FASB and the IASB have decided to follow different paths in how companies will offset financial assets and financial liabilities, especially derivatives, on the face of the balance sheet.
The boards are working jointly on writing new rules for when companies would be allowed to offset financial assets and financial liabilities on the balance sheet, a practice also known as “netting.” FASB and the IASB issued proposed standards that would bring U.S. rules closer to existing international rules and dramatically gross up U.S. balance sheets; now they are working through the feedback to determine how they will tweak the final standard.
The IASB has chosen an approach similar to its existing rules that would allow netting both in the normal course of business and in bankruptcy, insolvency, default, or any other case where an entity intends to settle a given financial asset and financial liability net or simultaneously. The majority of FASB members, however, support a different approach where derivatives are concerned—something closer to what is currently permitted under U.S. GAAP. Financial institutions in particular called on FASB to retain current allowances for companies to net derivatives that are subject to master netting agreements, and FASB has decided to permit it.
The new rules are significant because they will drive the total assets and liabilities that companies will report on their balance sheets, which in turn is critical to leverage and other key metrics that have a bearing on debt covenants and contractual agreements. The two boards have agreed if they will go different directions on netting that will allow for critical differences in those balance sheet metrics, they will at least fill the gap with disclosure requirements that will enable users of financial statements to sort out the differences.
Experts commented that the inability of the two boards to agree on the netting issue will allow one of the most significant disparities in IFRS vs. GAAP balance sheets to continue.