When Offsetting Goes Wrong: Common Pitfalls to Avoid

of assets and liabilities, or income and expenses, on a net basis in the financial statements. Both UK GAAP and IFRS are grounded in the overarching principle that offsetting is generally prohibited unless specifically required or permitted by a relevant standard. Improper application of offsetting can obscure the nature of transactions, reduce transparency, and impair the usefulness of financial statements for investors, regulators, and other stakeholders.

This article explores the guiding principles, permitted exceptions, and common pitfalls of offsetting, offering practical insight for preparers aiming for compliance and clarity.

General principle

Gross presentation is the default as it provides users with transparency over the entity’s gross inflows and outflows, enhancing the ability to assess financial performance and position. However, in certain cases set out in the relevant standards, net presentation is permitted or required when it reflects the underlying economic substance of the arrangements.

When is offsetting allowed or required?

Net presentations are permitted or required only in defined circumstances in the primary statements. However, relevant standards may require the additional disclosure of the gross balances in the notes to the financial statements. Below are key examples:

• Contract assets and liabilities under IFRS 15: when a customer contract has multiple performance obligations, an entity presents the contract assets and contract liabilities arising from such a contract net in the statement of financial position
• Receivables (net of impairment): expected credit losses or bad debt provisions are deducted to reflect the expected recovery
• Provisions and virtually certain reimbursements: the expense and reimbursement income may be presented net in profit or loss while the balance sheet provision and receivable must be presented gross
• Government grants: when applying IFRS or FRS 101 grant income may be netted against related expenses but must be shown gross when applying FRS 102. There are also differences on the balance sheet – under full IFRS the grant may be deducted from the cost of the asset but under FRS 101 and FRS 102 a capital grant must be presented as deferred income
• Financial instruments: offsetting is required if there is a legally enforceable right and intention to settle net
• Income tax and deferred tax: offsetting is required only within the same jurisdiction and tax entity, with enforceable rights
• Cash flow statement: netting is allowed for high-volume, short-maturity items (eg credit card settlements), or for business combinations when reporting net of cash acquired/disposed.

Common pitfalls in practice

Below are notable pitfalls and how to avoid them:

Income statement pitfalls

Pitfall 1: Unexplained netting of income and expenses
Rebates, reimbursements, or cost recoveries are sometimes inappropriately netted against related expenses without clear explanation or disclosure. This undermines the gross presentation principle and may mislead users by understating both income and expenses.

Entities must ensure that income and expenses are presented separately unless the offsetting is explicitly permitted such as net gain or loss on derivative financial instruments. Where netting is applied, the accounting policy must be clearly disclosed and supported by the substance of the transaction. Transparent presentation and disclosure are critical to maintaining the integrity and usefulness of the financial statements.

Pitfall 2: Agent vs principal misclassification
The nature of a commercial transaction can be misrepresented by recognising revenue on a gross basis when acting as an agent, or on a net basis when acting as a principal, leading to misstated income and expenses. These errors often stem from an incorrect assessment of whether the entity controls the goods or services before transfer.

Where the entity controls the goods or services, bears inventory or credit risk, and sets prices, it is acting as a principal and should recognise revenue on a gross basis. Conversely, if the entity simply facilitates the sale for another party without control, it is acting as an agent and should recognise only the net commission as revenue. Accurate classification ensures the financial statements reflect the economic reality of the transaction.

Statement of financial position pitfalls

Pitfall 3: Offsetting provisions and reimbursements
Even when reimbursement from a third party (eg an insurer) is virtually certain, the related provision and the reimbursement asset must be recognised separately in the statement of financial position as they arise from different contractual rights and obligations.

However, in the income statement, the related expense and any corresponding reimbursement income may be presented net, provided this reflects the substance of the transaction and is clearly disclosed.

Pitfall 4: Intercompany netting without legal right
Receivables and payables across group entities should not be offset unless conditions for the use of net presentation are met. Errors can arise when entities assume that internal group arrangements or clearing agreements are sufficient. If a counterparty can demand separate gross settlement in any circumstance such as default, insolvency, or termination, the legal right is not enforceable, and offsetting is not allowed.

Entities must ensure two conditions are met before presented such balances net: there must be a legally enforceable right to set-off in all circumstances, and a clear intention to settle net or to realise the asset and settle the liability simultaneously.

Pitfall 5: Cash pooling arrangements
Entities within a group participating in cash pooling arrangements will sometimes incorrectly offset positive cash balances and overdrafts. This should only be done if strict offsetting conditions are met. While a clearing and processing agreement may suggest a right of offset, this alone is insufficient.

For offsetting to be appropriate, the right must be legally enforceable in all circumstances and there must be demonstrated intention or consistent practice of net settlement. If further cash movements occur after the reporting date, suggesting ongoing transactions rather than settlement and there is no consistent history of net settlement in practice, the offsetting conditions are not met.

Pitfall 6: Deferred tax offsets across jurisdictions
Deferred tax assets and liabilities should be offset if, and only if, the entity has a legally enforceable right to offset current tax assets against current tax liabilities, and the deferred taxes relate to income taxes levied by the same tax authority, either on the same taxable entity or on different entities within the same tax group that intend to settle on a net basis.

Statement of cash flows pitfalls

Pitfall 7: Netting of borrowings
A common pitfall is presenting borrowing inflows and repayments on a net basis, ie showing only the increase or decrease in borrowings, which can obscure the nature and scale of financing activities. This often occurs with revolving credit facilities, where cash flows are netted in the statement of cash flows, despite related liquidity risk disclosures showing maturity exceeding three months.

Another frequent issue is the netting of intercompany movements that are funding in nature. While these may appear operational, they often reflect financing activity and should be presented gross.

To avoid misstatement, entities should ensure that all financing cash flows, including borrowings and group funding transactions, are separately presented unless there is clear and supportable justification for netting under the cash flow presentation requirements.

For further discussion or clarification on any of these topics, feel free to get in touch with Stuart Wood.