FRC Thematic Review: Offsetting in the financial statements

The FRC has published its latest Thematic Review: Offsetting in the financial statements which summarises areas of good practice and opportunities for improvement identified from routine work and by working with other FRC departments, focusing on areas of offsetting that were most frequently challenged.

The report does not intend to cover all aspects of the requirements for offsetting, however it does provide analysis of the key offsetting issues observed by the Corporate Reporting Review (CRR) team in the last four years.

In this blog we take a look at the key findings and lessons which can be learned by those preparing or auditing accounts of all companies where offsetting (also known as ‘netting’) is applicable, specifically focusing on the top areas where the CRR reported issues in.

Summary of offsetting accounting requirements

The thematic review includes a summary of offsetting accounting requirements confirming that, in general, offsetting assets and liabilities, income and expenses or cash inflows and outflows is prohibited under IFRSs, except in a few circumstances when it is required or permitted.

There are two instances where offsetting is required in all instances and without conditions; cash flow on a business acquisition or disposal net of the cash acquired or disposed and consideration received on disposal of a non-current asset net of the carrying amount and selling expenses.

In addition to this, if set conditions are met, offsetting is also required on financial instrument balances, income tax balances, defined benefit deficits and surpluses.

Transactions that reflect substance are also instances where offsetting (subject to conditions being met) is required. An example of this could be deducting from the amount of consideration received on disposal of non-current asset the carrying amount of that asset and any related expenses to present a net gain or loss on disposal. These transactions could also arise from a group of similar transactions: for example, gains and losses from foreign exchange or those arising on financial instruments held for trading.

Instances where offsetting is permitted include provision expense and reimbursement income; government grants and income; and expenses from a group of reinsurance contracts. Additionally, if conditions are satisfied cash flows from operating (direct method), investing and financing activities may also be offset.

Cash flow statement

Areas where the cash flow statement was commonly challenged included instances where companies that present net cash flow in relation to short-term borrowings within financing activities where the liquidity risk disclosures show a maturity period of greater than three months.

Another area of the cash flow statement which was challenged included where a company’s bank overdraft has remained as a liability over several previous reporting dates and is included in cash and cash equivalents. The FRC may ask the company to explain how such an overdraft meets the definition of cash and cash equivalents.

The Thematic Review also provides areas of good practice which included disclosure that enable users to reconcile cash outflows in relation to the acquisition of subsidiaries included in the cash flow statement to the corresponding business combination disclosures.

Other areas of good practice disclosures included describing whether bank overdrafts or other short-term borrowings are included within cash and cash equivalents in the statement of cash flows. Also, whether overdrafts of short-terms borrowings are offset against the cash and cash equivalents shown in the statement of financial position.  

Financial instruments

Although the thematic review does point out areas of good practice (disclosures in relation to offsetting financial instruments), key areas of challenge around offsetting financial instruments included:

• where the offsetting criteria did not apply to income and expenses (or gains and losses) from financial instruments
• the offsetting of positive bank balances and overdrafts that form port of a notional cash pooling arrangement
• where an overdraft balance exceeds the overdraft in the consolidated accounts and no explanation is

Provisions

Where applicable, companies should disclose an accounting policy to present reimbursement income gross or net of the related provision expense in the income statement and apply it consistently.

An area of challenge that the review mentioned in regard to provisions was where companies that have recognised a provision and disclose that all or part of the related expenditure may be reimbursed by another party, but the accounting treatment applied to this reimbursement is not clear from the accounts.

Other areas

Other areas of challenge included:

Income taxes where the first part of the conditions includes a legally enforceable right to offset current tax assets and liabilities. Where this is not the case then offsetting in income taxes would not be permitted.

Revenue from contracts with customers when (or as) a performance obligation is satisfied, revenue should be recognised as the amount of consideration to which is expected in exchange for transferring promised goods or services. This could in some circumstances be shown as net of certain charges depending on the contractual terms agreed.

Employee benefits are also areas where offsetting could be permitted under certain situations. These are highlighted in paragraph 131 of IAS 19 and are specific to defined benefit assets and liabilities relating to different plans.

Interim Financial Reporting - although IAS 34 does not contain a specific requirement for disclosures on offsetting, it does however require an entity to include explanations of events and transactions that are significant to an understanding of the changes in financial position and performance since the end of the last reporting period. Offsetting could be one of these changes where it was not applied previously. In regard to IFRS 5, non-current assets held for sale and discontinued operations where assets or liabilities of a disposal group classified as held for sale are presented separately from other assets or liabilities in the statement of financial position. Those assets and liabilities are not offset.

How can Mercia help?

Mercia offers a range of training courses and support products including manuals to aid compliance with the regulations. We also offer a comprehensive technical query service for advice on your specific circumstances.