Bank Overdraft

When a business' bank account has a negative balance it is said to be running a bank overdraft (more precisely an actual bank overdraft). It is a form of financing in which the bank honors presented checks even when there is no balance in the business account which results in negative balance in the bank account.

There is a special type of bank overdraft called 'book bank overdraft' which represent situation in which the balance as per cash book is negative while the balance as per bank book is positive. It arises when the checks written exceed the bank balance available thereby resulting in negative bank balance in books but since those checks are not yet presented so the bank balance is not negative and there is no 'actual bank overdraft'.

Balance sheet treatment of bank overdraft

When the bank has a right to offset the overdraft balance with another bank account of the business, the overdraft is netted off against the other bank accounts maintained with the same bank and the net bank balance is shown as the balance of cash at bank.

When the bank has no such right to offset, the overdraft is reported as a liability and when it is material it should be reported separately from other liabilities.

Bank overdraft and statement of cash flows

For the purpose of statement of cash flows, under US GAAP any changes in bank overdrafts for a period are appropriately reported as a cash flows from financing activities.

Under IFRS however, bank overdraft is treated as part of cash and cash equivalents and movement in bank overdraft is not reported anywhere in the statement of cash flows.

Example

Earth Inc. has four bank accounts: Account A and B which are maintained at Mars Bank. A has a balance of $20 million while B has an overdraft of $2 million. Account C and D are maintained at Venus Bank. C has a balance of $50 million and D has a balance of -$10 million. On Mars, banks are entitled to set off any negative bank balances with positive balances while Venetian banks have no such luxury. Earth applies US GAAP and Account B and D has no balance at the start of the year. Comment on balance sheet and statement of cash flows presentation of the overdraft.

Solution

On its balance sheet, Earth Inc. shall report cash and cash equivalents of $68 million ($20 million in Account A minus $2 million in Account B plus $50 million in Account C). It will show a corresponding bank overdraft liability of $10 million.

On its statement of cash flows, it shall report a cash inflow from 'changes in overdrafts' of $10 million under cash flows from financing activities.

Written by Obaidullah Jan, ACA, CFA