Offsetting of Financial Instruments Disclosure in 2013 Annual

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Offsetting of Financial
Instruments
Disclosure in 2013 Annual
Financial Statements
October, 2013
This newsletter is one of a
series to illustrate and explain
significant new IFRS disclosure
requirements applicable
for 2013 annual financial
statements.
Other newsletters in the series
include:
Disclosing Fair Values in
Annual Financial Statements—
Applying IFRS 13
Disclosing Fair Values in
Annual Financial Statements—
Applying IFRS 13 to Investment
Properties (A supplement)
Disclosing Employee Benefits
in 2013 Annual Financial
Statements
Disclosing Interests in Other
Entities in 2013 Annual
Financial Statements
For years starting in 2013, Canadian public companies must adopt an
amendment to IFRS 7, Financial instruments: Disclosures, requiring more
extensive disclosures about offsetting (also known as netting) of financial
instruments. The objective of the new disclosures is to enable users of a
company’s financial statements to evaluate the effect or the potential effect of
netting on the entity’s financial position.
The new rules will require companies to identify and disclose not only the financial
assets and liabilities that have been offset in the statement of financial position but also
those assets and liabilities that would be offset if future events, such as bankruptcy or the
termination of the contracts, were to arise. Identifying these arrangements may require
significant time and effort, and may require the participation of legal counsel.
We have prepared this newsletter to assist companies in understanding and applying these
requirements. The newsletter illustrates and explains the additional disclosures that a
hypothetical company, Sample Co., might provide in its December 31, 2013 annual financial
statements. Sample Co. is a manufacturing company with a calendar year-end. These
illustrations do not consider the special circumstances of financial institutions.
We hope you will find this newsletter helpful. If you have any questions, please do not
hesitate to contact your local PwC representative or office.
Offsetting of financial instruments
Disclosure in 2013 annual financial statements
Note X. Offsetting of financial instruments
Explanatory
Notes (ENs)
Commentary
This note illustrates the minimum disclosures required by IFRS 7 to be included in Sample Co.’s December 31,
2013 annual financial statements. These new requirements are explained in the accompanying notes. The notes
further discuss the relevant judgments that Sample Co. made in applying the new requirements.
The standard is silent as to the location of these disclosures within the financial statements. Sample Co. has
elected to put all offsetting disclosures as a separate note following the disclosure of financial instruments by
measurement category. Other approaches are possible. For example, an entity might include the discussion
about accounting treatment in its accounting policy disclosure note.
This example illustrates one possible format for the disclosures; there may be others.
Financial assets and liabilities are offset and the net amount reported in the statement of financial position where
Sample Co. currently has a legally enforceable right to set-off the recognized amounts and there is an intention to
settle on a net basis or realize the asset and settle the liability simultaneously. In the normal course of business,
Sample Co. enters into various master netting agreements or other similar arrangements that do not meet the
criteria for offsetting in the statement of financial position but still allow for the related amounts to be set off in
certain circumstances, such as bankruptcy or the termination of the contracts.
EN 1
The following table presents the recognized financial instruments that are offset, or subject to enforceable master
netting arrangements or other similar agreements but not offset, as at December 31, 2013 and 2012, and shows in
the ‘Net’ column what the net impact would be on the Company’s statement of financial position if all set-off
rights were exercised.
Financial assets
Amounts offset
Gross
assets
EN 2
EN 3
Gross
liabilities
offset
Amounts not offset
Net amounts
presented
Financial
instruments
Net
Cash
collateral
received
December 31, 2013
Restricted cash (a) (d)
EN 5
PwC
38
$
–
$
38
$
(38)
$
–
$
–
Derivative assets (a) (c)
163
–
163 (1)
(50)
–
113
Trade receivables (b)
506
(86)
420
–
–
420
$ 707
$ (86)
$
621
$
(88)
$
–
$
533
$
$
$
46
$
(46)
$
–
$
–
December 31, 2012
Restricted cash (a) (d)
EN 5
$
46
–
Derivative assets (a)
54
–
54 (1)
(54)
–
–
Trade receivables (b)
397
(101)
296
–
–
296
$ 497
$ (101)
$
396
$
(100)
$
–
$
296
(1) Included in Other Assets of $249 (December 31, 2012 – $190) in the statement of financial position.
2
Offsetting of financial instruments
Disclosure in 2013 annual financial statements
Financial liabilities
Amounts offset
Gross
liabilities
Gross
assets
offset
Amounts not offset
Net
amounts
presented
Financial
instruments
Net
Cash
collateral
pledged
December 31, 2013
EN 4
Derivative liabilities (a)
$
Trade payables (b)
Accrued interest (c)
Bank indebtedness (d)
66
$
–
$
66(2)
$
(48)
$
(18)
$ –
236
(86)
150
–
–
150
8
–
8(2)
(2)
–
6
398
–
398
–
(20)
378
(38)
$534
–
$ 39
$
708
$
(86)
$
622
$
(50)
$
93
$
–
$
93 (2)
$
(54)
$
December 31, 2012
Derivative liabilities (a)
Trade payables (b)
223
(101)
122
–
–
122
Bank indebtedness (d)
256
–
256
–
(46)
210
(54)
$ (46)
$371
$
EN5
EN6
EN4
$
572
$
(101)
$
471
$
(2) Included in Other Liabilities of $113 (December 31, 2012 – $148) in the statement of financial position.
(a) Sample Co. is subject to an enforceable master netting arrangement in the form of an ISDA agreement with a
derivative counterparty. Under the terms of this agreement, offsetting of derivative contracts is permitted
only in the event of bankruptcy or default of either party to the agreement. In order to manage the
counterparty credit risk associated with the long-term option trades, the parties have executed a collateral
support agreement. On every predetermined valuation date, the party with the negative fair value delivers
cash collateral to the party with the positive fair value. As at the last bank valuation date, Sample Co. has
pledged cash of $30 under an ISDA collateral support agreement with respect to the open derivative trades.
Due to the changes in market prices from that date to December 31, 2013, the fair value of the derivative
liability decreased to $18 as at the reporting date. As such, only $18 is disclosed in the table as cash collateral
pledged as at December 31, 2013. There were no open option contracts subject to the collateral support
agreement as at December 31, 2012.
(b) Standard terms of a long-term manufacturing and supply agreement include provisions allowing net
settlement of payments in the normal course of business.
(c) During 2013, Sample Co. issued a non-revolving fixed rate debt under a credit facility with a bank and
simultaneously entered into an interest rate swap with the same bank that effectively converts the fixed
interest payments on the debt to a floating rate. Under the terms of the credit facility, periodic interest
payments due under the debt and the swap are settled net.
(d) Sample Co. has provided cash collateral to the bank of $20 (December 31, 2012 – $46) as a payment
protection under the terms of the revolving loan. The bank has the right to invoke the collateral if the
minimum payment under the revolving portion of the debt is overdue by more than three business days.
PwC
3
Offsetting of financial instruments
Disclosure in 2013 annual financial statements
Requirements
Discussion
1.
Under IFRS 7, entities are now required to disclose information to enable users of its financial
statements to evaluate the effect or potential effect of netting arrangements on the entity's
financial position. This is accomplished by disclosing information about financial assets and
liabilities that are either (1) offset in the statement of financial position in accordance with IAS
32, Financial instruments: Presentation, or (2) not offset but subject to an enforceable master
netting arrangement or similar agreement.
Purpose and scope
of the new IFRS 7
offsetting disclosure
requirements
(IFRS 7.13A-13B and
B40-41)
Critical to the application of the new requirements is the meaning of the terms “enforceable
master netting arrangement” and “other similar agreement”. While IFRS 7 does not specifically
define these terms, IAS 32 describes master netting agreements as follows:
“An entity that undertakes a number of financial instrument transactions with a single
counterparty may enter into a 'master netting arrangement' with that counterparty.
Such an agreement provides for a single net settlement of all financial instruments
covered by the agreement in the event of default on, or termination of, any one
contract. These arrangements are commonly used by financial institutions to provide
protection against loss in the event of bankruptcy or other circumstances that result in
a counterparty being unable to meet its obligations. A master netting arrangement
commonly creates a right of set-off that becomes enforceable and affects the realization
or settlement of individual financial assets and financial liabilities only following a
specified event of default or in other circumstances not expected to arise in the normal
course of business.”
Examples of master netting or other similar agreements include but are not limited to:

Derivatives subject to International Swaps and Derivatives Association (“ISDA”) master
agreements.

Generally, trade receivables and payables with the same counterparty containing standard
commercial provision providing the right to set-off in case of a counterparty’s default.

A loan agreement that requires a borrower to simultaneously enter into a derivative
instrument with the same counterparty to mitigate credit risk.

Trade payables and receivables under a separate rebate agreement (e.g., in the retail and
pharmaceutical industries).

Receivables from car sales and payables relating to incentives and warranties (e.g., master
dealer arrangements in the auto sector).

Repurchase, reverse repurchase, securities borrowing and securities lending agreements.

Any transactions that are regularly settled net in the normal course of business.

Certain commodity or other exchange traded contracts.
There is an ongoing debate on whether the daily margin posted for a futures contract represents
the settlement of the contract (and entering into a new one) or the posting of collateral. We
PwC
4
Offsetting of financial instruments
Disclosure in 2013 annual financial statements
Requirements
Discussion
believe that if margin and periodic cash payments are considered collateral associated with the
open positions, they should be included in the offsetting disclosures. If such amounts are
considered a settlement of an open contract, then they would not be required to be included in
the quantitative offsetting disclosures. Consultation with legal counsel may be considered in
making this determination.
Two categories of financial instruments are specifically excluded from the scope of IFRS 7
offsetting disclosure. These are (1) loans and customer deposits with the same financial
institution (unless they are set off in the statement of financial position), and (2) financial
instruments that can be offset only with non-financial collateral.
Agreements qualify for offsetting or as master netting or other similar arrangements only if they
are enforceable. Determining whether the netting provisions of some agreements, including
manufacturing and supply agreements, are enforceable can be difficult and may require the
involvement of legal counsel. We discuss enforceability further in item 8 below.
After reviewing its contractual arrangements, and in consultation with its legal
counsel, Sample Co. has concluded that (1) the ISDA agreement with the
derivatives counterparty and long-term manufacturing and supply contracts are
enforceable master netting arrangements, and (2) the net interest payment and
collateral provisions under the credit facility are similar arrangements and thus
fall within the scope of the IFRS 7 offsetting disclosure requirements.
2.
Quantitative
disclosures
(IFRS 7.13C)
For financial assets and liabilities within the scope of the standard, entities are required to
disclose certain minimum quantitative information separately for assets and liabilities. This
information is generally presented in the tabular format and includes:
(a) the gross amounts;
(b) the amounts that are set off in the statement of financial position;
(c)
the net amounts presented in the statement of financial position;
(d) the amounts subject to an enforceable master netting arrangement or similar agreement
that are not set off in the statement of financial position including:
(i) amounts related to recognised financial instruments that do not meet some or all of the
criteria for offsetting in the statement of financial position; and
(ii) amounts related to financial collateral (including cash collateral); and
(e)
the net amount after deducting the amounts in (d) from the amounts in (c) above.
IFRS 7 does not require offsetting information to be disclosed in a separate note, but if it is
provided in different notes it is necessary to provide cross-references among the notes.
In Sample Co.’s table:
(i)
PwC
For derivative assets and liabilities covered by footnote (a) to the table, the
‘Net’ column includes potential net settlement amounts, taking into
account any cash collateral pledged or received, that would be paid or
collected, respectively, had all of the open derivative positions been settled
at the reporting date in accordance with the terms of ISDA master
agreement.
5
Offsetting of financial instruments
Disclosure in 2013 annual financial statements
Requirements
3.
Disclosure by type
or by counterparty
(IFRS 7.13D and
B49)
Discussion
(ii)
Gross information is disclosed for trade receivables and trade payables
under the contract explained in footnote (b) to the table that are offset in
the statement of financial position.
(iii)
Accrued amounts of non-revolving loan interest and periodic settlement
amounts under the swap described in footnote (c) to the table are included
in the respective line items as ‘Amounts not offset – Financial instruments’.
(iv)
Net exposure amount for bank indebtedness takes into account cash
collateral pledged.
The standard allows two options for reporting items (c) to (e) above. The entity may either group
this information by type of financial instrument or transaction, or by counterparty. If the entity
choses the latter, it is not required to disclose the names of the specific counterparties but
significant counterparties must be presented separately from the rest. Designation of
counterparties (Counterparty A, Counterparty B, Counterparty C, etc.) must remain consistent
from period to period to maintain comparability. Qualitative disclosures must be considered so
that further information can be given about the types of counterparties.
Sample Co. has decided to present the required information by type of financial
instrument.
4.
Limit on overcollateralized
positions
(IFRS 7.13C(d)(ii)
and B48)
The standard requires a disclosure of the fair value of those financial instruments that have been
pledged or received as collateral. However, it limits the total amount of potential set-off and
collateral that an entity can disclose to the carrying value of the associated financial instrument.
Excess collateral amounts are excluded, unless rights to collateral can be enforced across a
number of financial instruments.
Due to the limit on excess collateral disclosure, the offsetting balances disclosed may not agree
with the existing collateral disclosures required by other parts of IFRS 7. In this case, entities
may wish to provide additional disclosures to explain this.
Sample Co. has included the description of excess collateral provided under the
derivatives in footnote (a) and limited the amount disclosed in ‘Amounts not
offset – Financial instruments’ to $48 to bring the ‘Net’ amount disclosed to $0.
5.
PwC
Reconciliation to
the statement of
financial position
(IFRS 7.13C(c) and
B46)
The net amounts disclosed in the offsetting table must be reconciled to the individual line item
amounts presented in the statement of financial position if an entity determines that the
aggregation or disaggregation of the individual financial statement line item amounts provides
more relevant information.
Sample Co. has explained in the disclosure note that derivative assets, derivative
liabilities and interest accrued are included in Other assets and Other liabilities,
respectively, in the statement of financial position. Further disaggregation of
these balances was not considered necessary. Judgment is involved in
determining the level of disaggregation required. The extent of the Company’s
derivatives and other financial instruments activity as well as its business
purpose should be the drivers of this determination, in addition to materiality
considerations.
6
Offsetting of financial instruments
Disclosure in 2013 annual financial statements
Requirements
Discussion
6.
In addition to prescribed quantitative disclosures, the standard requires entities to provide
certain qualitative disclosures, including the description of the nature of the rights to set-off.
Furthermore, for any financial collateral received or pledged, the entity shall describe the terms
of the collateral agreement (for example, when the collateral is restricted).
Non-quantitative
disclosures
(IFRS 7.13E, B50
and B53)
Sample Co. has provided the descriptions of the nature of the rights of set-off in
the footnotes accompanying the table with quantitative information.
7.
Other disclosures
not illustrated in
this newsletter
(IFRS 7.13F)
8. Future changes –
Clarifications of the
scope of offsetting
of financial
instruments under
IAS 32
If the required information is disclosed in more than one note to the financial statements, an
entity is required to provide a cross-reference between these notes.
As financial instruments within the scope of the disclosures may be subject to different
measurement requirements (for example amortized cost or fair value), entities are required to
describe any resulting measurement difference in the related disclosures.
The IASB has amended the application guidance in IAS 32, Financial instruments:
Presentation, to clarify some of the requirements for offsetting financial assets and financial
liabilities on the statement of financial position. This amendment is effective for annual periods
beginning on or after 1 January 2014.
The amendments do not change the current offsetting model in IAS 32, which requires an entity
to offset a financial asset and financial liability in the statement of financial position only when
the entity currently has a legally enforceable right of set-off and intends either to settle the asset
and liability on a net basis or to realize the asset and settle the liability simultaneously. Rather,
the amendments clarify that the right of set-off must be available today – that is, it is not
contingent on a future event – and must be legally enforceable for all counterparties in the
normal course of business, as well as in the event of default, insolvency or bankruptcy. As a
result, 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, continue not to meet the
offsetting requirements.
The amendments also clarify 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
therefore satisfy the IAS 32 criterion in these instances.
It is possible that application of the amendments may cause an entity to change its existing
offsetting policies.
PwC
7
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