Offsetting financial assets and financial liabilities

Presenting gross exposures net makes a bank's balance sheet look smaller and less leveraged than it economically is, so IAS 32's strict two-part test (unconditional current legal right plus intent/mechanism to settle net or simultaneously) exists precisely to stop netting based on a master agreement alone. Getting this wrong overstates or understates total assets and liabilities, distorts leverage and capital ratios computed off the balance sheet, and can mask real gross counterparty exposure.

Does the entity currently hold a legally enforceable right of set-off, enforceable in the normal course of business, on default, and in insolvency, rather than a right conditional only on default? Does the entity actually intend to settle net or to realize the asset and settle the liability simultaneously, as distinct from merely having the ability to do so? Where a master netting agreement is enforceable only on default (not in the ordinary course), is the exposure being presented gross with the net amount disclosed, rather than offset on the balance sheet?

1. Confirm the entity currently has a legally enforceable right of set-off, not merely a contractual mechanism, but a right enforceable in the normal course of business, in default, and in bankruptcy/insolvency of either party.
2. Obtain a legal opinion where enforceability is not obvious, especially across jurisdictions, since bankruptcy law can override contractual netting rights.
3. Confirm the intention criterion: does the entity intend to settle net, or to realize the asset and settle the liability simultaneously (not merely have the ability to do so)?
4. Offset and present net only when both criteria are met at the same time, an unconditional right alone without intent to settle net is not sufficient, and vice versa.
5. Where a master netting agreement exists but the right is enforceable only on default (not in the normal course of business), do not offset on the balance sheet; instead provide the IFRS 7 gross/net disclosure.
6. Reassess the conclusion at each reporting date as facts, legal opinions, or agreements change.

Perform the offsetting assessment based on facts and circumstances at each reporting date, not merely the existence of a master agreement; where conditional rights are enforceable only on default, measure and present the asset and liability gross, but calculate and disclose the net exposure amount (gross amounts less amounts subject to enforceable netting arrangements not qualifying for balance sheet offset) for information purposes.

Disclose, typically in a dedicated offsetting table: (1) gross amounts of recognized financial assets and liabilities; (2) amounts offset in the statement of financial position; (3) net amounts presented; (4) amounts subject to enforceable master netting arrangements or similar agreements not offset on the balance sheet, including financial collateral; (5) the resulting net exposure amount; (6) a description of the rights of set-off and whether they are unconditional or conditional on default.

• Offsetting derivative assets and liabilities under a master netting agreement (e.g., ISDA) on the balance sheet when the right to offset is only enforceable on default, not in the normal course of business
• presenting repo and reverse repo balances net without a genuine simultaneous settlement mechanism and unconditional legal right
• assuming a legal opinion obtained for one jurisdiction or counterparty type automatically extends to all counterparties
• conflating the IFRS 7 gross/net disclosure requirement (which applies more broadly) with the stricter IAS 32 balance sheet offsetting criteria (which are rarely met by conditional netting agreements alone).