I am frequently challenged that cash equivalents at the year-end should include those financial assets that have reached a maturity of less than three months at the year-end date, having had a somewhat longer maturity when first acquired. How wrong the understanding!
The fundamental nature of cash equivalents is described in the opening sentence of paragraph 7 of IAS 7. “Cash equivalents are held for the purpose of meeting short-term cash commitments other than for investment or other purposes”. This means that at the date those investments were acquired, they were available for meeting those short-term needs – if the investments have a maturity of more than a few months (say 3 months), they were at the time of purchase NEVER available for meeting short-term needs. Paragraph 7 then goes on to say that if an investment is going to be available to meet those short-term needs, then it should be readily convertible into a known amount of cash, and subject to only an insignificant risk of value change. Again, the point is that the investments are held for meeting short-term cash commitments, which surely have been estimated and planned for, and so any suitable short-term investment of cash pending the planned outflow would need to have the twin characteristics of being highly liquid, and largely certain value, otherwise the short-term commitment may not be completely funded.
So, cash equivalents must be: highly liquid, readily convertible into known amounts of cash at the date of acquisition and throughout the period of holding (and so subject to only an insignificant risk of value change), and of a short maturity at the date of acquisition (say, 3 months). All these points have been examined by the Interpretations Committee over recent years. The IFRIC published their thinking about the maturity question in May 2013, in an agenda rejection decision (a non-IFRIC, or as I call them NIFRIC), answering the challenge that I mentioned in my introduction. And in July 2009, the IFRIC published a NIFRIC addressing the elements of the definition dealing with “…conversion into known amounts…” and the “… insignificant risk of changes in value.”
Clearly cash equivalents cannot include equity investments. Cash equivalents would include most bank term deposits with a short maturity period, and would most likely include government bonds that have around three months or less to maturity at the time of acquisition.
Cash equivalents would be presented in the statement of financial position (SOFP) within cash and cash equivalents. So… is the figure of cash and cash equivalents in the SOFP always the same as the total at the bottom of the Statement of Cash Flows? Apparently the answer is not always. If the two numbers were always the same, then IAS 7 has a redundant paragraph 45, requiring a reconciliation between cash and cash equivalents in the statement of cash flows, and the equivalent in the SOFP. There are reasons why the two numbers may not be the same, and the explanation hinges around what the entity has defined as cash and cash equivalents in its statement of cash flows, as opposed to the current asset item in the SOFP. For example, many entities manage their day-to-day banking arrangements (managing short-term cash commitments) to include the use of an overdraft facility periodically. In such a case, a bank overdraft that may exist at the instant of the year-end (and probably was not there a few days earlier, and probably not a few days later), is usually considered as part of cash and cash equivalents in the statement of cash flows, but would be a current liability in the SOFP. Hence the need for a reconciliation. A similar issue arises when an entity has a year-end deposit in an escrow account – it is a cash equivalent from the perspective of the Statement of Financial Position, but is clearly not available to meet short-term cash commitments.
Author: Ian Charles