ASC 210-20: Rules for Balance Sheet Offsetting

A company’s financial position is captured in its balance sheet, a statement that lists what the entity owns (assets) and what it owes (liabilities). Accounting principles require that assets and liabilities be presented separately on a gross basis. For instance, if a company owes a supplier $10,000 and that same supplier owes it $8,000 for goods purchased, both amounts would typically appear separately on the balance sheet.

There are specific, limited circumstances where these amounts can be combined, or “offset,” into a single net figure. This practice, known as balance sheet offsetting, is governed by strict accounting rules. Instead of showing a $10,000 liability and an $8,000 asset, the company might be permitted to show a single net liability of $2,000.

The primary guidance for this practice is found in the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) Topic 210. This guidance establishes that offsetting is the exception, not the rule, and is only appropriate when a definitive right of setoff exists.

The Core Principle of Setoff

The ability to offset a liability against an asset on the balance sheet hinges on the existence of a “right of setoff.” Four specific conditions must all be satisfied for this right to exist. The failure to meet even one of these conditions means the asset and liability must be presented separately.

The first condition is that each of the two parties owes the other determinable amounts. This means the amounts must be fixed or readily measurable. A company cannot offset a precisely calculated payable against a vague or contingent receivable whose value is unknown. For example, a $50,000 trade receivable and a $50,000 trade payable with the same counterparty are determinable amounts.

The second condition requires that the reporting party has the right to set off the amount it is owed with the amount it owes the other party. This right is not assumed; it must be explicitly established, typically through a contractual agreement between the two parties. The contract would contain a clause granting either party the ability to net their mutual obligations.

The third condition is that the reporting party intends to set off the balances. Having the right to offset is not enough; the company must also plan to exercise that right. This intent is a matter of management policy and can be demonstrated by past practices. If a company has a history of settling similar transactions with a particular counterparty on a net basis, it helps support the assertion of intent for current balances.

The final condition is that the right of setoff must be enforceable at law. This means the contractual right to offset must be legally sound and hold up in all relevant circumstances, including situations of financial distress or bankruptcy of the counterparty. Companies often need to obtain legal opinions to support the enforceability of their setoff rights in the applicable jurisdictions.

Application to Financial Instruments

The principles of setoff are frequently applied to complex financial instruments where two parties have multiple contracts and ongoing obligations with each other. A company might enter into several derivative transactions with the same financial institution. Over time, some of these contracts will be in an asset position (unrealized gains) while others are in a liability position (unrealized losses) for the company.

To manage this complexity, parties often use a master netting arrangement. This single legal contract governs all derivative transactions between them and contains provisions that allow for the netting of payments. If one party defaults, the agreement allows the non-defaulting party to terminate all outstanding contracts and calculate a single net amount to be paid or received. This contractual feature provides the legal basis for the right of setoff and its enforceability.

An important exception exists for derivatives under such agreements, specifically concerning the intent to set off. ASC 815-10 allows for netting even if the company does not intend to settle the gross amounts during the normal course of business. As long as a legally enforceable master netting arrangement is in place that allows for netting in the event of default, the company can present its derivative assets and liabilities with that counterparty on a net basis.

Repurchase agreements (repos) and securities lending transactions are another area where offsetting is common. In a repo, one party sells securities and agrees to buy them back later at a slightly higher price. Both transactions create mutual obligations that may be eligible for offsetting if they meet the four required criteria. Similar to derivatives, these arrangements are often governed by master agreements that establish a legal right of setoff.

Balance Sheet Presentation and Disclosure Requirements

Once a company determines it has a valid right of setoff, it can alter its balance sheet presentation. Instead of showing the gross asset and gross liability separately, the company reports a single net amount. For example, if a company has a derivative asset of $10 million and a derivative liability of $7.5 million with the same counterparty under a master netting agreement, it can present a net derivative asset of $2.5 million.

While offsetting changes the face of the balance sheet, it does not eliminate the need for transparency. To ensure that financial statement users understand the company’s full exposure, detailed disclosures are required in the footnotes. Accounting standards mandate a tabular disclosure that reconciles the gross amounts of the assets and liabilities subject to offsetting with the net amount presented on the balance sheet.

This disclosure must show the gross amounts of the recognized assets and liabilities, the amounts that were offset, and the resulting net amount. The table must also show the amounts of any related financial collateral that was not offset but could be used to reduce the net exposure in the event of default.

These disclosure requirements apply to derivatives, repurchase agreements, and securities lending transactions that are either offset or are subject to an enforceable master netting arrangement. The guidance makes it clear that offsetting is a matter of presentation only and does not mean the underlying assets and liabilities have been legally discharged or derecognized.