Client money – it makes the balance sheet go round!

CPA Canada’s IFRS Discussion Group recently discussed the issue of “client money,” introducing the topic as follows:

  • The term “client money” is used to describe a variety of arrangements in which an entity holds funds on behalf of its clients. Such arrangements may include:
  • a bank may hold money on deposit in a customer’s bank account;
  • a fund manager or stockbroker may hold money as a trustee on a customer’s behalf;
  • an insurance broker may hold premiums paid by policyholders before passing them on to an insurer; or
  • a lawyer or accountant may hold money on a client’s behalf, often in a separate client bank account where the interest earned is for the client’s benefit.
  • The variety in contractual terms, conditions and the economic substance of these arrangements can make the recognition of financial asset analysis complex for the entity.

That is, when should such amounts be recognized on the balance sheet? It’s well-established that a bank holding money on deposit in a customer’s bank account will record a financial asset (cash) and a financial liability (customer deposits), reflecting that it has control of the cash to use in whatever way it determines, and an obligation to deliver the funds, and any related interest, to the customer. On the other hand, a lawyer holding client money in a separate bank account typically doesn’t recognize an asset if the funds may only be disbursed pursuant to the client’s instructions and the lawyer isn’t entitled to any interest income. In other cases, the appropriate treatment may not be as clear.

In its discussion, the group focused on the basic definition of an asset – that is, a resource controlled by an entity as a result of past events, from which future economic benefits are expected to flow to the entity. It laid out the following matters to consider:

  • (a) The extent (if any) that the entity has the right to use the funds.
  • (b) Consider whether the entity has the right to control the investment policy in relation to the funds and the ability to commingle the funds.
  • (c) Whether the entity obtains the benefit of interest income earned from the funds.
  • (d) Whether the entity retains all the interest or pays a lower rate of interest to clients and receives an economic benefit from the client money.
  • (e) Whether the entity bears the credit risk associated with bank accounts in which funds are placed on deposit.
  • (f) Whether the entity has a contractual obligation to compensate its clients if the deposit-holding bank fails.
  • (g) The status of the funds in the event of the insolvency or bankruptcy of the reporting entity.
  • (h) Whether the funds are available to fund general claims from creditors or are ring-fenced and only available to reimburse the clients.

The meeting report doesn’t express it this way, but it appears that even the existence of a single one of these indicators would generally create a strong presumption that the amounts represent an asset. However, the presumption might be rebutted depending on the facts and circumstances. For example, “the entity may obtain a fee in the form of interest income from holding the client money without controlling the funds.” The meeting report contains the following real-life example of a trust mechanism set up by the National Energy Board in the energy industry.

  • Entities that own regulated pipelines collect funds from their customers for future betterment of their assets. The funds are held in a trust. Although the investment strategy is set by the entity owning the assets, the timing and the amount of disbursement from the trust is controlled by the NEB. Since the funds are not controlled by the entities with the pipelines, the funds held-in-trust are not recognized as assets on these entities’ balance sheets.

The group discussed the appropriateness of offsetting any such asset and liability, as allowed under IAS 32 when “an entity currently has a legally enforceable right to set off the recognized amounts and intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.” Clearly this wouldn’t typically apply in such cases, as the asset and liability will usually be due from and to different counterparties. The group also discussed various disclosure issues. Even when the amounts are reflected on the balance sheet, it may be appropriate to highlight the asset as being restricted, with accompanying disclosure. Conversely, even when the amounts aren’t on the balance sheet, disclosing the nature and extent of the activity “may be in the overall interest of the fair presentation of the accounts because of the potential liability if the entities were to fail in their fiduciary duties.”

As in that Energy Board example, these situations are presumably more likely to arise from established practices and mechanisms than from non-recurring, situation-specific actions. Speaking only for myself, if you don’t intend me to treat that cash as my asset, then I’d prefer you just hang on to it yourself!

The opinions expressed are solely those of the author

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