Investment

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Money Market Funds as Cash Equivalents There are a number of factors that will influence a treasurerís decision-making process if he/she is in the enviable position of investing surplus cash. Is it secure? Is it liquid? What return will it earn? As importantly, how will it appear on the balance sheet and cash flow statement?

Money Market Funds as Cash Equivalents

by Richard Norval, IMMFA Treasurer

There are a number of factors that will influence a treasurer’s decision-making process if he/she is in the enviable position of investing surplus cash. Is it secure? Is it liquid? What return will it earn? As importantly, how will it appear on the balance sheet and cash flow statement? The cash flow statement, often the first page in the accounts to which analysts turn, discloses information regarding cash generation and liquidity and is used as one of the key indicators of a company’s health.

The cash flow statement

The International Accounting Standards Board (IASB) establishes the standards for producing a cash flow statement. International Accounting Standard 7 (IAS 7) documents how the cash flow statement should be presented. As part of this standard, the reporting entity should disclose inflows and outflows of cash and cash equivalents. Cash equivalents are defined as short-term, highly liquid investments that are readily convertible to known amounts of cash and subject to an insignificant risk of changes in value.

Money market funds provide a viable treasury management solution, combining the provision of capital security with liquidity. They are widely used by corporate treasurers, and therefore their treatment under IAS 7 is important to many treasurers. Auditors tend to assess each situation on individual merits, and there is no blanket statement of whether or not money market funds should be considered as cash equivalent. Recognising the importance of this issue, the Institutional Money Market Funds Association (IMMFA) prepared a paper to assist corporate treasurers in categorising money placed in a money market fund.

How should money market funds be categorised?

To determine the treatment of investment in an IMMFA money market fund, we must consider the constituent parts of the cash equivalents definition and how these apply to an IMMFA fund:

  • Convertible at all times – All IMMFA money market funds provide same day liquidity, allowing investors to access their cash on the day of request, so long as the request is made before the cut-off time for the fund in question;
  • Into a known amount of cash – All IMMFA money market funds seek to maintain a constant net asset value (NAV) of, for example, £1 or €1. This constant NAV allows investors to appreciate the value of their investment at any given point in time;
  • Subject to an insignificant risk of changes in value – Although an IMMFA money market fund is not risk free (nor is a bank deposit), it is subject to a number of restrictions designed to limit the risk to which such funds become exposed. All IMMFA money market funds must:

-     hold a triple-A rating from one of more of the credit rating agencies. This limits the funds to investment in only high quality, liquid instruments;

-     maintain amounts of overnight and one week securities which are no less than prescribed minima, designed to mitigate liquidity risk;

-     not exceed the maximum weighted average maturity nor the maximum weighted average life, designed to limit interest rate and credit spread risks respectively; and

-     operate escalation procedures to address any variance between the amortised and mark-to-market values of a security or the portfolio, in order to limit the chances of a change in value of a share in the fund.

This analysis against the cash equivalents definition can also be complemented with staff papers from the International Financial Reporting Interpretation Committee (IFRIC). In 2008, the IFRIC was asked to consider the categorisation of money market funds. Although the conclusion of the IFRIC was that no formal guidance was necessary with regard to the content of IAS 7, the staff papers prepared for use when the matter was raised (which are publicly available) do help inform the analysis of how to treat an investment in a money market fund.

Money market funds provide a viable treasury management solution, combining the provision of capital security with liquidity.

Included within one of the staff papers prepared for use by the IFRIC is the statement that “units that don’t have a maturity date, but that are readily convertible into an amount of cash that is known at inception are subject to an insignificant risk of future changes in value. They thus meet the critical criteria in IAS 7 and can be considered ‘in substance’ cash equivalents”.

Using these staff papers, and in particular the above reference, it is the opinion of IMMFA that provided the cash is held to meet short-term commitments, investment in an IMMFA money market fund should be considered as a cash equivalent under IAS 7. The IMMFA paper on the treatment of investment in an IMMFA money market fund is available at http://www.immfa.org/press/2010-023-01.pdf.

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