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Offsetting of Financial Instruments Disclosure in 2013 Annual Financial Statements October, 2013 This newsletter is one of a series to illustrate and explain significant new IFRS disclosure requirements applicable for 2013 annual financial statements. Other newsletters in the series include: Disclosing Fair Values in Annual Financial Statements— Applying IFRS 13 Disclosing Fair Values in Annual Financial Statements— Applying IFRS 13 to Investment Properties (A supplement) Disclosing Employee Benefits in 2013 Annual Financial Statements Disclosing Interests in Other Entities in 2013 Annual Financial Statements

For years starting in 2013, Canadian public companies must adopt an amendment to IFRS 7, Financial instruments: Disclosures, requiring more extensive disclosures about offsetting (also known as netting) of financial instruments. The objective of the new disclosures is to enable users of a company’s financial statements to evaluate the effect or the potential effect of netting on the entity’s financial position. The new rules will require companies to identify and disclose not only the financial assets and liabilities that have been offset in the statement of financial position but also those assets and liabilities that would be offset if future events, such as bankruptcy or the termination of the contracts, were to arise. Identifying these arrangements may require significant time and effort, and may require the participation of legal counsel. We have prepared this newsletter to assist companies in understanding and applying these requirements. The newsletter illustrates and explains the additional disclosures that a hypothetical company, Sample Co., might provide in its December 31, 2013 annual financial statements. Sample Co. is a manufacturing company with a calendar year-end. These illustrations do not consider the special circumstances of financial institutions. We hope you will find this newsletter helpful. If you have any questions, please do not hesitate to contact your local PwC representative or office.

Offsetting of financial instruments Disclosure in 2013 annual financial statements

Note X. Offsetting of financial instruments

Explanatory Notes (ENs)

Commentary This note illustrates the minimum disclosures required by IFRS 7 to be included in Sample Co.’s December 31, 2013 annual financial statements. These new requirements are explained in the accompanying notes. The notes further discuss the relevant judgments that Sample Co. made in applying the new requirements. The standard is silent as to the location of these disclosures within the financial statements. Sample Co. has elected to put all offsetting disclosures as a separate note following the disclosure of financial instruments by measurement category. Other approaches are possible. For example, an entity might include the discussion about accounting treatment in its accounting policy disclosure note. This example illustrates one possible format for the disclosures; there may be others.

Financial assets and liabilities are offset and the net amount reported in the statement of financial position where Sample Co. currently has a legally enforceable right to set-off the recognized amounts and there is an intention to settle on a net basis or realize the asset and settle the liability simultaneously. In the normal course of business, Sample Co. enters into various master netting agreements or other similar arrangements that do not meet the criteria for offsetting in the statement of financial position but still allow for the related amounts to be set off in certain circumstances, such as bankruptcy or the termination of the contracts. EN 1

The following table presents the recognized financial instruments that are offset, or subject to enforceable master netting arrangements or other similar agreements but not offset, as at December 31, 2013 and 2012, and shows in the ‘Net’ column what the net impact would be on the Company’s statement of financial position if all set-off rights were exercised.

Financial assets

Amounts offset Gross assets

EN 2 EN 3

Gross liabilities offset

Amounts not offset

Net amounts presented

Financial instruments

Net

Cash collateral received

December 31, 2013 Restricted cash (a) (d)

EN 5

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38

$

–

$

38

$

(38)

$

–

$

–

Derivative assets (a) (c)

163

–

163 (1)

(50)

–

113

Trade receivables (b)

506

(86)

420

–

–

420

$ 707

$ (86)

$

621

$

(88)

$

–

$

533

$

$

$

46

$

(46)

$

–

$

–

December 31, 2012 Restricted cash (a) (d)

EN 5

$

46

–

Derivative assets (a)

54

–

54 (1)

(54)

–

–

Trade receivables (b)

397

(101)

296

–

–

296

$ 497

$ (101)

$

396

$

(100)

$

–

$

296

(1) Included in Other Assets of $249 (December 31, 2012 – $190) in the statement of financial position.

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Offsetting of financial instruments Disclosure in 2013 annual financial statements

Financial liabilities

Amounts offset Gross liabilities

Gross assets offset

Amounts not offset

Net amounts presented

Financial instruments

Net

Cash collateral pledged

December 31, 2013

EN 4

Derivative liabilities (a)

$

Trade payables (b) Accrued interest (c) Bank indebtedness (d)

66

$

–

$

66(2)

$

(48)

$

(18)

$ –

236

(86)

150

–

–

150

8

–

8(2)

(2)

–

6

398

–

398

–

(20)

378

(38)

$534

–

$ 39

$

708

$

(86)

$

622

$

(50)

$

93

$

–

$

93 (2)

$

(54)

$

December 31, 2012 Derivative liabilities (a) Trade payables (b)

223

(101)

122

–

–

122

Bank indebtedness (d)

256

–

256

–

(46)

210

(54)

$ (46)

$371

$

EN5 EN6

EN4

$

572

$

(101)

$

471

$

(2) Included in Other Liabilities of $113 (December 31, 2012 – $148) in the statement of financial position.

(a) Sample Co. is subject to an enforceable master netting arrangement in the form of an ISDA agreement with a derivative counterparty. Under the terms of this agreement, offsetting of derivative contracts is permitted only in the event of bankruptcy or default of either party to the agreement. In order to manage the counterparty credit risk associated with the long-term option trades, the parties have executed a collateral support agreement. On every predetermined valuation date, the party with the negative fair value delivers cash collateral to the party with the positive fair value. As at the last bank valuation date, Sample Co. has pledged cash of $30 under an ISDA collateral support agreement with respect to the open derivative trades. Due to the changes in market prices from that date to December 31, 2013, the fair value of the derivative liability decreased to $18 as at the reporting date. As such, only $18 is disclosed in the table as cash collateral pledged as at December 31, 2013. There were no open option contracts subject to the collateral support agreement as at December 31, 2012. (b) Standard terms of a long-term manufacturing and supply agreement include provisions allowing net settlement of payments in the normal course of business. (c) During 2013, Sample Co. issued a non-revolving fixed rate debt under a credit facility with a bank and simultaneously entered into an interest rate swap with the same bank that effectively converts the fixed interest payments on the debt to a floating rate. Under the terms of the credit facility, periodic interest payments due under the debt and the swap are settled net. (d) Sample Co. has provided cash collateral to the bank of $20 (December 31, 2012 – $46) as a payment protection under the terms of the revolving loan. The bank has the right to invoke the collateral if the minimum payment under the revolving portion of the debt is overdue by more than three business days.

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Offsetting of financial instruments Disclosure in 2013 annual financial statements

Requirements

Discussion

1.

Under IFRS 7, entities are now required to disclose information to enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on the entity's financial position. This is accomplished by disclosing information about financial assets and liabilities that are either (1) offset in the statement of financial position in accordance with IAS 32, Financial instruments: Presentation, or (2) not offset but subject to an enforceable master netting arrangement or similar agreement.

Purpose and scope of the new IFRS 7 offsetting disclosure requirements (IFRS 7.13A-13B and B40-41)

Critical to the application of the new requirements is the meaning of the terms “enforceable master netting arrangement” and “other similar agreement”. While IFRS 7 does not specifically define these terms, IAS 32 describes master netting agreements as follows: “An entity that undertakes a number of financial instrument transactions with a single counterparty may enter into a 'master netting arrangement' with that counterparty. Such an agreement provides for a single net settlement of all financial instruments covered by the agreement in the event of default on, or termination of, any one contract. These arrangements are commonly used by financial institutions to provide protection against loss in the event of bankruptcy or other circumstances that result in a counterparty being unable to meet its obligations. A master netting arrangement commonly creates a right of set-off that becomes enforceable and affects the realization or settlement of individual financial assets and financial liabilities only following a specified event of default or in other circumstances not expected to arise in the normal course of business.” Examples of master netting or other similar agreements include but are not limited to: 

Derivatives subject to International Swaps and Derivatives Association (“ISDA”) master agreements.



Generally, trade receivables and payables with the same counterparty containing standard commercial provision providing the right to set-off in case of a counterparty’s default.



A loan agreement that requires a borrower to simultaneously enter into a derivative instrument with the same counterparty to mitigate credit risk.



Trade payables and receivables under a separate rebate agreement (e.g., in the retail and pharmaceutical industries).



Receivables from car sales and payables relating to incentives and warranties (e.g., master dealer arrangements in the auto sector).



Repurchase, reverse repurchase, securities borrowing and securities lending agreements.



Any transactions that are regularly settled net in the normal course of business.



Certain commodity or other exchange traded contracts.

There is an ongoing debate on whether the daily margin posted for a futures contract represents the settlement of the contract (and entering into a new one) or the posting of collateral. We

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Offsetting of financial instruments Disclosure in 2013 annual financial statements

Requirements

Discussion believe that if margin and periodic cash payments are considered collateral associated with the open positions, they should be included in the offsetting disclosures. If such amounts are considered a settlement of an open contract, then they would not be required to be included in the quantitative offsetting disclosures. Consultation with legal counsel may be considered in making this determination. Two categories of financial instruments are specifically excluded from the scope of IFRS 7 offsetting disclosure. These are (1) loans and customer deposits with the same financial institution (unless they are set off in the statement of financial position), and (2) financial instruments that can be offset only with non-financial collateral. Agreements qualify for offsetting or as master netting or other similar arrangements only if they are enforceable. Determining whether the netting provisions of some agreements, including manufacturing and supply agreements, are enforceable can be difficult and may require the involvement of legal counsel. We discuss enforceability further in item 8 below. After reviewing its contractual arrangements, and in consultation with its legal counsel, Sample Co. has concluded that (1) the ISDA agreement with the derivatives counterparty and long-term manufacturing and supply contracts are enforceable master netting arrangements, and (2) the net interest payment and collateral provisions under the credit facility are similar arrangements and thus fall within the scope of the IFRS 7 offsetting disclosure requirements.

2.

Quantitative disclosures (IFRS 7.13C)

For financial assets and liabilities within the scope of the standard, entities are required to disclose certain minimum quantitative information separately for assets and liabilities. This information is generally presented in the tabular format and includes: (a) the gross amounts; (b) the amounts that are set off in the statement of financial position; (c)

the net amounts presented in the statement of financial position;

(d) the amounts subject to an enforceable master netting arrangement or similar agreement that are not set off in the statement of financial position including: (i) amounts related to recognised financial instruments that do not meet some or all of the criteria for offsetting in the statement of financial position; and (ii) amounts related to financial collateral (including cash collateral); and (e)

the net amount after deducting the amounts in (d) from the amounts in (c) above.

IFRS 7 does not require offsetting information to be disclosed in a separate note, but if it is provided in different notes it is necessary to provide cross-references among the notes. In Sample Co.’s table: (i)

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For derivative assets and liabilities covered by footnote (a) to the table, the ‘Net’ column includes potential net settlement amounts, taking into account any cash collateral pledged or received, that would be paid or collected, respectively, had all of the open derivative positions been settled at the reporting date in accordance with the terms of ISDA master agreement.

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Offsetting of financial instruments Disclosure in 2013 annual financial statements

Requirements

3.

Disclosure by type or by counterparty (IFRS 7.13D and B49)

Discussion (ii)

Gross information is disclosed for trade receivables and trade payables under the contract explained in footnote (b) to the table that are offset in the statement of financial position.

(iii)

Accrued amounts of non-revolving loan interest and periodic settlement amounts under the swap described in footnote (c) to the table are included in the respective line items as ‘Amounts not offset – Financial instruments’.

(iv)

Net exposure amount for bank indebtedness takes into account cash collateral pledged.

The standard allows two options for reporting items (c) to (e) above. The entity may either group this information by type of financial instrument or transaction, or by counterparty. If the entity choses the latter, it is not required to disclose the names of the specific counterparties but significant counterparties must be presented separately from the rest. Designation of counterparties (Counterparty A, Counterparty B, Counterparty C, etc.) must remain consistent from period to period to maintain comparability. Qualitative disclosures must be considered so that further information can be given about the types of counterparties. Sample Co. has decided to present the required information by type of financial instrument.

4.

Limit on overcollateralized positions (IFRS 7.13C(d)(ii) and B48)

The standard requires a disclosure of the fair value of those financial instruments that have been pledged or received as collateral. However, it limits the total amount of potential set-off and collateral that an entity can disclose to the carrying value of the associated financial instrument. Excess collateral amounts are excluded, unless rights to collateral can be enforced across a number of financial instruments. Due to the limit on excess collateral disclosure, the offsetting balances disclosed may not agree with the existing collateral disclosures required by other parts of IFRS 7. In this case, entities may wish to provide additional disclosures to explain this. Sample Co. has included the description of excess collateral provided under the derivatives in footnote (a) and limited the amount disclosed in ‘Amounts not offset – Financial instruments’ to $48 to bring the ‘Net’ amount disclosed to $0.

5.

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Reconciliation to the statement of financial position (IFRS 7.13C(c) and B46)

The net amounts disclosed in the offsetting table must be reconciled to the individual line item amounts presented in the statement of financial position if an entity determines that the aggregation or disaggregation of the individual financial statement line item amounts provides more relevant information. Sample Co. has explained in the disclosure note that derivative assets, derivative liabilities and interest accrued are included in Other assets and Other liabilities, respectively, in the statement of financial position. Further disaggregation of these balances was not considered necessary. Judgment is involved in determining the level of disaggregation required. The extent of the Company’s derivatives and other financial instruments activity as well as its business purpose should be the drivers of this determination, in addition to materiality considerations.

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Offsetting of financial instruments Disclosure in 2013 annual financial statements

Requirements

Discussion

6.

In addition to prescribed quantitative disclosures, the standard requires entities to provide certain qualitative disclosures, including the description of the nature of the rights to set-off. Furthermore, for any financial collateral received or pledged, the entity shall describe the terms of the collateral agreement (for example, when the collateral is restricted).

Non-quantitative disclosures (IFRS 7.13E, B50 and B53)

Sample Co. has provided the descriptions of the nature of the rights of set-off in the footnotes accompanying the table with quantitative information. 7.

Other disclosures not illustrated in this newsletter (IFRS 7.13F)

8. Future changes – Clarifications of the scope of offsetting of financial instruments under IAS 32

If the required information is disclosed in more than one note to the financial statements, an entity is required to provide a cross-reference between these notes. As financial instruments within the scope of the disclosures may be subject to different measurement requirements (for example amortized cost or fair value), entities are required to describe any resulting measurement difference in the related disclosures. The IASB has amended the application guidance in IAS 32, Financial instruments: Presentation, to clarify some of the requirements for offsetting financial assets and financial liabilities on the statement of financial position. This amendment is effective for annual periods beginning on or after 1 January 2014. The amendments do not change the current offsetting model in IAS 32, which requires an entity to offset a financial asset and financial liability in the statement of financial position only when the entity currently has a legally enforceable right of set-off and intends either to settle the asset and liability on a net basis or to realize the asset and settle the liability simultaneously. Rather, the amendments clarify that the right of set-off must be available today – that is, it is not contingent on a future event – and must be legally enforceable for all counterparties in the normal course of business, as well as in the event of default, insolvency or bankruptcy. As a result, master netting agreements where the legal right of offset is only enforceable on the occurrence of some future event, such as default of the counterparty, continue not to meet the offsetting requirements. The amendments also clarify that gross settlement mechanisms (such as through a clearing house) with features that both (i) eliminate credit and liquidity risk and (ii) process receivables and payables in a single settlement process, are effectively equivalent to net settlement and therefore satisfy the IAS 32 criterion in these instances. It is possible that application of the amendments may cause an entity to change its existing offsetting policies.

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