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Offsetting of financial assets and financial liabilities in the balance sheet: Key differences between U.S. GAAP and IFRSs

Under U.S. GAAP, entities apply the guidance in ASC 210-20 and ASC 815-10-45-1 through 45-7 when considering whether it is appropriate to offset assets and liabilities in the balance sheet.

Under IFRSs, entities apply the guidance in IAS 32, Financial Instruments: Presentation, and IFRS 7, Financial Instruments: Disclosures (for entities that have not yet adopted IFRS 9), when considering whether it is appropriate to offset financial assets and financial liabilities in the balance sheet.

The table below summarizes these differences and is followed by a detailed explanation of each difference.1

Subject U.S. GAAP IFRSs
Offsetting financial assets and financial liabilities in the balance sheet — elective versus mandatory nature Entities are not required to offset financial assets and financial liabilities in the balance sheet when the criteria for setoff are met; offsetting is elective. Entities are required to offset financial assets and financial liabilities in the balance sheet when the criteria for setoff are met.
Offsetting certain assets and liabilities in the balance sheet — intent to set off An entity may offset fair value amounts for certain assets and liabilities subject to master netting agreements even in the absence of an intention to set off. For an entity to qualify for offsetting, there must be intent to settle on a net basis or to realize the asset and settle the liability simultaneously. There is no exception for assets and liabilities subject to master netting agreements.
Offsetting certain assets and liabilities in the balance sheet — right to set off Each reporting entity assesses whether it has a right of setoff in determining whether to apply offsetting. To qualify for offsetting, all of the counterparties to the contract must currently have a legally enforceable right of setoff.
Offsetting amounts due from a third-party debtor against the amount due to a creditor Offsetting of an amount due from a third-party debtor against the amount due to a different creditor is not permitted. Offsetting of an amount due from a third party against the amount due to a different creditor is permitted in "unusual" circumstances.
Offsetting Disclosures Scope is limited to recognized derivative instruments accounted for in accordance with ASC 815, including bifurcated embedded derivatives, repurchase agreements accounted for as collateralized borrowings and reverse repurchase agreements, and securities borrowing and securities lending transactions that are (1) offset in accordance with ASC 210-20-45 or ASC 815-10-45 or (2) subject to a master netting arrangement or similar agreement. Scope includes all financial assets and financial liabilities.

Offsetting Financial Assets and Financial Liabilities in the Balance Sheet — Elective Versus Mandatory Nature

As stated in the table below, U.S. GAAP and IFRSs generally provide similar guidance on determining whether it is appropriate to offset (i.e., net) financial assets and financial liabilities (before consideration of the exceptions provided in U.S. GAAP).

U.S. GAAP IFRSs

ASC 210-20-45-1 — "A right of setoff exists when all of the following conditions are met:

  1. Each of two parties owes the other determinable amounts.
  2. The reporting party has the right to set off the amount owed with the amount owed by the other party.
  3. The reporting party intends to set off.
  4. The right of setoff is enforceable at law."

Paragraph 42 of IAS 32 — "A financial asset and a financial liability shall be offset and the net amount presented in the statement of financial position when, and only when an entity:

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

 

However, under U.S. GAAP, ASC 210-20-45-1 and 45-2 indicate that entities may, but are not required to, offset when the criteria for setoff are met. Whereas under IFRSs, paragraph 42 of IAS 32 provides that an entity must offset when the above conditions are met.

Offsetting Certain Assets and Liabilities in the Balance Sheet — Intent to Set Off

Although the general U.S. GAAP criteria for offsetting are similar to those in IFRSs, there are two exceptions to U.S. GAAP's general requirement that a reporting entity have the intent to set off when presenting an asset and a liability net in the balance sheet:

  • ASC 815-10-45-5 provides an exception for "fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from derivative instrument(s) recognized at fair value executed with the same counterparty under a master netting arrangement."
  • ASC 210-20-45-11 and 45-12 provide an exception for certain amounts recognized as payables under repurchase agreements accounted for as collateralized borrowings, and certain amounts recognized as receivables under reverse repurchase agreements accounted for as collateralized borrowings, when such agreements are executed with the same counterparty under a master netting arrangement and certain conditions are satisfied.

IFRSs, however, do not provide an exception to their "intends either to settle on a net basis [or to settle simultaneously]" requirement. Further, paragraph AG38B of IAS 32 indicates that "an entity must currently have a legally enforceable right of set-off." For an entity to satisfy this condition under paragraph AG38B, the right of setoff:

a. must not be contingent on a future event; and
b. must be legally enforceable in all of the following circumstances:
  i. the normal course of business;
  ii. the event of default; and
  iii. the event of insolvency or bankruptcy of the entity and all of the counterparties. [Emphasis added]

Therefore, rights that are enforceable only on the occurrence of some future event, such as a default of the counterparty do not meet the conditions for offset. Accordingly, under IFRSs, the existence of a master netting arrangement does not provide a basis for offsetting unless there is either an intent to set off or an expectation of simultaneous settlement. Because a party to a master netting arrangement will often not be permitted to set off amounts recognized for derivative assets and derivative liabilities (and related cash collateral) or repurchase agreements and reverse repurchase agreements, except in the case of default, IFRSs will usually prohibit setoff while U.S. GAAP will often permit it.

Offsetting Certain Assets and Liabilities in the Balance Sheet — Right to Set Off

In stating the conditions that must be met to conclude that a legally enforceable right of setoff exists, paragraph AG38B of IAS 32 indicates that the criterion must be met by "the entity and all of the counterparties." Thus, the criterion for a legally enforceable right of setoff must exist for all of the counterparties to the contract in order to offset recognized amounts of assets and liabilities. U.S. GAAP does not specifically require that each counterparty to a contract have a right of offset that is enforceable at law.

Offsetting Amounts Due From a Third-Party Debtor Against the Amount Due to a Creditor

Paragraph 45 of IAS 32 indicates the following: 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. [Emphasis added]

Thus, under IFRSs, there may be unusual circumstances in which an entity is able to set off amounts due from a third-party debtor against amounts due to a different creditor.

Under U.S. GAAP, there is no similar guidance. ASC 210-20-45-1 explicitly states that among the criteria that must be met for a right of setoff to exist is the requirement that "[e]ach of two parties owes the other determinable amounts." Thus, an entity applying U.S. GAAP is not permitted to set off amounts owed by a third-party debtor against an amount owed to a different creditor.

Offsetting Disclosures

U.S. GAAP and IFRSs each require the same tabular balance sheet offsetting disclosures of quantitative information on financial instruments. However, the types of financial instruments for which such disclosures are required will vary depending on which set of standards is applied.

Paragraph 13A of IFRS 7 states that the disclosures (1) are required for "all recognised financial instruments that are set off in accordance with paragraph 42 of IAS 32" and (2) "also apply to recognised financial instruments that are subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are set off in accordance with paragraph 42 of IAS 32."

ASC 210-20-50-1 states that the disclosures are required for "[r]ecognized derivative instruments accounted for in accordance with [ASC] 815, including bifurcated embedded derivatives, repurchase agreements accounted for as collateralized borrowings and reverse repurchase agreements, and securities borrowing and securities lending transactions that are [(1)] offset in accordance with either [ASC] 210-20-45 or [ASC] 815-10-45 [or (2)] subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either [ASC] 210-20-45 or [ASC] 815-10-45."

Thus, more financial instruments are subject to the balance sheet offsetting disclosures under IFRSs than under U.S. GAAP.

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1 Differences are based on comparison of authoritative literature under U.S. GAAP and IFRSs and do not necessarily include interpretations of such literature.

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