IFRS 32 IE1 Introduction Illustrative examples

Last Updated on 12/02/2020 by 75385885

IAS 32 Financial Instruments: PresentationIFRS 32 IE1 Introduction Illustrative examples

IE1 Introduction Illustrative examples

These examples accompany, but are not part of, IFRS 32 Financial Instruments: Presentation

Accounting for contracts on equity instruments of an entity


IE1 The following examples1 illustrate the application of paragraphs 1527 and IFRS 9 to the accounting for contracts on an entity’s own equity instruments (other than the financial instruments specified in paragraphs 16A and 16B or paragraphs 16C and 16D).

Example 1 Forward to buy shares

IE2 This example illustrates the journal entries for forward purchase contracts on an entity’s own shares that will be settled

  1. net in cash,
  2. net in shares, or
  3. by delivering cash in exchange for shares.

It also discusses the effect of settlement options (see (d) below).

To simplify the illustration, it is assumed that no dividends are paid on the underlying shares (ie the ‘carry return’ is zero) so that the present value of the forward price equals the spot price when the fair value of the forward contract is zero. The fair value of the forward has been computed as the difference between the market share price and the present value of the fixed forward price.

Assumptions:

Contract date 1 February 20X2
Maturity date 31 January 20X3
Market price per share on 1 February 20X2   CU100
Market price per share on 31 December 20X2 CU110
Market price per share on 31 January 20X3 CU106
Fixed forward price to be paid on 31 January 20X3 CU104
Present value of forward price on 1 February 20X2 CU100
Number of shares under forward contract 1,000
Fair value of forward on 1 February 20X2 CU0
Fair value of forward on 31 December 20X2 CU6,300
Fair value of forward on 31 January 20X3 CU2,000

(a) Cash for cash (‘net cash settlement’)

IE 3 In this subsection, the forward purchase contract on the entity’s own shares will be settled net in cash, ie there is no receipt or delivery of the entity’s own shares upon settlement of the forward contract.

On 1 February 20X2, Entity A enters into a contract with Entity B to receive the fair value of 1,000 of Entity A’s own outstanding ordinary shares as of 31 January 20X3 in exchange for a payment of CU104,000 in cash (ie CU104 per share) on 31 January 20X3. The contract will be settled net in cash. Entity A records the following journal entries.

1 February 20X2

The price per share when the contract is agreed on 1 February 20X2 is CU100. The initial fair value of the forward contract on 1 February 20X2 is zero.

No entry is required because the fair value of the derivative is zero and no cash is paid or received.

31 December 20X2

On 31 December 20X2, the market price per share has increased to CU110 and, as a result, the fair value of the forward contract has increased to CU6,300.

Dr Forward asset  CU6,300
Cr Gain CU6,300

To record the increase in the fair value of the forward contract.

31 January 20X3

On 31 January 20X3, the market price per share has decreased to CU106. The fair value of the forward contract is CU2,000 ([CU106 × 1,000] – CU104,000).

On the same day, the contract is settled net in cash. Entity A has an obligation to deliver CU104,000 to Entity B and Entity B has an obligation to deliver CU106,000 (CU106 × 1,000) to Entity A, so Entity B pays the net amount of CU2,000 to Entity A.

Dr Loss CU4,300
Cr Forward asset CU4,300

To record the decrease in the fair value of the forward contract (ie CU4,300 = CU6,300 – CU2,000).

Dr Cash CU2,000
Cr Forward asset CU2,000

To record the settlement of the forward contract.

(b) Shares for shares (‘net share settlement’)

IE4 Assume the same facts as in (a) except that settlement will be made net in shares instead of net in cash. Entity A’s journal entries are the same as those shown in (a) above, except for recording the settlement of the forward contract, as follows:

31 January 20X3

The contract is settled net in shares. Entity A has an obligation to deliver CU104,000 (CU104 × 1,000) worth of its shares to Entity B and Entity B has an obligation to deliver CU106,000 (CU106 × 1,000) worth of shares to Entity A. Thus, Entity B delivers a net amount of CU2,000 (CU106,000 – CU104,000) worth of shares to Entity A, ie 18.9 shares (CU2,000/CU106).

Dr Equity  CU2,000
Cr Forward asset  CU2,000

To record the settlement of the forward contract.

(c) Cash for shares (‘gross physical settlement’)

IE5 Assume the same facts as in (a) except that settlement will be made by delivering a fixed amount of cash and receiving a fixed number of Entity A’s shares. Similarly to (a) and (b) above, the price per share that Entity A will pay in one year is fixed at CU104. Accordingly, Entity A has an obligation to pay CU104,000 in cash to Entity B (CU104 × 1,000) and Entity B has an obligation to deliver 1,000 of Entity A’s outstanding shares to Entity A in one year. Entity A records the following journal entries.

1 February 20X2

Dr Equity CU100,000
Cr Liability CU100,000

To record the obligation to deliver CU104,000 in one year at its present value of CU100,000 discounted using an appropriate interest rate (see IFRS 39, paragraph AG64).

31 December 20X2

Dr Interest expense CU3,660
Cr Liability CU3,660

To accrue interest in accordance with the effective interest method on the liability for the share redemption amount.

31 January 20X3

Dr Interest expense  CU340
Cr Liability  CU340

To accrue interest in accordance with the effective interest method on the liability for the share redemption amount.

Entity A delivers CU104,000 in cash to Entity B and Entity B delivers 1,000 of Entity A’s shares to Entity A.

Dr Liability CU104,000
Cr Cash CU104,000

To record the settlement of the obligation to redeem Entity A’s own shares for cash.

(d) Settlement options

IE6 The existence of settlement options (such as net in cash, net in shares or by an exchange of cash and shares) has the result that the forward repurchase contract is a financial asset or a financial liability. If one of the settlement alternatives is to exchange cash for shares ((c) above), Entity A recognises a liability for the obligation to deliver cash, as illustrated in (c) above. Otherwise, Entity A accounts for the forward contract as a derivative.

Example 2 Forward to sell shares

IE7 This example illustrates the journal entries for forward sale contracts on an entity’s own shares that will be settled

  1. net in cash,
  2. net in shares, or
  3. by receiving cash in exchange for shares.

It also discusses the effect of settlement options (see (d) below).

To simplify the illustration, it is assumed that no dividends are paid on the underlying shares (ie the ‘carry return’ is zero) so that the present value of the forward price equals the spot price when the fair value of the forward contract is zero. The fair value of the forward has been computed as the difference between the market share price and the present value of the fixed forward price.

Assumptions:

Contract date 1 February 20X2 IE1 Introduction Illustrative examples
Maturity date 31 January 20X3 IE1 Introduction Illustrative examples
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Market price per share on 1 February 20X2 CU100 IE1 Introduction Illustrative examples
Market price per share on 31 December 20X2 CU110 IE1 Introduction Illustrative examples
Market price per share on 31 January 20X3 CU106 IE1 Introduction Illustrative examples
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Fixed forward price to be paid on 31 January 20X3 CU104 IE1 Introduction Illustrative examples
Present value of forward price on 1 February 20X2 CU100 IE1 Introduction Illustrative examples
Number of shares under forward contract 1,000 IE1 Introduction Illustrative examples
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Fair value of forward on 1 February 20X2 CU0 IE1 Introduction Illustrative examples
Fair value of forward on 31 December 20X2 (CU6,300) IE1 Introduction Illustrative examples
Fair value of forward on 31 January 20X3 (CU2,000) IE1 Introduction Illustrative examples

(a) Cash for cash (‘net cash settlement’)

IE8 On 1 February 20X2, Entity A enters into a contract with Entity B to pay the fair value of 1,000 of Entity A’s own outstanding ordinary shares as of 31 January 20X3 in exchange for CU104,000 in cash (ie CU104 per share) on 31 January 20X3. The contract will be settled net in cash. Entity A records the following journal entries.

1 February 20X2

No entry is required because the fair value of the derivative is zero and no cash is paid or received.

31 December 20X2

Dr Loss CU6,300
Cr Forward liability CU6,300

To record the decrease in the fair value of the forward contract.

31 January 20X3

Dr Forward liability CU4,300
Cr Gain CU4,300

To record the increase in the fair value of the forward contract (ie CU4,300 = CU6,300 – CU2,000).

The contract is settled net in cash. Entity B has an obligation to deliver CU104,000 to Entity A, and Entity A has an obligation to deliver CU106,000 (CU106 × 1,000) to Entity B. Thus, Entity A pays the net amount of CU2,000 to Entity B.

Dr Forward liability CU2,000
Cr Cash CU2,000

To record the settlement of the forward contract.

(b) Shares for shares (‘net share settlement’)

IE9 Assume the same facts as in (a) except that settlement will be made net in shares instead of net in cash. Entity A’s journal entries are the same as those shown in (a), except:

31 January 20X3

The contract is settled net in shares. Entity A has a right to receive CU104,000 (CU104 × 1,000) worth of its shares and an obligation to deliver CU106,000 (CU106 × 1,000) worth of its shares to Entity B. Thus, Entity A delivers a net amount of CU2,000 (CU106,000 – CU104,000) worth of its shares to Entity B, ie 18.9 shares (CU2,000/CU106).

Dr Forward liability CU2,000 IE1 Introduction Illustrative examples
Cr Equity CU2,000 IE1 Introduction Illustrative examples

To record the settlement of the forward contract. The issue of the entity’s own shares is treated as an equity transaction.

(c) Shares for cash (‘gross physical settlement’)

IE10 Assume the same facts as in (a), except that settlement will be made by receiving a fixed amount of cash and delivering a fixed number of the entity’s own shares. Similarly to (a) and (b) above, the price per share that Entity A will receive in one year is fixed at CU104. Accordingly, Entity A has a right to receive CU104,000 in cash (CU104 × 1,000) and an obligation to deliver 1,000 of its own shares in one year.

Entity A records the following journal entries.

1 February 20X2

No entry is made on 1 February. No cash is paid or received because the forward has an initial fair value of zero.

A forward contract to deliver a fixed number of Entity A’s own shares in exchange for a fixed amount of cash or another financial asset meets the definition of an equity instrument because it cannot be settled otherwise than through the delivery of shares in exchange for cash.

31 December 20X2

No entry is made on 31 December because no cash is paid or received and a contract to deliver a fixed number of Entity A’s own shares in exchange for a fixed amount of cash meets the definition of an equity instrument of the entity.

31 January 20X3

On 31 January 20X3, Entity A receives CU104,000 in cash and delivers 1,000 shares.

Dr Cash CU104,000
Cr Equity CU104,000

To record the settlement of the forward contract.

(d) Settlement options

IE 11 The existence of settlement options (such as net in cash, net in shares or by an exchange of cash and shares) has the result that the forward contract is a financial asset or a financial liability.

It does not meet the definition of an equity instrument because it can be settled otherwise than by Entity A repurchasing a fixed number of its own shares in exchange for paying a fixed amount of cash or another financial asset.

Entity A recognises a derivative asset or liability, as illustrated in (a) and (b) above. The accounting entry to be made on settlement depends on how the contract is actually settled.

Example 3 Purchased call option on shares

This example illustrates the journal entries for a purchased call option right on the entity’s own shares that will be settled (a) net in cash, (b) net in shares or (c) by delivering cash in exchange for the entity’s own shares. It also discusses the effect of settlement options (see (d) below):

Assumptions:

Contract date 1 February 20X2 IE1 Introduction Illustrative examples
Exercise date2  31 January 20X3 IE1 Introduction Illustrative examples
Exercise right holder Reporting entity (Entity A) IE1 Introduction Illustrative examples
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Market price per share on 1 February 20X2 CU100 IE1 Introduction Illustrative examples
Market price per share on 31 December 20X2 CU104 IE1 Introduction Illustrative examples
Market price per share on 31 January 20X3 CU104 IE1 Introduction Illustrative examples
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Fixed exercise price to be paid on 31 January 20X3 CU102 IE1 Introduction Illustrative examples
Number of shares under option contract 1,000 IE1 Introduction Illustrative examples
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Fair value of option on 1 February 20X2 CU5,000 IE1 Introduction Illustrative examples
Fair value of option on 31 December 20X2 CU3,000 IE1 Introduction Illustrative examples
Fair value of option on 31 January 20X3 CU2,000 IE1 Introduction Illustrative examples

(a) Cash for cash (‘net cash settlement’)

IE13 On 1 February 20X2, Entity A enters into a contract with Entity B that gives Entity B the obligation to deliver, and Entity A the right to receive the fair value of 1,000 of Entity A’s own ordinary shares as of 31 January 20X3 in exchange for CU102,000 in cash (ie CU102 per share) on 31 January 20X3, if Entity A exercises that right.

The contract will be settled net in cash. If Entity A does not exercise its right, no payment will be made. Entity A records the following journal entries.

1 February 20X2

The price per share when the contract is agreed on 1 February 20X2 is CU100. The initial fair value of the option contract on 1 February 20X2 is CU5,000, which Entity A pays to Entity B in cash on that date.

On that date, the option has no intrinsic value, only time value, because the exercise price of CU102 exceeds the market price per share of CU100 and it would therefore not be economic for Entity A to exercise the option. In other words, the call option is out of the money.

Dr Call option asset CU5,000
Cr Cash CU5,000

To recognise the purchased call option.

31 December 20X2

On 31 December 20X2, the market price per share has increased to CU104. The fair value of the call option has decreased to CU3,000, of which CU2,000 is intrinsic value ([CU104 – CU102] × 1,000), and CU1,000 is the remaining time value.

Dr Loss CU2,000
Cr Call option asset CU2,000

To record the decrease in the fair value of the call option.

31 January 20X3

On 31 January 20X3, the market price per share is still CU104. The fair value of the call option has decreased to CU2,000, which is all intrinsic value ([CU104 – CU102] × 1,000) because no time value remains.

Dr Loss CU1,000
Cr Call option asset CU1,000

To record the decrease in the fair value of the call option.

On the same day, Entity A exercises the call option and the contract is settled net in cash. Entity B has an obligation to deliver CU104,000 (CU104 × 1,000) to Entity A in exchange for CU102,000 (CU102 × 1,000) from Entity A, so Entity A receives a net amount of CU2,000.

Dr Cash CU2,000
Cr Call option asset CU2,000

To record the settlement of the option contract.

(b) Shares for shares (‘net share settlement’)

IE14 Assume the same facts as in (a) except that settlement will be made net in shares instead of net in cash. Entity A’s journal entries are the same as those shown in (a) except for recording the settlement of the option contract as follows:

31 January 20X3

Entity A exercises the call option and the contract is settled net in shares. Entity B has an obligation to deliver CU104,000 (CU104 × 1,000) worth of Entity A’s shares to Entity A in exchange for CU102,000 (CU102 × 1,000) worth of Entity A’s shares. Thus, Entity B delivers the net amount of CU2,000 worth of shares to Entity A, ie 19.2 shares (CU2,000/CU104).

Dr Equity CU2,000
Cr Call option asset CU2,000

To record the settlement of the option contract. The settlement is accounted for as a treasury share transaction (ie no gain or loss).

(c) Cash for shares (‘gross physical settlement’)

IE15 Assume the same facts as in (a) except that settlement will be made by receiving a fixed number of shares and paying a fixed amount of cash, if Entity A exercises the option.

Similarly to (a) and (b) above, the exercise price per share is fixed at CU102. Accordingly, Entity A has a right to receive 1,000 of Entity A’s own outstanding shares in exchange for CU102,000 (CU102 × 1,000) in cash, if Entity A exercises its option. Entity A records the following journal entries.

1 February 20X2

Dr Equity CU5,000
Cr Cash CU5,000

To record the cash paid in exchange for the right to receive Entity A’s own shares in one year for a fixed price. The premium paid is recognised in equity.

31 December 20X2

No entry is made on 31 December because no cash is paid or received and a contract that gives a right to receive a fixed number of Entity A’s own shares in exchange for a fixed amount of cash meets the definition of an equity instrument of the entity.

31 January 20X3

Entity A exercises the call option and the contract is settled gross. Entity B has an obligation to deliver 1,000 of Entity A’s shares in exchange for CU102,000 in cash.

Dr Equity CU102,000
Cr Cash CU102,000

To record the settlement of the option contract.

(d) Settlement options

IE16 The existence of settlement options (such as net in cash, net in shares or by an exchange of cash and shares) has the result that the call option is a financial asset.

It does not meet the definition of an equity instrument because it can be settled otherwise than by Entity A repurchasing a fixed number of its own shares in exchange for paying a fixed amount of cash or another financial asset.

Entity A recognises a derivative asset, as illustrated in (a) and (b) above. The accounting entry to be made on settlement depends on how the contract is actually settled.

Example 4 Written call option on shares

This example illustrates the journal entries for a written call option obligation on the entity’s own shares that will be settled (a) net in cash, (b) net in shares or (c) by delivering cash in exchange for shares. It also discusses the effect of settlement options (see (d) below).

Assumptions:

Contract date 1 February 20X2
Exercise date3 31 January 20X3
Exercise right holder Counterparty (Entity B)
Market price per share on 1 February 20X2 CU100
Market price per share on 31 December 20X2 CU104
Market price per share on 31 January 20X3 CU104
Fixed exercise price to be paid on 31 January 20X3 CU102
Number of shares under option contract 1,000
Fair value of option on 1 February 20X2 CU5,000
Fair value of option on 31 December 20X2 CU3,000
Fair value of option on 31 January 20X3 CU2,000

(a) Cash for cash (‘net cash settlement’)

IE18 Assume the same facts as in Example 3(a) above except that Entity A has written a call option on its own shares instead of having purchased a call option on them.

Accordingly, on 1 February 20X2 Entity A enters into a contract with Entity B that gives Entity B the right to receive and Entity A the obligation to pay the fair value of 1,000 of Entity A’s own ordinary shares as of 31 January 20X3 in exchange for CU102,000 in cash (ie CU102 per share) on 31 January 20X3, if Entity B exercises that right.

The contract will be settled net in cash. If Entity B does not exercise its right, no payment will be made. Entity A records the following journal entries.

1 February 20X2

Dr Cash CU5,000
Cr Call option obligation CU5,000

To recognise the written call option.

31 December 20X2

Dr Call option obligation CU2,000
Cr Gain CU2,000

To record the decrease in the fair value of the call option.

31 January 20X3

Dr Call option obligation CU1,000
Cr Gain CU1,000

To record the decrease in the fair value of the option.

On the same day, Entity B exercises the call option and the contract is settled net in cash. Entity A has an obligation to deliver CU104,000 (CU104 × 1,000) to Entity B in exchange for CU102,000 (CU102 × 1,000) from Entity B, so Entity A pays a net amount of CU2,000.

Dr Call option obligation CU2,000
Cr Cash CU2,000

To record the settlement of the option contract.

(b) Shares for shares (‘net share settlement’)

IE19 Assume the same facts as in (a) except that settlement will be made net in shares instead of net in cash. Entity A’s journal entries are the same as those shown in (a), except for recording the settlement of the option contract, as follows:

31 December 20X3

Entity B exercises the call option and the contract is settled net in shares. Entity A has an obligation to deliver CU104,000 (CU104 × 1,000) worth of Entity A’s shares to Entity B in exchange for CU102,000 (CU102 × 1,000) worth of Entity A’s shares.

Thus, Entity A delivers the net amount of CU2,000 worth of shares to Entity B, ie 19.2 shares (CU2,000/CU104).

Dr Call option obligation CU2,000
Cr Equity CU2,000

To record the settlement of the option contract. The settlement is accounted for as an equity transaction.

(c) Cash for shares (‘gross physical settlement’)

IE20 Assume the same facts as in (a) except that settlement will be made by delivering a fixed number of shares and receiving a fixed amount of cash, if Entity B exercises the option.

Similarly to (a) and (b) above, the exercise price per share is fixed at CU102. Accordingly, Entity B has a right to receive 1,000 of Entity A’s own outstanding shares in exchange for CU102,000 (CU102 × 1,000) in cash, if Entity B exercises its option. Entity A records the following journal entries.

1 February 20X2

Dr Cash CU5,000
Cr Equity CU5,000

To record the cash received in exchange for the obligation to deliver a fixed number of Entity A’s own shares in one year for a fixed price. The premium received is recognised in equity. Upon exercise, the call would result in the issue of a fixed number of shares in exchange for a fixed amount of cash.

31 December 20X2

No entry is made on 31 December because no cash is paid or received and a contract to deliver a fixed number of Entity A’s own shares in exchange for a fixed amount of cash meets the definition of an equity instrument of the entity.

31 January 20X3

Entity B exercises the call option and the contract is settled gross. Entity A has an obligation to deliver 1,000 shares in exchange for CU102,000 in cash.

Dr Cash CU102,000
Cr Equity CU102,000

To record the settlement of the option contract.

(d) Settlement options

IE21 The existence of settlement options (such as net in cash, net in shares or by an exchange of cash and shares) has the result that the call option is a financial liability.

It does not meet the definition of an equity instrument because it can be settled otherwise than by Entity A issuing a fixed number of its own shares in exchange for receiving a fixed amount of cash or another financial asset. Entity A recognises a derivative liability, as illustrated in (a) and (b) above. The accounting entry to be made on settlement depends on how the contract is actually settled.

Example 5: Purchased put option on shares

IE22 This example illustrates the journal entries for a purchased put option on the entity’s own shares that will be settled (a) net in cash, (b) net in shares or (c) by delivering cash in exchange for shares. It also discusses the effect of settlement options (see (d) below).

Assumptions:

Contract date 1 February 20X2
Exercise date4 31 January 20X3
Exercise right holder Reporting entity (Entity A)
Market price per share on 1 February 20X2 CU100
Market price per share on 31 December 20X2 CU95
Market price per share on 31 January 20X3 CU95
Fixed exercise price to be paid on 31 January 20X3 CU98
Number of shares under option contract 1,000
Fair value of option on 1 February 20X2 CU5,000
Fair value of option on 31 December 20X2 CU4,000
Fair value of option on 31 January 20X3 CU3,000

(a) Cash for cash (‘net cash settlement’)

IE23 On 1 February 20X2, Entity A enters into a contract with Entity B that gives Entity A the right to sell, and Entity B the obligation to buy the fair value of 1,000 of Entity A’s own outstanding ordinary shares as of 31 January 20X3 at a strike price of CU98,000 (ie CU98 per share) on 31 January 20X3, if Entity A exercises that right.

The contract will be settled net in cash. If Entity A does not exercise its right, no payment will be made. Entity A records the following journal entries.

1 February 20X2

The price per share when the contract is agreed on 1 February 20X2 is CU100. The initial fair value of the option contract on 1 February 20X2 is CU5,000, which Entity A pays to Entity B in cash on that date. On that date, the option has no intrinsic value, only time value, because the exercise price of CU98 is less than the market price per share of CU100.

Therefore it would not be economic for Entity A to exercise the option. In other words, the put option is out of the money.

Dr Put option asset CU5,000
Cr Cash CU5,000

To recognise the purchased put option.

31 December 20X2

On 31 December 20X2 the market price per share has decreased to CU95. The fair value of the put option has decreased to CU4,000, of which CU3,000 is intrinsic value ([CU98 – CU95] × 1,000) and CU1,000 is the remaining time value.

Dr Loss CU1,000
Cr Put option asset CU1,000

To record the decrease in the fair value of the put option.

31 January 20X3

On 31 January 20X3 the market price per share is still CU95. The fair value of the put option has decreased to CU3,000, which is all intrinsic value ([CU98 – CU95] × 1,000) because no time value remains.

Dr Loss CU1,000
Cr Put option asset CU1,000

To record the decrease in the fair value of the option.

On the same day, Entity A exercises the put option and the contract is settled net in cash. Entity B has an obligation to deliver CU98,000 to Entity A and Entity A has an obligation to deliver CU95,000 (CU95 × 1,000) to Entity B, so Entity B pays the net amount of CU3,000 to Entity A.

Dr Cash CU3,000
Cr Put option asset CU3,000

To record the settlement of the option contract.

(b) Shares for shares (‘net share settlement’)

IE24 Assume the same facts as in (a) except that settlement will be made net in shares instead of net in cash. Entity A’s journal entries are the same as shown in (a), except:

31 January 20X3

Entity A exercises the put option and the contract is settled net in shares. In effect, Entity B has an obligation to deliver CU98,000 worth of Entity A’s shares to Entity A, and Entity A has an obligation to deliver CU95,000 worth of Entity A’s shares (CU95 × 1,000) to Entity B, so Entity B delivers the net amount of CU3,000 worth of shares to Entity A, ie 31.6 shares (CU3,000/CU95).

Dr Equity CU3,000
Cr Put option asset CU3,000

To record the settlement of the option contract.

(c) Cash for shares (‘gross physical settlement’)

IE25 Assume the same facts as in (a) except that settlement will be made by receiving a fixed amount of cash and delivering a fixed number of Entity A’s shares, if Entity A exercises the option.

Similarly to (a) and (b) above, the exercise price per share is fixed at CU98. Accordingly, Entity B has an obligation to pay CU98,000 in cash to Entity A (CU98 × 1,000) in exchange for 1,000 of Entity A’s outstanding shares, if Entity A exercises its option. Entity A records the following journal entries.

1 February 20X2

Dr Equity CU5,000
Cr Cash CU5,000

To record the cash received in exchange for the right to deliver Entity A’s own shares in one year for a fixed price. The premium paid is recognised directly in equity. Upon exercise, it results in the issue of a fixed number of shares in exchange for a fixed price.

31 December 20X2

No entry is made on 31 December because no cash is paid or received and a contract to deliver a fixed number of Entity A’s own shares in exchange for a fixed amount of cash meets the definition of an equity instrument of Entity A.

31 January 20X3

Entity A exercises the put option and the contract is settled gross. Entity B has an obligation to deliver CU98,000 in cash to Entity A in exchange for 1,000 shares.

Dr Cash CU98,000
Cr Equity CU98,000

To record the settlement of the option contract.

(d) Settlement options

IE26 The existence of settlement options (such as net in cash, net in shares or by an exchange of cash and shares) has the result that the put option is a financial asset. It does not meet the definition of an equity instrument because it can be settled otherwise than by Entity A issuing a fixed number of its own shares in exchange for receiving a fixed amount of cash or another financial asset. Entity A recognises a derivative asset, as illustrated in (a) and (b) above.

The accounting entry to be made on settlement depends on how the contract is actually settled.

Example 6: Written put option on shares

IE27 This example illustrates the journal entries for a written put option on the entity’s own shares that will be settled (a) net in cash, (b) net in shares or (c) by delivering cash in exchange for shares. It also discusses the effect of settlement options (see (d) below).

Assumptions:

Contract date 1 February 20X2
Exercise date5 31 January 20X3
Exercise right holder Counterparty (Entity B)
Market price per share on 1 February 20X2 CU100
Market price per share on 31 December 20X2 CU95
Market price per share on 31 January 20X3 CU95
Fixed exercise price to be paid on 31 January 20X3 CU98
Present value of exercise price on 1 February 20X2 CU95
Number of shares under option contract  1,000
Fair value of option on 1 February 20X2 CU5,000
Fair value of option on 31 December 20X2 CU4,000
Fair value of option on 31 January 20X3 CU3,000

(a) Cash for cash (‘net cash settlement’)

IE28 Assume the same facts as in Example 5(a) above, except that Entity A has written a put option on its own shares instead of having purchased a put option on its own shares. Accordingly, on 1 February 20X2, Entity A enters into a contract with Entity B that gives Entity B the right to receive and Entity A the obligation to pay the fair value of 1,000 of Entity A’s outstanding ordinary shares as of 31 January 20X3 in exchange for CU98,000 in cash (ie CU98 per share) on 31 January 20X3, if Entity B exercises that right.

The contract will be settled net in cash. If Entity B does not exercise its right, no payment will be made. Entity A records the following journal entries.

1 February 20X2

Dr Cash CU5,000
Cr Put option liability CU5,000

To recognise the written put option.

31 December 20X2

Dr Put option liability CU1,000
Cr Gain CU1,000

To record the decrease in the fair value of the put option.

31 January 20X3

Dr Put option liability CU1,000
Cr Gain CU1,000

To record the decrease in the fair value of the put option.

On the same day, Entity B exercises the put option and the contract is settled net in cash. Entity A has an obligation to deliver CU98,000 to Entity B, and Entity B has an obligation to deliver CU95,000 (CU95 × 1,000) to Entity A. Thus, Entity A pays the net amount of CU3,000 to Entity B.

Dr Put option liability CU3,000
Cr Cash CU3,000

To record the settlement of the option contract.

(b) Shares for shares (‘net share settlement’)

IE29 Assume the same facts as in (a) except that settlement will be made net in shares instead of net in cash. Entity A’s journal entries are the same as those in (a), except for the following:

31 January 20X3

Entity B exercises the put option and the contract is settled net in shares. In effect, Entity A has an obligation to deliver CU98,000 worth of shares to Entity B, and Entity B has an obligation to deliver CU95,000 worth of Entity A’s shares (CU95 × 1,000) to Entity A. Thus, Entity A delivers the net amount of CU3,000 worth of Entity A’s shares to Entity B, ie 31.6 shares (3,000/95).

Dr Put option liability CU3,000
Cr Equity CU3,000

To record the settlement of the option contract. The issue of Entity A’s own shares is accounted for as an equity transaction.

(c) Cash for shares (‘gross physical settlement’)

IE30 Assume the same facts as in (a) except that settlement will be made by delivering a fixed amount of cash and receiving a fixed number of shares, if Entity B exercises the option. Similarly to (a) and (b) above, the exercise price per share is fixed at CU98.

Accordingly, Entity A has an obligation to pay CU98,000 in cash to Entity B (CU98 × 1,000) in exchange for 1,000 of Entity A’s outstanding shares, if Entity B exercises its option. Entity A records the following journal entries.

1 February 20X2

Dr Cash CU5,000
Cr Equity CU5,000

To recognise the option premium received of CU5,000 in equity.

Dr Equity CU95,000
Cr Liability CU95,000

To recognise the present value of the obligation to deliver CU98,000 in one year, ie CU95,000, as a liability.

31 December 20X2

Dr Interest expense CU2,750
Cr Liability CU2,750

To accrue interest in accordance with the effective interest method on the liability for the share redemption amount.

31 January 20X3

Dr Interest expense CU250
Cr Liability CU250

To accrue interest in accordance with the effective interest method on the liability for the share redemption amount.

On the same day, Entity B exercises the put option and the contract is settled gross. Entity A has an obligation to deliver CU98,000 in cash to Entity B in exchange for CU95,000 worth of shares (CU95 × 1,000).

Dr Liability CU98,000
Cr Cash CU98,000

To record the settlement of the option contract.

(d) Settlement options

IE31 The existence of settlement options (such as net in cash, net in shares or by an exchange of cash and shares) has the result that the written put option is a financial liability. If one of the settlement alternatives is to exchange cash for shares ((c) above), Entity A recognises a liability for the obligation to deliver cash, as illustrated in (c) above. Otherwise, Entity A accounts for the put option as a derivative liability.

Entities such as mutual funds and Co-operatives whose share capital is not equity defined in IAS 32


Example 7: Entities with no equity

IE32 The following example illustrates a format of a statement of comprehensive income and statement of financial position that may be used by entities such as mutual funds that do not have equity as defined in IAS 32. Other formats are possible.

IFRS 32 IE1 Introduction Illustrative examples

Example 8: Entities with some equity

IE33 The following example illustrates a format of a statement of comprehensive income and statement of financial position that may be used by entities whose share capital is not equity as defined in IAS 32 because the entity has an obligation to repay the share capital on demand but does not have all the features or meet the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D. Other formats are possible.

IFRS 32 IE1 Introduction Illustrative examples

Accounting for compound financial instruments

Example 9: Separation of a compound financial instrument on initial recognition

IE34 Paragraph 28 describes how the components of a compound financial instrument are separated by the entity on initial recognition. The following example illustrates how such a separation is made.

IE35 An entity issues 2,000 convertible bonds at the start of year 1. The bonds have a three-year term, and are issued at par with a face value of CU1,000 per bond, giving total proceeds of CU2,000,000.

Interest is payable annually in arrears at a nominal annual interest rate of 6 per cent. Each bond is convertible at any time up to maturity into 250 ordinary shares. When the bonds are issued, the prevailing market interest rate for similar debt without conversion options is 9 per cent.

IE36 The liability component is measured first, and the difference between the proceeds of the bond issue and the fair value of the liability is assigned to the equity component. The present value of the liability component is calculated using a discount rate of 9 per cent, the market interest rate for similar bonds having no conversion rights, as shown below.

CU

Present value of the principal – CU2,000,000 payable at the end of three years

1,544,367

Present value of the interest – CU120,000 payable annually in arrears for three years

303,755

Total liability component

1,848,122

Equity component (by deduction)

151,878

Proceeds of the bond issue

2,000,000

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Source EU rules on financial information disclosed by companies

 

Last Updated on 12/02/2020 by 75385885

Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). Individual jurisdictions around the world may require or permit the use of (locally authorised and/or amended) IFRS Standards for all or some publicly listed companies.  The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. The specific status of IFRS Standards should be checked in each individual jurisdiction. Use at your own risk. Annualreporting is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org or the local representative in your jurisdiction.