Offsetting of financial assets and financial liabilities

IAS 32 prescribes rules for the offsetting of financial assets and financial liabilities. It specifies that a financial asset and a financial liability should be offset and the net amount reported when and only when, an enterprise: Offsetting of financial assets and financial liabilities

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

Offsetting is usually inappropriate when: Offsetting of financial assets and financial liabilities

  • several different financial instruments are used to emulate the features of a single financial instrument (a ‘synthetic instrument’);
  • financial assets and financial liabilities arise from financial instruments having the same primary risk exposure (for example, assets and liabilities within a portfolio of forward contracts or other derivative instruments) but involve different counterparties;
  • financial or other assets are pledged as collateral for non-recourse financial liabilities;
  • financial assets 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 (for example, a sinking fund arrangement); or  Offsetting of financial assets and financial liabilities
  • obligations incurred as a result of events giving rise to losses are expected to be recovered from a third party by virtue of a claim made under an insurance contract.

An entity is required to offset a financial asset and financial liability when, and only when, the entity currently has a legally enforceable right to set-off and intends to settle the asset and liability on a net basis or realise the asset and settle the liability simultaneously.

The accounting rules have been amended to clarify:

  • That the right of set off must be available today – That is, it is not contingent on a future event;
  • That the right of set off must be legally enforceable for all counterparties in the normal course of business, as well as in the event of default, insolvency or bankruptcy; and
  • That gross settlement mechanisms, such as through a clearing house, with features that both (i) eliminate credit and liquidity risk; and (ii) process receivables and payables in a single settlement process, are effectively equivalent to net settlement and as a result they would satisfy the criterion in these instances.

Master netting agreements where the legal right of offset is only enforceable on the occurrence of some future event, such as default of the counterparty, does not typically meet the offsetting requirements

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