A restricted cash audit identifies balances the client cannot freely use, such as loan collateral, escrow deposits or grant funds held for a set purpose. The auditor finds them in loan agreements, bank confirmations and account titles, checks that each is classified by how long the restriction lasts, and tests that the notes describe it.
Where does a restricted cash audit find restricted balances?
Restrictions are written in documents outside the bank statement, so a restricted cash audit starts with the agreements and the bank's own reply. A statement shows a balance; it rarely says the balance is pledged. Read the debt agreements, the bank confirmation, leases, escrow letters and grant terms, and list every account they touch.
The checklist below is a working example. The accounts and balances are invented to show the kind of entry each document produces.
| Source document | Restriction it can reveal | Example entry |
|---|---|---|
| Bank confirmation reply | Balances pledged as collateral or held as compensating balances | Savings ending 4410, 75,000.00 pledged against a credit line |
| Loan or credit agreement | Minimum balance or cash collateral covenant | Keep 50,000.00 in the operating account at all times |
| Escrow or trust letter | Funds held by a third party until a condition is met | 120,000.00 held on a building sale pending a title issue |
| Lease agreement | Security deposit in a separate account | 18,000.00 in a landlord-controlled account |
| Grant or donor terms | Cash usable only for a stated purpose | 40,000.00 for a named program |
| Card or merchant agreement | Reserve or cash collateral held by the issuer | 25,000.00 held against a corporate card program |
| Account titles on statements | Escrow, trust or reserve accounts | "Client escrow" account ending 0921 |
Reading the confirmation for pledges
The bank confirmation is the document most likely to surface a restriction the client forgot to mention. Ask the bank to report collateral, liens and compensating balance arrangements on every account. Then agree each reply to the client's debt schedule. A pledge on the confirmation with no matching note in the draft statements is a disclosure gap.
Accounts held abroad
Cash held in another country can be restricted by law rather than by contract, through exchange controls that limit sending it home. If the client keeps balances overseas, the questions in auditing foreign bank accounts and currency balances belong in the same workpaper.
Restricted cash classification: current or noncurrent?
Restricted cash is classified by when the restriction ends and what the cash will pay for. Cash restricted for less than a year, or set aside to settle a current liability, can sit in current assets. Cash restricted for longer, or held to buy a long-lived asset or repay long-term debt, belongs in noncurrent assets, presented separately from unrestricted cash.
Testing the split
For each restricted balance, record the end date of the restriction from the source document and the liability or purpose it relates to. Then compare that with where the client put the balance. Common errors are pledged deposits left inside cash and cash equivalents, and an escrow released after year end classified as noncurrent because the classification was copied from the prior year.
Why small amounts still matter
Cash often has a low materiality threshold, because readers treat the cash figure as close to exact and covenant tests depend on it. A restricted balance that moves between categories can change a liquidity ratio even if total assets do not change. Audit materiality for cash and why it runs so low explains how to set that threshold.
Testing the restricted cash disclosure in the notes
The disclosure test checks that the notes name each material restriction, its amount and its terms, and that the figures tie to the balance sheet and the cash flow statement. Agree each restricted amount to the confirmation or the statement, and each description to the agreement it came from.
For public companies, SEC rules spell out the requirement. Regulation S-X Rule 5-02 as published in the Code of Federal Regulations requires separate disclosure of cash and cash items restricted as to withdrawal or usage, with the restrictions described in a note. It also covers compensating balances that are not legally restricted, which still need describing along with the amount where it can be determined.
Tie-out steps
- Agree each restricted balance to the bank's confirmation or the statement at year end.
- Agree the total of cash and restricted cash in the cash flow statement to the balance sheet lines that make it up.
- Read the note against each agreement on your checklist.
- Check that the classification in the note matches the balance sheet.
- Record the tie-outs on a report a reviewer can follow; a reconciliation report sample for audit workpapers shows a format with sign-off and tickmarks.
PreciseBankFlow foots each statement and matches its lines to the ledger, which gives you checked year-end balances for every account before you sort them into restricted and free. Classifying a balance, and judging whether the note is adequate, remain auditor decisions.
When is cash not restricted even though it looks restricted?
Cash is restricted only when an outside party, a contract or the law limits its use. A balance the board has set aside for a future purchase, or one the client calls a reserve in its own chart of accounts, is a designation, not a restriction. The client can change its mind, so the cash stays unrestricted.
Designations versus restrictions
Ask who could stop the client spending the money. If the answer is only management or the board, the balance is free cash, though the client may describe the designation. If a lender, a donor, a court or a regulator could stop it, the balance is restricted.
Collateral that looks like operating cash
The reverse case is the risk. Cash collateral for a card program can sit in an ordinary-looking account, and the restriction appears only in the issuer's agreement. Card programs carry their own risks too; employee credit card misuse patterns and proof covers what to look for in the card activity itself.
If you want every statement footed and matched before you classify the year-end balances, PreciseBankFlow is opening to audit firms in small groups.