4.2.1 Balance Sheet Considerations
4.2.1.1 Book Overdrafts
A book overdraft represents the amount of outstanding checks in excess of funds on deposit for a particular bank account, resulting in a credit cash balance reported on an entity’s balance sheet as of a reporting date. For financial reporting purposes, an entity should reinstate a liability (e.g., accounts payable) to the extent of the book overdraft in such a way that the cash balance is reported as a zero balance.
When an entity maintains separate funding and disbursem*nt accounts with the same bank, it may not be as easy to determine the amount of the book overdraft. For example, an entity may have a cash management arrangement with a bank in which checks written are issued from a dedicated disbursem*nt account that is funded from a separate deposit account as the checks are presented for payment to the bank. In such a scenario, the disbursem*nt account may be designed to maintain a zero balance. Further, it is not uncommon for a bank to have the contractual right and ability to automatically sweep cash from the funding account to cover checks presented for payment from the disbursem*nt account. Because of timing differences between when checks are written by an entity and when they are funded by the bank, the disbursem*nt account may reflect a book overdraft as of a reporting date, which by design would represent the entire population of outstanding checks.
In practice, questions have arisen regarding how an entity should determine the book overdraft in such an arrangement to reinstate accounts payable. Two alternative approaches to making this determination have emerged:
The single account approach ― The deposit and disbursem*nt accounts with the same bank would be viewed as a single account in the determination of the book overdraft.
The liability extinguishment approach ― The book overdraft with the same bank would be determined independently from any funds held in the deposit account, resulting in the reinstatement of the entire population of outstanding checks.
4.2.1.1.1 The Single Account Approach
The balance sheet offsetting guidance in ASC 210-20 focuses on whether a “right of setoff” exists. A right of setoff is defined as “a debtor’s legal right . . . to discharge all or a portion of the debt owed to another party by applying against the debt an amount that the other party owes to the debtor.” However, ASC 210-20-55-18A states that “[c]ash on deposit at a financial institution shall be considered by the depositor as cash rather than as an amount owed to the depositor.” Because cash on deposit is held by the bank for the entity in a fiduciary capacity, the cash on deposit would not be considered an “amount owed” to the entity. Although the offsetting guidance in ASC 210-20 would not apply to the separate deposit and disbursem*nt accounts in the above scenario, we nonetheless believe that it would be acceptable — to the extent that the following conditions are met — for entities to analogize to the offsetting guidance in deciding whether to view the disbursem*nt and deposit accounts as a single bank account in the determination of the book overdraft:
Under the terms of the depositor relationship, the financial institution has the right, ability, and intent to offset a positive balance in one account against an overdrawn amount in the other.
Amounts in each of the accounts are unencumbered and unrestricted with respect to use.
Further, we believe that the single account approach is also consistent with the nonauthoritative guidance in AICPA Technical Q&As Section 1100.08, which states:
Inquiry — Should the amount of checks that have been issued and are out of the control of the payor but which have not cleared the bank by the balance sheet date be reported as a reduction of cash?
Reply — Yes. A check is out of the payor’s control after it has been mailed or delivered to the payee. The balance sheet caption “cash” should represent an amount that is within the control of the reporting enterprise, namely, the amount of cash in banks plus the amount of cash and checks on hand and deposits in transit minus the amount of outstanding checks. Cash is misrepresented if outstanding checks are classified as liabilities rather than a reduction of cash.
Under the single account approach, a book overdraft would not exist to the extent that the funding account has sufficient funds to cover the amount of outstanding checks. Therefore, to the extent that outstanding checks exceed the amount in the deposit account, this excess would be considered the book overdraft and should be presented as a liability for financial reporting purposes.
4.2.1.1.2 The Liability Extinguishment Approach
Under the liability extinguishment approach, the disbursem*nt account is viewed independently from the deposit account in the determination of the amount of the book overdraft. The accounting basis for this approach is that the liability (e.g., accounts payable) that will be settled through the issuance of the outstanding checks has not been legally extinguished as of the reporting date in accordance with ASC 405-20. Therefore, under the liability extinguishment approach, a book overdraft represents what is, in substance, a payable to the original creditor.
Accordingly, the existence of a deposit account with the same financial institution is not relevant to the accounting analysis. Specifically, ASC 405-20 indicates that a liability is not extinguished until a creditor is paid. Under this view, payment to the creditor occurs when the counterparty presents the check to the bank for payment rather than when the entity issues the check from the disbursem*nt account. In addition, proponents of the liability extinguishment approach note that even if one were to support the view that book overdrafts are within the scope of ASC 210-20, offsetting is not required when the right of setoff exits. Instead, as noted in ASC 210-20-45-2, offsetting is permitted, but not required, provided that the right of setoff exists.
Consequently, under the liability extinguishment approach, the entire population of outstanding checks (i.e., all checks written from the disbursem*nt account) would represent the book overdraft as of the end of the reporting period. Therefore, although there may be funds in the deposit account, accounts payable would be reinstated for such an amount. Further, while the liability extinguishment approach is based on a situation in which the separate disbursem*nt and funding accounts are maintained with a bank, we believe that an entity would reach the same view when it uses one bank account for deposits and disbursem*nts. That is, if an entity’s policy is that the liability derecognition guidance in ASC 405-20 does not apply until the counterparty presents the check to the bank for payment, we think that such a policy should be neutral regarding whether there are separate accounts (that are linked) or whether a single account is used for both funding and disbursem*nts.
Regardless of whether an entity elects the single account approach or the liability extinguishment approach, we believe that the entity should consistently apply and transparently disclose the approach it uses.
4.2.1.2 Bank Overdrafts
A bank overdraft represents the amount by which funds disbursed by a bank exceed funds held on deposit for a given bank account. Therefore, a bank overdraft represents a loan from the bank to an entity and, for financial reporting purposes, the bank overdraft should be classified as a liability. There may be situations in which an entity maintains several bank accounts held by its subsidiaries at the same financial institution. Such subsidiary bank accounts are contractually linked, and the bank will allow the subsidiary cash accounts to be in a bank overdraft position, as long as sufficient funds are held on deposit at other subsidiary bank accounts that are part of the linked arrangement. Although the offsetting guidance in ASC 210-20 would not apply to such an arrangement (for the same reasons noted in Section 4.2.1.1), we nonetheless believe that for financial reporting purposes at the consolidated/parent level, the parent would be permitted but not required to offset bank overdraft balances in subsidiary bank accounts against positive cash account balances maintained in other subsidiary bank accounts with the same bank that are part of the contractual arrangement. For such offsetting to be acceptable, however, the following conditions would need to be met:
Under the terms of the depositor relationship, the financial institution has the right and ability to offset a positive balance in one account against an overdrawn amount in the other.
Amounts in each of the accounts are unencumbered and unrestricted with respect to use.
In addition, when a subsidiary prepares financial statements on a stand-alone basis, the presentation of the subsidiary’s bank accounts in the stand-alone financial statements should reflect the individual subsidiary’s facts and circ*mstances (i.e., in presenting bank accounts with the same financial institution, the subsidiary should not consider how the bank accounts are presented in the parent company’s consolidated financial statements).
4.2.2 Considerations Related to the Statement of Cash Flows
The nonauthoritative guidance in AICPA Technical Q&As Section 1300.15 stipulates that a net change in overdrafts should be classified as a financing activity in the statement of cash flows. Because this guidance appears to address only bank overdrafts, an entity that is in a bank overdraft position must show the net change in liability related to the bank overdraft as a financing activity.
However, we believe that if an entity is in a book overdraft position, it is acceptable for the entity to show the net change in the liability related to the book overdraft as either an operating activity or a financing activity in the statement of cash flows. This position is supported by the fact that at the time of the book overdraft, the entity has no financing activity with the bank (i.e., the bank has not extended credit, as would be the case if the bank account were overdrawn). The presentation of book overdrafts as either operating or financing activities is an accounting policy decision that the entity should apply consistently.
