Updated July 7, 2023
Definition of Restricted Cash
Restricted Cash represents Cash held for a specific purpose, such as meeting bank loan requirements, repaying debt, or fulfilling specific commitments. The balance sheet presents Cash separately, along with a clear rationale for restricting it and designating a specific duration for the restriction.
Explanation
It is Cash held for a specific purpose that is to be defined in notes to accounts so that readers of the financial statement can easily understand the reason and transparency of the organization’s commitments. The classification of the asset depends on its holding period, which determines whether it falls under current or non-current assets. It is categorized as a non-current asset if held for over a year. Operational purposes cannot utilize it, which is not considered in liquidity, cash, or quick ratios. It should be presented separately on the balance sheet. It forms part of Cash when preparing the cash flow statement. The cash balance, freely available for operations and other activities, is an available cash balance.
Examples
Example #1
An Ltd. has $ 500,000 as a cash balance. The bank requires that the company keeps aside, i.e., restricts the cash balance of $100,000 until the loan is fully repaid. Also, the company wants to repair the building, for which it set-asides a cash balance of $ 150,000. Therefore, compute the restricted cash balance and unrestricted cash balance.
Solution:
Restricted cash balance refers to Cash set aside for a specific purpose. So, the calculation of the available cash balance is as under:
Unrestricted Cash Balance = Amount Set Aside as Per Bank Requirements + Set Aside for Repairs
- Unrestricted Cash Balance = $100,000 + $150,000
- Unrestricted Cash Balance =$250,000
The calculation for Unrestricted Cash Balance is:
Unrestricted Cash Balance = Total Cash Balance – Restricted Cash Balance
- Unrestricted Cash Balance = $500,000 – $250,000
- Unrestricted Cash Balance = $250,000
Example #2
The balance sheet of C Ltd. is as follows:
| Particulars | Amount ($) |
| Equity and Liabilities | |
| Equity Share Capital | 500,000 |
| Reserves and Surplus | 100,000 |
| Secured Loans | |
| Bank Loan | 150,000 |
| Current Liabilities | |
| Sundry Creditors | 50,000 |
| Outstanding Expenses | 20,000 |
| Total | 820,000 |
| Assets | |
| Non-Current Assets | |
| Plant and Machinery | 150,000 |
| Immovable Property | 200,000 |
| Long Term Investments | 100,000 |
| Current Assets | |
| Sundry Debtors | 80,000 |
| Prepaid Expenses | 20,000 |
| Cash and Equivalents | |
| Restricted | 150,000 |
| Unrestricted | 120,000 |
| Total | 820,000 |
Note: Cash is restricted to replacing machinery parts as the law requires.
Solution:
The calculation for quick Ratio is:
Quick Ratio = Total Quick Assets / Total Quick Liabilities
Quick Ratio = Debtors + Prepaid Expenses + Cash and Equivalents (unrestricted) / Creditors + Outstanding Expenses
- Quick Ratio = 80,000 + 20,000 + 120,000 / (50,000 + 20,000)
- Quick Ratio = 220,000 / 70,000
- Quick Ratio = 3.14
Example #3
C Bank has $ 500 Million as Cash and equivalent, out of which 5% of the limit of the bank is the Cash reserve ratio, i.e., Mandatorily, the bank is to keep the minimum Cash and the limit if the bank as per guidelines from the head office is $ 100 Million, the rest is to be set aside for sending to the head office on alternate days. Therefore, compute the restricted Cash and unrestricted Cash.
Solution:
The calculation for Unrestricted Cash is:
Unrestricted Cash = Limit of the Organization
- Unrestricted Cash = $100 Million
The calculation for restricted cash is:
Restricted Cash = Cash to Be Maintained as Per Guidelines + Set Aside for Sending to Head Office.
- Restricted Cash = (100 Million * 5%) + (500 Million – 5 Million – 100 Million)
- Restricted Cash = 5 + 395
- Restricted Cash = 400 Million
Restricted Cash on the Balance Sheet
The balance sheet shows it separately to differentiate it from unrestricted Cash and enable easy comparison and quick calculations of the required ratios. Its classification depends upon the period for which it is held. If the Cash is intended to restrict for the long term, it is classified as non-current assets. Therefore, it does not form part of operating expenses and does not include calculating the current or quick Ratio. Any amount left after the spending for restricted Cash will be transferred to unrestricted Cash.
Restricted Cash in Cash Flow Statement
Cash Flow refers to the statement of movement of the Cash and equivalents. It is the reconciliation or verification of the flow of the cash balance. The cash flow statement will present a restricted cash balance according to the type or reason for restricting Cash from operating, investing, and financing activities. The bank classifies the Cash as restricted from financing activities, as per the norms, for bank loan purposes. If the company sets aside cash for purchasing property or equipment, it classifies it as Cash from investing activities.
Restricted Cash vs Security Deposit
- The specific purpose requires setting aside a certain amount of cash, while a particular purpose necessitates giving an amount as a security deposit.
- It forms part of Cash and equivalents and can be classified as a current or non-current asset. In contrast, security deposit forms part of current or non-current assets, and only refundable deposits form part.
- A temporary expenditure must be spent for the purpose held, whereas a security deposit can be permanent, such as a non-refundable deposit. On the other hand, restricted Cash in banks may be permanent.
Conclusion
The company sets aside a portion of cash and cash equivalents for specific purposes such as meeting bank requirements, funding designated capital expenditures, or fulfilling customers’ instructions for a particular order. The classification of this portion depends on the duration of the restriction. In the balance sheet, it is presented separately, along with an explanation of the restriction in the notes to the accounts. Furthermore, it is included in the cash flow statement and categorized based on the nature of the restriction in operating, investing, and financing activities. This differs from a security deposit as it represents a payment made for a specific purpose in exchange for certain benefits.
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