Introduction

For offsetting purposes under IAS 32, the set of requirements is, and always has been; (i) a legal basis, (ii) the legal enforceable right to offset (iii) the intention to settle. In the past it was argued that, though it seems a contradiction in termini, the intention can only be demonstrated by actual settlement, otherwise there is no intention. Hence the latter was facilitated for cash pools by various ways of physically offsetting balances (transfers) at a certain point in time in the year.

One of the suggested “alternatives” is the physical offset (usually SWAP) that occurs exactly on the reporting date itself, quarter-end for example (irrespective the underlying contract). These quarter-end SWAPS may effectively extinguish assets and liabilities on the reporting date itself (a few days of the year), but what about meeting the IAS 32 requirements as indicated above? What about the legal basis, the enforceable right and intention? One could argue that this zero balancing exactly on the reporting date could completely circumvent the IAS 32 requirements due to its specific timing. This is tricky (form over substance).

However, what it achieves, is enabling the auditor to simply examine and record account balances on the date of reporting, which are netted. The rest (legal basis and enforceable right) is often disregarded. Reason might be that not all of the requirements can be met in the first place. Or alternatively the auditor prefers to avoid the discussion altogether, and therefore opts for this approach.

It is far more difficult to actually meet the requirements as set forth by the accounting standards, and accordingly base the offset on the balance sheet thereon. Physical offset could still take place, but not necessarily on the reporting date (which may be even better). Difficult, yes, but surely not impossible. And certainly rewarding, as it will bring a valuable long term solution, once implemented correctly and consequently approved. How? Well, IFRIC (the IFRS In­ter­pre­ta­tions Committee) may have provided us with interesting guidance, though a bit cryptic.

Recently, IFRIC concluded that;

  • periodical settlement doesn’t necessarily show intention (more precisely; if settlement does not occur, it doesn’t necessarily indicate there is no intention, whilst meanwhile, if settlement does occurs, it doesn’t necessarily indicate there is an intention),
  • what classifies as intention needs to be determined by the company itself.

 

Intention:[in-ten-shuh n]

The act or fact of intending; determination to do a specified thing or act in a specified manner; anything intended or planned; aim, end, or purpose; an aim that guides action.

 

How it all got started

In November 2015, the IFRIC discussed whether par­tic­u­lar cash pooling arrange­ments would meet the re­quire­ments for off­set­ting in IAS 32. Specifically, whether the regular physical transfers of balances (but not at the reporting date) into a netting account would be sufficient to demonstrate an intention to settle the entire period-end account balances on a net basis in accordance with paragraph 42(b) of IAS 32. This was followed in April 2016, by an Agenda Rejection Notice (ARN) on off-setting and cash pool arrangements. Although ARNs do not have an official status, it does provide insight in how transactions and events should be accounted for.

The In­ter­pre­ta­tions Committee ten­ta­tively decided that the issue should not be taken into its agenda because (i) many different types of cash pooling arrange­ments exist in practice and that, con­se­quently, the de­ter­mi­na­tion of what con­sti­tutes an intention to settle on a net basis would depend on the in­di­vid­ual facts and cir­cum­stances of each case; and (ii) the results of the outreach did not suggest that the par­tic­u­lar type of cash pooling arrange­ment described by the submitter was wide­spread.

Considerations

For the purposes of the analysis, the Interpretations Committee considered a cash pooling arrangement involving a number of subsidiaries within a group, each of which have legally separate bank accounts. Both the bank and the group have the necessary legally enforceable right to set off balances in these bank accounts in accordance with paragraph 42(a) of IAS 32. Interest is calculated on a notional basis using the net balance of all the separate bank accounts. In addition, the group instigates regular physical transfers of balances into a single netting account. However, such transfers are not required under the terms of the arrangement and are not performed at the reporting date. Furthermore, based on expected activity, the period end balances may change prior to the next net settlement date as group entities place further cash on deposit or withdraw cash to settle other obligations.

In considering whether the group could demonstrate an intention to settle on a net basis in accordance with paragraph 42(b) of IAS 32, the Interpretations Committee observed that:

  • as highlighted in paragraph 46 of IAS 32, net presentation more appropriately reflects the amounts and timings of the expected future cash flows only when there is an intention to exercise a legally enforceable right to set off; and
  • in accordance with paragraph 47 of IAS 32, when assessing whether there is an intention to net settle, an entity should consider normal business practices, the requirements of the financial markets and other circumstances that may limit the ability to settle net.

Consequently, within the context of the particular cash pooling arrangement described by the submitter, the Interpretations Committee noted;

that the entity should consider the guidance above in order to assess whether, at the reporting date, there is an intention to settle individual account balances on a net basis or whether the intention is for various entities within the group to use those individual account balances for other purposes prior to the next net settlement date

In this regard, the Interpretations Committee observed that in the example presented, it is stated that prior to the next net settlement date the period end balances may change as group entities place further cash on deposit or withdraw cash to settle other obligations. Because the entity does not expect to settle the period end balances on a net basis due to the expected future activity prior to the next net settlement date, the Interpretations Committee noted that it would not be appropriate for the entity to assert that it had the intention to settle the entire period-end balances on a net basis. This is because presenting these balances net would not appropriately reflect the amounts and timings of the expected future cash flows, taking into account the entity’s normal business practice. However, the Interpretations Committee also observed that in other cash pooling arrangements, an entity may not expect the period end balances to change prior to the next net settlement date and consequently it was noted that an entity would be required to apply its judgement in determining whether there was an intention to settle on a net basis in those circumstances.

In Conclusion

In order to achieve offset, companies need to determine themselves what “intention” in their specific situation exactly is. This needs to be comprehensively identified, and is not simply achieved by performing netting. Cases differ due to the specific situation or business of a company, in combination with what is stated in the agreement. This includes a legal basis and the legal enforceable right to offset. There is not one common factor, but it varies per company. Nevertheless, I’m certain some cash management experts have already sorted this out and have enhanced their product offering accordingly. In one of my earlier posts  I underlined the importance of strategic partnerships with trusted advisors. This is typically a situation where this may pay off.

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