Escrow accounts are a subset of what accountants call restricted cash. Suppose you run a bank that opens an escrow account for a homebuyer. They deposit enough at the start of the year to cover mortgage payments and property taxes, then the payments come out of the account when due. Accounting rules say you treat the money as an asset on financial statements. However, you have to make it clear that it's not cash you can spend as you choose.
Escrow is only one variety of restricted cash. Any cash that's reserved for a specific purpose qualifies. For example, if you set aside revenue to pay for dividends to shareholders, or to make a payment to your bondholders, that's restricted cash. If you expect to lose a lawsuit and reserve a pot of cash to pay the judgment, that's another example.
Balance Sheet Assets
When you make out the company balance sheet, you include all your assets and liabilities. The owners' stake in the company equals the value of the assets, less the liabilities. Escrow counts as an asset.
Suppose that a homebuyer deposited $15,000 in escrow at your bank this year to make mortgage and tax payments. As you'll withdraw the money over the next year for the payments, the account qualifies as a current asset, one that will be used up in the next 12 months. Reserved cash you don't expect to pay out for 18 months would be a long-term asset.
The balance sheet doesn't include escrow money as part of cash accounts. Restricted accounts get listed in their own, separate section of the assets. If your bank holds a net $240,000 in escrow accounts, that's $240,000 in restricted assets. Your accountant will explain in footnotes or added documentation how the money is restricted. Accounting rules don't define exactly what has to be explained. The usual policy is to spell out what kind of restrictions apply, the reason for them and the amount of restricted cash you hold.
Reporting Cash Flows
Up until 2016, bookkeeping rules left room for interpretation when reporting cash movements to and from restricted accounts. Some businesses treated the movements as cash flow, to be reported on the cash-flow statement. Other businesses assumed that since the money was restricted, it wasn't really liquid and should be listed as a non-cash asset.
The updated rules treat escrow and other restricted accounts as cash assets; money moving in or out of the account may have to go on the cash statement. The exact treatment depends on the details of the transaction. As with the balance sheet, the cash-flow statement should explain the restrictions in the footnotes.
Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com