Restricted Cash and Compensating Balances
Restricted cash is basically defined as monies that are set aside to be used either in part or in whole for purposes or reasons that have been bound through agreed contracts. These monies are a component of restricted assets and they are usually not used for current or day to day operations of the institution. In the contrary, income accruing from other assets and which are conditionally used according to grantors or donors’ specifications are referred to as restricted funds (Humphrey, Pulley, 1997, p.22).
The management may have the intention of using restricted cash for specific reasons such as future expansion, debt payment or for retirement of bonds. Other forms include cash accounts specifically restricted for various purposes e.g. the payroll accounts, dividend funds and the regular petty cash. Restricted cash can as well comprise of funds that could be internally allocated from endowments that are externally restricted. A good example of this is research funds in universities provided to undertake specific projects in research, with internally acceptable transfers that utilize these endowed resources under externally executed restrictions. Restricted cash is separately reported either in the non-current or the current section of the balance sheet assets. The type of reporting depends on the cash disbursement or availability date accordingly (Humphrey, 1997, p.34).
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Compensating balance on the other hand refers to a certain minimum amount of money that a bank’s customer is required by the bank to maintain in the account for the purposes of enjoying other services such as a bank loan. This money provides support against the borrowed funds or the loan as required by the lending institution. It is reserved against arrangements made for borrowing purposes. This money must be deposited in an account that does not earn any interest whatsoever. It acts as compensation, indirectly, for a variety of services such as a loan or any other special service that a bank gives in exchange.
Financial institutions take compensating balance as a prerequisite in order for them to give the customer a certification of the loan’s terms of agreement. Corporate borrowers can either deposit the money in a savings account, checking accounts or may obtain a deposit certificate according to the agreed terms and conditions. This money is separately reported in the non-current section or the current section of the assets in the balance sheet, depending on whether the arrangements made for borrowing are long-term or short-term. Long-term related obligations on compensating balances must be reported in the non-current assets section of the balance sheet whereas those of a short- term background are reported as current assets.
In book keeping and accounting, compensating balances should be reported and recorded within the disclosure notes that are attached to the company’s financial statements. Compensating balances that are of material nature must, regardless of cash classification, be disclosed. In this case, classification is said to depend upon the nature of related debt’s classification and the nature of the particular restriction (Humphrey, Pulley, 1997, p.46).
Both types of cash require specific and proper control because problems can result from availability of either too little or too much. Two major procedures that are commonly used in cash control are bank statement reconciliations and the petty cash control system. Balance reflected in the bank statement must be reconciled with the balance in the book. Like any other categories of funds, restricted and compensating balances flows must be appropriately reported. This applies to both profit oriented institutions as well as those which are not, such as charitable or non-governmental organizations that basically depend on donor or grantor funds.
Humphrey David & Pulley Lawrence (1997) Bank’s Response to Deregulation: Profits, Technology, and Efficiency. Journal of Money, Credit & Banking, Vol.29, pp.22, 34, 46