Restricted cash | China Accounting Blog | Paul Gillis

Restricted cash

The Emerging Issues Task Force (EITF) is a group of accounting experts who help the FASB with complex accounting issues. The EITF has been working on a project to deal with diversity in the balance sheet presentation and cash flow classification of changes in restricted cash – including transfers between restricted cash and unrestricted cash, as well as direct changes in restricted cash (for example, when disbursements occur directly from restricted cash). Some believe that this diversity is also attributed to the lack of definition of restricted cash in U.S. GAAP.

In earlier meetings, most Task Force members agreed that restricted cash should be defined based on there being contractual or legal restrictions and not extended to self-designations by management. Some Task Force members preferred narrowing the definition to only cash that is controlled by another party, such as where a trustee or escrow agent restricts access to the cash. However, a majority of Task Force members wanted to also include situations where cash access is limited only through some type of economic penalty for failure to comply with the legal or contractual restrictions.

At a March 3 meeting, the EITF reached a consensus-for-exposure that an entity would include in its cash and cash-equivalent balances in the statement of cash flows those amounts that are deemed to be restricted cash and restricted cash equivalents. Further, the Task Force decided that an entity would be required to reconcile, either on the statement of cash flows or in the financial statement footnotes, the cash and cash-equivalent amounts in the statement of cash flows to the amounts in the statement of financial condition (including identification of the line items where those amounts are presented). In addition, an entity would be required to disclose the nature and types of restrictions on the amounts deemed to be restricted cash and restricted cash equivalents. The Task Force decided not to define restricted cash and restricted cash equivalents. That is a shame, since I believe a better definition of restricted cash would significantly improve financial reporting for U.S. listed Chinese companies.

China has strict currency controls that regulate when Chinese companies can convert renminbi (RMB) into foreign currency. Furthermore, many U.S. listed Chinese companies use the variable interest entity structure which makes it considerably more difficult, if not impossible, to convert RMB into foreign currency. U.S. listed Chinese companies routinely disclose the risk that they will be unable to convert RMB to foreign currency.

For example, New Oriental (NYSE:EDU) points out that restrictions on the availability of foreign currency may affect the ability of our PRC subsidiaries and consolidated affiliated entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. NQ Mobile warns: Furthermore, cash transfers from our PRC subsidiaries to our subsidiaries outside of China are subject to PRC government control of currency conversion. Restrictions on the availability of foreign currency may affect the ability of our PRC subsidiaries and consolidated affiliated entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations.Most investors appear to ignore these important warnings, which are all the more important since China has recently cracked down on currency exchange.

New Oriental classifies only $944K of its cash as restricted cash which is described as RMB deposits in bank accounts as deposits for establishing new schools and subsidiaries. New Oriental reports over $500 million in unrestricted cash, nearly all of which is in RMB. It also reports $600 million invested in wealth management products at Chinese banks, which is also presumably RMB denominated. New Oriental does not disclose how much of the cash or wealth management investments are held by its VIE.

NQ Mobile (NYSE: NQ) reports $3.8 million of restricted cash out of total cash reported of $273 million. NQ Mobile defines restricted cash as cash that is deposited in the bank but restricted for a specific purpose and therefore not available for immediate and general use by the Company. The company reports that $247 million of that cash is located in the PRC, presumably denominated in RMB and much of it appears to be in its VIEs.

The EITF appeared to be headed towards defining restricted cash to include legal restrictions on its use. That might have led to both New Oriental and NQ Mobile characterizing much of their cash as restricted. That is useful information to shareholders, particularly in VIE situations, since many U.S. listed Chinese companies have significant dollar denominated debt and it likely that the company will need access to VIE cash for debt servicing. Explaining what portion of the cash on the balance sheet is actually available for creditors of the parent company is critical information for investors.The FASB should demand that the EITF go back and define restricted cash.

Copyright 2017 Paul L. Gillis all rights reserved