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Presenting restricted cash · PwC's accounting podcast

0:00
SPEAKER_01: Thought leadership from PwC's National Office.
0:06
SPEAKER_00: Welcome to PwC's Accounting Podcast.
0:09
SPEAKER_00: I'm Heather Horn.
0:11
SPEAKER_00: It's reporting and earnings seasons.
0:14
SPEAKER_00: So this episode continues our month of podcasts focused on financial statement presentation.
0:20
SPEAKER_02: We've seen uptick in not only interest but also questions in the area lately.
0:26
SPEAKER_02: And maybe there's a couple things in play.
0:27
SPEAKER_02: I think as you noted, uh there is a focus in the market on liquidity and liquidity resources.
0:33
SPEAKER_02: I think we're also seeing in arrangements where there's more cash being restricted due to requirements and debt arrangements, could be litigation settlements, escrow accounts, and the like.
0:44
SPEAKER_02: So with all that going on uh and with the general focus on the financial segment presentation, we thought it would be a good time for a refresher.
0:56
SPEAKER_00: That was Brett Dooley, Deputy Chief Accountant in PWC's national office who leads our financial instruments team.
1:03
SPEAKER_00: And he's joining us today to talk about something that requires more judgment than you may think restricted cash.
1:10
SPEAKER_00: With an increased focus on liquidity and the SEC's recent emphasis on the cash flow statement, this is an area you definitely want to make sure you get right.
1:19
SPEAKER_00: Although, as I say that, you actually definitely want to make sure you get all your areas right.
1:24
SPEAKER_00: So whether you're working through year-end reporting or thinking ahead to your next reporting cycle, this is an episode you don't want to miss.
1:32
SPEAKER_00: So, Brett, welcome to the podcast.
1:34
SPEAKER_00: So happy to have you on.
1:35
SPEAKER_00: And this is another great topic, restricted cash.
1:38
SPEAKER_00: And one thing I shared in past episodes is that we're focused on our most popular guide, the financial statement presentation guide.
1:46
SPEAKER_00: And in fact, restricted cash is one of the most popular sections of the guide, which I have to admit, I personally found to be a little bit surprising.
1:55
SPEAKER_00: So just curious, maybe before we get into the topic, of some perspective from you of why we think it is such a popular topic.
2:03
SPEAKER_02: Sure.
2:04
SPEAKER_02: I mean, that's that's interesting to hear.
2:06
SPEAKER_02: I guess we're in awards season, so I don't know if I get a small trophy for that.
2:10
SPEAKER_02: But anyway, thanks for having me.
2:13
SPEAKER_02: Um but you're exactly right.
2:14
SPEAKER_02: We've it we've seen uptick in not only interest, but also questions in the area lately.
2:19
SPEAKER_02: Um and maybe there's a couple things at play.
2:21
SPEAKER_02: I think as you noted, uh there is a focus in the market on liquidity and liquidity resources.
2:27
SPEAKER_02: Um, I think we're also seeing arrangements where there's more cash being restricted due to requirements and debt arrangements, could be litigation settlements, escrow accounts, and the like.
2:38
SPEAKER_02: Uh so with all that going on uh and with the general focus on the financial statement presentation, we thought it would be a good time for a refresher on it.
2:45
SPEAKER_00: All right.
2:46
SPEAKER_00: And I think what's interesting is when you dig into it and make sense why this impacts liquidity in particular.
2:52
SPEAKER_00: But on the surface, you know, I guess that people will think, oh, well, it's just cash you can't get access to, but it's a little deeper than that.
2:59
SPEAKER_00: So can you share when you think about restricted cash and the context of liquidity, what are some of the factors that you think about?
3:05
SPEAKER_02: Yeah, I I think that um obviously cash that's that's available for general uses, that's what financial statement uh readers are looking for.
3:14
SPEAKER_02: When you get into, and we'll get into the definition of restricted cash a little bit, there can be um variation in policies related to them.
3:22
SPEAKER_02: And so understanding the nature of the restrictions when some of that cash is restricted can be important.
3:29
SPEAKER_02: So I think when you're evaluating liquidity, like all cash is not created equal.
3:33
SPEAKER_02: And so financial statement users really need to know how much of that cash is available on hand, how much is restricted, and and maybe what some of those restrictions are are for.
3:44
SPEAKER_00: So, Brett, one of the things I think is interesting when we think about restricted cash in particular is the impact it can have on a company's ratios, because again, you said cash, but not all cash is equal.
3:56
SPEAKER_00: And I think this is a place we really see the impact of that.
3:59
SPEAKER_00: So, what do you see?
4:00
SPEAKER_02: Yeah, I mean, there's a couple fairly standard liquidity ratios that we see used.
4:04
SPEAKER_02: And then obviously when you get in the world of non-gap measures, there could be some additional ones.
4:09
SPEAKER_02: But um, think of a basic cash ratio, which is cash and cash equivalents divided by current liabilities.
4:16
SPEAKER_02: You know, how much how much liquidity you have to cover those um current liabilities.
4:21
SPEAKER_02: There's also a quick ratio, which is cash, cash equivalence, and adding in marketable securities divided by current liabilities.
4:30
SPEAKER_02: Now, both of those don't include restricted cash.
4:33
SPEAKER_02: You generally have that backed out.
4:35
SPEAKER_02: But obviously, if you don't exclude them, if you include restricted cash in there, you get sort of um it, you know, it's gonna make the company look more liquid than it is that could be misleading.
4:45
SPEAKER_02: So I think that restricted cash is very key to liquidity.
4:49
SPEAKER_02: Um, and so there's we're gonna walk through a little bit later the specific gap and SEC disclosure requirements to make sure that users can understand how much of the cash is restricted.
4:59
SPEAKER_00: Well, and so it's interesting, Brett, you say that because it made me realize maybe the first question I should have asked you before we even started is when we say restricted cash, what do we mean?
5:10
SPEAKER_00: Because I think there's a lot of different ways you can think about that.
5:13
SPEAKER_02: Yeah.
5:13
SPEAKER_02: And that sounds like a simple question.
5:15
SPEAKER_02: Like just like you think that the definition of restricted cash should be easy.
5:19
SPEAKER_02: We're gonna get into that a little bit.
5:21
SPEAKER_02: I want to spend some time thinking about what those restrictions can be.
5:25
SPEAKER_02: And you'll see there there could be some, like I mentioned, some differences in practice and policies around what different companies may consider to be restricted and how and how they show it.
5:35
SPEAKER_00: All right.
5:35
SPEAKER_00: And I think that leads to a question then, Brett, just in terms of when we say restricted cash, what do we really mean?
5:43
SPEAKER_00: Because to your point, not all cash is equal, but if when we're actually disclosing it's restricted, what types of restrictions are we talking about?
5:52
SPEAKER_02: Yeah.
5:52
SPEAKER_02: Uh it's a great question, and it's one that we get most often.
5:56
SPEAKER_02: Um, and maybe the reason we get that question is GAAP doesn't actually define restricted cash.
6:01
SPEAKER_02: Um, the FASB and the EITF dealt with this issue or some issues around restricted cash in 2016, but interestingly, they purposely did not provide a definition of restricted cash in that ASU, which got a fair amount of debate at the time, frankly.
6:18
SPEAKER_02: During deliberations, the ITF noted that actually the definition of restricted cash hasn't been a significant um source of diversity in practice.
6:27
SPEAKER_02: So there are some questions around if there's not that much diversity in practice, is practice just kind of okay on its own.
6:34
SPEAKER_02: And then also when the EITF was talking about, and you think of the wide range of restrictions, getting very prescriptive and giving a formal definition seemed to be complicated.
6:46
SPEAKER_02: And so instead, they gave a reporting entity a choice to continue with its own definition.
6:52
SPEAKER_02: So at the time, the intent was specifically not to change any practice in the area and just let practice uh be what it was.
7:00
SPEAKER_00: Although it's interesting, maybe there's not diversity, but to your point, I guess one of the reasons this guide section is so popular is because people do have questions around what is restricted cash.
7:11
SPEAKER_00: So it sort of seems like if it had been that easy, they could have just given a definition.
7:15
SPEAKER_00: But uh putting that aside then, so like where does that leave us?
7:19
SPEAKER_00: How does a company start to evaluate whether cash is restricted?
7:23
SPEAKER_02: Right.
7:23
SPEAKER_02: Maybe I start out with kind of what our view at PWC has been on this.
7:27
SPEAKER_02: And and we think at a minimum, restricted cash should include that cash that is either legally or contractually restricted for withdrawal or use.
7:37
SPEAKER_02: That implies like a third-party, you know, legal or contractual restriction.
7:42
SPEAKER_02: Classification of additional amounts as restricted beyond those is subject to a reporting entity's own accounting policy.
7:49
SPEAKER_02: Uh so generally, self-imposed either segregations or designations wouldn't be presented as restricted cash unless a company has an explicit policy uh to do that.
8:00
SPEAKER_02: And any policy created should be obviously applied consistently.
8:04
SPEAKER_02: And maybe to lay this out, when I think about cash, I think of it on a continuum.
8:09
SPEAKER_02: Like start off with the basic, I've got cash on hand, I can use it freely, there's no restrictions, it's just in my bank account.
8:17
SPEAKER_02: Clearly, that's not restricted cash.
8:19
SPEAKER_02: I think I think people get that right.
8:21
SPEAKER_02: That's easy.
8:21
SPEAKER_02: Yeah.
8:22
SPEAKER_02: Maybe the next step is to say that is to look at cash that's just been voluntarily set aside, maybe even in a special account, but to be used for a designated purpose.
8:32
SPEAKER_02: Think of this as like a self-imposed designation.
8:34
SPEAKER_02: I've got some part of my cash that I intend to use for debt service or for a specific purpose.
8:41
SPEAKER_02: It's not legally restricted.
8:43
SPEAKER_02: I could change my intent, and it may or may not be restricted cash depending on a company's restricted cash policy.
8:50
SPEAKER_02: This is the area where there could be some diversity in practice in companies' own policies and how they think of restricted cash.
8:57
SPEAKER_02: I could go one step further in my restrictions and say I could have cash in a bank account, you know, that's in the company's name, but it's legally restricted by a third party or by contract as to how that's going to be used or withdrawn.
9:12
SPEAKER_02: The company can't freely access it, right?
9:14
SPEAKER_02: It can't use the cash for general purposes because of this contractual restriction.
9:18
SPEAKER_02: Um, it could also be imposed by a regulatory or government authority as well.
9:23
SPEAKER_02: This is the category that I talked about that must be restricted cash in in our view.
9:29
SPEAKER_02: I can go one step further and say there may be cash that's sitting in an account that the company doesn't even have control over.
9:36
SPEAKER_00: Okay.
9:37
SPEAKER_00: Right?
9:37
SPEAKER_02: The company doesn't have, maybe they don't have legal ownership or they don't have title over the funds.
9:42
SPEAKER_02: And this is where I think it can get be a bit complex because there may be some indicators around ownership or control rights that we'll talk about here.
9:50
SPEAKER_02: But in some cases, this amount is so restricted and the control is so limited, you start to question whether it's cash at all.
9:57
SPEAKER_02: Maybe it's just a receivable from that account.
10:00
SPEAKER_02: Or in some arrangements that we'll talk about a little later, it may be not recognized as an asset at all because it's just held essentially in trust or as an agent for a third party.
10:10
SPEAKER_00: Wow.
10:10
SPEAKER_00: Okay.
10:11
SPEAKER_00: Well, let's get to that.
10:12
SPEAKER_00: But maybe, so if I think about this continuum and I like the way you laid that out, on the one hand, we have this cash that's mine.
10:19
SPEAKER_00: It's very clear.
10:20
SPEAKER_00: I do whatever I want.
10:21
SPEAKER_00: And for a lot of companies, actually, you know, they may not even keep that much of that type of cash around because they're they want to do something with it.
10:29
SPEAKER_00: Where I think this starts to get very interesting is this difference between something I designated and something that's externally restricted, because I could see that could start to get a little bit blurry.
10:41
SPEAKER_00: And so how should we think about it then?
10:44
SPEAKER_00: If I I'm gonna give you an example, one I saw frequently back in my audit partner days.
10:49
SPEAKER_00: And so basically, I'm collecting cash on behalf of a third party, but I keep it in a separate bank account so I can hold it and then disperse it at the right point in time.
11:00
SPEAKER_00: So I have the cash right now, but I put it in its own account.
11:05
SPEAKER_00: It needs to at some point go to someone else.
11:07
SPEAKER_00: Is that treated as restricted, or is that my cash until I give it away?
11:12
SPEAKER_02: Yeah.
11:12
SPEAKER_02: Yeah.
11:13
SPEAKER_02: Let's talk through this.
11:14
SPEAKER_02: It's an interesting um example to go through.
11:17
SPEAKER_02: And this is where it's going to depend on the accounting policy a little bit.
11:20
SPEAKER_02: So let's assume that the company we're talking about treats only that only cash that's legally restricted as restricted cash.
11:27
SPEAKER_02: And so let's say you've got a million dollars that's been collected, hasn't been remitted to the customer.
11:32
SPEAKER_02: So you've got the million dollars sitting in the separate bank account, and you've got a million dollar liability on the balance sheet because you know you have to deliver that to the to the customer.
11:41
SPEAKER_02: So in order to think about if that cash is legally restricted, think about the legal rights of withdrawal over that account and whether there's contractual restrictions about how it can be used.
11:51
SPEAKER_02: So, first of all, is there a legal restriction on withdrawal?
11:54
SPEAKER_02: If the company is named as the party that has the legal right to deposit into and withdraw from that bank account, sounds to me like there may be no legal restriction on withdrawal.
12:04
SPEAKER_02: Um, the fact is that that there's a separate bank account to set up may just be a matter of internal record keeping and not actually a legal restriction at all.
12:14
SPEAKER_02: Then the second question is, is there a legal restriction on how the company can use that cash collected?
12:21
SPEAKER_02: Is there any contractual consequence of the company taking that money and using it for other purposes?
12:27
SPEAKER_02: If there's no contractual requirement that the cash is set aside for remittance, there may be no legal restriction on that usage of cash.
12:35
SPEAKER_02: You know, maybe the company is not required to use the cash that sits in the account to pay the third party, then there's nothing legally to stop the company from using that cash in the account for other operations.
12:45
SPEAKER_02: And then when it comes time to pay that liability, it's got to just use other resources or other cash inflows to pay that liability.
12:53
SPEAKER_00: So, Brett, then in this fact pattern, when I set it up, I specifically said it was a separate account.
12:59
SPEAKER_00: And what you're saying is actually that separate account isn't really a determining factor necessarily, because it more depends on who has the rights to the money.
13:10
SPEAKER_00: And, you know, are you setting up that separate account just because it's easier for you or because it's maybe demanded by the contract or otherwise?
13:17
SPEAKER_02: I think that's exactly right.
13:19
SPEAKER_00: All right, that's definitely a lot to think about.
13:21
SPEAKER_00: And I think it's easy to see where it can get blurry.
13:25
SPEAKER_00: But then you mentioned at the beginning sort of that this actually depends on the company's policy.
13:30
SPEAKER_00: So you're saying even in a case where I have the ability to use the money until it's time to remit it, I could have an accounting policy that cash collected on behalf of others is restricted cash, and then I just account for it that way.
13:45
SPEAKER_02: I think that's right.
13:46
SPEAKER_02: And I think there are companies that would certainly classify that type of scenario as restricted cash because they've set up this general policy to treat it as such.
13:57
SPEAKER_02: And so, like I said, I think the important point around that policy is to apply it consistently and and make sure it's well disclosed.
14:04
SPEAKER_00: All right.
14:05
SPEAKER_00: And I know you mentioned this sort of uptick on questions.
14:08
SPEAKER_00: And so I think sometimes when we get new questions, it's because maybe people haven't thought about a policy before, and maybe the situations they had before were black and white, and you know, this question didn't really come up.
14:20
SPEAKER_00: But sounds like once you set your policy, you have to make sure it's applied consistently.
14:24
SPEAKER_00: So even if you're dealing with a new transaction, you need to be considering what you've done historically in that area.
14:30
SPEAKER_00: And for the listener's benefit, Brett is nodding at me right now.
14:34
SPEAKER_00: I should say yes, and I just nod at you.
14:36
SPEAKER_00: Exactly.
14:38
SPEAKER_02: Podcast mode, not webcast mode.
14:40
SPEAKER_00: Exactly.
14:40
SPEAKER_00: And sometimes webcasts are easier from that point of view.
14:42
SPEAKER_00: And I guess, Brett, before we move to the next step in your continuum, maybe there was a step we almost missed in the continuum, which is as a company, I'm saying, oh, I'm gonna set aside these funds because I want to use them for this future capital project or otherwise.
14:57
SPEAKER_00: And that type of internal designation you would not expect to see as restricted cash because there really is no external restriction on what happens to it.
15:07
SPEAKER_02: Well, that's the example where you have a policy choice.
15:11
SPEAKER_02: You know, if under your policy you're gonna consider those types of internal designations to be a restriction, I think GAAP would permit you to classify that as restricted cash.
15:23
SPEAKER_02: I think we see that probably less frequently in practice in part because when you get into just an internal designation like that, like cash is fungible.
15:35
SPEAKER_02: So it's often hard to hard to define and and harder to be consistent with that.
15:39
SPEAKER_00: All right, that's helpful.
15:40
SPEAKER_00: And that's where I think we use the word consistent, and that's important because you can't sort of pick and choose of some internal designations and not other.
15:48
SPEAKER_00: And to your point, because cash is fungible, it's very hard to track.
15:52
SPEAKER_00: But let's move then along the spectrum because we mentioned specifically cash that's legally restricted.
15:58
SPEAKER_00: So, in let's go back to my example, you are collecting this money on behalf of another company, but you're required to put it into a legally restricted account.
16:08
SPEAKER_00: Then what's the counting scenario there?
16:10
SPEAKER_00: It's still a choice.
16:11
SPEAKER_02: Yeah, um, maybe to describe what that looks like.
16:14
SPEAKER_02: So you may have a contractual arrangement with a third party where any funds that are collected on their behalf must be put into a specific escrow account.
16:23
SPEAKER_02: Now the company's name is on the account, you have legal ownership over the account, but by the contract, once cash goes into that account, it can only be released from the escrow account to make payments to that specific third party.
16:36
SPEAKER_02: So in that case, because the company can only use that amount to pay the specific third party, that use of funds in the account is legally restricted.
16:46
SPEAKER_00: All right.
16:46
SPEAKER_00: So in this case, then I can only use it for one purpose.
16:49
SPEAKER_00: So it's clearly legally restricted, and then I would have to put it as restricted cash.
16:55
SPEAKER_00: But I don't know, it's easy when you explain the fact pattern.
16:58
SPEAKER_00: But as we all know, in practice, things are not quite so clear.
17:02
SPEAKER_00: So I'm sure in some cases, then this is more of a legal determination.
17:06
SPEAKER_02: Yeah, I mean, I I laid out my continuum as four very neat buckets, and and it's definitely uh, you know, aligned with with blurry lines in but in between.
17:16
SPEAKER_02: So how do you work through those?
17:17
SPEAKER_02: I mean, as new situations arise, you've often got to look in details about the legal and contractual rights in each situation.
17:24
SPEAKER_02: And there are scenarios where just new situations are gonna arise that companies didn't think about.
17:30
SPEAKER_02: Uh, one example that comes to mind we ran into a few years ago when economic sanctions were imposed against Russia.
17:37
SPEAKER_02: So the economic sanctions, if you remember, um, impacted the ability of companies to use or withdraw cash held at Russian financial institutions.
17:47
SPEAKER_02: Now, companies could use their cash freely within Russia, but they were precluded from transferring cash to a bank account outside of Russia.
17:55
SPEAKER_02: And so, you know, some companies had stopped operations in in Russia and so couldn't transfer that remaining cash out of their Russian bank accounts into overseas bank accounts.
18:04
SPEAKER_02: And so they started asking questions, well, it should this cash be considered restricted?
18:09
SPEAKER_02: And our view is well, if the cash is held in a Russian financial institution, it can be used freely within Russia.
18:17
SPEAKER_02: It generally wouldn't be considered legally restricted.
18:20
SPEAKER_02: Um But again, if you had a policy to present cash that's restricted beyond legal restrictions, you should consider that policy in light of these sanctions.
18:29
SPEAKER_02: And so at the time, you know, some companies said, I I haven't ever contemplated this sort of scenario.
18:35
SPEAKER_02: They didn't have anything in their policy.
18:37
SPEAKER_02: So at the time, if a company decided to present those cash balances affected by sanctions as restricted cash, we didn't think it was a change in accounting principle.
18:46
SPEAKER_02: Rather, it was a clarification of their policy that applied to kind of new events uh under their existing policy that just hadn't been contemplated.
18:53
SPEAKER_00: Yeah, I can imagine that international sanctions was probably not something for most companies, maybe years and years ago, maybe they would have dealt with it.
19:01
SPEAKER_00: But it is an interesting point because I think you kind of think of an accounting policy as you set it and then you continue to apply it.
19:09
SPEAKER_00: But I think the point you're making here is that if you do come across a new situation, and maybe it doesn't have to be something as I'll use the word drastic as economic sanctions, then that maybe your policy can evolve.
19:22
SPEAKER_02: I think that's right.
19:22
SPEAKER_02: And in some cases, existing policy was broad enough to cover the situation.
19:27
SPEAKER_02: But like I said, and sometimes you've got a new restriction, you've got to first look at my existing policy and just maybe a new fact pattern.
19:33
SPEAKER_00: Yeah.
19:34
SPEAKER_00: And I guess I'm curious, and maybe our listeners are as well.
19:38
SPEAKER_00: Did we see then in general companies were putting that as restricted cash or truly was just facts and circumstances?
19:45
SPEAKER_02: I think it was facts and circumstances.
19:46
SPEAKER_02: Um, you know, that was also a unique situation with economic sanctions.
19:50
SPEAKER_02: Yes.
19:50
SPEAKER_02: Lots of complications going on with in Russia at the time.
19:53
SPEAKER_00: Very, fair, very fair.
19:54
SPEAKER_00: All right.
19:54
SPEAKER_00: So we've hit three of the buckets, but there was a fourth one, which was interesting to me that was on even almost the continuum because it does seem like it's starting to go into the receivable perspective.
20:07
SPEAKER_00: But how do you think about the case then if you have cash and you don't even have rights to take the money out of that account?
20:14
SPEAKER_00: What is the line then between cash and receivables?
20:17
SPEAKER_02: Yeah, again, it's gonna, in some cases, be a blurry line.
20:20
SPEAKER_02: And I want to talk through a situation where it may not be a receivable, it just may not be an asset at all.
20:27
SPEAKER_02: It may be held in trust.
20:28
SPEAKER_02: And so we're gonna get a little complex.
20:30
SPEAKER_02: So I'll try to go and think through this slowly with you and just give you some things to think about here.
20:35
SPEAKER_02: And obviously, I think this is an area where there's gonna be, you know, a fair amount of judgment.
20:40
SPEAKER_02: So let's say you've got a company that's a payroll payment processor.
20:43
SPEAKER_02: So as part of the arrangement, they're collecting cash on behalf of others and remitting those payments collected on behalf of others.
20:51
SPEAKER_02: Um the company arranges for this transfer of cash between multiple parties.
20:54
SPEAKER_02: They receive funds from their customers and then just disperse the funds according to their to their service agreement.
21:02
SPEAKER_02: The funds are received in advance of the payment due dates, right?
21:04
SPEAKER_02: So you've got the company collecting large amounts of funds for others, and you have this question about what where do I show that cash that's been collected?
21:13
SPEAKER_02: Is it restricted cash or should it off balance sheet?
21:16
SPEAKER_02: And I think you start here with thinking about what party controls the funds.
21:21
SPEAKER_02: And this is consistent.
21:23
SPEAKER_02: There's an AI CPA technical QA that talks about the balance sheet caption cash should be should represent an amount that's within the control of the company.
21:33
SPEAKER_02: So you have to think about how you determine whether you have control of the funds.
21:37
SPEAKER_02: And this can be complex and and make you think hard about the legal rights that that you have.
21:43
SPEAKER_02: Um I think control can mean a lot of things in an accounting context.
21:47
SPEAKER_02: But when I'm talking about control over the funds, I think about a couple things.
21:52
SPEAKER_02: One, are the funds held in the account that's in the name of the company?
21:56
SPEAKER_02: Like, do they have legal access access?
21:58
SPEAKER_02: And then does the company have The ability to direct the payments of the funds.
22:03
SPEAKER_02: So maybe break that down in into those two pieces.
22:07
SPEAKER_02: When the funds are held in the name of a company, are they simply held in trust for your customers?
22:12
SPEAKER_02: If so, that account is not held in the name of the company, and the company often would not have control of it.
22:18
SPEAKER_02: On the other hand, the company may have legal ownership or title to the funds, like the that funds, that account is in the company's own name.
22:27
SPEAKER_02: Here, it's also helpful, I think, to think about what happens in the event of bankruptcy.
22:32
SPEAKER_02: Will the funds in that account be part of the bankruptcy estate of the company, or are they going to be deemed to be the assets of others?
22:40
SPEAKER_02: And then the second piece I mentioned, uh, the ability to direct payments.
22:44
SPEAKER_02: Does the company actually have the right to use those funds for their own purpose or are they just performing under the terms of the arrangement?
22:52
SPEAKER_02: You know, if the funds are sitting there for a while, can they invest it?
22:56
SPEAKER_02: Who earns the investment income off those investments?
23:00
SPEAKER_02: Um again, if the funds can be used by the company or the company gets to invest the funds and earn a return, that may point to the company being in in control of the funds.
23:10
SPEAKER_02: So if you determine that the company has the fund in its own name and does have the ability to direct payments, then the funds should generally be on the balance sheet as an asset cash.
23:20
SPEAKER_02: And then the next step is to determine is it going to be restricted cash?
23:24
SPEAKER_02: Again, go back to your policy and those legal restrictions.
23:28
SPEAKER_02: And obviously, in that case, all the activity in and out of the account would be reflected on the statement of cash flow.
23:33
SPEAKER_02: And cash collected and remitted on behalf of others, we generally see as treated as uh financing transactions.
23:41
SPEAKER_02: I think that's consistent with the SEC's staff view.
23:44
SPEAKER_02: On the other hand, if you don't have the funds in your name and and company doesn't have the ability to direct payments, it may not be appropriate to present the funds as assets at all and wouldn't be in the account or on the statement of cash flows.
24:00
SPEAKER_02: So I think this is an area where, especially if this is a material activity, where you should you know disclose the criteria and judgments you used to determine whether you control those funds in the first place.
24:10
SPEAKER_00: So, Brad, it's interesting because when you set up this scenario, you said it was a payroll payment processor.
24:16
SPEAKER_00: And so I was thinking, oh, this is kind of narrow, not going to apply to a lot of people other than payroll payment processors.
24:23
SPEAKER_00: However, it also sounds very similar then to the case where like I have to give a deposit for something, and then that deposit maybe is held in escrow and maybe isn't held in escrow.
24:34
SPEAKER_00: That is actually the same scenario, right?
24:36
SPEAKER_00: Same thing.
24:36
SPEAKER_02: It's it's a similar thing.
24:38
SPEAKER_02: Like anytime you're putting funds or you're holding funds in escrow, you have to think about who is the legal owner of that escrow account.
24:44
SPEAKER_02: And I think you're right.
24:45
SPEAKER_02: I think you know you can talk through an example like this, and we did it because it helps people think of those cash flows.
24:51
SPEAKER_00: Well, that's what helped me think it through.
24:53
SPEAKER_02: But it's one of a hundred different scenarios where you can have the same, you know, conceptual uh flow of funds.
24:59
SPEAKER_00: Right.
24:59
SPEAKER_00: Because again, if you have a contract and someone puts a deposit down, but then they might have the legal right to have it back.
25:05
SPEAKER_00: Like there's a lot of scenarios actually where something like this, maybe between that category three and category four on your continuum could come into play.
25:14
SPEAKER_00: I think that's right.
25:15
SPEAKER_00: All right.
25:15
SPEAKER_00: Well, so definitely a lot to think about on that, more probably than meets the eye to begin with.
25:20
SPEAKER_00: So, Brett, I think another place then, if we kind of just take a step back where we can get a question about restrictions and otherwise, are cash equivalents.
25:29
SPEAKER_00: So we've talked about cash equivalents before because the question is a cash equivalent or an investment.
25:34
SPEAKER_00: Basically, you would be a cash equivalent if it's highly liquid, so it's readily convertible to a known amount of cash, and it's short-term.
25:42
SPEAKER_00: So the maturity is three months or less from the original purchase date, which we can get into in another podcast.
25:49
SPEAKER_00: But by definition, we're saying it's highly liquid.
25:53
SPEAKER_00: So could you really have a cash equivalent that's restricted?
25:56
SPEAKER_00: Because obviously something restricted is not highly liquid.
25:59
SPEAKER_00: So it's a little circular.
26:01
SPEAKER_02: Right.
26:01
SPEAKER_02: It it it can be, but break it down into the characteristics of the instrument itself and then what it can be used for.
26:09
SPEAKER_02: So the characteristics of the instrument itself could be short-term.
26:13
SPEAKER_02: That instrument itself could be highly liquid, but I've just placed other restrictions on how it can be used in the same way that cash is liquid, but cash can be restricted.
26:24
SPEAKER_02: So I could just substitute my cash for a short-term treasury bill, highly liquid, but I could still put that in an account or put other restrictions on how that treasury bill can be used.
26:36
SPEAKER_00: All right.
26:37
SPEAKER_00: So that makes sense to me.
26:38
SPEAKER_00: And actually, as soon as you said that we say can say cash is restricted, it makes sense that a cash equivalent could be.
26:45
SPEAKER_00: But can you just give an example of the types of restrictions we might see on what would otherwise be a short-term highly liquid investment?
26:54
SPEAKER_02: Um well, here's an example.
26:56
SPEAKER_02: Like think about a situation where a company is required to put assets into escrow to fund a litigation settlement.
27:03
SPEAKER_02: Unfortunately, a fairly common scenario you would see.
27:07
SPEAKER_02: Um there's a restriction often over that escrow account, and amounts put in that escrow account can only be dispersed to fund the legal settlement.
27:15
SPEAKER_02: So anything that goes into that fund is going to be considered legally restricted.
27:20
SPEAKER_02: Oftentimes we see that if that fund is gonna sit there for a while, you don't want to see that fund just sitting there in cash.
27:27
SPEAKER_02: And so they'll rather than putting cash in, there may be other investments, money markets, treasury bills that meet the company's policy to be a cash equivalent.
27:37
SPEAKER_02: In that case, those cash equivalents would be considered restricted, just like the cash in escrow example that we were talking about earlier.
27:45
SPEAKER_00: Oh, okay.
27:46
SPEAKER_00: Yeah, so I think that's helpful.
27:48
SPEAKER_00: And uh I think you know, often companies do kind of think of cash and cash equivalents just all sort of the same thing anyway.
27:55
SPEAKER_00: So I think it makes sense the restricted cash would apply the same way.
27:59
SPEAKER_00: How about though, financial statement presentation?
28:02
SPEAKER_00: Because again, I think this is a place where it's easy to kind of get tripped up.
28:06
SPEAKER_00: So what are the requirements there?
28:08
SPEAKER_02: Yeah.
28:09
SPEAKER_02: I start with for SEC filers.
28:11
SPEAKER_02: There's a rule in SX that requires separate disclosure of accounts that are restricted as to withdrawal or use, just like what we were talking about.
28:20
SPEAKER_02: So that rule notes that uh separate disclosure of restricted cash is required and suggests to some people that footnote disclosure would be adequate because it's talking about disclosure.
28:30
SPEAKER_02: But I think prevailing practice is often to present that restricted cash separate from other cash on the face of the balance sheet, either as a separate line item itself, uh if significant, or aggregated somewhere in other assets.
28:44
SPEAKER_02: And I think that separate presentation, in addition to disclosing the nature of those restrictions in the footnotes, is probably best practice.
28:51
SPEAKER_02: We talked about the importance to ratios and being used, and just putting that different uh separate on the face of the balance sheet often helps users, you know, do their computations and their ratios the the way they want to.
29:03
SPEAKER_00: So yeah, and I think Brett, even in practice, we also see that private companies will often also split that out separately.
29:10
SPEAKER_00: Because to your point, it really does help from a transparency perspective.
29:14
SPEAKER_00: One thing that's interesting though, that I think is an area where I know when I was in practice I had questions.
29:21
SPEAKER_00: So I'm presuming you get questions, is just is restricted cash always current?
29:26
SPEAKER_00: Because for even in your example of the litigation settlement, is what if that's not going to be paid out in the next year?
29:33
SPEAKER_00: Do you ever get into a situation then when you can have restricted cash that's actually non-current, which almost seems to go against the definition of cash?
29:40
SPEAKER_02: So it's confusing because I think I think a lot of people have the same gut reaction.
29:45
SPEAKER_02: Like cash seems to be highly liquid and just strikes people as a current asset.
29:51
SPEAKER_02: Um, but ASC210 um gives guidance for what's current versus non-current and it defines current assets as cash and other assets uh that are reasonably expected to be realized in cash or sold or consumed in a normal operating cycle, right?
30:08
SPEAKER_02: So it lists things that should be excluded from current assets and lists some things that are related to cash, uh, cash that's restricted as to withdrawal, uh, cash designated for the expenditure or acquisition of non-current assets, uh, cash that's segregated for the liquidation of long-term debt.
30:27
SPEAKER_02: And it goes on to say if that cash or the funds are considered to offset maturing debt that's been set up as a current liability, then it can be used as included as a current asset.
30:38
SPEAKER_02: So maybe like just to give a simple example, um, you have a situation where cash is legally restricted to pay that litigation settlement that we're talking about.
30:48
SPEAKER_02: That related liability for the settlement is shown as current.
30:52
SPEAKER_02: If it is, because you the payment's gonna be made in a year, then that restricted cash would also be current.
30:57
SPEAKER_02: But if that litigation liability is considered long-term because the payment's not gonna be made for several years, then that's a scenario where that restricted cash tagged to the settlement would also be shown as not current.
31:08
SPEAKER_02: So I think of it as look at what it's restricted for, and you're gonna look to match up the current non-current status to that liability.
31:17
SPEAKER_00: And Brett, from a cash flow perspective, I think you mentioned this, but restricted cash is included in cash on your cash flow statement?
31:26
SPEAKER_02: It is.
31:26
SPEAKER_00: And so even that long-term restricted cash is included in cash on your cash flow statement?
31:31
SPEAKER_00: Correct.
31:32
SPEAKER_00: Okay.
31:32
SPEAKER_00: Although I guess if it's long term, you wouldn't be expecting to see activity related to it.
31:36
SPEAKER_00: But okay.
31:37
SPEAKER_00: All right, that's a helpful clarification.
31:39
SPEAKER_00: And then you also mentioned earlier a disclosure and talked about best practice.
31:44
SPEAKER_00: So what is required from a disclosure perspective?
31:46
SPEAKER_02: Sure.
31:47
SPEAKER_02: Um, maybe two things to think about.
31:49
SPEAKER_02: Um, I mentioned the SX disclosure about separate presentation or separate disclosure.
31:54
SPEAKER_02: There's also some disclosure requirements directly um in ASC 230 uh that's talking about the nature of the restrictions.
32:02
SPEAKER_02: And the ASC 230 guidance doesn't provide a lot of detail, but there is some SEC guidance in SX that provides some sample disclosures that are often helpful for all companies to consider, I think.
32:14
SPEAKER_02: In those sample disclosures, they talk about the expected duration of the restriction, the purpose and term of those restrictions, and the amount of cash subject to restriction.
32:24
SPEAKER_02: So we always say those sample disclosures shouldn't be just a checklist, but it's a good starting point, you know, of things to think about.
32:31
SPEAKER_02: And obviously, companies have the flexibility to disclose any relevant information about the nature of those, depending on specific facts.
32:38
SPEAKER_00: All right, that's helpful.
32:39
SPEAKER_00: And then anything specific from an FCC perspective?
32:42
SPEAKER_02: I think um the only thing specific are those examples and then and then obviously they have what, like I mentioned before, that separate disclosure of accounts that are going to be restricted.
32:52
SPEAKER_00: All right, that's very helpful.
32:53
SPEAKER_00: And then I jumped ahead of this a little because I was thinking about this long-term question.
32:58
SPEAKER_00: But restricted cash and the cash flow statement, I also think trips people up a bit.
33:02
SPEAKER_00: So can you just share big picture what is required from a cash flow perspective?
33:07
SPEAKER_02: Yeah, I I think you know, for some of us old timers, we may have a harder time with that because you're thinking about you know what we used to think of the cash flow statement was just cash.
33:17
SPEAKER_02: And when I talked about the EITF discussion in 2016, they made changes to that.
33:22
SPEAKER_02: So even before restricted cash wasn't part of total cash.
33:27
SPEAKER_02: And so when you had movements in and between cash and restricted cash, that was uh included in the cash flow statement just like any other movement.
33:35
SPEAKER_02: But in 2016, uh the ASU was uh was issued, and I think all entities have adopted by now.
33:42
SPEAKER_02: So that the beginning and the ending cash balances on that cash flow statement include both cash and restricted cash.
33:49
SPEAKER_02: And so all of that flow shown in the cash flow statement is going to include both accounts.
33:55
SPEAKER_02: And if you have movement between cash and restricted cash, it's nowhere in the cash flow because it's in the beginning and ending balance.
34:03
SPEAKER_02: I think part of this complication is tying then the cash flow statement back to the balance sheet.
34:08
SPEAKER_02: We talked about companies often present these in separate line items.
34:12
SPEAKER_02: So there is another disclosure requirement that requires a company reconciles the amount in the beginning and ending of their cash flow statement and where those amounts were presented back on the balance sheet.
34:24
SPEAKER_02: Some companies do this on the face of the cash flow statement, others do it in the footnote, either a narrative or or tabular form.
34:31
SPEAKER_02: We we see both.
34:32
SPEAKER_02: But either way, there should be a reconciliation.
34:35
SPEAKER_02: So I can do that that mapping from the balance sheet to the cash flow statement.
34:39
SPEAKER_00: Yeah, clearly I'm still in the old timer category because I I do have questions that cutting my head around this, hence my question earlier.
34:46
SPEAKER_00: But I mean, I it makes sense.
34:47
SPEAKER_00: It is the company's cash if you've put it in that category.
34:50
SPEAKER_02: So but you are you're thinking about the cash flow statement.
34:53
SPEAKER_02: And so that's that's very topical now.
34:55
SPEAKER_00: Yes, there you go.
34:56
SPEAKER_00: Thank you, Brett.
34:57
SPEAKER_02: We always say on every podcast we should we should tie this, what we're talking about, how does it flow through the cash flow statement?
35:02
SPEAKER_02: So you win a gold star.
35:04
SPEAKER_02: All right, thank you.
35:04
SPEAKER_00: You got a blue ribbon and I got a gold star.
35:06
SPEAKER_00: So that's a good note to end on then.
35:08
SPEAKER_00: So with that, maybe we'll wrap things up and just want to thank you again for joining me.
35:12
SPEAKER_00: And I will remind our listeners that you should check out the show notes for references, including, in this case, very helpful discussion in chapter six of the financial statement presentation guide.
35:22
SPEAKER_02: Thanks.
35:24
SPEAKER_00: That's our show for today.
35:27
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35:32
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35:47
SPEAKER_00: From Thought Leadership at PwC, I'm Heather Horn.
35:51
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36:02
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36:04
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