Published: August 01, 2011
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 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.
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:
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.
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. [[[PAGE]]]
The IASB (and concurrently its equivalent in the US) issued in 2010 a staff paper relating to potential changes to the presentation of financial statements. Included within this staff paper was the proposal to remove the concept of cash equivalents. The rationale for this proposal was simply that the risk profile of cash and cash equivalents was not identical. If this proposal is to materialise as a standard (and it is not yet an agreed change), any cash placed in a money market fund as at a financial reporting date would need to be recorded as an investment. Only physical cash and overnight deposits are likely to be capable of designation as cash.
Understandably, companies want to report the best cash position possible. Therefore, if these changes come into effect, corporate treasurers may seek to move cash from a money market fund to an overnight deposit for those days on which the financial statements are prepared. This activity would have significant implications for the money market fund manager. If material volumes of redemption requests are received, the fund would need to be structured to deliver large volumes of liquidity at specific dates. Whilst this restructuring is entirely consistent with the objectives of a money market fund, such wholesale redemptions are at present a rarity. Consequently, the yield payable by a fund may suffer if appetite for longer-dated securities diminishes as key reporting dates approach. This will not necessarily detract from the key objectives of a money market fund, namely security and liquidity, but investors would need to appreciate the confines within which the fund was operating and therefore what return it could realistically be able to achieve.
The treatment of an investment in a money market fund is important to many corporate investors as it directly affects the presentation of the cash position of the company. For this reason, IMMFA has assessed the criteria, and documented those matters which we believe should be considered when identifying which treatment should be applied. Although discussions with individual auditors will still be necessary, the IMMFA paper should help corporate treasurers assess the likely treatment. However, the future could potentially change what may be included on a cash flow statement, and would have implications for many cash management solutions, not just money market funds.
IMMFA is actively working with corporate treasury representatives to lobby for appropriate treatment of money market funds, and does not support the implementation of changes which result in treasurers having to unnecessarily ‘window dress’ the cash position of the company prior to the production of the financial statements. Although we accept that the risk profile of cash and cash equivalents may differ, this does not require the concept of cash equivalents to be removed. As an alternative, we believe that separately identifiable line items for cash and cash equivalents would achieve the same objective in terms of the transparency of the cash flow statement, and would not result in corporate treasurers having to materially change their day-to-day cash management activities.
Richard Norval
IMMFA Treasurer
Richard Norval is Treasurer of IMMFA, having been a board member for two years. He is Head of UK Short Term Market Sales for RBS, running the distribution team for the RBS suite of Money Market Funds. Before RBS, Richard worked at Goldman Sachs Asset Management selling money funds, having spent 12 years previously at Barclays. Richard has been involved in the money fund industry since 1999. He is an Economics graduate from Leicester University.
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