Offsetting a financial asset and a financial liability

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Some guy
Posts: 5
Joined: 30 Nov 2021, 20:39

Offsetting a financial asset and a financial liability

Post by Some guy »

Hey all,

I have another financial instrument question that continues down the path started from my previous question I posted (viewtopic.php?f=4&t=794)

Summary:
* Company has fixed rate debt and measures it at amortized cost
* Entered into floating interest rate swap (receive fixed, pay variable)
* Debt is with Bank A and the swap contract is with Bank B
* Applying hedge accounting (fair value hedge)
* On reporting dates the fair value of the SWAP is reclassified from the PnL and recorded against the Debt.

The last bullet is from where my question originates. Logically, this reclassification to the debt is what we're looking to accomplish, but then I came across IAS 32 par 42 which outlines when we can offset financial assets and liabilities.

To offset we need to have the enforeable right and intend either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

Furthermore IAS 32 AG39 states:
The Standard does not provide special treatment for so‑called ‘synthetic instruments’, which are groups of separate financial instruments acquired and held to emulate the characteristics of another instrument. For example, a floating rate long‑term debt combined with an interest rate swap that involves receiving floating payments and making fixed payments synthesises a fixed rate long‑term debt. Each of the individual financial instruments that together constitute a ‘synthetic instrument’ represents a contractual right or obligation with its own terms and conditions and each may be transferred or settled separately. Each financial instrument is exposed to risks that may differ from the risks to which other financial instruments are exposed. Accordingly, when one financial instrument in a ‘synthetic instrument’ is an asset and another is a liability, they are not offset and presented in an entity’s statement of financial position on a net basis unless they meet the criteria for offsetting in paragraph 42.
AG39 seems to say that 'synthetic instruments' do not receive any special treatment and would still need to comply with paragraph 42 in order to offset the presentation of financial assets and liabilities. In our case the debt and the swap contracts are with different banks, so we have no enforceable right to set off.

I find the above is at odds with all examples I have seen on hedge accounting and its presentation.

What obvious aspect am I not seeing or misunderstanding?
DJP
Trusted Expert
Posts: 345
Joined: 26 Jun 2020, 15:57

Re: Offsetting a financial asset and a financial liability

Post by DJP »

Hello. There seems to be some confusion here. This has nothing to do with offsetting.

I understand that you are applying hedge accounting (fair value) on your swap. Please note that your last bullet is not correct: "On reporting dates the fair value of the SWAP is reclassified from the PnL and recorded against the Debt."
You don't reclassify the fair value of the swap from PnL. Your swap will be accounted for at fair value and the fair value changes are recognised in PnL (and stay there). What you do when applying fair value hedge accounting is that you will book fair value changes (only due to changes in the risk being hedged) on top of the amortised cost of your debt; those fair value changes are booked in PnL to "meet" the fair value changes of your swap.

Hope this helps.
Some guy
Posts: 5
Joined: 30 Nov 2021, 20:39

Re: Offsetting a financial asset and a financial liability

Post by Some guy »

Thanks for your input DJP,

Regarding the offsetting, I realized I was wrong in my assessment last night. Thanks for confirming.

With regards to the accounting for a fair value hedge on a debt measured at amortized cost, assuming the hedge is perfectly effective I believe the way you and I described it would land us on the same spot.

For reference I'm basing the fair value hedge accounting on a debt measured at amortized cost on the PwC Illustration 6 (page 156 of the pdf)
https://www.pwc.com/gx/en/audit-service ... ifrs-9.pdf

In the example it has 2 types of hedges. A "long term" fair value hedge and a "short term" cash flow hedge. I'm basing myself on the former.
Some guy
Posts: 5
Joined: 30 Nov 2021, 20:39

Re: Offsetting a financial asset and a financial liability

Post by Some guy »

To avoid confusion, I agree with your description and believe its the accepted way to describe it.

Thanks again.
DJP
Trusted Expert
Posts: 345
Joined: 26 Jun 2020, 15:57

Re: Offsetting a financial asset and a financial liability

Post by DJP »

👌 good luck!
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