FAR · Select balance sheet accounts · 6 practice questions
Restricted Cash and Compensating Balances: Current or Noncurrent?
Legally restricted balances stay outside cash and cash equivalents, even when they are highly liquid. Sort Lark's year-end balances by restriction and debt timing, then try free practice questions.
Try one first
Hint
Ask which item is not available for ordinary use, even if it looks liquid.
Answer A. This balance is subject to a legal restriction under a long-term borrowing agreement and is not available for general use. Even though the funds may be liquid in form, the compensating balance must be reported separately as restricted cash and excluded from cash and cash equivalents.
Why not B: Some candidates overgeneralize that funds are investments to be excluded, but a government money market fund with same-day redemption used for cash management is treated as a cash equivalent when there is no restriction.
Why not C: Tempting because it's a bank balance, but a normal demand deposit is immediately available for use and therefore qualifies as cash; no limiting condition is stated.
Why not D: Although a Treasury bill is a debt instrument, a 60-day T-bill (original maturity under three months) held for cash management is a cash equivalent; nothing indicates it is restricted.
Sort it
Available for general use and either cash or an investment meeting the cash-equivalent tests.
Legally restricted for repayment or support of a current debt obligation.
Legally restricted for repayment or support of a long-term debt obligation.
| Item | Goes to |
|---|---|
| Checking account legally restricted as a compensating balance for a loan due in 18 months. | Noncurrent restricted cashThe legal restriction excludes the balance from cash and cash equivalents. The related loan is long-term. |
| Government money market fund redeemable daily, informally designated by management for plant expansion. | Cash and cash equivalentsAn informal management designation does not legally restrict use. The fund remains available for general purposes. |
| Government money market fund legally restricted to repay short-term borrowing due in six months. | Current restricted cashDaily liquidity does not remove the restriction. The related short-term borrowing makes the balance current. |
| 60-day Treasury bill in a bond-indenture account restricted until the bonds mature in two years. | Noncurrent restricted cashThe bill's short maturity does not control presentation. The funds remain restricted for long-term debt. |
| Unrestricted Treasury bill acquired with 90 days to maturity for short-term cash management. | Cash and cash equivalentsNo restriction blocks general use, and the maturity at acquisition meets the cash-equivalent test. |
| Demand-deposit compensating balance legally restricted through repayment of a loan due in six months. | Current restricted cashBeing a demand deposit does not make the funds unrestricted. The related loan is current. |
| Government money market fund redeemable on demand but legally restricted for bonds due in two years. | Noncurrent restricted cashThe ability to redeem the fund does not permit general use of its proceeds. The related bonds are long-term. |
| Separate payroll checking account funded for next week's payroll, with no legal restriction. | Cash and cash equivalentsA separate account and an intended use do not create a legal restriction. |
| 60-day Treasury bill legally restricted to repay short-term debt due in six months. | Current restricted cashThe bill meets the maturity test, but the legal restriction requires separate presentation. The related debt is current. |
| Bank deposit legally restricted as collateral for a long-term loan due in two years. | Noncurrent restricted cashThe deposit is unavailable for general operations and supports a long-term obligation. |
| Bank-requested compensating balance that Lark may withdraw freely, with no legal restriction. | Cash and cash equivalentsThe compensating-balance label alone does not establish a restriction. The funds remain available for general use. |
| Legally restricted portion of an operating account, reserved for repayment of a loan due in six months. | Current restricted cashSharing an account with operating cash does not remove the restriction. Separate this portion and classify it as current. |
Key points
- Remember: Ask whether the money is available for general use before asking how liquid it is.
- For unrestricted investments, the maturity test is three months or less from acquisition, not the balance sheet date.
- A separate bank account alone does not make cash restricted.
- Disclose the nature and amounts of restrictions.
How the exam traps you
- Including a restricted money market fund because it is redeemable on demand. Legal limits on use override liquidity. Present the restricted balance separately.
- Including a compensating balance because the related borrowing is short-term. Short-term debt makes the restricted balance current, not unrestricted.
- Using a Treasury bill's maturity to classify a long-term restricted balance. Use the related obligation or restriction period, not the investment's maturity.
Question 2
| Instrument | Amount |
|---|---|
| Cash on hand | $4,000 |
| Checking account at Bank A (includes a $25,000 compensating balance maintained as a condition for a 5‑year bank loan; those funds are not available for current operations) | $120,000 |
| Checking account at Bank B | $30,000 |
| Bank B overdraft in a separate account (Bank B has a contractual right to offset deposits against overdrafts and routinely nets the company’s accounts) | $12,000 |
| Money market mutual fund (redeemable on demand) | $40,000 |
| Treasury bill purchased December 1, 2025 with original maturity at purchase of 60 days; carrying amount | $20,000 |
| Treasury bill purchased October 1, 2025 with original maturity at purchase of 180 days; carrying amount | $50,000 |
| Sinking‑fund cash restricted for repayment of long‑term debt (noncurrent restriction) | $15,000 |
| Certificate of deposit purchased January 1, 2025 with original maturity of 12 months | $10,000 |
Hint
Apply the original‑maturity test for cash equivalents (at acquisition), exclude balances contractually restricted by long‑term borrowing, and consider whether an overdraft can be offset against deposits at the same bank.
Answer C. Include cash on hand ($4,000), the unrestricted portion of Bank A ($120,000 − $25,000 compensating balance = $95,000), the net Bank B balance ($30,000 − $12,000 = $18,000), the money market fund ($40,000), and the T‑bill purchased Dec 1 whose original maturity at acquisition was 60 days ($20,000). Exclude the T‑bill purchased Oct 1 (original maturity 180 days), the sinking‑fund restriction, and the 12‑month CD. Sum = $4,000 + $95,000 + $18,000 + $40,000 + $20,000 = $177,000.
Why not A: Plausible if a candidate treated the Bank B overdraft as a separate liability and did not net it against deposits. However, because Bank B has a contractual right to offset and routinely nets the company's accounts, the overdraft is netted against the deposit for cash presentation.
Why not B: Attractive because it counts the full $120,000 at Bank A as available, but the $25,000 compensating balance is contractually restricted by a long‑term loan and not available for current operations, so it must be excluded from cash and cash equivalents.
Why not D: Tempting if one focuses on remaining days to maturity rather than original maturity at acquisition. The Oct 1 T‑bill had an original maturity of 180 days when purchased, so it does not meet the cash‑equivalent (≤3 months at acquisition) criterion and must be excluded.
Question 3
Hint
First decide whether the issue is defining a cash equivalent or deciding whether the company can actually treat the balance as available cash.
Answer D. Although the T-bill meets the liquidity and original-maturity characteristics of a cash equivalent, classification depends on availability for general use when a legal or contractual restriction exists. The bond indenture prevents Norwalk from using the funds for general operating purposes at year-end, so the balance should be presented as restricted cash rather than included in unrestricted cash and cash equivalents.
Why not A: This distractor appeals to the "three-month" rule for cash equivalents (measured from purchase), which matters for determining whether an investment qualifies as a cash equivalent. It is secondary here because a legal restriction on use at the balance sheet date prevents inclusion in unrestricted cash even if the instrument otherwise qualified.
Why not B: This restates core cash-equivalent features and is true per the stem, but the harder classification issue is whether the company may treat the balance as available cash given the contractual restriction.
Why not C: The duration of a restriction affects current versus noncurrent presentation of restricted assets, but any material legal restriction on use at the balance sheet date keeps the amount out of unrestricted cash and cash equivalents regardless of whether the restriction ends within 12 months.
Question 4
Hint
First decide which items are unrestricted, then apply the cash-equivalent maturity test based on when the investment was acquired.
Answer D. Include the demand deposits ($120,000) and the 60-day Treasury bill ($40,000) for a total of $160,000. Cash equivalents are short-term, highly liquid investments with an original maturity of three months or less when acquired; the 60-day bill qualifies while the 6-month bill (original maturity six months) does not. The $30,000 compensating balance is legally restricted and should be reported as restricted cash, not included in cash and cash equivalents.
Why not A: This answer includes both the 6-month Treasury bill and the restricted compensating balance. Both items are excluded from cash and cash equivalents for the reasons above: the 6-month bill's original maturity exceeds three months, and the compensating balance is legally restricted.
Why not B: This answer adds the $30,000 compensating balance to the $160,000 total. However, compensating balances that are legally restricted under a borrowing agreement are excluded from cash and cash equivalents and reported separately as restricted cash.
Why not C: This answer includes the 6-month Treasury bill because three months remain until maturity at year-end. Classification is based on the investment's original maturity when acquired (six months in this case), so it does not qualify as a cash equivalent.
Question 5
Hint
Focus on whether the cash is merely earmarked for a purpose or actually unavailable because of a contractual or legal restriction.
Answer C. The compensating balance is contractually restricted and therefore not available for general current operations; it should not be included in the single line item cash and cash equivalents. Legal restrictions override mere liquidity when classifying cash. Such amounts are presented as restricted cash or otherwise separately classified based on the nature and timing of the restriction.
Why not A: An informal management designation is merely internal earmarking and does not legally restrict availability. Because the fund is redeemable on demand and highly liquid, it can still qualify as cash or a cash equivalent.
Why not B: A Treasury bill with an original maturity of 90 days is a classic cash equivalent: it is highly liquid and presents insignificant interest-rate risk. Crossing year-end does not change its classification when the investment's original maturity at purchase was three months or less.
Why not D: Earmarking cash for payroll does not by itself create a contractual or legal restriction that removes it from cash and cash equivalents. Absent a binding restriction, funds held for imminent payroll disbursements remain part of cash.
Question 6
Hint
Remember to check (1) remaining maturity from date of purchase when deciding cash-equivalent status and (2) whether legally restricted cash is earmarked for long-term obligations (affecting current vs. noncurrent classification).
Answer C. Under U.S. GAAP, cash equivalents are highly liquid investments with maturities of three months or less from the date of purchase; the commercial paper had 45 days remaining at purchase and therefore qualifies as a cash equivalent, and the recently purchased money market funds are cash equivalents. The $300,000 is legally restricted for repayment of long-term debt maturing in Year 6 and is not available for operations, so it should be shown as restricted cash and classified as noncurrent.
Why not A: This distractor appeals to the mistaken belief that original issue term (rather than remaining maturity at purchase) determines cash-equivalent status; GAAP looks to maturity from date of purchase, so 45 days remaining qualifies as a cash equivalent. Also, the sinking-fund balance is for a long-term bond and must be shown as restricted cash classified by expected timing of use (noncurrent here), not as current.
Why not B: This is tempting because all amounts are cash-like and in bank/investment accounts, but restricted funds that are legally earmarked for long-term debt repayment are not reported as cash and cash equivalents. The $300,000 must be shown separately as restricted cash and classified noncurrent because it is held for a long-term obligation.
Why not D: This is tempting because the restricted funds are physically in a bank account, but classification depends on the purpose and expected timing of use, not location. Because the $300,000 is legally restricted to repay a bond maturing in Year 6, it should be shown as noncurrent restricted cash rather than current.
Common questions
Are compensating balances included in cash and cash equivalents?
A legally restricted compensating balance is excluded from the balance sheet's cash and cash equivalents caption. Present it separately as current or noncurrent based on the related borrowing.
Is restricted cash a current or noncurrent asset?
Cash legally restricted for short-term debt is current restricted cash. Cash legally restricted for long-term debt is noncurrent restricted cash.
Can a restricted Treasury bill qualify as a cash equivalent?
It can meet the maturity and liquidity tests and still be restricted. On the balance sheet, the legal restriction keeps it outside unrestricted cash and cash equivalents.
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