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Cashing Out: FASB Proposes End of Cash Equivalent Status

  • By Salome J. Tinker, CPA
  • Published: 2010-12-30

This story was excerpted from the December 2010 issue of Exchange.

One of the pillars of stable corporate funding is now under intense scrutiny: Money market funds—currently used as a stable, low-risk investment option due to its ability to receive the cash equivalent classification under financial reporting. Building upon last month's article regarding the proposed changes to the way companies present their financial statement, the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are challenging the subcomponents of cash reported on the balance sheet.

The joint FASB/IASB staffdraft on Financial Statement Presentation was issued on July 1. This proposed guidance prescribes the new basis for the presentation of financial statements. It sets out overall requirements for the presentation of financial statements, requirements for the structure of financial statements, and principles for classification and disaggregation of information in the statements. The boards believe that the changes ultimately will promote comparability with the financial statements of other entities.

Currently, cash includes not only currency on hand but demand deposits with banks and other financial institutions. Cash also includes other kinds of accounts that have the general characteristics of demand deposits that the customer may deposit additional funds at any time, and also effectively may withdraw funds at any time without prior notice or penalties.

Cash equivalents are considered short-term, highly illiquid investments that are both readily convertible to known amounts of cash, or so near their maturity that they present insignificant risk of changes in value in the event of changes in interest rates. Generally, only investments with original maturities of three months or less qualify under this definition.

The two boards are proposing to eliminate the classification of cash equivalents as a subcomponent of cash on the balance sheet. Paragraph 118 of the staff draft states, "Cash does not include short-term investments regardless of their liquidity or nearness to maturity." The staff noted the reasons for their proposed change in Paragraph BC126-127 as stated below:

The Boards observed that cash equivalents do not possess the same characteristics as cash and have different risks from cash. Thus, presenting cash equivalents separately from cash avoids grouping dissimilar assets in the same line item. Additionally, that presentation better reflects liquidity in the statement of financial position. Some respondents to the Discussion Paper disagreed with the proposal to present cash and cash equivalents separately, noting that an entity usually manages those items together because cash equivalents can be a critical component of an entity's cash management function. In reaching their conclusion, the Boards observed that although cash and cash equivalents may be managed similarly, they are different assets. The boards noted that the proposal to classify assets and liabilities on the basis of their use was not meant to provide management with flexibility to aggregate items that do not have the same economic characteristics.

The FASB staff draft proposes that investments currently considered as cash equivalents be classified under investments listed in their order of liquidity.

The boards are not formally inviting comments on this staff draft at this time; however, they welcome input from interested parties. Originally, the boards expected to publish an exposure draft for public comment in early 2011. In light of all of the other significant changes being proposed to current accounting guidance, the boards decided to place this issue on the back burner.

This decision is a blessing in disguise for AFP members. It offers AFP the opportunity to better educate its members on this controversial proposal that has seemingly fallen under the radar. More importantly, it allows companies the opportunity to respond to the FASB via comment letter.

While AFP plans to issue a comment letter expressing its concern on behalf of the members, there is strength in numbers. More weight is given to individual letters from issuers citing specific examples of how this will adversely impact their investment decision-making than from the Association's one comment letter. We urge members to address their concerns directly to the accounting standard setters. In recent months cash equivalents, such as money market funds, have been under a great deal scrutiny from FASB and the SEC. In the Exposure Draft on Financial Instruments, FASB questioned whether MMFs should be reported at fair market value for the issuers rather than at amortized costs. The SEC recently has issued requirements for companies to disclose the shadow NAV in their footnotes. In fact, they are contemplating radical changes to the 2a-7 rules, such as eliminating the use of the stable net asset value (NAV) altogether and moving toward a fair market valuation. AFP's response to FASB in a recent comment letter stated that more clarity should be provided if fair value is required for issuers. AFP is concerned that the fair value treatment may be inadvertently required for the holder as well—resulting in a direct impact on members' ability to invest in these products. AFP's comment letter to the FASB is coupled with extensive dialogue with the SEC explaining the potential consequences that could result should they decided to move forward with the proposed changes to 2a-7 funds.

If these efforts are successful, corporate investment strategies might need to be reworked, and certain products once considered stable investments because of their cash equivalent classification will have to be reconsidered as viable investment options. This will once again lead to a situation where accounting standards drive corporate investment decisions rather than vice versa. The end result will be that either corporate investment policies will have to change to allow corporate treasurers more flexibility to invest in highly liquid investments, or corporate treasurers will no longer see MMFs and other similar cash equivalent products as viable options. What occurred with the auction rate securities market may very well be the same fate for MMFs and other cash equivalent products.

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All rights reserved.

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