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This paper sets out the key differences between these approaches and explains the reasoning that leads to the current position. The terms of netting, offsetting and set-off are often used to express the same notion but they are very different concepts. A better understanding of the terminology and the way in which derivatives are traded, managed and settled provides an understanding of why US GAAP accounting standard-setters have consistently agreed to reporting derivatives net rather than gross on the balance sheet and why this differs from reporting under IFRS.
The paper covers the following topics:
The paper articulates the reasons ISDA favours reporting derivatives ‘net’ instead of ‘gross’ on the face of the balance sheet.
ISDA believes that net presentation, in accordance with US GAAP, provides the most faithful representation of an entity’s financial position, solvency, and its exposure to credit and liquidity risk. Individual derivative transactions that are subject to enforceable master netting agreements should be eligible for netting in the balance sheet on the basis that such financial statement presentation is most faithfully representative of an entity’s resources and claims and provides the most useful information for investment decisions.
The paper is recommended for anyone seeking a deeper understanding of the practical application of the offsetting rules and the new disclosure requirements for derivatives and other financial instruments published by the FASB and the IASB in December 2011.