How to test bank overdraft classification between cash equivalents and borrowings

Testing bank overdraft classification means answering two separate questions with two separate rules: for the statement of cash flows under Ind AS 7, whether the overdraft is repayable on demand and forms an integral part of the entity's cash management, in which case it is included as a component of cash and cash equivalents; and for the balance sheet, whether the overdraft is a drawn borrowing facility, in which case it is presented as a current borrowing regardless of how it is treated in the cash flow statement. These two answers do not have to match, and auditors who assume they must often misclassify one or the other.

Why the same balance can be treated two different ways

Ind AS 7's cash equivalents test is about the role the overdraft plays in cash management — does the balance fluctuate between debit and credit as part of the entity's day-to-day pooling of funds, repayable on demand. Ind AS 1's balance sheet presentation is about what the overdraft actually is — a drawn facility from a bank, which is a borrowing. A facility can fail the cash-pooling test and still need to sit as a current borrowing on the balance sheet; it can pass the cash-pooling test and still need separate disclosure as a borrowing rather than being netted silently into a cash figure.

The testing sequence

1. 01Obtain every overdraft and cash credit facility and its sanction letterConfirm the facility limit, whether it is repayable on demand, and whether it is linked to a cash-pooling or sweep arrangement across accounts.
2. 02Trace the account's actual behaviour through the yearPull the bank statement or ledger for the full year and check whether the balance genuinely moves between debit and credit as receipts and payments flow through it, rather than sitting permanently drawn as a term-like facility that happens to be structured as an overdraft.
3. 03Test whether the facility is repayable on demand in substance, not just in the sanction letter's boilerplateA facility renewed every year as a formality, with no history of the bank calling it, may still be legally repayable on demand — the legal right is what matters for the cash equivalents test, not the bank's practice.
4. 04Conclude on the Ind AS 7 cash equivalents question account by accountOnly accounts that both swing between debit and credit as part of cash management and are legally repayable on demand qualify for inclusion in cash and cash equivalents; a permanently drawn cash credit account used as working capital finance does not.
5. 05Separately test the balance sheet presentationA drawn overdraft or cash credit balance, whether or not it is netted into cash equivalents in the cash flow statement, is disclosed as a current borrowing on the balance sheet and in the borrowings note, with the facility and the drawn amount both stated.
6. 06Confirm no inappropriate netting across different bank accounts or entitiesA debit balance in one account cannot be netted against a credit balance in an unrelated account unless there is a legal right of set-off and an intention to settle net; cross-account netting without that right is a presentation error, not a classification nuance.
7. 07Agree the movement in overdraft balances treated as cash equivalents to the cash flow statement reconciliationThe opening and closing cash and cash equivalents note should include exactly the accounts concluded on above, and the reconciliation to the balance sheet should tie without a plug.