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8/7/2019 FASB_Heads UP

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Heads Up

FASB Proposes Guidance onBalance Sheet Osetting orFinancial Assets and FinancialLiabilitiesby Shahid Shah and Mark Bolton, Deloitte & Touche LLP

IntroductionOn January 28, 2011, the FASB issued an exposure drat (ED), Offsetting, in a joint eort

between the FASB and the IASB (the boards) to converge their accounting standards onthe osetting o nancial assets and nancial liabilities.1

Dierences in the boards rules on osetting nancial assets and nancial liabilities haveresulted in signicant quantitative presentation dierences in balance sheets prepared

under U.S. GAAP and IFRSs (see Appendix A o this Heads Upor a comparison o theosetting requirements under U.S. GAAP, IFRSs, and the ED). Such dierences impair the

comparability o nancial statements produced by entities with large nancial instrumentand derivative portolios. The rules proposed by the boards are intended to address this

disparity. The proposed model or osetting is similar to the osetting requirements

under IAS 322

and could represent a signicant change or entities that prepare nancialstatements under U.S. GAAP because it could require a signicant expansion (i.e.,

grossing up) o their balance sheets. This, in turn, could skew traditional nancial ratios(e.g., leverage ratio) and perormance metrics unless such measures are redened by

regulators and analysts to take into account the new requirements.

The proposed osetting requirements apply to all recognized nancial assets and nancialliabilities, including derivative instruments (nancial and nonnancial).3 Comments on theproposal are due April 28, 2011.

Offsetting CriteriaThe ED would require an entity to oset a recognized nancial asset and a recognized

nancial liability and present the net amount in its statement o nancial position i the

entity both: Hasanunconditional and legally enforceable right to set o the nancial

asset and nancial liability.

Intends either to settle the nancial asset and nancial liability net or to realizethe nancial asset and settle the nancial liability simultaneously.

February 2, 2011

Volume 18, Issue 4

Dierences in theboards rules onosetting fnancialassets and fnancialliabilities haveresulted insignifcantquantitative

presentationdierences inbalance sheetsprepared under U.S.GAAP and IFRSs.

1 The IASB also issued an ED on the same date. There are subtle dierences between the FASBs and IASBs EDs, primarily with

respect to terminology used under U.S. GAAP and IFRSs. However, the two EDs are meant to achieve convergence between the

standards on osetting under U.S. GAAP and IFRSs.2 IAS 32, Financial Instruments: Presentation.3 All reerences in this Heads Upto nancial assets and nancial liabilities include derivative instruments (nancial and

nonnancial). Note that the FASBs ED uses the term eligible assets and liabilities when reerring collectively to nancial and

derivative assets and liabilities.

In This Issue:

Introduction

Osetting Criteria

Bilateral and Multilateral

Seto Arrangements

Margin Accounts and

Collateral Obtained orPledged

Disclosures

Eective Date and Transition Appendix A Comparison

o Osetting RequirementsUnder U.S. GAAP, IFRSs, and

the ED

Appendix B Disclosure

Illustration
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The ED specifesthat or entities tooset a fnancialasset and a fnancialliability in thestatement ofnancial position,

the right o setomust be bothunconditional andlegally enorceable.

An entity that ails to satisy either criterion would be prohibited rom osetting thenancial asset and the nancial liability in the statement o nancial position. The ED also

prohibits an entity rom osetting a transerred nancial asset that ails the derecognitioncriteria against the related nancial liability.

Editors Note: The boards rationale or these criteria (which are described in greaterdetail below) is that nancial assets and nancial liabilities that meet the criteria are,essentially, a single asset or liability and should be presented as such in the statement

o nancial position. The boards believe that a net presentation or such instruments

refects an entitys expected cash fows rom settling two or more separate nancialinstruments and its right to or obligation or only the net amount.

Unconditional and Legally Enforceable Right Criterion

The ED species that or entities to oset a nancial asset and a nancial liability inthe statement o nancial position, the right o seto must be both unconditional

and legally enorceable. The right o seto is considered unconditional i its exercise isnot contingent upon the occurrence o a uture event; it is considered conditional i itbecomes exercisable only upon the occurrence o a uture event, such as bankruptcy,

insolvency, deault, or change in control.

In addition to being unconditional, the right o seto also must be legally enorceable inboth the normal course o business and in other situations, such as deault, insolvency,

or bankruptcy (i.e., it must be legally enorceable in all circumstances). Thereore, anentity would need to consider the laws and regulations governing the contracts in each

applicable jurisdiction to determine whether the legally enorceable requirement is met.I the unconditional right o seto is not legally enorceable in all circumstances, an entitywould be precluded rom osetting the nancial asset and the nancial liability in its

statement o nancial position.

The ED also species that the right o seto that was conditional at inception o thecontract may meet the unconditional criterion i the contingent event occurs. However,

a right o seto that is contingent upon some certain uture event or that is exercisableonly beore a specied date does not meet the unconditional right o seto criterion.

Editors Note: Derivative instruments and related cash collateral receivables

or payables subject to master netting arrangements are not likely to qualiy orosetting under the proposed model because netting provisions under master nettingarrangements usually permit osetting o assets and liabilities only in the case o

deault. Such a right o seto would be considered conditional under the proposedmodel and would not satisy the unconditional requirement. This may result in a

signicant expansion (grossing up) o balance sheets or nancial institutions and otherentities that have large portolios o nancial instruments.

Intent to Settle Net or Simultaneously Criterion

Under the ED, in addition to meeting the unconditional and legally enorceable right

criterion (discussed above), an entity also must intend either to settle the nancialasset and nancial liability net or to settle them simultaneously to qualiy or osetting

presentation.

The intent to settle net or settle simultaneously is assessed rom a reporting entitys

perspective and can be demonstrated by past practices, documented risk managementand operating policies, and normal operating practices.

Editors Note: Although an entity may have the right to settle a nancial asset andnancial liability net, i the entitys common practice is to settle the nancial asset andnancial liability separately (and not simultaneously) because o any circumstance (e.g.,

system limitations or business reasons), it will ail the intent criterion.


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When an entityassesses whether acontract satisfes theintent to settle netor simultaneouslycriterion, it needs tounderstand the

settlementmechanismsavailable or itscontracts.

An entity may still be able to oset, even though it does not intend to settle net, iit can demonstrate that it intends to settle the nancial asset and nancial liability

simultaneously. The ED claries that simultaneous settlement means the settlementsoccur at the same moment (i.e., the entity has exposure only to the net amount).

Editors Note: An entity would not meet the simultaneous settlement criterion iprocessing limitations resulted in settlement occurring over a short period, even thoughthe settlement value was xed. In addition, i the settlement o the nancial asset and

nancial liability occurs at the same stated time, but in dierent time zones, it is not

considered simultaneous, because it would not have been considered to have occurredat the same moment.

Application of the Intent to Settle Net or Simultaneously Criterionto Instruments Subject to Master Netting Arrangements, CentralClearing, or Exchanges

When an entity assesses whether a contract satises the intent to settle net orsimultaneously criterion, it needs to understand the settlement mechanisms availableor its contracts, including (1) the settlement provisions o the contract or master netting

arrangement to which the contract is subject or (2) the settlement rules or any exchangeor clearinghouse through which the contract may be settled. Such mechanisms may

indicate that osetting is required. For example, the settlement provisions o a master

netting arrangement that require automatic seto o payments that are due on thesame day and in the same currency, or a clearinghouses rules that require automaticnetting and cancellation o osetting contracts, may satisy the intent to settle netrequirement.

Similarly, the ED indicates that certain central clearing counterparties or exchanges may

give participants the right to set o amounts receivable and payable and may requirethat amounts or dierent product types be settled separately (i.e., gross settlement)

but instantaneously (i.e., there is exposure only to the net amount). Such settlementprovisions may satisy the simultaneous-settlement requirement.

Bilateral and Multilateral Setoff ArrangementsGenerally, the notion o osetting applies to bilateral arrangements and involves only

two parties; however, the EDs proposed model applies to all types o arrangements.Thereore, the ED may require osetting or multilateral arrangements i the criteria orosetting are satised. For example, entities A, B, and C may agree to set o amounts

owed by A to B against amounts owed to A by C. In such an unusual circumstance, tothe extent that the osetting criteria are met, the ED requires osetting o multilateralcontracts.

Margin Accounts and Collateral Obtained or PledgedCertain contractual arrangements may require an entity to maintain a margin account

with the counterparty or an exchange. The ED proposes that such margin accounts,which normally include liquid assets such as cash and securities, be reported separately;they would not be eligible or oset presentation. In addition, in certain transactions

(e.g., repurchase agreements and reverse repurchase agreements), one o the parties maysell collateral pledged to it and recognize an obligation to return the collateral. The ED

requires separate presentation o such collateral obligations. In its statement o nancialposition, an entity is prohibited rom osetting recognized nancial assets and nancial

liabilities against any (1) pledged collateral, (2) right to reclaim collateral pledged, or (3)obligation to return collateral sold.


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The boards seekeedback romconstituents on theamount o time andeort they wouldneed to implement

the proposedrequirements.

DisclosuresThe ED proposes new qualitative and quantitative disclosure requirements or nancialassets and nancial liabilities subject to oset. As o each reporting date, an entity would

be required to present,4 separately or nancial assets and nancial liabilities, and by classo nancial instrument, the ollowing (see example in Appendix B):

a. The gross carrying amounts (beore application o osetting and portolio level

credit risk adjustments).

b. Amounts oset under the proposed model to determine the carrying amounts in

the statement o nancial position.

c. Portolio level adjustments related to credit risk.

d. The net carrying amount reported in the statement o nancial position (i.e., (a)minus (b) minus (c)).

e. The amounts o nancial assets and nancial liabilities that satisy theunconditional and legally enorceable right o seto criterion but ail the

intent to settle net or simultaneously criterion.

. The amounts o nancial assets and nancial liabilities or which an entity has aconditional right o seto (e.g., amounts subject to master netting arrangementsthat did not qualiy or osetting) disclosed separately by each type o

conditional right.g. Net amount o nancial assets and nancial liabilities, ater taking into account

the preceding items (i.e., (d) minus (e) minus ()).

h. Amount o cash obtained or pledged as collateral (excluding any collateral that

exceeds the amount in (d) above).

i. Fair value o other nancial instruments obtained or pledged as collateral

(excluding any amounts that exceed the amount in (d) above).

j. The net amount o nancial assets and nancial liabilities ater considering allpreceding items (i.e., (g) minus (h) minus (i)).

The ED species that the disclosure should be presented in a tabular ormat (unlessanother ormat is more appropriate). Further, an entity may aggregate the amounts

disclosed in () above by similar rights o seto (although those rights exercisable ondeault, bankruptcy, or insolvency must be distinguished rom those exercisable in the

normal course o business). An entity also must describe each type o conditional right oseto, such as the nature o those rights and how an entity determines each type o right

o seto.

Editors Note: The boards proposed these disclosures because they believe thatnancial statement users should be inormed about the net credit exposures o the

entity. Entities need not provide these disclosures i their nancial assets or nancialliabilities are not, as o the reporting date, subject to (1) a right o seto and (2)collateral arrangements.

Effective Date and TransitionThe ED does not speciy an eective date. The boards seek eedback rom constituents

on the amount o time and eort they would need to implement the proposedrequirements. The boards plan to discuss the eective date o the nal standard atertaking into consideration eedback received on the ED and the Effective Dates and

Transition Methodsdiscussion paper.5

The proposed presentation and disclosure guidance will be applied retrospectively to allperiods presented.

4 I the required disclosures are presented in dierent ootnotes, an entity must provide cross-reerences to enable a reader to

locate all o the required inormation.5 See Deloittes October 21, 2010, Heads Up.
http://www.deloitte.com/view/en_US/us/Services/audit-enterprise-risk-services/Financial-Statement-Internal-Control-Audit/Accounting-Standards-Communications/0e2319fc0cfcb210VgnVCM2000001b56f00aRCRD.htmhttp://www.deloitte.com/view/en_US/us/Services/audit-enterprise-risk-services/Financial-Statement-Internal-Control-Audit/Accounting-Standards-Communications/0e2319fc0cfcb210VgnVCM2000001b56f00aRCRD.htm


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Appendix A Comparison of Offsetting Requirements Under U.S. GAAP, IFRSs,and the ED

The ollowing table compares the osetting requirements under U.S. GAAP, IFRSs, and the ED.

Subject U.S. GAAP (ASC 210-206) IFRSs (IAS 32) ED

Osetting nancial assets andnancial liabilities elective or

required

Elective. Required i all criteria are met. Required i all criteria are met.

Osetting criteria Entity may oset assets and liabilitiesin the balance sheet i a right o

seto exists. A right o seto existswhen all o the ollowing conditions

are met:

Eachoftwopartiesowesthe

other determinable amounts.

Thereporting[entity]hastheright to set o the amount owed

with the amount owed by the

other party.

Thereporting[entity]intendstoset o.

Therightofsetoffisenforceable

at law.

Requires osetting o a nancialasset and nancial liability i both

criteria are met:

Entitycurrentlyhasalegallyenorceable right to set o the

recognised amounts.

Entityintendseithertosettle

on a net basis, or to realisethe asset and settle the liability

simultaneously.

Requires osetting o a nancialasset and nancial liability i both

criteria are met:

Entityhasanunconditionaland legally enorceable right

to set o the nancial asset and

nancial liability.

Entityintendseitherto(1)settlethe nancial asset and nancial

liability on a net basis or (2) realize

the nancial asset and settle thenancial liability simultaneously.

Exceptions Certain exceptions granted (e.g.,derivatives subject to master

netting arrangements, repurchaseagreements).

Not permitted. No exceptionsgranted.

Not permitted. No exceptionsgranted.

Osetting amounts due

rom a third-party debtoragainst the amount due to a

creditor (multilateral osetting

arrangements)

Not permitted. Is permitted in unusual

circumstances.

Is permitted in unusual

circumstances.

6 FASB Accounting Standards Codication Subtopic 210-20, Balance Sheet: Offsetting.


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Appendix B Disclosure Illustration

The ollowing table, adapted rom the ED, illustrates one possible method o meeting the EDs tabular disclosure requirements.

Entities would also need to provide a similar table or nancial liabilities subject to osetting.

CU Million

As of December31, 20XX (i) (ii) (iii) = (i) (ii)* (iv) (v)

(vi) = (iii) (iv) (v)

(vii)

CollateralPledged (viii)

Description

Gross

Amount of

Assets

GrossAmount of

Liabilities

OffsetAgainst

Assets in theStatement

of Financial

Position

Net Amountof Assets

in theStatement

of Financial

Position

Gross

Amount ofLiabilities

Subject toConditional

Rights of

Setoff

Gross Amount

of LiabilitiesSubject to an

Unconditionaland Legally

Enforceable

Right ofSetoff but the

Entity DoesNot Intend to

Settle Net or

Simultaneously

Net Amount

of AssetsBefore

Deducting

Collateral Cash

Fair Value

of Other

FinancialInstru-

mentsReceived

as

Collateral Net Exposure

Exchange

traded nancialinstruments

X X X X X X X X X

OTC derivatives,

repurchase andstock borrowing

agreements, and

similar nancialinstruments

X X X X X X X X X

Other nancial

instrumentsX X X X X X X X X

Financial assets

at air value

through protor loss

X X X X X X X X X

Total X X X X X X X X X

Financial assets atamortized cost

X X X X X X X X X

Total X X X X X X X X X

* Assumes the entity has not made portolio-level adjustments in the air value measurement o derivatives.


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