a right to reimbursement, such as a contractual right to distributions once all the
decommissioning has been completed or on winding up the fund, may be an equity
instrument within the scope of IFRS 9. [IFRIC 5.5].
3.11 Disposal groups classified as held for sale and discontinued
operations
The disclosure requirements in IFRS 7 will not apply to financial instruments within
a disposal group classified as held for sale or within a discontinued operation, except
for disclosures about the measurement of those assets and liabilities (see Chapter 50
at 4) if such disclosures are not already provided in other notes to the financial
statements. [IFRS 5.5B]. However, additional disclosures about such assets (or disposal
groups) may be necessary to comply with the general requirements of IAS 1 –
Presentation of Financial Statements – particularly for financial statements to achieve
3434 Chapter 41
a fair presentation and to disclose information about assumptions made and the
sources of estimation uncertainty (see Chapter 3 at 4.1.1.A and 5.2.1 respectively).
[IAS 1.15, 125, IFRS 5.5B].
3.12 Indemnification
assets
IFRS 3 specifies the accounting treatment for ‘indemnification assets’, a term that is not
defined but is described as follows:
‘The seller in a business combination may contractually indemnify the acquirer for
the outcome of a contingency or uncertainty related to all or part of a specific asset
or liability. For example, the seller may indemnify the acquirer against losses above
a specified amount on a liability arising from a particular contingency; in other
words, the seller will guarantee that the acquirer’s liability will not exceed a
specified amount. As a result, the acquirer obtains an indemnification asset.’
[IFRS 3.27].
An indemnification asset will normally meet the definition of a financial asset within
IAS 32. In some situations the asset might be considered a right under an insurance
contract (see 3.3 above) and in others it could be seen as similar to a reimbursement
right (see 3.10 above). However, there will be cases where these assets are, strictly,
within the scope of IFRS 9, creating something of a tension with IFRS 3. This appears
to be nothing more than an oversight and, in our view, entities should apply the more
specific requirements of IFRS 3 when accounting for these assets which are covered in
more detail in Chapter 9 at 5.6.4.
3.13 Rights and obligations within the scope of IFRS 15
An unconditional right to consideration (i.e. only the passage of time is required before
the payment of that consideration is due) in exchange for goods and services transferred
to the customer (a receivable) is accounted for in accordance with IFRS 9. [IFRS 9.2.1(j),
IFRS 15.108]. A conditional right to consideration in exchange for goods or services
transferred to a customer (a contract asset) is accounted for in accordance with IFRS 15,
which requires an entity to assess contract assets for impairment in accordance with
IFRS 9. [IFRS 15.107]. Other rights and obligations within the scope of IFRS 15 are
generally not accounted for as financial instruments.
The credit risk disclosure requirements within IFRS 7.35A-35N apply to those rights
that IFRS 15 specifies are accounted for in accordance with IFRS 9 for the purposes of
measurement of impairment gains and losses (i.e. contract assets). [IFRS 7.5A].
4
CONTRACTS TO BUY OR SELL COMMODITIES AND
OTHER NON-FINANCIAL ITEMS
Contracts to buy or sell non-financial items do not generally meet the definition of a
financial instrument (see 2.2.5 above). However, many such contracts are standardised
in form and traded on organised markets in much the same way as some derivative
financial instruments. The application guidance explains that a commodity futures
contract, for example, may be bought and sold readily for cash because it is listed for
trading on an exchange and may change hands many times. [IAS 32.AG20]. In fact, this is
Financial instruments: Definitions and scope 3435
not strictly true because such contracts are bilateral agreements that cannot be
transferred in this way. Rather, the contract would normally be ‘closed out’ (rather than
sold) by entering into an offsetting agreement with the original counterparty or with the
exchange on which it is traded.
The ability to buy or sell such a contract for cash, the ease with which it may be
bought or sold (or, more correctly, closed out), and the possibility of negotiating a
cash settlement of the obligation to receive or deliver the commodity, do not alter
the fundamental character of the contract in a way that creates a financial
instrument. The buying and selling parties are, in effect, trading the underlying
commodity or other asset. However, the IASB is of the view that there are many
circumstances where they should be accounted for as if they were financial
instruments. [IAS 32.AG20].
Accordingly, the provisions of IAS 32, IFRS 7 and IFRS 9 are normally applied to those
contracts to buy or sell non-financial items that can be settled net in cash or another
financial instrument or by exchanging financial instruments or in which the non-
financial instrument is readily convertible to cash, effectively as if the contracts were
financial instruments (see 4.1 below). However, there is an exception for what are
commonly termed ‘normal’ purchases and sales or ‘own use’ contracts (these are
considered in more detail at 4.2 below). [IAS 32.8, IFRS 9.2.4, IFRS 7.5].
Typically the non-financial item will be a commodity, but this is not necessarily the
case. For example, an emission right, which is an intangible asset (see Chapter 17 at 11.2),
is a non-financial item. Therefore, these requirements would apply equally to contracts
for the purchase or sale of emission rights if they could be settled net. These
requirements will also be appropriate for determining whether certain commodity
leases are within the scope of IFRS 9. Commodity leases generally do not fall within the
scope of IAS 17 or IFRS 16 as they do not relate to a specific or identified asset.
4.1
Contracts that may be settled net
IFRS 9 explains that there are various ways in which a contract to buy or sell a non-
financial item can be settled net, including when: [IAS 32.9, IFRS 9.2.6, BCZ2.18]
(a) the terms of the contract permit either party to settle it net;
(b) the ability to settle the contract net is not explicit in its terms, but the entity has a
practice of settling similar contracts (see 4.2.1 below) net (whether with the
counterparty, by entering into offsetting contracts or by selling the contract before
its exercise or lapse);
(c) for similar contracts (see 4.2.2 below), the entity has a practice of taking delivery
of the underlying 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; and
(d) the non-financial item that is the subject of the contract is readily convertible to
cash (see below).
There is no further guidance in IFRS 9 explaining what is meant by ‘readily
convertible to
cash’. Typically, a non-financial item would be considered readily
convertible to cash if it consists of largely fungible units and quoted spot prices are
3436 Chapter 41
available in an active market that can absorb the quantity held by the entity without
significantly affecting the price.
Whether there exists an active market for a non-financial item, particularly a
physical one such as a commodity, will depend on its quality, location or other
characteristics such as size or weight. For example, if a commodity is actively traded
in London, this may have the effect that the same commodity located in, say,
Rotterdam is considered readily convertible to cash as well as if it was located in
London. However, if it were located in Siberia it might not be considered readily
convertible to cash if more than a little effort were required (often because of
transportation needs) for it to be readily sold.
Like loan commitments, most contracts could as a matter of fact be settled net if both
parties agreed to renegotiate terms. Again we do not believe the IASB intended the
possibility of such renegotiations to be considered in determining whether or not such
contracts may be settled net. Of more relevance is the question of whether one party
has the practical ability to settle net, e.g. in accordance with the terms of the contract
or by the use of some market mechanism.
4.2
Normal sales and purchases (or own use contracts)
As indicated at 4 above, the provisions of IAS 32, IFRS 9 and IFRS 7 are not normally
applied to those contracts to buy or sell non-financial items that can be settled net if
they were entered into and continue to be held for the purpose of the receipt or delivery
of the non-financial item in accordance with the entity’s expected purchase, sale or
usage requirements (a ‘normal’ purchase or sale). [IAS 32.8, IFRS 7.5, IFRS 9.2.4]. However, an
entity may in certain circumstances be able to designate such a contract at fair value
through profit or loss (see 4.2.6 below). It should be noted that this is a two-part test,
i.e. in order to qualify as a normal purchase or sale, the contract needs to both (a) have
been entered into, and (b) continue to be held, for that purpose. Consequently, a
reclassification of an instrument can be only one way. For example, if a contract that
was originally entered into for the purpose of delivery ceases to be held for that purpose
at a later date, it should subsequently be accounted for as a financial instrument under
IFRS 9. Conversely, where an entity holds a contract that was not originally held for the
purpose of delivery and was accounted for under IFRS 9, but subsequently its intentions
change such that it is expected to be settled by delivery, the contract remains within
the scope of IFRS 9.
The IASB views the practice of settling net or taking delivery of the underlying and
selling it within a short period after delivery as an indication that the contracts are not
normal purchases or sales. Therefore, contracts to which (b) or (c) at 4.1 above apply
cannot be subject to the normal purchase or sale exception. Other contracts that can be
settled net are evaluated to determine whether this exception can actually apply.
[IAS 32.9, IFRS 9.2.6, BCZ2.18].
The implications of this requirement are considered further at 4.2.1 and 4.2.2 below.
Financial instruments: Definitions and scope 3437
The implementation guidance illustrates the application of the exception as follows:
[IFRS 9.A.1]
Example 41.3: Determining whether a copper forward is within the scope of
IFRS 9
Company XYZ enters into a fixed-price forward contract to purchase 1,000 kg of copper in accordance with
its expected usage requirements. The contract permits XYZ to take physical delivery of the copper at the end
of twelve months, or to pay or receive a net settlement in cash, based on the change in fair value of copper.
The contract is a derivative instrument because there is no initial net investment, the contract is based on the
price of copper, and it is to be settled at a future date. However, if XYZ intends to settle the contract by taking
delivery and has no history of settling similar contracts net in cash, or of taking delivery of the copper 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 is accounted for as an executory contract rather than as a derivative.
Sometimes a market design or process imposes a structure or intermediary that
prevents the producer of a non-financial item from physically delivering it to the
customer. For example, a gold miner may produce gold bars (dore) that are physically
delivered to a mint for refining and, whilst remaining at the mint, the gold could be
credited to either the producer’s or a counterparty’s ‘gold account’. Where the producer
enters into a contract for the sale of gold which is settled by allocating gold to the
counterparty’s gold account, this may constitute ‘delivery’ as that term is used in the
standard. Accordingly, a contract that is expected to be settled in this way could
potentially be considered a normal sale (although of course it would need to meet all
the other requirements). However, if the gold is credited to the producer’s account and
the sale contract was settled net in cash, this would not constitute delivery. In these
circumstances, treating the contract as a normal sale would, in effect, link a non-
deliverable contract entered into with a customer with a transaction to buy or sell
through an intermediary as a single synthetic arrangement, contrary to the general
requirements on linking contracts discussed in Chapter 42 at 8.12
4.2.1
Net settlement of similar contracts
If the terms of a contract do not explicitly provide for net settlement but an entity has
a practice of settling similar contracts net, that contract should be considered as capable
of being settled net (see 4.1 above). Net settlement could be achieved either by entering
into offsetting contracts with the original counterparty or by selling the contract before
its maturity. In these circumstances the contract cannot be considered a normal sale or
purchase and is accounted for in accordance with IFRS 9 (see 4.1 above). [IAS 32.9,
IFRS 9.2.4, BCZ2.18].
The standard contains no further guidance on what degree of past practice would be
necessary to prevent an entity from treating similar contracts as own use. We do not
believe that any net settlement automatically taints an entity’s ability to apply the own
use exception, for example where an entity is required to close out a number of
contracts as a result of an exceptional disruption arising from external events at a
production facility. However, judgement will always need to be applied based on the
facts and circumstances of each individual case.
3438 Chapter 41
Read literally, the reference to ‘similar contracts’ could be particularly troublesome. For
example, it is common for entities in, say, the energy sector to have a trading arm that
is managed completely separately from their other operations. These trading operations
commonly trade in contracts on non-financial assets, the te
rms of which are similar, if
not identical, to those used by the entity’s other operations for the purpose of physical
supply. Accordingly, the standard might suggest that the normal purchase or sale
exemption is unavailable to any entity that has a trading operation. However, we
believe that a more appropriate interpretation is that contracts should be ‘similar’ as to
their purpose within the business (e.g. for trading or for physical supply) not just as to
their contractual terms.
4.2.2
Commodity broker-traders and similar entities
IFRS 9 contains no further guidance on what degree of net settlement (or trading) is
necessary to make the normal sale or purchase exemption inapplicable, but in many
cases it will be reasonably clear. For example, in our view, the presumption must be
that contracts entered into by a commodity broker-trader that measures its inventories
at fair value less costs to sell in accordance with IAS 2 – Inventories (see Chapter 22
at 2) falls within the scope of IFRS 9. However, there will be situations that are much
less clear-cut and the application of judgement will be necessary. Factors to consider in
making this assessment might include:
• how the entity manages the business and intends to profit from the contract;
• whether value is added by linking parties which are normal buyers and sellers in
the value chain;
• whether the entity takes price risk;
• how the contract is settled; and
• the entity’s customer base.
Again the reference in the standard to ‘similar contracts’ in this context may be troublesome
for certain entities. However, as noted at 4.2.1 above, we believe contracts should be
‘similar’ as to their purpose within the business (e.g. for trading or for physical supply) not
just as to their contractual terms.
4.2.3
Written options that can be settled net
The IASB does not believe that a written option to buy or sell a non-financial item that
can be settled net can be regarded as being for the purpose of receipt or delivery in
accordance with the entity’s expected sale or usage requirements. Essentially, this is
because the entity cannot control whether or not the purchase or sale will take place.
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 679