Settlement date accounting is a method of recording purchases and sales of financial assets under which the asset is recognised in, or removed from, the books on the date it is delivered, the settlement date. Under this method nothing is entered in the main asset accounts on the day the deal is struck. It is used by banks, companies and some investment entities for securities that settle a short, fixed time after trading.
The alternative is trade date accounting, under which the asset and the obligation to pay for it are recorded as soon as the entity commits to the trade. The two methods give the same result once a trade has settled; they differ only in what the balance sheet shows during the gap between the trade date and the settlement date, which depends on the market's settlement cycle.
Treatment under IFRS 9
Under IFRS 9, the choice between the two methods is available for a "regular way" purchase or sale: a transaction under a contract whose terms require delivery within the time frame established by regulation or convention in the market concerned. An entity may use either method but must apply the same one consistently to all purchases and sales of financial assets that are classified in the same way.
Settlement date accounting under the standard has a particular feature. Although the asset is not recognised until delivery, a buyer must still account for any change in the asset's fair value between trade date and settlement date in the same way as it will account for the asset once acquired:
- For assets measured at amortised cost, the change in value is not recognised.
- For assets measured at fair value through profit or loss, the change is recognised in profit or loss.
- For assets measured at fair value through other comprehensive income, the change is recognised there.
For a sale, the asset is derecognised and any gain or loss on disposal is recorded on the day of delivery. The seller does not record changes in fair value between the two dates, because its right to them ended on the trade date. A contract that does not meet the regular way definition, for example because settlement is delayed beyond the market norm, is treated as a derivative in the intervening period.
Worked example
An entity agrees on 29 December to buy a bond for 1,000, for settlement on 2 January. Its year end is 31 December, when the bond's fair value is 1,010; on 2 January it is 1,012. The bond will be measured at fair value through profit or loss.
Under settlement date accounting, no asset is recorded on 29 December. At 31 December the entity recognises the 10 increase in value as a receivable and a gain in profit or loss. On 2 January it recognises a further gain of 2, pays 1,000 in cash and records the bond at 1,012. Under trade date accounting, the bond and a payable of 1,000 would have appeared on 29 December, with the same gains recognised at the same times. Profit is identical; only the gross assets and liabilities reported at year end differ. Had the bond been measured using amortised cost accounting, no change in value would have been recorded before settlement.
Where each method is used
Settlement date accounting is common among banks and corporate treasuries for debt securities and money market instruments, partly because cash, custody and ledger records then move together and the general ledger agrees with the custodian's settled positions.
Trade date accounting is the norm where exposure matters more than possession. Investment funds generally reflect trades in the net asset value calculation no later than the first valuation after the trade date, so that investors entering or leaving the fund bear the right share of gains and losses; this is a basic rule of fund accounting. Broker-dealers under US accounting practice also record proprietary trades on trade date. Derivatives are outside the choice altogether: they are recognised when the entity becomes party to the contract.
Operational considerations
A firm using settlement date accounting still needs to track unsettled trades. Positions for risk limits, liquidity forecasting and regulatory capital are normally measured from trade date, so systems hold both a traded and a settled view. Pending trades are kept in memorandum records, and the fair value movements required by the standard must be calculated at each reporting date. If a trade fails to settle on the intended date, recognition of the asset is delayed until actual delivery, although the commitment and the exposure to settlement risk remain.
Shorter settlement cycles have reduced the practical difference between the two methods. With the United States having moved to settlement one business day after trade in May 2024, and European markets planning to follow in October 2027, fewer trades are outstanding over any reporting date.
Limitations
The main criticism is that the balance sheet does not show assets to which the entity is already economically exposed, or the liability to pay for them, so gross positions can be understated at a period end. Disclosure of the accounting policy is therefore required, and comparisons between entities using different methods need care. The method is also unavailable for anything other than regular way transactions in financial assets.