Entity XYZ owns an office building. XYZ enters into a put option with an investor that permits XYZ to put the building to the investor for CU150 million. The current value of the building is CU175 million1. The option expires in five years. The option, if exercised, may be settled through physical delivery or net cash, at XYZ’s option. How do both XYZ and the investor account for the option?
XYZ’s accounting depends on XYZ’s intention and past practice for settlement. Although the contract meets the definition of a derivative, XYZ does not account for it as a derivative if XYZ intends to settle the contract by delivering the building if XYZ exercises its option and there is no past practice of settling net (paragraph 2.4 of IFRS 9; but see also paragraph 2.5 of IFRS 9).
The investor, however, cannot conclude that the option was entered into to meet the investor’s expected purchase, sale or usage requirements because the investor does not have the ability to require delivery (IFRS 9, paragraph 2.7). In addition, the option may be settled net in cash. Therefore, the investor has to account for the contract as a derivative. Regardless of past practices, the investor’s intention does not affect whether settlement is by delivery or in cash. The investor has written an option, and a written option in which the holder has a choice of physical settlement or net cash settlement can never satisfy the normal delivery requirement for the exemption from IFRS 9 because the option writer does not have the ability to require delivery.
However, if the contract were a forward contract instead of an option, and if the contract required physical delivery and the reporting entity had no past practice of settling net in cash or of taking delivery of the building and selling it within a short period after delivery for the purpose of generating a profit from short-term fluctuations in price or dealer’s margin, the contract would not be accounted for as a derivative. (But see also paragraph 2.5 of IFRS 9).