FASB and the IASB today issued investor-focused common disclosure requirements on the effect or potential effect of offsetting arrangements on a company’s financial position.
U.S. GAAP and IFRS differ on the criteria for offsetting, also known as netting. Offsetting presents net amounts of assets and liabilities in the balance sheet as a result of an entity’s rights of set-off.
Neither IFRS nor U.S. GAAP previously required disclosure of all amounts set off in the balance sheet, and that prevented investors from comparing the rights of set-off between entities applying IFRS and U.S. GAAP.
Companies and organizations use rights of set-off as a risk management tool to reduce counterparty credit risk and manage liquidity risk. Enforceability of rights of set-off vary by contract and jurisdiction, according to an IFRS project summary.
U.S. GAAP allows companies to set off their derivative assets and derivative liabilities in the balance sheet if there is an agreement to set off, even if that right of set-off is only available in the case of bankruptcy or default. IFRS does not give companies that option.
This meant that a balance sheet prepared in accordance with U.S. GAAP would generally present smaller amounts of these assets and liabilities than a balance sheet prepared in accordance with IFRS standards, the project summary states.
To address the differences, FASB and the IASB issued an exposure draft in January 2011 proposing new, joint criteria that were narrower than the current U.S. GAAP conditions. But after receiving feedback, the boards chose to retain their existing offsetting models and instead issue new disclosure requirements to allow investors to better compare financial statements prepared in accordance with IFRS or U.S. GAAP.
The new rules will require entities to disclose gross amounts subject to rights of set-off, amounts set off in accordance with the accounting standards followed, and the related net credit exposure, according to the IASB. The boards concluded that this will help investors understand the extent of set-off in a balance sheet and the effects of rights of set-off on the entity’s rights and obligations. The requirements are intended to improve transparency in the reporting of how companies mitigate credit risk, including disclosure of related collateral pledged or received.
“The expanded disclosures are responsive to the feedback we received from investors, who wanted to understand both the gross and net amounts for items offset in accordance with legally enforceable netting arrangements,” FASB Chairman Leslie Seidman said in a statement. “We are also requiring expanded information about the collateral pledged in these arrangements.”
The disclosure requirements take effect for annual periods beginning Jan. 1, 2013, and interim periods within those annual periods. Retrospective application will be required to maximize comparability between periods.
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