COMMENTS ON IFRIC TENTATIVE AGENDA DECISION - Demand Deposits with Restrictions on Use
Given below are the comments of GAAP Advisors submitted to The Institute of Chartered Accountants of India (ICAI) for consideration while submitting comments on the Tentative Agenda Decision to IFRIC:
1. Demand deposit restricted for use as component of ‘cash and cash equivalents’:
a) Conclusion as expressed in Tentative Agenda Decision:
Restrictions on use of a demand deposit arising from a contract with a third party do not result in the deposit no longer being cash, unless those restrictions change the nature of the deposit in a way that it would no longer meet the definition of cash in IAS 7.
b) Our views:
We do not agree with the conclusion expressed above. Given below are the reasons for our disagreement:
i. IAS 7 defines cash as cash comprises cash on hand and demand deposits. IAS 7 does not define demand deposits though. We did a Google search on ‘demand deposit meaning’ and we got the following definition:
A deposit of money that can be withdrawn without prior notice e.g. in a current account.
Thus, a deposit for which an entity is required to give notice prior to its withdrawal / use to any party is not demand deposit. The tentative agenda decision moves at a superficial level rather than going into the granularity of the issue as to what is a demand deposit and whether presenting a deposit having restrictions on its use as cash would provide relevant information that faithfully represents the state of affairs of the entity. This is because, given the clarification in paragraph 7 of IAS 7, the line item cash and cash equivalent is understood as having amounts that are not restricted which will be available to the entity immediately and to the extent of cash equivalents in a maximum of three months. Absence of definition of demand deposit in IAS 7 and the requirement of paragraph 66(d) of IAS 1 are aspects requiring amendment in IAS 7 and IAS 1 and not a permission to consider deposits subject to restrictions as demand deposit. Without a clear definition and application guidance on the term ‘demand deposit’, the tentative agenda decision remains vague and serves no purpose. Therefore, we recommend IAS 7 be amended to define ‘Demand Deposit’.
ii. The tentative agenda decision includes a rider that ‘unless those restrictions change the nature of the deposit in a way that would no longer meet the definition of cash in IAS 7’. It is not clear what restrictions could make the deposit cash or not cash. Neither IAS 7 nor IAS 1 provide any guidance in this regard. Therefore, we recommend that IAS 7 be amended to provide guidance on what sort of restrictions would or would not make a deposit, cash, else the tentative agenda decision remains vague and serves no purpose.
iii. The economics of restricted deposit remains the same regardless of the party putting those restrictions and regardless of the restriction being specified in the deposit contract or through another contract or by law. In all the cases, the depositor is either required to seek permission for using the amount deposited for a purpose other than those agreed to or is prohibited from doing the same. Where the depositor uses the deposited amount without seeking permission or despite prohibition for its use other than permitted by the contract or law, the depositor would be in breach of contract or law. It is contrary to rational thinking that such a deposit be presented as demand deposit and therefore, as cash. Where the depositor regards the deposit as giving present right to demand the amount deposited despite restrictions on its use, the depositor must also give regards to the consequential present obligation that shall arise due to breach of contract or law. Though the restrictions are specified in a separate contract with a third party, the depositor entity never considers the deposit as demand deposit till the time the restrictions are in place. Presenting a deposit as demand deposit when the management does not consider that it has present right to demand the amount deposited results in financial statements not presenting the state of affairs in the way the business is managed. Accounting for a deposit having restrictions on its use must be similar regardless of the party restricting its use. Simply because the restrictions on the use of a deposit is by a third party or under a separate contract, the restricted deposit does not become a demand deposit.
2. Presentation in the Statement of Financial Position:
a) Conclusion as expressed in Tentative Agenda Decision:
i. The depositor entity presents the demand deposit as cash and cash equivalents in its statement of financial position in accordance with paragraph 54 of IAS 1.
ii. When relevant to an understanding of its financial position the depositor entity would disaggregate the cash and cash equivalents line item and present the demand deposit subject to contractual restrictions on use separately in an additional line item based on the requirement of paragraph 55 of IAS 1.
iii. Where the depositor entity presents assets as current or non-current, the depositor entity would classify the demand deposit as current unless the deposit is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period in accordance with paragraph 66(d) of IAS 1.
b) Our views:
We do not agree with the conclusions expressed above. Below are given the reasons for our disagreement:
i. The line item cash and cash equivalents suggests that the amount reported under that line item will be available to the entity in a maximum of three months and not later. This is based on the clarification given in paragraph 7 of IAS 7. If a deposit has restrictions longer than three months from the date of its origination, the deposit is neither cash nor cash equivalent. Presenting a deposit restricted for use for more than three months as cash and cash equivalent will be obscuring given the clarification in paragraph 7 of IAS 7. Therefore, such deposit regardless of the party putting those restrictions must not be reported as cash and cash equivalent.
ii. IAS 7 defines cash equivalents as 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. Paragraph 7 of IAS 7 clarifies the definition of cash equivalents. The example of preferred shares acquired within a short period and with a specified redemption date as equity investment is not proper as such preferred shares do not meet the definition of equity instrument in IAS 32. However, this being not the issue under consideration, we do not discuss further on the same. The Committee may consider the same while amending IAS 7 to address the issue of demand deposits with restrictions on use.
We are at a loss to understand that a deposit to be cash equivalent, the restriction must not be more than three months whereas a deposit to be demand deposit and therefore cash, the restriction could be for more than 12 months. An amount to be cash must not have any restrictions. If there are restrictions on cash, that item becomes a cash equivalent provided such restriction is for not more than three months from the date the restriction commenced. If an amount that is restricted for more than twelve months could be cash, the definition of cash equivalent loses its relevance and the clarification in paragraph 7 of IAS 7 becomes redundant. Cash equivalent means that the investment is equivalent to cash. Therefore, paragraph 7 says that cash equivalents are for short-term cash commitments and not for long-term. If cash equivalent cannot be non-current, how can cash be non-current. A deposit that has restrictions for more than three months from its origination can be neither cash nor cash equivalent. Paragraph 66(d) of IAS 1 is redundant in the sense that the definition of cash equivalent in IAS 7 requires it to be only current and thereby requires cash also to be only current. Regardless of the requirements of paragraph 66(d), cash and cash equivalent will always be presented as current in accordance with the clarification given in paragraph 7 of IAS 7. The inconsistency between definition of cash equivalent in IAS 7 and paragraph 66(d) in IAS 1 is the reason for the conclusion expressed in the tentative agenda decision that cash can be non-current or that a deposit remains demand deposit though restricted in use. Therefore, we recommend that paragraph 66(d) of IAS 1 be amended as under:
(d) the asset is cash or cash equivalent (as defined in IAS 7).
3. Disclosures:
a) Conclusion as expressed in Tentative Agenda Decision:
Applying the requirements of paragraphs 45 and 48 of IAS 7, the entity discloses the demand deposit subject to contractual restrictions on use as a component of cash and cash equivalents and the amount of significant cash and cash equivalent balances unavailable for use by the group, as well as information about that amount.
b) Our views:
We do not agree with the conclusion expressed above. Below are given the reasons for our disagreement:
i. Paragraphs 45 and 48 of IAS 7 use the term ‘cash and cash equivalents’. Whether a deposit that is restricted for use for more than three months meets the definition of cash, given the clarification on cash equivalent in paragraph 7 of IAS 7, should have been considered by the committee. A deposit that is restricted for use for more than three months, regardless of the party imposing those restrictions, is neither cash equivalent nor cash. As stated previously, it is contrary to rational thinking that cash equivalent is for only short-term cash commitments whereas cash can be available only for long-term commitments. Therefore, paragraph 45 of IAS 7 applies to only those deposits that are not restricted for use beyond three months of their origination.
ii. Paragraph 48 of IAS 7 applies to deposits that are restricted for use for not more than three months, given the clarification in paragraph 7 of IAS 7, and other unrestricted deposits of the depositor entity that are not available for use by the depositor group, that is, the amounts may be available to the depositor entity but shall not be available for use by other entities in the depositor group. This non-availability to other entities of the group could be for more than 12 months from the end of the reporting period. This could be a reason for the requirement in paragraph 66(d) of IAS 1. Paragraph 48 of IAS 7 uses the words ‘cash and cash equivalent balances held by the entity that are not available for use by the group’. Paragraph 48 of IAS 7 does not say ‘cash and cash equivalent balances held by the entity that are not available for use by the entity’. If the committee would like to extend the disclosure requirements in paragraph 48 of IAS 7 to individual entity level, we recommend that paragraph 48 be amended to replace the words ‘by the group’ with ‘by the entity and the group’. Till the time paragraph 48 remains as is presently worded, paragraph 48 cannot be said to be applicable in the given case.
4. Conclusion:
Considering the above, we conclude that the principles and requirements in IFRS standards do not provide an adequate basis for an entity to determine whether to include demand deposits subject to contractual restrictions on use, regardless of the party that put those restrictions, as a component of cash and cash equivalents in its statement of cash flows and financial position. Accordingly, we recommend amendment to IAS 7 and IAS 1 as suggested above.