Option valuation models

Option valuation models

Option valuation models use mathematical techniques to identify a range of possible future share prices at the exercise date. From these possible future share prices, the pay-off of an option can be calculated. These intrinsic values at exercise are then probability-weighted and discounted to their present value to estimate the fair value of the option at the grant date.

This narrative is part of the IFRS 2 series, look here.

Model selection

There are three main models used to value options:

  • closed-form models: e.g. the BSM model;
  • lattice models; and
  • simulation models: e.g. Monte Carlo models.

These models generally result in very similar values if the same assumptions are used. However, certain models may be more restrictive than others – e.g. in terms of the different pay-offs that can be considered or assumptions that can be incorporated.

For example, a BSM model incorporates early exercise behaviour by using an expected term assumption that is shorter than the contractual life, whereas a lattice model or Monte Carlo model can incorporate more complex early exercise behaviour.

Simple model explanation

The approach followed in, for example, a lattice model illustrates the principles used in an option valuation model in a simplified manner.

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Disclosure non-financial assets and liabilities example

Disclosure non-financial assets and liabilities example

The guidance for this disclosure example is provided here.

8 Non-financial assets and liabilities

This note provides information about the group’s non-financial assets and liabilities, including:

  • specific information about each type of non-financial asset and non-financial liability
    • property, plant and equipment (note 8(a))
    • leases (note 8(b))
    • investment properties (note 8(c))
    • intangible assets (note 8(d))
    • deferred tax balances (note 8(e))
    • inventories (note 8(f))
    • other assets, including assets classified as held for sale (note 8(g))
    • employee benefit obligations (note 8(h))
    • provisions (note 8(i))
  • accounting policies
  • information about determining the fair value of the assets and liabilities, including judgements and estimation uncertainty involved (note 8(j)).

8(a) Property, plant and equipment

Amounts in CU’000

Freehold land

Buildings

Furniture, fittings and equipment

Machinery and vehicles

Assets under construction

Total

At 1 January 2019

Cost or fair value

11,350

28,050

27,510

70,860

137,770

Accumulated depreciation

-7,600

-37,025

-44,625

Net carrying amount

11,350

28,050

19,910

33,835

93,145

Movements in 2019

Exchange differences

-43

-150

-193

Revaluation surplus

2,700

3,140

5,840

Additions

2,874

1,490

2,940

4,198

3,100

14,602

Assets classified as held for sale and other disposals

-424

-525

-2,215

3,164

Depreciation charge

-1,540

-2,030

-4,580

8,150

Closing net carrying amount

16,500

31,140

20,252

31,088

3,100

102,080

At 31 December 2019

Cost or fair value

16,500

31,140

29,882

72,693

3,100

153,315

Accumulated depreciation

-9,630

-41,605

-51,235

Net carrying amount

16,500

31,140

20,252

31,088

3,100

102,080

Movements in 2020

Exchange differences

-230

-570

-800

Revaluation surplus

3,320

3,923

7,243

Acquisition of subsidiary

800

3,400

1,890

5,720

11,810

Additions

2,500

2,682

5,313

11,972

3,450

25,917

Assets classified as held for sale and other disposals

-550

-5,985

-1,680

-8,215

Transfers

950

2,150

-3,100

Depreciation charge

-1,750

-2,340

-4,380

-8,470

Impairment loss (ii)

-465

-30

-180

-675

Closing net carrying amount

22,570

38,930

19,820

44,120

3,450

128,890

At 31 December 2020

Cost or fair value

22,570

38,930

31,790

90,285

3,450

187,025

Accumulated depreciation

-11,970

-46,165

-58,135

Net carrying amount

22,570

38,930

19,820

44,120

3,450

128,890

(i) Non-current assets pledged as security

Refer to note 24 for information on non-current assets pledged as security by the group.

(ii) Impairment loss and compensation

The impairment loss relates to assets that were damaged by a fire – refer to note 4(b) for details. The whole amount was recognised as administrative expense in profit or loss, as there was no amount included in the asset revaluation surplus relating to the relevant assets. [IAS 36.130(a)]

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Derivative meaning for IFRS 9

Derivative meaning

A derivative, by definition, is a financial instrument or other contract within the scope IFRS 9 with all three of the following characteristics:

  • its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called the ‘underlying’).
  • it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors.
  • it is settled at a future date.

Accounting

A derivative financial asset is always classified as held at fair value through profit or loss (FVPL).

A derivative financial liability is also always classified as held at fair value through profit or loss (FVPL).

Always is at initial recognition and subsequent measurement

Fair value changes of a derivative financial liability attributable to own credit risk is recognized in OCI except if this creates or enlarges an accounting mismatch.

Example derivatives

Typical examples of derivatives are futures and forward, swap and option contracts. A derivative usually has a notionalDerivative meaning amount, which is an amount of currency, a number of shares, a number of units of weight or volume or other units specified in the contract. However, a derivative instrument does not require the holder or writer to invest or receive the notional amount at the inception of the contract.

Alternatively, a derivative could require a fixed payment or payment of an amount that can change (but not proportionally with a change in the underlying) as a result of some future event that is unrelated to a notional amount. For example, a contract may require a fixed payment of CU1,000 if six-month LIBOR increases by 100 basis points. Such a contract is a derivative even though a notional amount is not specified.

Gross/Net Settlement

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Cash flow forecasting

A Basic Guide to Cash Flow Forecasting

Nobody wants their business to fail. Although it’s impossible to predict the future with 100% accuracy, a cash flow forecast is a tool that will help you prepare for different possible scenarios in the future.

In a nutshell, cash flow forecasting involves estimating how much cash will be coming in and out of your business within a certain period and gives you a clearer picture of your business’ financial health

What is Cash Flow Forecasting?

Cash flow forecasting is the process of estimating how much cash you’ll have and ensuring you have a sufficient amount to meet your obligations. By focusing on the revenue you expect to generate and the expenses you need to pay, cash flow forecasting can help you better manage your working capital and plan for various positive or difficult scenarios.

A cash flow forecast is composed of three key elements: beginning cash balance, cash inflows (e.g., cash sales, receivables collections), and cash outflows (e.g., expenses for utilities, rent, loan payments, payroll).

Building Out Cash Flow Scenario Models

It’s always good to create best case, worst-case and moderate financial scenarios. Through cash flow forecasting, you’ll Cash flow forecastingbe able to see the impact of these three scenarios and implement the suitable course of action. You can use the models to predict what needs to happen especially during difficult and uncertain times.

In situations where variables shift quickly such as during a recession, it is highly recommended to review and update your cash flow forecasts regularly on a monthly or even weekly basis. By monitoring your cash flow forecast closely, you’ll be able to identify warning signs such as declining revenue or increasing expenses.

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Lessee accounting under IFRS 16

Lessee accounting under IFRS 16

The key objective of IFRS 16 is to ensure that lessees recognise assets and liabilities for their major leases.

1. Lessee accounting model

A lessee applies a single lease accounting model under which it recognises all leases on-balance sheet, unless it elects to apply the recognition exemptions (see recognition exemptions for lessees in the link). A lessee recognises a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make payments. [IFRS 16.22]

[IFRS 16.47, IFRS 16.49]

IFRS 16 Balance sheet Profit or loss

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IFRS 16 Lessor accounting

IFRS 16 Lessor accounting

Lessors continue to classify leases as finance or operating leases.

1. Lessor accounting model

The lessor follows a dual accounting approach for lease accounting. The accounting is based on whether significant risks and rewards incidental to ownership of an underlying asset are transferred to the lessee, in which case the lease is classified as a finance lease. This is similar to the previous lease accounting requirements that applied to lessors. The lessor accounting models are also essentially unchanged from IAS 17 Leases. [IFRS 16.B53, IFRS 16.BC289]

Are the lessee and lessor accounting models consistent?

No. A key consequence of the decision to retain the IAS 17 dual accounting model for lessors is a lack of consistency with the new lessee accounting model. This can be seen in the case Lease classification below:

There are also more detailed differences. For example, lessees and lessors use the same guidance for determining the lease term and assessing whether renewal and purchase options are reasonably certain to be exercised, and termination options not reasonably certain to be exercised. However, unlike lessees, lessors do not reassess their initial assessments of lease term and whether renewal and purchase options are reasonably certain to be exercised, and termination options not reasonably certain to be exercised (see changes in the lease term in the link).

Other differences are more subtle. For example, although the definition of lease payments is similar for lessors and lessees (see lease payments in the link), the difference is the amount of residual value guarantee included in the lease payments.

  • The lessor includes the full amount (regardless of the likelihood that payment will be due) of any residual value guarantees provided to the lessor by the lessee, a party related to the lessee or a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee.
  • The lessee includes only any amounts expected to be payable to the lessor under a residual value guarantee.

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Leveraged buyout IFRS 3 best reporting

Leveraged buyout IFRS 3 best reporting – In corporate finance, a leveraged buyout (LBO) is a transaction where a company is acquired using debt as the main source of consideration. These transactions typically occur when a private equity (PE) firm borrows as much as they can from a variety of lenders (up to 70 or 80 percent of the purchase price) and funds the balance with their own equity. Leveraged buyout IFRS 3 best reporting

1 The process and business reason

The use of leverage (debt) enhances expected returns to the private equity firm. By putting in as little of their own money as possible, PE firms can achieve a large return on equity (ROE) and internal rate of return … Read more

IAS 16 Generation assets for Power and Utilities

Generation assets for Power and Utilities

– are often large and complex installations. They are expensive to construct, tend to be exposed to harsh operating conditions and require periodic replacement or repair. This environment leads to specific accounting issues.

1 Fixed assets and components

IFRS has a specific requirement for ‘component’ depreciation, as described in IAS 16 Property, Plant and Equipment. Each significant part of an item of property, plant and equipment is depreciated separately. Significant parts of an asset that have similar useful lives and patterns of consumption can be grouped together. This requirement can create complications for utility entities, because many assets include components with a shorter useful life than the asset as a whole.

Identifying components of an asset

Generation assets might comprise a significant number of components, many of which will have differing useful lives. The significant components of these types of assets must be separately identified. This can be a complex process, particularly on transition to IFRS, because the detailed record-keeping needed for componentisation might not have been required in order to comply with national generally accepted accounting principles (GAAP). This can particularly be an issue for older power plants. However, some regulators require detailed asset records, which can be useful for IFRS component identification purposes.

An entity might look to its operating data if the necessary information for components is not readily identified by the accounting records. Some components can be identified by considering the routine shutdown or overhaul schedules for power stations and the associated replacement and maintenance routines. Consideration should also be given to those components that are prone to technological obsolescence, corrosion or wear and tear that is more severe than that of the other portions of the larger asset.

First-time IFRS adopters can benefit from an exemption under IFRS 1 First-time Adoption of International Financial Reporting Standards. This exemption allows entities to use a value that is not depreciated cost in accordance with IAS 16, and IAS 23 Borrowing Costs as deemed cost on transition to IFRS. It is not necessary to apply the exemption to all assets or to a group of assets.

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