Other circumstances where the offsetting criteria are generally not met, and therefore
offsetting is usually inappropriate, include: [IAS 32.49(b), (c), (d), (e)]
(a) financial assets and financial liabilities which arise from financial instruments having
the same primary risk exposure (e.g. assets and liabilities within a portfolio of forward
contracts or other derivative instruments) but involving different counterparties;
(b) financial or other assets that are pledged as collateral for non-recourse financial
liabilities (see 7.4.1.F below);
(c) financial assets which are set aside in trust by a debtor for the purpose of
discharging an obligation without those assets having been accepted by the
creditor in settlement of the obligation (e.g. a sinking fund arrangement); or
(d) obligations incurred as a result of events giving rise to losses that are expected to be
recovered from a third party by virtue of a claim made under an insurance policy.
Derivative assets and liabilities that are not transacted through central clearing systems
are very unlikely to qualify for offsetting. For example, it is rare that they will be settled
net in the normal course of business and even where associated offsetting agreements
exist they are usually conditional on the default of one of the counterparties.
7.4.1.E
Cash pooling arrangements
Groups often use what are commonly known as cash pooling arrangements. Typically
these will involve a number of subsidiaries within a group each having a legally separate
bank account with the same bank that may have positive or negative (overdrawn)
balances. In many respects these accounts will be managed on an aggregated basis, for
example interest will normally be determined on a notional basis using the net balance
of all accounts; similarly any overdraft limit will normally apply to the net balance.
These arrangements may or may not give the group a legally enforceable right to set off
the balances in these accounts. Clearly if there is no such right the balances should not
be offset in the group financial statements. However, where such a right exists and
meets criterion (a), the entity should assess whether there is an intention to settle the
balances net or simultaneously, i.e. to what extent criterion (b) is met.
The Interpretations Committee considered criterion (b) for a particular cash pooling
arrangement where:
• the group instigated regular physical transfers of balances into a single netting account;
• such transfers were not required under the terms of the cash-pooling arrangement
and were not performed at the reporting date; and
• at the reporting date, the group expected that its subsidiaries would use their bank
accounts before the next net settlement date by placing further cash on deposit or
by withdrawing cash to settle other obligations.
The committee observed that the group expects cash movements to take place on
individual bank accounts before the next net settlement date because the group expects
its subsidiaries to use those bank accounts in their normal course of business.
Consequently, to the extent the group did not expect to settle its subsidiaries’ period-
end account balances on a net basis, it would not be appropriate for the group to assert
it had the intention to settle the entire period-end balances on a net basis at the
Financial
instruments:
Presentation and disclosure 4255
reporting date. Therefore, presenting these balances net would not appropriately reflect
the amounts and timings of the expected future cash flows, taking into account the
entity’s normal business practices.
In other cash-pooling arrangements, a group’s expectations regarding how subsidiaries
will use their bank accounts before the next net settlement date may be different.
Consequently, in those circumstances, the group would be required to apply judgement
in determining whether there was an intention to settle on a net basis at the reporting
date. The committee also noted that many different cash pooling arrangements exist in
practice and the determination of what constitutes an intention to settle on a net basis
would depend on the individual facts and circumstances of each case. The related
disclosure requirements (see 7.4.2 below) should also be considered.23
7.4.1.F
Offsetting collateral amounts
Many central counterparty clearing houses require cash collateral in the form of
variation margin to cover the fluctuations in the market value of ‘over-the-counter’ and
exchange-traded derivatives. Historically IAS 32 has not addressed the offsetting of
collateral although entities sometimes did offset the market values of the derivatives
against the cash collateral, on the basis that all payments on the derivatives will be made
net using the cash collateral already provided. In effect, the collateral is represented as
an advance payment for settlement of the cash flows arising on the derivatives.
In the basis for conclusions to the 2011 amendment, the IASB clarified that the offsetting
criteria do not give special consideration to items referred to as ‘collateral’. Accordingly,
a recognised financial instrument designated as collateral should be set off against the
related financial asset or financial liability if, and only if, it meets the offsetting criteria
in IAS 32. This might be the case, for instance, if variation margin is used to settle cash
flows on derivative contracts. However, the IASB also noted that if an entity can be
required to return or receive back collateral, the entity would not currently have a
legally enforceable right of set-off in all relevant circumstances and therefore offsetting
would not be appropriate. [IAS 32.BC103].
In practice, to set off collateral against related financial assets and liabilities, a reporting
entity would also need to assess, among other factors: (i) whether the amounts paid or
received (however they might be described) actually represent a partial settlement of
the amounts due under the derivative contracts (see below); (ii) whether the right of
offset is legally enforceable in the event of default, insolvency or bankruptcy of either
party as well as in the normal course of business; (iii) whether the right to offset the
collateral and the open position is conditional on a future event; (iv) whether the
collateral will form part of the actual net settlement of the underlying contracts; and (v)
whether there is a single process for both the settlement of the underlying contracts and
the transfer of the collateral.
The analysis of whether payments or receipts, whether described as margin payments
or otherwise, are in fact partial settlements of an open position and hence result in
partial derecognition of the derivative, can require the application of significant
judgement, including particularly an assessment of the legal relationship between the
clearing member and the clearing house. When the strike price of a derivative contract
is effectively reset each day following a margin payment based on the contract’s change
4256 Chapter 50
in fair value, this might indicate it is appropriate to regard the margin payment as a
partial settlement of the derivative. This situation sometimes occurs with excha
nge
traded futures for which gains and losses on the open position are realised over time as
opposed to being accumulated until the final settlement date.
The accounting outcome for a payment mechanism considered to represent a partial
settlement is unlikely to be significantly different from one that is considered to give
rise to collateral if the collateral qualifies for offset. However, the regulatory capital
consequences can be very different (and the disclosure requirements are different too
– see 7.4.2 below). Consequently, many clearing houses provide their members with a
choice of payment mechanisms, one of which is designed to achieve partial settlement
and the other the provision of collateral.
7.4.1.G
Unit of account
IAS 32 does not specify the ‘unit of account’ to which the offsetting requirements should
be applied. For example, they could be applied to individual financial instruments, such
as entire derivative assets or liabilities, or they could be applied to identifiable cash
flows arising on those financial instruments. In practice, both approaches are seen with
the former being more commonly applied by financial institutions and the latter by
energy producers and traders. This diversity became apparent to the IASB during its
project that amended IAS 32 in December 2011. Nevertheless, whilst the IASB
considered imposing an approach based on individual cash flows (which, on a
conceptual level, it favoured), it concluded that the different interpretations applied
today do not result in inappropriate application of the offsetting criteria. The Board also
concluded that the benefits of amending IAS 32 would not outweigh the costs for
preparers. [IAS 32.BC105-BC111]. Accordingly, IAS 32 was not amended, thereby allowing
this diversity to continue. Reporting entities should establish an accounting policy and
apply that policy consistently.
7.4.2
Offsetting financial assets and financial liabilities: disclosure
This section discusses the requirements of IFRS 7 introduced by the IASB in December
2011. These requirements are similar to requirements introduced into US GAAP by the
FASB at around the same time and are intended to assist users in identifying major
differences between the effects of the IFRS and US GAAP offsetting requirements
(without requiring a full reconciliation). [IAS 32.BC77].
7.4.2.A Objective
The objective of these requirements is to disclose information to enable users of
financial statements to evaluate the effect or potential effect of netting arrangements,
including rights of set-off associated with recognised financial assets and liabilities, on
the reporting entity’s financial position. [IFRS 7.13B].
To meet this objective, the minimum quantitative disclosure requirements considered
at 7.4.2.C below may need to be supplemented with additional (qualitative) disclosures.
Whether such disclosures are necessary will depend on the terms of an entity’s
enforceable master netting arrangements and related agreements, including the nature
of the rights of set-off, and their effect or potential effect on the entity’s financial
position. [IFRS 7.B53].
Financial
instruments:
Presentation and disclosure 4257
7.4.2.B Scope
The disclosure requirements considered at 7.4.2.C below are applicable not only to all
recognised financial instruments that are set off in accordance with IAS 32 (see 7.4.1
above), but also to recognised financial instruments that are subject to an enforceable
master netting arrangement or ‘similar agreement’ that covers similar financial
instruments and transactions, irrespective of whether they are set off in accordance with
IAS 32. [IFRS 7.13A, B40].
In this context, enforceability has two elements: first, enforceability as a matter of law
under the governing laws of the contract; and second, consistency with the bankruptcy
laws of the jurisdictions where the reporting entity and counterparty are located. The
latter is critical since, regardless of the jurisdiction selected to govern the contract, local
insolvency laws in an insolvent counterparty’s jurisdiction can override contractual
terms in the event of insolvency. Determining whether an agreement is enforceable for
the purposes of these disclosures may require judgement based on a legal analysis that
is sometimes, but not necessarily, based on legal advice.
These ‘similar agreements’ include, but are not limited to, derivative clearing
agreements, global master repurchase agreements, global master securities lending
agreements, and any related rights to financial collateral. The ‘similar financial
instruments and transactions’ include, but are not restricted to, derivatives, sale and
repurchase agreements, reverse repurchase agreements, securities borrowing and
securities lending agreements. However, loans and customer deposits with the same
financial institution would not be within the scope of these disclosure requirements,
unless they are set off in the statement of financial position; nor would financial
instruments that are subject only to a collateral agreement. [IFRS 7.B41].
The scope of equivalent disclosures in US GAAP is restricted to derivatives, repurchase
and reverse repurchase agreements and securities lending and borrowing arrangements.
In November 2012, the IASB considered this and effectively confirmed that the scope of
IFRS 7 is broader than US GAAP. As a result, trade or other receivables and payables, such
as balances with brokers, that are subject to an umbrella netting arrangement (normally
where an entity’s customer is also a supplier, and vice versa), are likely to fall within the
scope of these disclosure requirements. Extract 50.10 (BP) at 7.4.2.D below illustrates one
company’s disclosures about receivables and payables in addition to derivatives.
7.4.2.C Disclosure
requirements
To meet the objective at 7.4.2.A above, the standard requires entities to disclose, at the
end of the reporting period, in a tabular format unless another format is more
appropriate, the following information separately for recognised financial assets and for
recognised financial liabilities: [IFRS 7.13C]
• the gross amounts of those recognised financial assets and recognised financial
liabilities within the scope of the disclosures (see 7.4.2.B above) [Amount (a)].
This excludes any amounts recognised as a result of collateral agreements that do
not meet the offsetting criteria in IAS 32. Instead these will be disclosed in
Amount (d) (see below); [IFRS 7.B43]
4258 Chapter 50
• the amounts that are set off in accordance with the criteria in IAS 32 when
determining the net amounts presented in the statement of financial position
[Amount (b)].
These amounts will be disclosed in both the financial asset and financial liability
disclosures. However, the amounts disclosed (in, for example, a table) should be
limited to the amounts subject to set-off. For example, an entity may have a
recognised derivative asset and a recognised derivative liability that meet the
offsetting criteria. If the gross amount of the asset is larger than the gross amount
of the li
ability, the financial asset disclosure table will include the entire amount of
the derivative asset in Amount (a) and the entire amount of the derivative liability
in Amount (b). However, while the financial liability disclosure table will include
the entire amount of the derivative liability in Amount (a), it will only include the
amount of the derivative asset that is equal to the amount of the derivative liability
in Amount (b); [IFRS 7.B44]
• the net amounts presented in the statement of financial position [Amount (c) =
Amount (a) – Amount (b)].
For instruments that are within the scope of these disclosure requirements but
which do not meet the offsetting criteria in IAS 32, the amounts included in
Amount (c) would equal the amounts included in Amount (a). [IFRS 7.B45].
Amount (c) should be reconciled to the individual line item amounts presented in
the statement of financial position. For example, if an entity determines that the
aggregation or disaggregation of individual line item amounts provides more
relevant information, it should reconcile the aggregated or disaggregated amounts
included in Amount (c) back to the individual line item amounts presented in the
statement of financial position; [IFRS 7.B46]
• the amounts subject to an enforceable master netting arrangement or similar
agreement that are not included in the amounts subject to set-off above
[Amount (d)], including:
• amounts related to recognised financial instruments that do not meet some or
all of the offsetting criteria in IAS 32 [Amount (d)(i)].
This might include, for example, current rights of set-off where there is no
intention to settle the open positions subject to these rights net or
simultaneously, or conditional rights of set-off that are enforceable and
exercisable only in the event of the default, insolvency or bankruptcy of any
of the counterparties; [IFRS 7.B47] and
• amounts related to financial collateral (including cash collateral) [Amount (d)(ii)].
The fair value of those financial instruments that have been pledged or received
as collateral should be disclosed. To ensure that the disclosures reflect the
maximum net exposure to credit risk, the amendments require the amounts
disclosed for financial collateral not offset to include actual collateral received,
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 843
