IAS 32 Offsetting financial assets and financial liabilities

Offsetting financial assets and financial liabilities

This is part of the explanation of presentation narratives in IAS 32 Financial Instruments Presentation, use the link if you want to start reading from the beginning. Or if you want to read every post about Financial Instruments use the link.

Offsetting financial assets and financial liabilities

Rules for restricting the offsetting of assets and liabilities were considered necessary with the increasing complexity of financial instruments and the resulting accounting noise. The rules detail that a financial asset and a financial liability should be offset and the net amount reported when, and only when, a reporting entity:

  • has a legally enforceable right to set off the amounts; and
  • intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

In all other cases offsetting of financial assets and financial liabilities is not allowed. Another way of looking at this (see also below for the formal dealings) is that if the asset and liability lead to one cash in- or outflow they should be netted. Otherwise the financial position may be unclear since it includes assets that do not lead to a normally expected cash inflow or liabilities the do not lead to a normally expected cash outflow.

Note one special issue: In accounting for a transfer of a financial asset that does not qualify for derecognition (see section on derecognition), the transferred asset and the associated liability may not be offset.

Accounting issues

The legal option regarding offsetting of financial assets and financial liabilities is a rather strict one, the second option regarding offsetting of financial assets and financial liabilities leaves management with room to manoeuvre. However there are some considerations to judge a reporting entity’s assertions against:

  • Only the existence of an enforceable right to set off a financial asset and a financial liability, by itself, is not a sufficient basis for offsetting. In the absence of an intention to exercise the right or to settle simultaneously, the amount and timing of an entity´s future cash flows are not affected.When an entity intends to exercise the right or to settle simultaneously, presentation of the asset and liability on a net basis reflects more appropriately the amounts and timing of the expected future cash flows, as well as the risks to which those cash flows are exposed.The mere intention by one or both parties to settle on a net basis without the legal right to do so is not sufficient to justify offsetting because the rights and obligations associated with the individual financial asset and financial liability remain unchanged.Off course, the existence of an enforceable right to set off a financial asset and a financial liability  affects the rights and obligations associated with a financial asset and a financial liability and may affect an entity´s exposure to credit and liquidity risk, however that is part of risk management not financial reporting,
  • Offsetting a recognised financial asset and a recognised financial liability and presenting the net amount differs from de-recognition of a financial asset or a financial liability. Although offsetting does not give rise to recognition of a gain or loss, the de-recognition of a financial instrument not only results in the removal of the previously recognised item from the statement of financial position but also may result in recognition of a gain or loss,
  • A right of set-off is a debtor’s legal right, by contract or otherwise, to settle or otherwiseOffsetting financial assets and financial liabilities eliminate all or a portion of an amount due to a creditor by applying against that amount an amount due from the creditor. In unusual circumstances, a debtor may have a legal right to apply an amount due from a third party against the amount due to a creditor provided that there is an agreement between the three parties that clearly establishes the debtor‟s right of set-off. Because the right of set-off is a legal right, the conditions supporting the right may vary from one legal jurisdiction to another and the laws applicable to the relationships between the parties need to be considered,
  • In other circumstances, financial assets and financial liabilities are presented separately from each other consistently with their characteristics as resources or obligations of the entity.
  • If it is the regular/normal business accounting practice and/or contract or trading rule of the reporting entity or requirements of the financial market to receive or pay a single net amount of cash flow for a combination of financial asset(s) and financial liability(ies), and the reporting entity has the intention to actually settle in a single net cash flow or to realize the asset and the liability simultaneously the effect of the right on the entity´s credit risk exposure is disclosed as a net position in the credit risk of the qualitative disclosure of the Nature and Extent of Risks Arising from Financial Instruments from IAS 7 #36. <link to content will follow>

See an example of the presentation of offsetting below, derived from the Annual Report 2011 of TPV Technology Limited listed in Hong Kong.

TPV technology offsetting

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