Learning Outcomes
This article covers the presentation and disclosure requirements of IAS 32 and IFRS 7 with particular focus on offsetting financial assets and liabilities and the classification and disclosure of own equity instruments. You will learn to apply the strict offsetting criteria, distinguish equity from liability, and understand key disclosures relevant to financial reporting. These are core areas for the ACCA SBR exam.
ACCA Strategic Business Reporting (SBR) Syllabus
For ACCA Strategic Business Reporting (SBR), you are required to understand how to present and disclose information about financial instruments in line with IAS 32 and IFRS 7. The following syllabus areas are addressed in this article:
- The principles relating to the offsetting of financial assets and financial liabilities
- The criteria for classification of financial instruments as liabilities or equity
- The presentation and disclosure of own equity instruments within the financial statements
- The requirements for disclosure about offsetting, including reconciliations and risk implications
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- Under what circumstances can a company offset a financial asset and a financial liability on the statement of financial position?
- A company repurchases its own shares. How should these be presented in the statement of financial position according to IAS 32?
- True or false? Offsetting is permitted solely because an entity expects to settle assets and liabilities on a net basis in the normal course of business.
- List two disclosures required by IFRS 7 for financial instruments subject to offsetting.
Introduction
IAS 32 and IFRS 7 set out the rules on how financial instruments are classified, presented, and disclosed. A core principle is the clear and appropriate presentation of an entity’s financial position. This includes the strict treatment of offsetting financial assets and liabilities and the correct accounting for transactions in an entity’s own equity instruments. Offsetting reduces the gross amounts recognized, which affects reported assets and liabilities. Meanwhile, how an entity accounts for its own equity instruments (e.g., treasury shares) impacts reported equity and the understanding stakeholders have of capital structure.
Key Term: Financial instrument
A contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
PRESENTATION: OFFSETTING CRITERIA
IAS 32 generally forbids the offsetting of financial assets and financial liabilities except under strict conditions. Offsetting is only appropriate when it results in the presentation of the entity’s actual rights and obligations, not just intentions or expectations.
Key Term: Offsetting
The presentation of a net amount for a financial asset and a financial liability in the statement of financial position, instead of showing gross amounts.
The Two-Point Test
An entity may only offset a financial asset and a financial liability when both of the following criteria are met:
- The entity currently has a legally enforceable right to set off the recognised amounts.
- The entity intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.
Both conditions must be satisfied at the reporting date—not just based on normal practice, but according to legal enforceability.
Key Term: Legally enforceable right
The right that is enforceable in all circumstances, including insolvency and default, not just in normal operations.
Transactions Not Eligible for Offsetting
Offsetting is not permitted merely because:
- The entity expects to receive and pay similar amounts.
- The entity engages in related transactions with the same counterparty.
- Balances arise from different instruments (e.g., a deposit and a loan).
Exam Warning
Offsetting is not allowed just because an entity expects to settle amounts on a net basis or uses netting as part of order processing. The legal right to offset and simultaneous gross settlement is mandatory.
Practical Significance
The requirements for offsetting ensure that financial statements present the economic substance of transactions rather than simply reducing reported totals. Incorrect offsetting could materially misstate an entity’s gearing and risk exposure.
Worked Example 1.1
A company holds a deposit of $2 million at Bank Z and also has a $1.5 million loan from Bank Z. The agreements for both do not include legal rights of set-off, but management expects net settlement.
Should the company offset these balances?
Answer:
No. Offset is not permitted because there is no legally enforceable right to set off the deposit and the loan. Expectation of net settlement is not sufficient.
Netting Arrangements and Umbrella Agreements
Umbrella netting arrangements are common in derivative transactions. If an umbrella agreement gives the legal right to offset all individual contracts covered, offsetting is permitted provided simultaneous settlement occurs or netting is legally enforceable in all circumstances.
Worked Example 1.2
Two companies have entered into an umbrella netting agreement for a group of derivatives. At the year-end, the fair value of derivatives with counterparty X is a $500,000 asset and a $600,000 liability. The umbrella agreement is legally enforceable.
How should these be presented?
Answer:
If net settlement is intended and legally enforceable at all times (including bankruptcy), the entity presents a net liability of $100,000.
OWN EQUITY INSTRUMENTS (TREASURY SHARES AND MORE)
IAS 32 defines how entities must account for transactions in their own equity instruments, such as share repurchases (treasury shares) or issuing shares to settle obligations.
Key Term: Own equity instruments
Shares or other equity instruments issued by the entity and reacquired, held, or reissued by the entity itself.
Presentation of Own Equity Instruments
When an entity acquires its own equity instruments (e.g., via buy-back), these instruments must be deducted directly from equity, not recognised as a financial asset. Any subsequent resale or reissue does not affect profit or loss but is also recognised in equity.
Key Term: Treasury shares
Own equity instruments held by the entity itself, pending cancellation, reissuance, or other disposition.Key Term: Equity instrument
Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
Worked Example 1.3
A company repurchases 50,000 of its own shares at $4 each for $200,000. The shares are held as treasury shares and not cancelled.
How should this transaction be presented?
Answer:
The $200,000 is deducted from equity as 'treasury shares'. No gain or loss is recognised in profit or loss, regardless of the repurchase price.
Cancellation and Reissue
If the repurchased shares are later cancelled, the amount deducted remains in equity. If the shares are reissued at a price higher or lower than the repurchase cost, any difference is also recorded within equity—not in the statement of profit or loss.
DISCLOSURE REQUIREMENTS (IFRS 7)
IFRS 7 mandates disclosures to inform users about the significance of financial instruments and offsetting arrangements. Entities must disclose:
- The gross amounts of recognised financial assets and liabilities subject to offsetting.
- The amounts offset in accordance with IAS 32.
- The net amounts presented in the statement of financial position.
- Amounts subject to enforceable umbrella netting agreements or similar arrangements that are not offset.
These disclosures allow users to assess the real exposure to credit risk and the effects of offsetting.
Worked Example 1.4
ABC Ltd has $8 million recognised in financial assets and $6 million in financial liabilities subject to an umbrella netting agreement, of which only $5 million can be offset under IAS 32.
What should be disclosed?
Answer:
Disclose $8 million gross recognised assets, $5 million offset per IAS 32, and $3 million net assets presented. Also, reconcile residual netting agreements and exposures not offset.
Summary
IAS 32 prohibits offsetting except when offset criteria are strictly met: a currently enforceable legal right and intent to net settle or realize and settle simultaneously. Own equity instruments, including treasury shares, are always deducted from equity, never shown as financial assets or liabilities, with no impact on profit or loss. IFRS 7 requires extensive disclosures about offsetting to inform users of the real exposures and effects.
Key Point Checklist
This article has covered the following key knowledge points:
- Define and apply the offsetting criteria for financial assets and liabilities under IAS 32
- Explain when offsetting is not permitted even if net settlement is expected
- Describe the correct presentation of own equity instruments, including treasury shares
- Recognise that repurchases and resales of own shares are shown only within equity
- List the key IFRS 7 disclosures for offsetting and exposure to credit risk
Key Terms and Concepts
- Financial instrument
- Offsetting
- Legally enforceable right
- Own equity instruments
- Treasury shares
- Equity instrument