Restricted Cash and Compensating Balances: A Simple Guide
Restricted cash is cash a company controls but cannot use for general payments because it is limited by law, contract, or a specific stated purpose. It appears as a current or noncurrent asset depending on the purpose of the restriction and when the funds become available or are used, and it stays in the totals on the statement of cash flows. Compensating balances count only when legally restricted.
Students often assume that every positive bank balance is available for operations or that every restriction makes cash noncurrent. This guide walks through each decision for students in our Intermediate Accounting course and for CPA exam candidates. All numerical examples are hypothetical.
Watch: Cash and Cash Equivalents — restricted cash discussion
What is restricted cash?
Restricted cash is money whose withdrawal or use is limited to a particular purpose. The company may own the deposit while being unable to use it for rent, salaries, or general supplier payments. The reporting issue is availability, not whether the bank balance is positive.
Here is something that surprises many students: US GAAP does not actually define restricted cash. The Financial Accounting Standards Board (FASB), which sets US accounting standards, chose not to define it when it issued Accounting Standards Update (ASU) 2016-18. Each company applies its own policy consistently and discloses the nature of its restrictions (ASC 230-10-50-7).
Examples include a deposit pledged under a borrowing agreement, an amount reserved for a specified capital project, or money subject to currency-transfer restrictions. Evaluate the actual restriction and the intended use. A foreign location by itself does not prove that cash is restricted.
Other common examples include cash collateral for a letter of credit, escrow deposits, and debt service reserves. In each case, the money is held back for a specific purpose instead of being free for everyday bills.
For companies subject to Securities and Exchange Commission (SEC) reporting requirements, Regulation S-X, Rule 5-02(1) requires separate disclosure of restricted cash items and an explanation of the restrictions. The rule also addresses compensating balances that are not legally restricted.
That SEC rule applies to SEC registrants. US GAAP does not specifically require a separate balance sheet line for other companies, although it does require disclosure of the nature of the restrictions. Textbooks and exam questions still generally expect a material restricted balance to be reported apart from regular cash.
Is restricted cash current or noncurrent?
Restricted cash can appear in either category. Consider when the amount becomes available or is disbursed, and whether its purpose relates to current operations or a long-term objective. Do not classify every restricted amount as noncurrent merely because it has a restriction.
Measure the time from the balance sheet date, not from the day a loan began. For example, if a five-year loan is due eight months after year-end and the deposit will be released when the loan is repaid, the deposit is current in these examples.
The guidance behind this is ASC 210-10-45-4(a). It excludes from current assets any cash restricted for uses other than current operations, cash designated for buying or building noncurrent assets, and cash set aside to pay long-term debt.
| Hypothetical situation | Presentation | Key reason |
|---|---|---|
| Material deposit restricted to settle a current obligation in four months | Separately identified current asset | Restriction relates to a current obligation |
| Deposit unavailable until a loan matures in three years | Noncurrent restricted deposit | Supports long-term financing |
| Cash set aside for a long-term plant expansion project | Noncurrent asset | Reserved for a long-term purpose |
| Small ordinary petty cash or payroll fund | Generally included in cash | Routine funds are usually too small to need their own line |
For ordinary current-asset analysis, the operating cycle matters as well as one year. The operating cycle is the time needed to acquire goods or services, sell them, and collect the proceeds. In the examples here, assume an operating cycle shorter than one year.
A separate bank account is evidence to investigate, not a complete classification rule. A company may use several unrestricted accounts for convenience. Conversely, restrictions can affect money even when it sits within an account that also serves other purposes. Materiality asks whether separate information could affect a user’s assessment of the financial statements.
What is a compensating balance?
A compensating balance is a deposit balance a borrower agrees to maintain with a lender as part of a borrowing or credit arrangement. The bank benefits from keeping funds on deposit. The borrower receives credit but may have less money available for immediate use.
Legally restricted balance: identify the restricted amount separately. A balance supporting short-term borrowing is generally current; one maintained for long-term borrowing is generally noncurrent. Current classification does not make a legally restricted deposit freely available.
No legal withdrawal restriction: do not automatically remove the amount from ordinary cash. Disclose the arrangement and the determinable amount when required. SEC rules distinguish this note disclosure from restricted-cash presentation.
The agreement is therefore essential. “Compensating balance” describes the relationship with the lender; “restricted cash” describes a limitation on availability. The terms overlap, but a minimum-balance understanding does not always create a legally restricted deposit.
How much is material? For SEC registrants, the usual guide is 15 percent. Reportable compensating balances above 15 percent of liquid assets (current cash, restricted and unrestricted, plus marketable securities) are generally treated as material. Smaller amounts can still be material if they significantly affect the cost of borrowing.
How does a compensating balance raise the cost of borrowing?
A compensating balance makes a loan cost more than its stated rate. Suppose a company borrows $100,000 at 8 percent and must keep 10 percent, or $10,000, on deposit earning no interest. It pays $8,000 of interest but can use only $90,000. The effective annual cost is $8,000 ÷ $90,000, or about 8.89 percent. These figures are hypothetical.
Restricted cash example: how does it look on the balance sheet?
Hypothetical example: Maple Equipment has $92,000 in deposits. Of that amount, $12,000 must remain on deposit until a loan due nine months after the balance sheet date is repaid. Another $25,000 is unavailable until a borrowing due three years after the balance sheet date matures. Both restrictions are legally enforceable and material. The remaining $55,000 is unrestricted.
| Balance-sheet caption | Amount |
|---|---|
| Cash available for general use — current | $55,000 |
| Restricted compensating balance — current | $12,000 |
| Restricted compensating balance — noncurrent | $25,000 |
| Total cash and restricted cash | $92,000 |
The classification does not create an expense or remove ownership of the deposits. It explains why $92,000 in total deposits does not mean $92,000 is available for general payments. The related loans remain liabilities; the company does not subtract these deposits from its debt merely because the arrangements are connected.
A concise hypothetical note could explain: “The company maintains $12,000 and $25,000 of legally restricted deposits supporting borrowings due in nine months and three years, respectively. The deposits are presented in current and noncurrent assets.” Real disclosures must reflect the actual terms.
How is restricted cash reported on the statement of cash flows?
Restricted cash stays in the total on the statement of cash flows. Since ASU 2016-18, the statement explains the change in cash equivalents, cash, and restricted amounts together (ASC 230-10-45-4).
That gives you two rules to remember:
- Moving money between regular cash and restricted cash is not a cash flow. It is not an operating, investing, or financing activity (ASC 230-10-45-5).
- If these amounts sit on more than one balance sheet line, the company must show how those lines add up to the total on the statement of cash flows. This can appear on the statement or in the notes, as a table or in words (ASC 230-10-50-8).
Let’s return to Maple Equipment. Assume it started the year with $60,000, all unrestricted, and that all three ending balances are cash.
| Statement of cash flows line | Amount |
|---|---|
| Net cash provided by operating activities | $12,000 |
| Net cash used in investing activities (equipment purchases) | ($180,000) |
| Net cash provided by financing activities (loan proceeds) | $200,000 |
| Net increase in cash and restricted cash | $32,000 |
| Cash and restricted cash, beginning of year | $60,000 |
| Cash and restricted cash, end of year | $92,000 |
The $37,000 moved into restricted deposits ($12,000 + $25,000) does not appear in any of the three activity sections. Maple then ties the ending total back to its balance sheet: $55,000 + $12,000 + $25,000 = $92,000.
In the ledger, the move is only a transfer between asset accounts:
Debit Restricted cash, current: $12,000
Debit Restricted cash, noncurrent: $25,000
Credit Cash: $37,000
No revenue or expense results from this entry.
Exam tip: If a question asks for the ending balance on the statement of cash flows, include restricted cash, even the noncurrent part. If it asks for the cash line on the balance sheet, leave restricted cash out.
Want more practice? The Intermediate Accounting course includes 10 multiple-choice questions on cash and cash equivalents and 35 on the statement of cash flows.
Common mistakes with restricted cash
Treating every designated fund as noncurrent. Payroll and petty cash arrangements often serve ordinary operations. Check purpose, timing, restrictions, and materiality.
Subtracting a compensating balance from the loan. Asset classification and liability measurement are separate questions. Offset only when all conditions in ASC 210-20-45-1 are met, including an enforceable right of setoff and the intent to offset. For the different issue of positive and negative bank accounts, study bank overdraft accounting and offsetting.
Ignoring the notes. A balance-sheet caption cannot explain all withdrawal conditions. Describe the arrangement clearly so readers understand availability.
Confusing restricted cash with a longer-term investment. An investment can fail the cash-equivalent maturity test without being restricted. Maturity and availability are separate tests.
Reporting a transfer to restricted cash as a cash flow. Moving cash into a restricted account is not an investing or financing activity. The total on the statement of cash flows already includes both amounts.
Check your understanding: Complete this seven-question restricted cash exercise to review designated funds, materiality, current versus noncurrent classification, and currency-transfer restrictions.
Keep this distinction in mind: Setting cash aside for petty cash, payroll, or dividends does not by itself establish a legal withdrawal restriction. For SEC registrants, though, a specific deposit earmarked for a stated purpose can still need separate disclosure, so apply the purpose, availability, and materiality distinctions explained above.
Restricted Cash: Interactive Practice Exercise
What is restricted cash? Restricted cash is held by a company for a specific purpose and is not available for immediate general use. Petty cash, payroll funds, and dividend funds are examples of cash set aside for a particular purpose, but setting cash aside is not the same as a legal restriction. These small funds usually stay in regular cash.
Choose one answer for each of the seven questions. Select “Check answers” to see your score and explanations.
Restricted cash answer guide and explanations
- What is restricted cash?
- Restricted cash is held for a specific purpose and is not available for immediate general use.
- Which group contains examples of cash set aside for a particular purpose?
- Petty cash, payroll, and dividend funds are all examples of cash set aside for a particular purpose.
- How are these fund balances usually reported when they are not material?
- In most situations, these balances are not material, so companies do not separate them from cash in the financial statements.
- What happens when restricted cash is material in amount?
- When material in amount, restricted cash is separated from regular cash for reporting purposes.
- Where can restricted cash be classified?
- Companies classify restricted cash in either current assets or long-term assets.
- What determines whether restricted cash is classified as current or long-term?
- Classification depends on the purpose of the restriction and when the funds become available or are used. Measure timing from the balance sheet date.
- What should companies check about cash in accounts outside the United States?
- Companies need to determine whether regulations against the exportation of currency restrict any cash in accounts outside the United States.
Three practice questions with explanations
1. A current restriction
A company must keep $8,000 in a deposit to settle a current obligation in five months. The amount is material. Is it automatically a noncurrent asset?
No. Under these facts, identify it separately within current assets. The limitation on use does not change the current nature of the obligation it supports.
2. A long-term compensating balance
A bank requires a borrower to maintain $18,000 until a loan due four years after the balance sheet date is repaid. The borrower cannot withdraw it. How should it be reported?
As a noncurrent restricted deposit or compensating balance. Explain the material restriction in the notes. Do not include it in cash available for current general payments or deduct it from the loan.
3. An informal arrangement
A borrower agrees to maintain an average $6,000 balance, but withdrawal is not legally restricted. Must the company always classify $6,000 as restricted cash?
No. Evaluate the arrangement rather than assuming a legal restriction. The balance may remain in ordinary cash, with disclosure of the arrangement and determinable amount as applicable.
Key takeaways
- Restricted cash is cash a company controls but cannot use for general payments.
- Classification as current or noncurrent depends on the purpose of the restriction and when the funds become available or are used. Measure timing from the balance sheet date.
- A compensating balance is presented as restricted only when it is legally restricted. Otherwise, it may stay in cash with note disclosure.
- The statement of cash flows includes restricted cash in its totals, and transfers are not cash flows.
- US GAAP does not define restricted cash, so companies disclose the nature of their restrictions.
Frequently asked questions
Does restricted cash still count as an asset?
Yes, as long as the company controls the funds. A limitation on use changes presentation and disclosure, but it does not by itself create an expense.
Is a compensating balance always noncurrent?
No. Its classification depends on the related arrangement and duration. Short-term and long-term borrowing arrangements can produce different classifications.
Does money held overseas automatically become restricted cash?
No. Examine the relevant legal or regulatory limits. The location alone does not establish whether the company can use or transfer the money.
Is restricted cash included in cash and cash equivalents?
On the balance sheet, a material amount is usually reported apart from cash and cash equivalents. On the statement of cash flows, it is included in the beginning and ending totals.
Does US GAAP define restricted cash?
No. ASC 230 refers to “amounts generally described as restricted cash” but does not define the term. Companies apply a consistent policy and disclose the nature of their restrictions.
Is a transfer to restricted cash a cash flow?
No. Transfers between cash and restricted cash are not operating, investing, or financing activities.
What are common examples of restricted cash?
Common examples include cash collateral for a letter of credit, escrow deposits, debt service reserves, and legally restricted compensating balances.
Sources
- 17 CFR 210.5-02, Balance sheets
- FASB ASC 230-10-45-4, 230-10-45-5, 230-10-50-7, and 230-10-50-8
- FASB ASC 210-10-45-4 and ASC 210-20-45-1
- FASB ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash
- SEC Financial Reporting Release Section 203 and Staff Accounting Bulletin Topic 6.H
- EY, Financial reporting developments: Statement of cash flows, July 2026
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