IE7-11-Example 2 Forward to sell shares

Last Updated on 12/02/2020 by 75385885

IAS 32 Financial Instruments: PresentationIE7-11-Example 2 Forward to sell shares

IE7-11-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

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)

IE8-(a) Cash for cash (‘net cash settlement’)

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.

IE9-(b) Shares for shares (‘net share settlement’)

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

Cr Equity                                                                                                 CU2,000

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

IE10-(c) Shares for cash (‘gross physical settlement’)

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.

IE11-(d) Settlement options

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.

Source EU rules on financial information disclosed by companies

 

Last Updated on 12/02/2020 by 75385885

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