The Financial Accounting Standards Board (FASB) recently issued new disclosure requirements for companies that “offset" certain assets and liabilities on their financial statements. Accounting Standards Update (ASU) 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities, includes less strict requirements for offsetting (or “netting") than those the FASB had been considering along with the International Accounting Standards Board (IASB).
US companies can continue their current offsetting practices but must provide clarifying information. The requirements mainly affect companies that hold derivative assets (such as large financial institutions), but they apply in other circumstances as well.
The offsetting issue
The FASB and IASB have been working on ways to converge the generally accepted accounting principles in the United States of America (US GAAP) with the International Financial Reporting Standards (IFRS). As part of this project, they had proposed new criteria for offsetting that were narrower than current US GAAP criteria.
Offsetting is the practice of using a net amount for an asset and a liability to show a single amount on the balance sheet — as opposed to showing separate gross figures for both the asset and the liability. US GAAP allows offsetting for derivatives that are subject to legally enforceable netting arrangements with the same party, even if the offset rights are available only in the event of default or bankruptcy.
For example, a company might have a derivative asset with a fair value of $100 million and a derivative liability with a fair value of $80 million, both with the same party. If the criteria are met, the company can offset the derivative liability against the derivative asset in its balance sheet, resulting in the presentation of a net derivative asset of only $20 million.
IFRS doesn’t allow the offset of derivatives. The differences in the offsetting requirements under the two sets of standards result in a significant difference in the amounts presented on balance sheets — the assets and liabilities would appear smaller on US GAAP balance sheets. The disparity makes it difficult to compare balance sheets that aren’t prepared under the same standards.
After receiving feedback on the proposed criteria for a single offsetting model, the FASB and IASB opted to retain their separate existing models. However, the FASB released the new disclosure requirements found in ASU 2011-11 to allow investors to better compare balance sheets and assess the effect or potential effect of netting arrangements on a company’s financial position.
The required disclosures
The new rules apply to derivatives as well as to financial instruments such as sale and repurchase agreements, reverse sale and repurchase agreements, and securities borrowing and lending agreements. Companies must disclose the gross amounts subject to offset rights, amounts that have been offset and the related net credit exposure.
Companies are also required to disclose expanded information about collateral pledged in netting arrangements and a description of the offset rights associated with covered assets and liabilities subject to netting arrangements.
Affected companies must apply the new disclosure requirements for annual reporting periods beginning on and after Jan. 1, 2013, and interim periods within those annual periods. The required disclosures should be provided retrospectively. If you have questions about whether the new requirements affect you or how to comply with them, we’d be pleased to help.