1,000 shares at the forward price of €104 per share). As IAS 32 classifies such contracts as derivative financial
assets or liabilities (see 11 and 5.2.7 above), which are carried at fair value through profit or loss under
IFRS 9, A records the following accounting entries:
€
€
1 February 2019
No entry is required because the fair value of the contract is zero
at inception
31 December 2019
Loss on forward (profit or loss)
6,300
Forward contract (statement of financial position)
6,300
To record movement in fair value of forward from zero to €(6,300)
31 January 2020
Forward contract (statement of financial position)
4,300
Gain on forward (profit or loss)
4,300
To record movement in fair value of forward from €(6,300) to €(2,000)
Forward contract (statement of financial position)
2,000
Equity
2,000
To record net settlement of forward by delivery of €2,000 worth of A’s
shares to B (€2000/106=18.9 shares)
C Gross
settlement
If the contract is entered into as gross-settled on 1 February 2019, settlement on 31 January 2020 will take
the form of delivery of 1,000 own shares by A to B in exchange for a payment of €104,000. IAS 32 classifies
this derivative contract as an equity instrument (see 5.4 above) and therefore no entries are recorded other
than on settlement on the contract. While a forward sale is economically a ‘mirror’ of a forward purchase and
both are classified as equity instruments, the accounting impact is different. A forward sale does not result in
any accounting entries until the shares are finally issued/delivered, while a forward purchase establishes an
obligation to pay the settlement amount and therefore meets the definition of a financial liability which needs
to be recorded upon entering the contract (see part C of Example 43.16 above).
€
€
31 January 2020
Cash 104,000
Equity
104,000
To record settlement of forward contract through delivery of
1,000 shares for the payment of €104,000
D Settlement
options
If there are settlement options (such as net in cash, net in shares or by an exchange of cash and shares), the
forward contract is a financial asset or a financial liability – see 5.2.8 above. A accounts for the forward
contract as a derivative (as in A and B above), with the accounting entry made on settlement determined by
the manner of settlement (i.e. equity or cash).
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11.1.3 ‘Back-to-back’
forward
contracts
The accounting treatment in 11.1.1 and 11.1.2 above produces rather strange results when
applied to ‘back-to-back’ forward contracts, such as might be entered into by a financial
institution with two different clients. Example 43.18 below illustrates the point.
Example 43.18: ‘Back-to-back’ forward contracts
Suppose that a bank entered into the forward purchase contract in Example 43.16 above with a client and laid
off its risk by entering into the reciprocal forward sale contract in Example 43.17 above with a second client.
If both contracts are required to be settled gross, the overall effect of the accounting entries required to be
made by the bank (assuming that the bank was the reporting entity in Examples 43.16 and 43.17 can be
summarised as set out below. Note that these are not the actual entries that would be made, but the arithmetical
sum of all the entries:
€
€
Profit or loss (interest expense on liability for purchase contract)
4,000
Equity (€104,000 on sale less €100,000 on purchase)
4,000
If the purchase contract is required to be settled gross, but the sale contract net in cash, the required accounting
entries (again, not the actual entries, but the arithmetical sum of all the entries) can be summarised as:
€
€
Profit or loss (loss on sale contract €2,000 plus interest on
6,000
liability for purchase contract €4,000)
Equity (purchase contract)
100,000
Cash (€104,000 on purchase, €2,000 on sale)
106,000
If the purchase contract is required to be settled net in cash, but the sale contract gross, the required accounting
entries (again, not the actual entries, but the arithmetical sum of all the entries) can be summarised as:
€
€
Cash (€104,000 in on sale, €2,000 in on purchase)
106,000
Profit or loss (gain on purchase contract)
2,000
Equity (sale contract)
104,000
If both contracts are net settled, no net gain or loss arises.
Some might argue that this exposes a flaw in the requirements of IAS 32. Self-evidently,
these contracts are matched and should therefore, if both run to term, give rise to no
economic profit or loss, irrespective of how they are settled. However, IAS 32 requires
three different results to be shown depending on whether both contracts are settled
gross, or one gross and the other net. This is less understandable in the case where both
contracts are settled gross. However, in cases where one contract is settled net and that
contract gives rise to an initial receipt or payment of cash, then some difference is bound
to occur due to interest effects.
11.2 Call
options
11.2.1
Purchased call option
In a purchased call option, the entity pays a counterparty for the right, but not the
obligation, to purchase a given number of its own equity instruments from the
Financial instruments: Financial liabilities and equity 3577
counterparty for a fixed price at a future date. The accounting for such a contract is
illustrated in Example 43.19 below. [IAS 32.IE12-16].
Example 43.19: Purchased call option on own shares
The reporting entity (A), which has a functional currency of Euro and a year end of 31 December, purchases
a call option over its own shares from another party (B), for which the following are the major assumptions.
Contract date
1 February 2019
Exercise date (European terms – i.e. can be exercised only on maturity)
31 January 2020
Fixed exercise price to be paid on 31 January 2020
€102
Number of shares under contract 1,000
Market price per share on 1 February 2019
€100
Market price per share on 31 December 2019
€104
Market price per share on 31 January 2020
€104
Fair value of option to A on 1 February 2019
€5,000
Fair value of option to A on 31 December 2019
€3,000
Fair value of option to A on 31 January 2020
€2,000
The fair value of the option would be computed using an option pricing model and would be a function of a
number of factors, principally the market value of the shares, the exercise price, and the time value of money.
A Net
cash
; settlement
If the contract is entered into as net cash-settled on 1 February 2019, then A can, on the exercise date
31 January 2020, require B to make a cash payment to A for the excess, if any, of the fair value of 1,000 of
A’s own shares, as of 31 January 2020, over €102,000 (i.e. 1,000 shares at the option price of €102 per share).
Since IAS 32 classifies such contracts as derivative financial assets (see 11 and 5.2.7 above), which are
carried at fair value through profit or loss under IFRS 9, A records the following accounting entries:
1 February 2019
€ €
Call option asset 5,000
Cash
5,000
Payment of option premium (equal to fair value of option) to B
31 December 2019
Loss on option (profit or loss)
2,000
Call option asset
2,000
To record movement in fair value of option from €5,000 to €3,000
31 January 2020
€ €
Loss on option (profit or loss)
1,000
Call option asset
1,000
To record movement in fair value of option from €3,000 to €2,000
Cash 2,000
Call option asset
2,000
To record net settlement of option by payment of €2,000 cash by B to A
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B
Net share settlement
If the contract is entered into as net share-settled on 1 February 2019, then A can, on the exercise date
31 January 2020, require B to deliver to A as many of A’s own shares as have a fair value equal to any excess
of 1,000 of A’s own shares fair value, as of 31 January 2020 over €102,000 (i.e. 1,000 shares at the option price
of €102 per share). Since IAS 32 classifies such contracts as derivative financial assets (see 11 and 5.2.7 above),
which are carried at fair value through profit or loss under IFRS 9, A records the following accounting entries.
1 February 2019
€ €
Call option asset 5,000
Cash
5,000
Payment of option premium (equal to fair value of option) to B
31 December 2019
Loss on option (profit or loss)
2,000
Call option asset
2,000
To record movement in fair value of option from €5,000 to €3,000
31 January 2020
Loss on option (profit or loss)
1,000
Call option asset
1,000
To record movement in fair value of option €3,000 to €2,000
Equity 2,000
Call option asset
2,000
To record net settlement of option by transfer of €2,000 worth of A’s
shares by B to A. This is shown as a deduction from equity in accordance
with IAS 32’s requirements for treasury shares (see 9 above).
C Gross
settlement
If the contract is entered into as gross-settled, on 1 February 2019, then A can, on the exercise date 31 January
2020, require B to deliver 1,000 of A’s shares in return for a payment by A of €102,000. IAS 32 classifies
such a derivative contract as an equity instrument (see 5.4 above); therefore no entries are recorded, other
than to record the cash flows arising under the contract:
1 February 2019
€ €
Equity 5,000
Cash
5,000
Payment of option premium (equal to fair value of option) to B
31 January 2020
€ €
Equity 102,000
Cash
102,000
To record gross settlement of option by payment of €102,000 cash to B
in exchange for 1,000 own shares. This is shown as a deduction from
equity in accordance with IAS 32’s requirements for treasury shares (see
9 above).
If the option had lapsed unexercised, because the market price of A’s shares had fallen below €102 as at
31 January 2020, the €5,000 premium would remain in equity, even though it is, from an economic
Financial instruments: Financial liabilities and equity 3579
perspective, clearly a loss rather than an amount paid to repurchase A’s own shares. This is because IFRS
regards any holder of an instrument classified as equity under IAS 32 as an ‘owner’.
In contrast to the treatment of a gross-settled forward purchase (see 11.1.1 above) and a gross-settled written
put option (see 11.3.2 below), which also require a gross outflow of cash on settlement, there is no
requirement to record a liability at the outset of the contract on which interest is accrued during the period of
the contract. This is because:
• in a gross-settled forward purchase or written put option, the entity can be required to make a payment
of cash, but
• in a purchased call option, there is no liability, since the entity has no obligation to exercise its right to
call for the shares even if the option is ‘in the money’ and it is in the entity’s interest to do so.
D Settlement
options
If there are different settlement options (such as net in cash, net in shares or by an exchange of cash and
shares), the option is a financial asset. A accounts for the forward contract as a derivative (as in A and
B above), with the accounting entry made on settlement determined by the manner of settlement (i.e.
equity or cash).
11.2.2
Written call option
In a written call option, the entity receives a payment from a counterparty for granting
to the counterparty the right, but not the obligation, to purchase a given number of the
entity’s own equity instruments from the entity for a fixed price at a future date. The
accounting for such a contract is illustrated in Example 43.20 below. [IAS 32.IE17-21].
Example 43.20: Written call option on own shares
The reporting entity (A), which has a functional currency of Euro and a year end of 31 December, writes a
call option over its own shares with another party (B), for which the following are the major assumptions.
Contract date
1 February 2019
Exercise date (European terms – i.e. can be exercised only on maturity)
31 January 2020
Fixed exercise price to be paid on 31 January 2020
€102
Number of shares under contract 1,000
Market price per share on 1 February 2019
€100
Market price per share on 31 December 2019
€104
Market price per share on 31 January 2020
€104
Fair value of option to A on 1 February 2019
€(5,000)
Fair value of option to A on 31 December 2019
€(3,000)
Fair value of option to A on 31 January 2020
€(2,000)
The fair value of the option would be computed using an option pricing model and would be a function of a
number of factors, principally the market value of the shares, the exercise price, and the time value of money.
A Net
cash
settlement
If the contract is entered into as net cash-settled on 1 February 2019, then B can, on the exercise date
31 January 2020, require A to make a cash payment to B for the excess, if any, of the fair value of 1,000
of A’s own shares, as of 31 January 2020, over €102,000 (i.e. 1,000 shares at the option price of €102
<
br /> per share). Since IAS 32 classifies such contracts as derivative financial liabilities (see 11 and 5.2.7
above), which are carried at fair value through profit or loss under IFRS 9, A records the following
accounting entries:
3580 Chapter 43
€
€
1 February 2019
Cash
5,000
Call option liability
5,000
Receipt of option premium (equal to fair value of option) from B
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 707