Former executives from Anglo Irish Bank (“Anglo”) and Irish Life and Permanent (“ILP”) are alleged to have conspired to mislead investors by setting up a €7.2bn circular transaction scheme to bolster Anglo’s balance sheet in 2008.
The simplified debits and credits (from Anglo’s perspective) for the “circular transaction” are as follows:
Part 1) Amount put on deposit with Anglo by ILP:
Dr Cash €7.2bn
Cr Customer Deposits €7.2bn (shown as a liability)
Part 2) Amount “lent” back to ILP by Anglo:
Dr Loans and Advances to Banks €7.2bn (shown as an entirely separate asset)
Cr Cash €7.2bn
Per the above, the transaction is cash neutral, so what’s the big deal? The issue is that the €7.2bn recorded as a customer deposit with the bank would be (and was) incorrectly interpreted by the bank’s wider stakeholders as a measure of customer confidence in the bank.
So where do the accounting rules stand on this?
First, International Accounting Standard 32 (“IAS 32”) states: A financial asset and a financial liability are offset only when there is a legally enforceable right to offset and an intention to settle net or to settle both amounts simultaneously.
Anglo, in drawing up it’s 2008 accounts, treated the two transactions gross of each other on it’s balance sheet in order to achieve the desired effect of increasing it’s 31 December 2008 customer deposits figure (an approach known as “snapshot accounting”).
However, after year end, the transaction was actually settled net i.e. no transfer of cash, the balances were just written off against each other:
Dr Customer Deposits €7.2bn
Cr Loans and Advances to Banks €7.2bn
Furthermore, ILP are maintaining that it was always the intention of both parties that the transactions would ultimately be netted against each other.
Therefore, based on the above, it would appear that the transactions should have been netted in the 2008 accounts i.e. no gross figures shown on the balance sheet with just some disclosures of the transactions made in the notes to the accounts.
Even if you could excuse the inappropriate treatment under IAS 32 (which I can’t), there is another stumbling block whereby in order for accounts to present a true and fair view of the affairs of a company under International Financial Reporting Standards (IFRS), transactions must be accounted for under their economic substance and not just their legal form. It can be argued that the transaction had no economic substance at all, and therefore the amounts should have been netted on the year end accounts, but at a minimum, it is hard to argue that some disclosure providing details of the overall arrangement was not required.