IE27-31-Example 6 Written put option on shares

Last Updated on 12/02/2020 by 75385885

IAS 32 Financial Instruments: PresentationIE27-31-Example 6 Written put option on shares

IE27-31-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 date1                                                                                             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.

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.

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.

Source EU rules on financial information disclosed by companies

 

Last Updated on 12/02/2020 by 75385885

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