed” to the entity. Although the offsetting guidance in ASC 210-20 would not apply to the separate deposit and disbursement accounts in the above scenario, it would still be acceptable — to the extent that the following conditions are met — for entities to analogize to the offsetting guidance in deciding whether to view the disbursement and deposit accounts as a single bank account in the determination of the book overdraft:

  • Under the terms of the depositor relationship, the financial institution has the right, ability, and intent to offset a positive balance in one account against an overdrawn amount in the other.
  • Amounts in each of the accounts are unencumbered and unrestricted with respect to use. Bank overdrafts and cash and cash equivalents

Further, the single account approach is also consistent with the non-authoritative guidance in AICPA Technical Q&As Section 1100.08, which states:

  • Inquiry — Should the amount of checks that have been issued and are out of the control of the payor but which have not cleared the bank by the balance sheet date be reported as a reduction of cash? Bank overdrafts and cash and cash equivalents
  • Reply — Yes. A check is out of the payor’s control after it has been mailed or delivered to the payee. The balance sheet caption “cash” should represent an amount that is within the control of the reporting enterprise, namely, the amount of cash in banks plus the amount of cash and checks on hand and deposits in transit minus the amount of outstanding checks. Cash is misrepresented if outstanding checks are classified as liabilities rather than a reduction of cash. Bank overdrafts and cash and cash equivalents

Under the single account approach, a book overdraft would not exist to the extent that the funding account has sufficient funds to cover the amount of outstanding checks. Therefore, to the extent that outstanding checks exceed the amount in the deposit account, this excess would be considered the book overdraft and should be presented as a liability for financial reporting purposes.

The Liability Extinguishment Approach
Under the liability extinguishment approach, the disbursement account is viewed independently from the deposit account in the determination of the amount of the book overdraft. The accounting basis for this approach is that the liability (e.g., accounts payable) that will be settled through the issuance of the outstanding checks has not been legally extinguished as of the reporting date in accordance with ASC 405-20. Therefore, under the liability extinguishment approach, a book overdraft represents what is, in substance, a payable to the original creditor.

Accordingly, the existence of a deposit account with the same financial institution is not relevant to the accounting analysis. Specifically, ASC 405-20 indicates that a liability is not extinguished until a creditor is paid. Under this view, payment to the creditor occurs when the counterparty presents the check to the bank for payment rather than when the entity issues the check from the disbursement account.

In addition, proponents of the liability extinguishment approach note that even if one were to support the view that book overdrafts are within the scope of ASC 210-20, offsetting is not required when the right of setoff exits. Instead, as noted in ASC 210-20-45-2, offsetting is permitted, but not required, provided that the right of setoff exists.

Consequently, under the liability extinguishment approach, the entire population of outstanding checks (i.e., all checks written from the disbursement account) would represent the book overdraft as of the end of the reporting period. Therefore, although there may be funds in the deposit account, accounts payable would be reinstated for such an amount.

Further, while the liability extinguishment approach is based on a situation in which the separate disbursement and funding accounts are maintained with a bank, an entity would reach the same view when it uses one bank account for deposits and disbursements.

That is, if an entity’s policy is that the liability derecognition guidance in ASC 405-20 does not apply until the counterparty presents the check to the bank for payment, commonly such a policy should be neutral regarding whether there are separate accounts (that are linked) or whether a single account is used for both funding and disbursements.

Regardless of whether an entity elects the single account approach or the liability extinguishment approach, the entity should consistently apply and transparently disclose the approach it uses.

Example bank overdrafts

Entity A has two bank accounts with different financial institutions, Bank X and Bank Y. As at entity A’s reporting date, the two bank balances are:

––Bank X: positive balance of CU1,000, Bank overdrafts and cash and cash equivalents

––Bank Y: overdraft of CU200. Bank overdrafts and cash and cash equivalents

From Entity A’s perspective, the bank overdraft is an integral part of its cash management. However, there is no arrangement involving Entity A, Bank X and Bank Y that give Entity A a legally enforceable right to offset the two recognised amounts.

(Note: in practice, it is very unlikely that any such offset arrangement between two separate banks would be entered into.)

Consequently, Entity A recognises amounts in its primary financial statements as follows:

Statement of financial position CU

Current assets Bank overdrafts and cash and cash equivalents

  •  Cash and cash equivalents               1,000 Bank overdrafts and cash and cash equivalents

Current liabilities Bank overdrafts and cash and cash equivalents

  • Bank overdraft                                     (200)

Statement of cash flows Bank overdrafts and cash and cash equivalents

Cash and cash equivalents                            800 Bank overdrafts and cash and cash equivalents

In addition, for those entities that operate in a range of different jurisdictions worldwide, it will be important to distinguish those countries in which bank overdrafts form part of the entity’s cash management, and those where they do not.

See also: The IFRS Foundation

Bank overdrafts and cash and cash equivalents

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