Can Bank Balances in a Notional Cash Pool be Offset under IFRS?

Many companies in the Netherlands and the UK have entered into interest-netting arrangements with banks. Under an interest-netting arrangement (notional cash pool), the bank and the company agree that only the net balance of a system of bank accounts is the basis of calculating interest. In a notional cash pool, the company’s individual entities generally assume liability towards the bank in case of any entity being in default.

From an economic point of view, such systems appear to represent a single bank account for the company as a whole. If all entities participating in such a pool are included in the company’s consolidated financial statements, only the net amount of the pool is shown in the balance sheet. This was common practice in the Netherlands.

The introduction of IFRS gave rise to a new focus on netting practices. In the case of notional pools, we have found that entities:

• do not always have a legally enforceable right to demand offsetting of positive balances with negative balances without cash being transferred; and
• do not intend to settle the various balances on a net basis or simultaneously, e.g. because the balances are part of (the control of) several independent business processes.

However, according to IAS 32 a financial asset and a financial liability are offset and the net amount is presented in the balance sheet only when an entity has both the enforceable right to offset and the intention to settle net or to settle simultaneously.

The application of these conditions can be illustrated with an example taken from commodity trading, e.g. petroleum trading. In this business normally both conditions to offset are satisfied when:

• the parties have entered into a netting arrangement specifying that if two parties are each other’s supplier as well as each other’s customer, they both shall have a legally enforceable right to offset amounts payable and amounts receivable. It is legally permitted to pay the creditor by setting off the amount due from him against the amount owed to him.
• parties settle their balances by a single payment at a fixed date in the month after delivery and receipt of the goods.

So what should a group of companies do to obtain the right to set off bank balances under IFRS and avoid an increase in the consolidated balance sheet total? Firstly, the legal documentation underlying the arrangement between the bank and the group may have to be adapted or supplemented. The legal documentation should always allow the groups of companies to offset balances without obtaining prior permission from the bank.

Additionally, the group’s companies needs to have the intention to settle simultaneously or to settle net with the bank. Given the nature of the accounts in these systems, having an intention must be followed by a realization of that intention in order to uphold the existence of the intention. Accordingly, individual financial assets in a cash pool need to be transferred to a single bank account from time to time or, in case of a financial liability, cleared from a single bank account. This so-called “sweep” does not necessarily have to be performed at balance sheet or reporting date, provided that the legal rights to offset exist. The sweeps are performed periodically and they are not subsequently unwound. If a company has performed a sweep during a reporting period, it is deemed to have had the intention to settle.

Application of IAS 32 in connection with financial reporting on notional cash pools may lead to an increase in the balance sheet total when the offsetting requirements are not met.