Returns On Financial Instruments: TSB Education

IAS 32 - Financial Instrument: Presentation and Disclosure NOTES
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Liability or equity?
Financial instruments issued by a company must be classified as either liabilities or equity. This classification should be
based on the substance of the contract, rather than the legal form.
A financial liability is any liability where the issuer has a contractual obligation:
• To deliver cash or another financial asset to another entity, or
• To exchange financial instruments with another entity on potentially unfavourable terms.
The owner of an equity instrument is entitled to receive a dividend, but the company does not have a contractual obligation
to make the payment. So equity does not meet the above definition of a financial liability.
An equity instrument is defined as any contract that offers the residual interest in the assets of the company after deducting
all of the liabilities.
Returns on financial instruments

Returns on financial instruments are reported differently, depending on whether the instrument is a liability or equity. The
classification of the financial instrument determines the treatment of the interest, dividends, gains and losses.
• Interest expense, dividend payments, gains and losses relating to a financial liability are recognised in the statement of
profit or loss.
• Distributions to equity holders are debited to equity and shown in the statement of changes in equity.
Preference shares: debt or equity?

Preference shares are shares that are entitled to a payment of their dividend, usually a fixed amount each year, before the
ordinary shareholders can be paid any dividend or that rank ahead of ordinary shares for any distribution of net assets in
the event of a winding up of the company.
Preference shares include the following types:

• Redeemable preference shares are those that the entity has an obligation to buy back (or the right to buy back) at a future
date.
• Irredeemable (perpetual) preference shares are those that will not be bought back at any time in the future.
• convertible preference shares are those that are convertible at a future date into another financial instrument, usually
into ordinary equity shares of the entity.
Classification of preference shares

Depending on their characteristics, preference shares issued by a company might be classified as:
• equity; or
• a financial liability of the company; or
• a compound financial instrument containing elements of both financial liability and equity.
IAS 32 states (in a guidance note) that the key factor for classifying preference shares is the extent to which the entity is
obliged to make future payments to the preference shareholders.
• Redeemable preference shares.
o Redemption is mandatory: Since the issuing entity will be required to redeem the shares, there is an obligation. The
shares are a financial liability.
o Redemption at the choice of the holder: Since the issuing entity does not have an unconditional right to avoid
delivering cash or another financial asset there is an obligation. The shares are a financial liability.
o Redemption at the choice of the issuer: The issuing entity has an unconditional right to avoid delivering cash or
another financial asset there is no obligation. The shares are equity.
• Irredeemable non-cumulative preference shares should be treated as equity, because the entity has no obligation to the
shareholders that the shareholders have any right to enforce.
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Compound instruments
A compound instrument is a financial instrument, issued by a company that cannot be classified as simply a liability or as
equity, because it contains elements of both debt and equity. An example of a compound instrument is a convertible bond.
The company issues a bond that can be converted into equity in the future or redeemed for cash. Initially, it is a liability,
but it has a call option on the company’s equity embedded within it.
Typically, a convertible bond pays a rate of interest that is lower than the market rate for a nonconvertible bond (a ‘straight
bond’) with the same risk profile. This is because the terms of the conversion normally allow the bondholder to convert the
bond into shares at a rate that is lower than the market price.
Split accounting for compound instruments

On initial recognition of compound instrument, the credit entry for the financial instrument must be split into the two
component parts, equity and liability.
When convertible bonds are issued they are shown in the statement of financial position partly as debt finance and partly
as equity finance. The question is how to determine the amount of the issue price that is debt and the amount that is equity.
The method to use is to calculate the equity element as the residual after determining the present value of the debt element:
• The present value of the interest payments and the redemption value of the convertible is found using a market interest
rate for similar debt finance which is not convertible (normally a higher interest rate as there is no conversion element).
• Compare this present value to the proceeds of the bond issue to find the residual equity element.
• Any transaction costs incurred by issuing the instrument should be allocated to each component, the liability and equity,
according to the split in value above.
Comment on the measurement of the debt element

The process starts by deriving a fair value for the liability, on the assumption that the bond has no conversion rights, and
is a ‘straight’ fixed rate bond that will be redeemed at par at maturity.
If the company had sold a bond with identical features but with no conversion rights, how much could it have been sold
for? To answer this question, it is necessary to recognise that the fair value of a bond is simply the present value of the
future cash flows that the bond will generate, discounted at the market rate of interest, which in the following example is
8%.
Example: Convertible bond

A company issues Rs. 10 million of 6% convertible bonds at par on 1 January 20X1.
The bonds are redeemable at par after four years or can be converted at any time up to that date into shares with a nominal
value of Rs. 2,000,000.
The market rate of interest for similar debt which is not convertible is 8%.
The bonds should be recorded in the statement of financial position at the date of issue as follows:
Step 1: Measure the liability component first by discounting the interest payments and the amount that would be paid on
redemption (if not converted) at the prevailing market interest rate of 8%.
31 December 20X1 to 20X4 Cash flow DF (8%) Rs.
Interest: 10,000,000 x 6% 600,000 3.312 1,987,200
20x4:
Repayment of principle 10,000,000 0.735 7,350,000
Value of debt element 9,337,200
Step 2: Compare the value of the debt element to the cash raised. The difference is the equity element.
Total proceeds 10,000,000
Value of equity element (residual) 662,800
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The initial double entry to recognise the bond would be as follows:
Dr Cr
Cash 10,000,000
Liability 9,337,200
Equity 662,800
The liability component is measured at amortised cost in the usual way at each subsequent reporting date.
Example (continued): Subsequent measurement of the debt element of the convertible bond
Amortised cost at start Interest at effective Cash Flow (interest Amortised cost at year
of the year rate (8%) actually paid at 6%) end
20X1 9,337,200 746,976 (600,000) 9,484,176
20X2 9,484,176 758,734 (600,000) 9,642,910
20X3 9,642,910 771,433 (600,000) 9,814,343
20X4 9,814,343 785,557 (600,000) 10,000,000
Note that the final interest expense of Rs. 785,557 includes a rounding adjustment of Rs. 510).
There is no guidance on the subsequent accounting treatment of the equity element. One approach would be to retain it as
a separate component of equity and then release it to retained earnings when the bond is paid or converted.
Example (continued): Double entry on repayment or conversion of the bond.

At 31 December 20X4 the bond will either be paid or converted. Possible double entries in each case are as follows:
Dr Cr
If the bond is repaid
Liability 10,000,000
Cash 10,000,000
Equity component 662,800

Retained earnings 662,800
If the bond is converted:

Liability 10,000,000
Share capital 2,000,000
Share premium 8,000,000
Equity component 662,800

Retained earnings 662,800
Practice question
A company issued a convertible bond for Rs. 2,000,000 on 1 January 20X5.
The bond is to be redeemed on 31 December 20X7 (3 years after issue). The bond holders can take cash or shares with a
nominal value of Rs. 1,200,000 on this date.
The bond pays interest at 5% but the market rate of interest for similar risk bonds without the conversion feature was 9%
at the date of issue.
Required
a) Calculate the liability and equity components of the bond on initial recognition.
b) Construct the necessary journal on initial recognition.
c) Construct an amortisation table to show how the liability component would be measured over the life of the bond.
d) Construct the journal to reflect the possible conversion of the bonds to shares on 31 December 20X7.
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Solution
a) Split of liability and equity on initial recognition
Discount Present Value
31st December Cash (Rs.)
factor 9% (Rs.)
20X5 – interest 100,000 0.9174 91,743
20X6 – interest 100,000 0.8417 84,168
20X7 – interest 100,000 0.7722 77,218
20X7 – principal 2,000,000 0.7722 1,544,367
Fair value of bond 1,797,496
Value of equity (balance) 202,504
Proceeds from issue of bond 2,000,000
b) Journal on initial recognition

Dr (Rs.) Cr (Rs.)
Cash 2,000,000
Liability 1,797,496
Equity 202,504
c) Amortisation table
Liability at start of Finance charge at Liability at end of
Interest paid
year 9% year
Rs.
Rs. Rs. Rs.
20X5 1,797,496 161,775 (100,000) 1,859,271
20X6 1,859,271 167,334 (100,000) 1,926,605
20X7 1,926,605 173,395 (100,000) 2,000,000
d) Journal on conversion to shares

Dr (Rs.) Cr (Rs.)
Bond 2,000,000
Equity - option proceeds 202,504
Share capital 1,200,000
Share premium 1,002,504
Transactions in own equity

A company may reacquire its own shares. Such shares are called treasury shares. The company might then hold on to the
shares until it uses them for a particular purpose, such as awarding shares to employees in a share grant scheme. The
accounting treatment of treasury shares is that they should be deducted from equity.
Any gain or loss on transactions involving treasury shares is recognised directly in equity, and should not be reported in
the statement of profit or loss and other comprehensive income.
IAS 32 requires that the amount of treasury shares held should be disclosed separately, either:
• on the face of the statement of financial position as a deduction from share capital, or
• offset against share capital and disclosed in the notes to the accounts.
Offsetting
Offsetting an asset and a liability and presenting a net amount on the face of the statement of financial position can result
in a loss of information to the users. IAS 1 prohibits offset unless required or permitted by an IFRS.
The idea is that offset should only be allowed if it reflects the substance of the transactions or balances.
IAS 32 adds more detail to this guidance in respect of offsetting financial assets and liabilities.
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IAS 32 requires the presentation of financial assets and financial liabilities in a way that reflects the company’s future cash
flows from collecting the cash from the asset and paying the cash on the liability. It limits a company’s ability to offset a
financial asset and a financial liability to those instances when the cash flows will occur at the same time.
The IAS 32 rule is that a financial asset and a financial liability must be offset and shown net in the statement of financial
position when and only when an entity:
• Currently has a legal right to set off the amounts; and
• Intends either to settle the amounts net, or to realise (sell) the asset and settle the liability simultaneously.
In order for a legal right of set off to be current it must not be contingent on a future event. Furthermore it must be legally
enforceable in all of the following circumstances:
• The normal course of business;
• The event of default;
• The event of insolvency or bankruptcy of the entity and all of the counterparties
Note: The existence of a legal right to set off a cash balance in one account with an overdraft in another is insufficient for
offsetting to be allowed. The company must additionally show intent to settle the balances net, and this is likely to be rare
in practice. Consequently, cash balances in the bank and bank overdrafts are usually reported separately in the statement
of financial position, and not ‘netted off’ against each other.
Many companies adopting IFRS for the first time find that they have net amounts in the statement of financial position
under their old GAAP that have to be shown as a separate financial asset and financial liability under IFRS. The net position
is described as being “grossed up”.
Distributable profit
Dividends are declared, in respect of a period, in a general meeting on the recommendation of the directors.
A dividend cannot exceed the amount recommended by the directors.
Dividends are payable only out of the distributable profits of the company (but not profit on the sale of capital assets).
Dividends are paid by individual entities. When a group announces that it is paying a dividend it is actually the parent
company that is making the payment.
Example: Group distributions

P acquired 80% of S on 1 January 20X1 for Rs. 230,000.
The retained profits of S were Rs. 100,000 at that date and are Rs. 300,000 at the current year end.
P has retained profits of Rs. 400,000 at the current year end.
The consolidated retained profits are as follows:

Consolidated retained profits: Rs.
All of P’s retained profits 400,000
P’s share of the post-acquisition retained profits of S (80% of (300,000 100,000)) 160,000
560,000
The maximum distribution that can be made by the group (i.e. as a dividend paid to P’s shareholders) is Rs. 400,000.
The share of post-acquisition retained profits of S are contained in a separate legal entity and are not available for
distribution by the parent.
If S were to pay a dividend, 80% would pass to P and hence become available for P to pay out to its owners. (The remaining
20% would be owned by the NCI).
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INTERPRETATIONS
IFRIC 2: Members shares in cooperative entities and similar instruments
Background
IFRIC 2 applies to financial instruments within the scope of IAS 32, including financial instruments issued to members of
co-operative entities that evidence the members’ ownership interest in the entity.
Co-operatives (and similar entities) are formed by groups of persons to meet common economic or social needs. Members’
interests in a co-operative are often described as “members’ shares”.
Members’ shares have characteristics of equity. For example they give the member the rights to vote and to participate in
dividend distributions.
Members’ shares may also give the holder the right to request redemption for cash or another financial asset but include
limits on whether the financial instruments will be redeemed.
The issue
IAS 32 gives guidance on classification of financial instruments as financial liabilities or equity. The guidance covers
instruments that allow the holder to put those instruments to the issuer for cash or another financial instrument (“puttable
instruments”).
IFRIC 2 explains how redemption terms should be evaluated in determining whether the financial instruments should be
classified as liabilities or equity
Consensus
A contractual right of a holder to request redemption does not in itself mean that the financial instrument must be classified
as a financial liability.
An entity must consider all of the terms and conditions of the financial instrument to determine its classification, including
relevant local laws, regulations and the entity’s governing charter in effect at the date of classification.
Members’ shares that give holders the right to request redemption are classified as equity when:
• the instrument would be classified as equity if there were no such terms attached; and
• the entity has an unconditional right to refuse redemption of the members’ shares; or
• redemption is unconditionally prohibited by local law, regulation or the entity’s governing charter.
Example: Equity or liability

X co-operative has a charter which allows redemption of members’ shares at sole discretion of the co-operative but
redemption has never been refused.
Analysis
X co-operative has the unconditional right to refuse redemption so the members’ shares are equity.
The fact that redemption has never been refused is not relevant in deciding the status of the instruments.
Provisions that prohibit redemption only if conditions (such as liquidity constraints) are met/not met do not result in
members’ shares being equity.
Example: Equity or liability

X co-operative has a charter which allows redemption of members’ shares at sole discretion of the co-operative but also
states that redemption is automatic unless X cannot make payments without violating local regulations regarding liquidity.
Analysis
X co-operative does not have the unconditional right to refuse redemption so the members’ shares are liabilities.
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Unconditional prohibition may be:
• absolute
o all redemptions are prohibited
o members shares are equity
• partial
o redemption prohibited where it causes the number of members’ shares or amount of paid-in capital from members’
shares to fall below a specified level
▪ Members’ shares above this level – liability
▪ Members’ shares below this level – equity
The limit may change from time to time – leading to a transfer between financial liabilities and equity.
IFRIC 17: Distributions of non-cash assets to owners

Introduction
IFRIC 17 sets out guidance on how an entity should measure distributions of assets other than cash when it pays dividends
to owners in their capacity as owners.
Issues addressed:
• When should an entity recognise a dividend payable?
• How should an entity measure the dividend payable?
• When an entity settles the dividend payable, how should it account for any difference between the carrying amount of
the assets distributed and the carrying amount of the dividend payable?
A dividend payable should be recognised when it is appropriately authorised and is no longer at the discretion of the entity
Dividend payable should be measured at the fair value of the net assets to be distributed
Any difference between the dividend paid and the carrying amount of the net assets distributed is recognised in profit and
loss
Scope
Within scope:
• Distributions of non-cash assets (e.g. items of property, plant and equipment, businesses as defined in IFRS 3, ownership
interests in another entity or disposal groups under IFRS 5).
• Distributions that give owners choice of settlement in cash or non-cash assets.
The IFRIC applies only to distributions in which all owners of the same class of equity instruments are treated equally.
Outside of the scope

• Distributions of non-cash assets that are ultimately controlled by the same party/parties before and after the
distribution, in separate, individual and consolidated financial statements.
• Distributions of part ownership interests in a subsidiary with retention of control.
IFRIC 17 does not address the accounting for the non-cash distribution by the shareholders who receive the distribution
Recognition of dividend payable

Dividend payable should be recognised when it is appropriately authorised and is no longer at the discretion of the entity
This is:
• when the declaration is approved by the relevant authority where such approval is required in the jurisdiction; or
• when the dividend is declared if no such approval is required
Measurement of a dividend payable

A liability to distribute non-cash assets to the owners as a dividend must be measured at the fair value of the assets to be
distributed
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If the owners have a choice of receiving a non-cash asset or a cash alternative, the fair value of each and the associated
probability of owners selecting each alternative must be estimated.
Subsequent measurement:
The carrying amount of the dividend payable must be reviewed at the end of each reporting period and at settlement with
any changes in the amount of the dividend payable must be recognised in equity.
Accounting for any difference

Any difference between the carrying amount of the assets distributed and the carrying amount of the dividend payable at
settlement must be recognised in profit and loss
Presentation and disclosure

Any difference between the carrying amounts of the dividend payable and the assets distributed must be presented as a
separate line item in the statement of profit or loss.
An entity must disclose:

• The brought forward and carried forward carrying amount of the dividend payable.
• Any decrease/increase in the carrying amount as a result of the change in the fair value of the assets to be distributed
When a dividend of non-cash assets is declared after the end of the period but before the financial statements are authorised
for issue the entity must disclose the:
• nature of asset;
• carrying amount at period end;
• estimated fair value; and
• estimation methodology as required by IFRS 7
IFRS 7: DISCLOSURE
Objectives of IFRS 7
All companies are exposed to various types of financial risk. Some risks are obvious from looking at the statement of
financial position. For example, a loan requiring repayment in the next year is reported as a current liability, and users of
the financial statements can assess the risk that the company will be unable to repay the loan.
However, there are often many other risks that a company faces that are not apparent from the financial statements. For
example if a significant volume of a company’s sales are made overseas, there is exposure to the risk of exchange rate
movements.
Example:
A UK company has an investment of units purchased in a German company’s floating rate silverlinked bond. The bond
pays interest on the capital, and part of the interest payment represents bonus interest linked to movements in the price of
silver.
There are several financial risks that this company faces with respect to this investment.
It is a floating rate bond. So if market interest rates for bonds decrease, the interest income from the bonds will fall.
Interest is paid in euros. For a UK company there is a foreign exchange risk associated with changes in the value of the euro.
If the euro falls in value against the British pound, the value of the income to a UK investor will fall.
A bonus is linked to movements in the price of silver. So there is exposure to changes in the price of silver.
There is default risk. The German company may default on payments of interest or on repayment of the principal when the
bond reaches its redemption date.
IFRS 7 requires that an entity should disclose information that enables users of the financial statements to ‘evaluate the
significance of financial instruments’ for the entity’s financial position and financial performance.
There are two main parts to IFRS 7:
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A section on the disclosure of ‘the significance of financial instruments’ for the entity’s financial position and financial
performance
A section on disclosures of the nature and extent of risks arising from financial instruments.
Statement of financial position disclosures

The carrying amounts of financial instruments must be shown, either in the statement of financial position or in a note to
the financial statements, for each class of financial instrument:
• Financial assets at fair value through profit or loss
• Financial liabilities at fair value through profit or loss
• Financial liabilities measured at amortised cost.
The above categories are replaced by the following if IFRS 9 is being followed:
• Financial assets at fair value through profit or loss
• Financial assets at amortised cost
• Financial liabilities at fair value through profit or loss
• Financial liabilities measured at amortised cost.
Other disclosures relating to the statement of financial position are also required. These include the following:
• Collateral. A note should disclose the carrying amount of financial assets that the entity has pledged as collateral for
liabilities or contingent liabilities, the terms and conditions relating to its pledge.
• Allowance account for credit losses. The carrying amount of financial assets measured at fair value through other
comprehensive income (in accordance with paragraph 4.1.2A of IFRS 9) is not reduced by a loss allowance and an entity
should not present the loss allowance separately in the statement of financial position as a reduction of the carrying
amount of the financial asset. However, an entity must disclose the loss allowance in the notes to the financial statements.
• Defaults and breaches. For loans payable, the entity should disclose details of any defaults during the period in the loan
payments, or any other breaches in the loan conditions.
With some exceptions, for each class of financial asset and financial liability, an entity must disclose the fair value of the
assets or liabilities in a way that permits the fair value to be compared with the carrying amount for that class. An important
exception is where the carrying amount is a reasonable approximation of fair value, which should normally be the case for
shortterm receivables and payables.
Statement of profit or loss disclosures
An entity must disclose the following items either in the statement of profit or loss or in notes to the financial statements:
• Net gains or losses on financial assets or financial liabilities at fair value through profit or loss.
• Net gains or losses on available-for-sale financial assets, showing separately:
o the gain or loss recognised in other comprehensive income (and so directly in equity) during the period, and
o the amount removed from equity and reclassified from equity to profit and loss through other comprehensive income
in the period.
• Total interest income and total interest expense, calculated using the effective interest method, for financial assets or
liabilities that are not at fair value through profit or loss.
• Fee income and expenses arising from financial assets or liabilities that are not at fair value through profit or loss.
Other disclosures
IFRS 7 also requires other disclosures. These include the following:
• With some exceptions, for each class of financial asset and financial liability, an entity must disclose the fair value of the
assets or liabilities in a way that permits the fair value to be compared with the carrying amount for that class. An
important exception is where the carrying amount is a reasonable approximation of fair value, which should normally
be the case for short-term receivables and payables.
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Risk disclosures
IFRS 7 also requires that an entity should disclose information that enables users of its financial statements to evaluate the
nature and extent of the risks arising from its financial instruments.
These risks typically include, but are not restricted to:

• Credit risk
• Liquidity risk and
• Market risk
For each category of risk, the entity should provide both quantitative and qualitative information about the risks.
• Qualitative disclosures. For each type of risk, there should be disclosures of the exposures to risk and how they arise;
and the objectives policies and processes for managing the risk and the methods used to measure the risk.
• Quantitative disclosures. For each type of risk, the entity should also disclose summary quantitative data about its
exposures at the end of the reporting period. This disclosure should be based on information presented to the entity’s
senior management, such as the board of directors or chief executive officer.
Credit risk
Credit risk is the risk that someone who owes money (a trade receivable, a borrower, a bond issuer, and so on) will not pay.
An entity is required to disclose the following information about credit risk exposures:
• A best estimate of the entity’s maximum exposure to credit risk at the end of the reporting period and a description of
any collateral held.
Liquidity risk
Liquidity risk is the risk that the entity will not have access to sufficient cash to meet its payment obligations when these
are due. IFRS 7 requires disclosure of:
• A maturity analysis for financial liabilities, showing when the contractual liabilities fall due for payment
• A description of how the entity manages the liquidity risk that arises from this maturity profile of payments.
Market risk
Market risk is the risk of losses that might occur from changes in the value of financial instruments due to changes in:
• Exchange rates,
• Interest rates, or
• Market prices.
An entity should provide a sensitivity analysis for each type of market risk to which it is exposed at the end of the reporting
period. The sensitivity analysis should show how profit or loss would have been affected by a change in the market risk
variable (interest rate, exchange rate, market price of an item) that might have been reasonably possible at that date.
Alternatively, an entity can provide sensitivity analysis in a different form, where it uses a different model for analysis of
sensitivity, such as a value at risk (VaR) model. These models are commonly used by banks.
Illustration 1
On 2 March 20x3, ABC ordered 2 tons of aluminum which will be delivered on 12 July 20x3 for the fixed price.
Illustration 2
On 3 March 20x3, ABC entered into a fixed-price forward contract to purchase 3 tons of aluminum in 6 months. According
to terms of the contract, ABC can either take physical delivery at the end of 6 months, or to pay or receive a net cash based
on the change in market price of aluminum.
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Example 1: Forward to buy shares
This example illustrates the journal entries for forward purchase contracts on an entity’s own shares that will be settled (a)
net in cash, (b) net in shares or (c) by delivering 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
Example 2: Forward to sell shares

This example illustrates the journal entries for forward sale contracts on an entity’s own shares that will be settled (a) net
in cash, (b) net in shares or (c) 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:
Maturity date 31 January 20X3

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)
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Example 3: Purchased call option on shares
This example illustrates the journal entries for a purchased call option right on the entity’s own shares that will be settled
(a) net in cash, (b) net in shares or (c) by delivering cash in exchange for the entity’s own shares. It also discusses the effect
of settlement options (see (d) below):
Assumptions:
Exercise date 31 January 20X3
(European
terms, ie it can
be exercised
only at
maturity)
Exercise right holder Reporting entity
(Entity A)

Fixed exercise price to be paid on 31 January 20X3 CU102

Number of shares under option contract 1,000
Fair value of option on 1 February 20X2 CU5,000

Fair value of option on 31 December 20X2 CU3,000
Fair value of option on 31 January 20X3 CU2,000
Example 4: Written call option on shares

This example illustrates the journal entries for a written call option obligation on the entity’s own shares that will be settled
(a) net in cash, (b) net in shares or (c) by delivering cash in exchange for shares. It also discusses the effect of settlement
options (see (d) below).
Assumptions:
(European
terms, ie it can
be exercised
only at
maturity)
Exercise right holder Counterparty
(Entity B)



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Example 5: Purchased put option on shares

This example illustrates the journal entries for a purchased put option on the entity’s own shares that will be settled (a) net
in cash, (b) net in shares or (c) by delivering cash in exchange for shares. It also discusses the effect of settlement options
(see (d) below).
Assumptions:
(European
terms, ie it can
be exercised
only at
maturity)
Exercise right holder Reporting entity
(Entity A)


Example 6: Written put option on shares

This example illustrates the journal entries for a written put option on the entity’s own shares that will be settled (a) net in
cash, (b) net in shares or (c) by delivering cash in exchange for shares. It also discusses the effect of settlement options (see
(d) below).
Assumptions:
(European
terms, ie it can
be exercised
only at
maturity)
Exercise right holder Counterparty
(Entity B)


Present value of exercise price on 1 February 20X2 CU95
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[ACCA SBR Kaplan Book]

1. Coasters – (Liabilities or equity)
Coasters wishes to purchase a new ride for its ‘Animation Galaxy’ theme park but requires extra funding. On 30
September 20X3, Coasters issued the following preference shares:
• 1 million preference shares for $3 each. No dividends are payable. Coasters will redeem the preference shares in
three years' time by issuing ordinary shares worth $3 million. The exact number of ordinary shares issuable will
be based on their fair value on 30 September 20X6.
• 2 million preference shares for $2.80 each. No dividends are payable. The preference shares will be redeemed in
two years' time by issuing 3 million ordinary shares.
• 4 million preference shares for $2.50 each. They are not mandatorily redeemable. A dividend is payable if, and
only if, dividends are paid on ordinary shares.
Required:
Discuss whether these financial instruments should be classified as financial liabilities or equity in the financial
statements of Coasters for the year ended 30 September 20X3.
[ACCA SBR BPP – Practice Kit]

2. Avco
The directors of Avco, a public limited company, are reviewing the financial statements of two entities which are
acquisition targets, Cavor and Lidan. They have asked for clarification on the treatment of the following financial
instruments within the financial statements of the entities.
Cavor has two classes of shares: A and B shares. A shares are Cavor's ordinary shares and are correctly classed as
equity. B shares are not mandatorily redeemable shares but contain a call option allowing Cavor to repurchase them.
Dividends are payable on the B shares if, and only if, dividends have been paid on the A ordinary shares. The terms
of the B shares are such that dividends are payable at a rate equal to that of the A ordinary shares. Additionally,
Cavor has also issued share options which give the counterparty rights to buy a fixed number of its B shares for a
fixed amount of $10 million. The contract can be settled only by the issuance of shares for cash by Cavor.
Lidan has in issue two classes of shares: A shares and B shares. A shares are correctly classified as equity. Two
million B shares of nominal value of $1 each are in issue. The B shares are redeemable in two years' time. Lidan has
a choice as to the method of redemption of the B shares. It may either redeem the B shares for cash at their nominal
value or it may issue one million A shares in settlement. A shares are currently valued at $10 per share. The lowest
price for Lidan's A shares since its formation has been $5 per share.
Required
Discuss whether the above arrangements regarding the B shares of each of Cavor and Lidan should be treated as
liabilities or equity in the financial statements of the respective issuing companies.
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Solutions
1. Coasters – (Liabilities or equity)

1m preference shares
IAS 32 states that a financial liability is any contract that may be settled in the entity’s own equity instruments and is
a non-derivative for which the entity is obliged to deliver a variable number of its own equity instruments.
Therefore, a contract that requires the entity to deliver as many of the entity’s own equity instruments as are equal
in value to a certain amount should be treated as debt.
Coasters must redeem the first set of preference shares by issuing ordinary shares equal to the value of $3 million.
The $3 million received from the preference share issue should be classified as a liability on the statement of financial
position.
A contract that will be settled by the entity receiving (or delivering) a fixed number of its own equity instruments in
exchange for a fixed amount of cash or another financial asset is an equity instrument.
Coasters will redeem the second preference share issue with a fixed number of ordinary shares. Therefore, the $5.6
million from the second preference share issue should be classified as equity in the statement of financial position.
A financial liability exists if there is an obligation to deliver cash or another financial asset.
There is no obligation for Coasters to repay the instrument.
Dividends are only payable if they are also paid on ordinary shares. There is no obligation to pay dividends on
ordinary shares so there is no obligation to pay dividends on these preference shares.
The instrument is not a financial liability. The proceeds from the preference share issue should therefore be classified
as equity in the statement of financial position.
2. Avco
(i) Cavor
B shares
The classification of Cavor's B shares will be made by applying the principlesbased definitions of equity and
liability in IAS 32, and considering the substance, rather than the legal form of the instrument. 'Substance' here
relates only to consideration of the contractual terms of the instrument. Factors outside the contractual terms are
not relevant to the classification. The following factors demonstrate that Cavor's B shares are equity instruments.
1) Dividends are discretionary in that they need only be paid if paid on the A shares, on which there is no
obligation to pay dividends. Dividends on the B shares will be paid at the same rate as on the A shares,
which will be variable.
2) Cavor has no obligation to redeem the B shares.
Share options
The 'fixed test' must be applied. If the amount of cash or own equity shares to be delivered is variable, then the
contract is a debt instrument. Here, however, the contract is to be settled by Cavor issuing a fixed number of its
own equity instruments for a fixed amount of cash. Accordingly there is no variability, and the share options
are classified as an equity instrument.
(ii) Lidan
A financial liability under IAS 32 is a contractual obligation to deliver cash or another financial asset to another
entity. The contractual obligation may arise from a requirement to make payments of principal, interest or
dividends. The contractual obligation may be explicit, but it may be implied indirectly in the terms of the
contract.
In the case of Lidan, the contractual obligation is not explicit. At first glance it looks as if Lidan has a choice as
to how much it pays to redeem the B shares. However, the conditions of the financial instrument are such that
the value of the settlement in own shares is considerably greater than the cash settlement obligation. The effect
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of this is that Lidan is implicitly obliged to redeem the B shares at for a cash amount of $1 per share. The own-
share settlement alternative is uneconomic in comparison to the cash settlement alternative, and cannot therefore
serve as a means of avoiding classification as a liability.
IAS 32 states further that where a derivative contract has settlement options, all of the settlement alternatives
must result in it being classified as an equity instrument, otherwise it is a financial asset or liability.
In conclusion, Lidan's B shares must be classified as a liability.
Example 1: Forward to buy shares

a) Cash for cash (‘net cash settlement’)
In this subsection, the forward purchase contract on the entity’s own shares will be settled net in cash, ie there is no
receipt or delivery of the entity’s own shares upon settlement of the forward contract.
On 1 February 20X2, Entity A enters into a contract with Entity B to receive the fair value of 1,000 of Entity A’s own
outstanding ordinary shares as of 31 January 20X3 in exchange for a payment of 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
The price per share when the contract is agreed on 1 February 20X2 is CU100. The initial fair value of the forward
contract on 1 February 20X2 is zero.
No entry is required because the fair value of the derivative is zero and no cash is paid or received.
31 December 20X2
On 31 December 20X2, the market price per share has increased to CU110 and, as a result, the fair value of the forward
contract has increased to CU6,300.
Dr Forward asset CU6,300

Cr Gain CU6,300
To record the increase in the fair value of the forward contract.
31 January 20X3
On 31 January 20X3, the market price per share has decreased to CU106. The fair value of the forward contract is
CU2,000 ([CU106 × 1,000] – CU104,000).
On the same day, the contract is settled net in cash. Entity A has an obligation to deliver CU104,000 to Entity B and
Entity B has an obligation to deliver CU106,000 (CU106 × 1,000) to Entity A, so Entity B pays the net amount of
CU2,000 to Entity A.
Dr Loss CU4,300
Cr Forward asset CU4,300
To record the decrease in the fair value of the forward contract (ie CU4,300 = CU6,300 – CU2,000).
Dr Cash CU2,000
To record the settlement of the forward contract.
31 January 20X3
On 31 January 20X3, the market price per share has decreased to CU106. The fair value of the forward contract is
CU2,000 ([CU106 × 1,000] – CU104,000).
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On the same day, the contract is settled net in cash. Entity A has an obligation to deliver CU104,000 to Entity B and
Entity B has an obligation to deliver CU106,000 (CU106 × 1,000) to Entity A, so Entity B pays the net amount of
CU2,000 to Entity A.
Dr Loss CU4,300
To record the decrease in the fair value of the forward contract (ie CU4,300 = CU6,300 – CU2,000).
Dr Cash CU2,000
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) above, except for recording the settlement of the forward contract,
as follows:
31 January 20X3
The contract is settled net in shares. Entity A has an obligation to deliver CU104,000 (CU104 × 1,000) worth of its
shares to Entity B and Entity B has an obligation to deliver CU106,000 (CU106 × 1,000) worth of shares to Entity A.
Thus, Entity B delivers a net amount of CU2,000 (CU106,000 – CU104,000) worth of shares to Entity A, ie 18.9 shares
(CU2,000/CU106).
Dr Equity CU2,000
c) Cash for shares (‘gross physical settlement’)

Assume the same facts as in (a) except that settlement will be made by delivering a fixed amount of cash and receiving
a fixed number of Entity A’s shares. Similarly to (a) and (b) above, the price per share that Entity A will pay in one
year is fixed at CU104. Accordingly, Entity A has an obligation to pay CU104,000 in cash to Entity B (CU104 × 1,000)
and Entity B has an obligation to deliver 1,000 of Entity A’s outstanding shares to Entity A in one year. Entity A
records the following journal entries.
1 February 20X2
Dr Equity CU100,000
Cr Liability CU100,000
To record the obligation to deliver CU104,000 in one year at its present value of CU100,000 discounted using an
appropriate interest rate.
31 December 20X2
Dr Interest expense CU3,660
To accrue interest in accordance with the effective interest method on the liability for the share redemption amount.
31 January 20X3
Dr Interest expense CU340
Cr Liability CU340
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Entity A delivers CU104,000 in cash to Entity B and Entity B delivers 1,000 of Entity A’s shares to Entity A.
Dr Liability CU104,000
Cr Cash CU104,000
To record the settlement of the obligation to redeem Entity A’s own shares for cash.
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 repurchase contract is a financial asset or a financial liability. If one of the settlement
alternatives is to exchange cash for shares ((c) above), Entity A recognises a liability for the obligation to deliver cash,
as illustrated in (c) above. Otherwise, Entity A accounts for the forward contract as a derivative.
Example 2: Forward to sell shares

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.
Cr Cash CU2,000

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).
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.
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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
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.
Example 3: Purchased call option on shares

On 1 February 20X2, Entity A enters into a contract with Entity B that gives Entity B the obligation to deliver, and
Entity A the right to receive the fair value of 1,000 of Entity A’s own ordinary shares as of 31 January 20X3 in exchange
for CU102,000 in cash (ie CU102 per share) on 31 January 20X3, if Entity A exercises that right. The contract will be
settled net in cash. If Entity A does not exercise its right, no payment will be made. Entity A records the following
journal entries.
1 February 20X2
The price per share when the contract is agreed on 1 February 20X2 is CU100. The initial fair value of the option
contract on 1 February 20X2 is CU5,000, which Entity A pays to Entity B in cash on that date. On that date, the option
has no intrinsic value, only time value, because the exercise price of CU102 exceeds the market price per share of
CU100 and it would therefore not be economic for Entity A to exercise the option. In other words, the call option is
out of the money.
Dr Call option asset CU5,000
Cr Cash CU5,000
To recognise the purchased call option.
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31 December 20X2
On 31 December 20X2, the market price per share has increased to CU104. The fair value of the call option has
decreased to CU3,000, of which CU2,000 is intrinsic value ([CU104 – CU102] × 1,000), and CU1,000 is the remaining
time value.
Dr Loss CU1,000
Cr Call option asset CU1,000
To record the decrease in the fair value of the call option.
On the same day, Entity A exercises the call option and the contract is settled net in cash. Entity B has an obligation
to deliver CU104,000 (CU104 × 1,000) to Entity A in exchange for CU102,000 (CU102 × 1,000) from Entity A, so Entity
A receives a net amount of CU2,000.
Dr Cash CU2,000
To record the settlement of the option contract.

journal entries are the same as those shown in (a) except for recording the settlement of the option contract as follows:
31 January 20X3
Entity A exercises the call option and the contract is settled net in shares. Entity B has an obligation to deliver
CU104,000 (CU104 × 1,000) worth of Entity A’s shares to Entity A in exchange for CU102,000 (CU102 × 1,000) worth
of Entity A’s shares. Thus, Entity B delivers the net amount of CU2,000 worth of shares to Entity A, ie 19.2 shares
(CU2,000/CU104).
Dr Equity CU2,000
To record the settlement of the option contract. The settlement is accounted for as a treasury share transaction (ie no
gain or loss).

Assume the same facts as in (a) except that settlement will be made by receiving a fixed number of shares and paying
a fixed amount of cash, if Entity A exercises the option. Similarly to (a) and (b) above, the exercise price per share is
fixed at CU102. Accordingly, Entity A has a right to receive 1,000 of Entity A’s own outstanding shares in exchange
for CU102,000 (CU102 × 1,000) in cash, if Entity A exercises its option. Entity A records the following journal entries.
1 February 20X2
Dr Equity CU5,000
Cr Cash CU5,000
To record the cash paid in exchange for the right to receive Entity A’s own shares in one year for a fixed price. The
premium paid is recognised in equity.
31 December 20X2
No entry is made on 31 December because no cash is paid or received and a contract that gives a right to receive 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
Entity A exercises the call option and the contract is settled gross. Entity B has an obligation to deliver 1,000 of Entity
A’s shares in exchange for CU102,000 in cash.
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Dr Equity CU102,000
Cr Cash CU102,000
result that the call option is a financial asset. 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, as illustrated in (a) and (b) above.
The accounting entry to be made on settlement depends on how the contract is actually settled.
Example 4: Written call option on shares

Assume the same facts as in Example 3(a) above except that Entity A has written a call option on its own shares
instead of having purchased a call option on them. Accordingly, on 1 February 20X2 Entity A enters into a contract
with Entity B that gives Entity B the right to receive and Entity A the obligation to pay the fair value of 1,000 of Entity
A’s own ordinary shares as of 31 January 20X3 in exchange for CU102,000 in cash (ie CU102 per share) on 31 January
20X3, if Entity B exercises that right. The contract will be settled net in cash. If Entity B does not exercise its right, no
payment will be made. Entity A records the following journal entries.
1 February 20X2
Dr Cash CU5,000
Cr Call option obligation CU5,000
To recognise the written call option.
31 December 20X2
Dr Call option obligation CU2,000
Cr Gain CU2,000
To record the decrease in the fair value of the call option.
31 January 20X3
Cr Gain CU1,000
To record the decrease in the fair value of the option.
On the same day, Entity B exercises the call option and the contract is settled net in cash. Entity A has an obligation
to deliver CU104,000 (CU104 × 1,000) to Entity B in exchange for CU102,000 (CU102 × 1,000) from Entity B, so Entity
A pays a net amount of CU2,000.

Cr Cash CU2,000

journal entries are the same as those shown in (a), except for recording the settlement of the option contract, as
follows:
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31 December 20X3
Entity B exercises the call option and the contract is settled net in shares. Entity A has an obligation to deliver
CU104,000 (CU104 × 1,000) worth of Entity A’s shares to Entity B in exchange for CU102,000 (CU102 × 1,000) worth
of Entity A’s shares. Thus, Entity A delivers the net amount of CU2,000 worth of shares to Entity B, ie 19.2 shares
(CU2,000/CU104).
Cr Equity CU2,000
To record the settlement of the option contract. The settlement is accounted for as an equity transaction.

Assume the same facts as in (a) except that settlement will be made by delivering a fixed number of shares and
receiving a fixed amount of cash, if Entity B exercises the option. Similarly to (a) and (b) above, the exercise price per
share is fixed at CU102. Accordingly, Entity B has a right to receive 1,000 of Entity A’s own outstanding shares in
exchange for CU102,000 (CU102 × 1,000) in cash, if Entity B exercises its option. Entity A records the following journal
entries.
1 February 20X2
Dr Cash CU5,000
Cr Equity CU5,000
To record the cash received in exchange for the obligation to deliver a fixed number of Entity A’s own shares in one
year for a fixed price. The premium received is recognised in equity. Upon exercise, the call would result in the issue
of a fixed number of shares in exchange for a fixed amount of cash.
31 December 20X2
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
Entity B exercises the call option and the contract is settled gross. Entity A has an obligation to deliver 1,000 shares
in exchange for CU102,000 in cash.
Dr Cash CU102,000
Cr Equity CU102,000
result that the call option is a financial liability. It does not meet the definition of an equity instrument because it can
be settled otherwise than by Entity A issuing a fixed number of its own shares in exchange for receiving a fixed
amount of cash or another financial asset. Entity A recognises a derivative liability, as illustrated in (a) and (b) above.
The accounting entry to be made on settlement depends on how the contract is actually settled.
Example 5: Purchased put option on shares

On 1 February 20X2, Entity A enters into a contract with Entity B that gives Entity A the right to sell, and Entity B the
obligation to buy the fair value of 1,000 of Entity A’s own outstanding ordinary shares as of 31 January 20X3 at a
strike price of CU98,000 (ie CU98 per share) on 31 January 20X3, if Entity A exercises that right. The contract will be
settled net in cash. If Entity A does not exercise its right, no payment will be made. Entity A records the following
journal entries.
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1 February 20X2
The price per share when the contract is agreed on 1 February 20X2 is CU100. The initial fair value of the option
contract on 1 February 20X2 is CU5,000, which Entity A pays to Entity B in cash on that date. On that date, the option
has no intrinsic value, only time value, because the exercise price of CU98 is less than the market price per share of
CU100. Therefore it would not be economic for Entity A to exercise the option. In other words, the put option is out
of the money.
Dr Put option asset CU5,000
Cr Cash CU5,000
To recognise the purchased put option.
31 December 20X2
On 31 December 20X2 the market price per share has decreased to CU95. The fair value of the put option has
decreased to CU4,000, of which CU3,000 is intrinsic value ([CU98 – CU95] × 1,000) and CU1,000 is the remaining time
value.
Dr Loss CU1,000
Cr Put option asset CU1,000
To record the decrease in the fair value of the put option.
31 January 20X3
On 31 January 20X3 the market price per share is still CU95. The fair value of the put option has decreased to CU3,000,
which is all intrinsic value ([CU98 – CU95] × 1,000) because no time value remains.
Dr Loss CU1,000
To record the decrease in the fair value of the option.
On the same day, Entity A exercises the put option and the contract is settled net in cash. Entity B has an obligation
to deliver CU98,000 to Entity A and Entity A has an obligation to deliver CU95,000 (CU95 × 1,000) to Entity B, so
Entity B pays the net amount of CU3,000 to Entity A.
Dr Cash CU3,000
journal entries are the same as shown in (a), except:
31 January 20X3
Entity A exercises the put option and the contract is settled net in shares. In effect, Entity B has an obligation to deliver
CU98,000 worth of Entity A’s shares to Entity A, and Entity A has an obligation to deliver CU95,000 worth of Entity
A’s shares (CU95 × 1,000) to Entity B, so Entity B delivers the net amount of CU3,000 worth of shares to Entity A, ie
31.6 shares (CU3,000/CU95).
Dr Equity CU3,000

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 Entity A’s shares, if Entity A exercises the option. Similarly to (a) and (b) above, the exercise price
per share is fixed at CU98. Accordingly, Entity B has an obligation to pay CU98,000 in cash to Entity A (CU98 × 1,000)
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in exchange for 1,000 of Entity A’s outstanding shares, if Entity A exercises its option. Entity A records the following
journal entries.
1 February 20X2
Dr Equity CU5,000
Cr Cash CU5,000
To record the cash received in exchange for the right to deliver Entity A’s own shares in one year for a fixed price.
The premium paid is recognised directly in equity. Upon exercise, it results in the issue of a fixed number of shares
in exchange for a fixed price.
31 December 20X2
Entity A’s own shares in exchange for a fixed amount of cash meets the definition of an equity instrument of Entity
A.
31 January 20X3
Entity A exercises the put option and the contract is settled gross. Entity B has an obligation to deliver CU98,000 in
cash to Entity A in exchange for 1,000 shares.
Dr Equity CU98,000
Cr Cash CU98,000
result that the put option is a financial asset. It does not meet the definition of an equity instrument because it can be
settled otherwise than by Entity A issuing a fixed number of its own shares in exchange for receiving a fixed amount
of cash or another financial asset. Entity A recognises a derivative asset, as illustrated in (a) and (b) above. The
accounting entry to be made on settlement depends on how the contract is actually settled.
Example 6: Written put option on shares

Assume the same facts as in Example 5(a) above, except that Entity A has written a put option on its own shares
instead of having purchased a put option on its own shares. Accordingly, on 1 February 20X2, Entity A enters into a
contract with Entity B that gives Entity B the right to receive and Entity A the obligation to pay the fair value of 1,000
of Entity A’s outstanding ordinary shares as of 31 January 20X3 in exchange for CU98,000 in cash (ie CU98 per share)
on 31 January 20X3, if Entity B exercises that right. The contract will be settled net in cash. If Entity B does not exercise
its right, no payment will be made. Entity A records the following journal entries.
1 February 20X2
Dr Cash CU5,000
Cr Put option liability CU5,000
To recognise the written put option.
31 December 20X2
Dr Put option liability CU1,000
Cr Gain CU1,000
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31 January 20X3
Cr Gain CU1,000
On the same day, Entity B exercises the put option and the contract is settled net in cash. Entity A has an obligation
to deliver CU98,000 to Entity B, and Entity B has an obligation to deliver CU95,000 (CU95 × 1,000) to Entity A. Thus,
Entity A pays the net amount of CU3,000 to Entity B.
Cr Cash CU3,000

journal entries are the same as those in (a), except for the following:
31 January 20X3
Entity B exercises the put option and the contract is settled net in shares. In effect, Entity A has an obligation to deliver
CU98,000 worth of shares to Entity B, and Entity B has an obligation to deliver CU95,000 worth of Entity A’s shares
(CU95 × 1,000) to Entity A. Thus, Entity A delivers the net amount of CU3,000 worth of Entity A’s shares to Entity B,
ie 31.6 shares (3,000/95).
Cr Equity CU3,000
To record the settlement of the option contract. The issue of Entity A’s own shares is accounted for as an equity
transaction.

Assume the same facts as in (a) except that settlement will be made by delivering a fixed amount of cash and receiving
a fixed number of shares, if Entity B exercises the option. Similarly to (a) and (b) above, the exercise price per share
is fixed at CU98. Accordingly, Entity A has an obligation to pay CU98,000 in cash to Entity B (CU98 × 1,000) in
exchange for 1,000 of Entity A’s outstanding shares, if Entity B exercises its option. Entity A records the following
journal entries.
1 February 20X2
Dr Cash CU5,000
Cr Equity CU5,000
To recognise the option premium received of CU5,000 in equity.
Dr Equity CU95,000
To recognise the present value of the obligation to deliver CU98,000 in one year, ie CU95,000, as a liability.
31 December 20X2
Dr Interest expense CU2,750
31 January 20X3
Dr Interest expense CU250
Cr Liability CU250
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On the same day, Entity B exercises the put option and the contract is settled gross. Entity A has an obligation to
deliver CU98,000 in cash to Entity B in exchange for CU95,000 worth of shares (CU95 × 1,000).
Dr Liability CU98,000
Cr Cash CU98,000
result that the written put option is a financial liability. If one of the settlement alternatives is to exchange cash for
shares ((c) above), Entity A recognises a liability for the obligation to deliver cash, as illustrated in (c) above.
Otherwise, Entity A accounts for the put option as a derivative liability.
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TSB Education

Returns On Financial Instruments: TSB Education

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Returns On Financial Instruments: TSB Education

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IAS 32 - Financial Instrument: Presentation and Disclosure NOTES

Returns on financial instruments

Preference shares: debt or equity?

Preference shares include the following types:

Classification of preference shares

Split accounting for compound instruments

Comment on the measurement of the debt element

Example: Convertible bond

Example (continued): Double entry on repayment or conversion of the bond.

Equity component 662,800

If the bond is converted:

Equity component 662,800

b) Journal on initial recognition

d) Journal on conversion to shares

Transactions in own equity

Example: Group distributions

The consolidated retained profits are as follows:

Example: Equity or liability

Example: Equity or liability

IFRIC 17: Distributions of non-cash assets to owners

Outside of the scope

Recognition of dividend payable

Measurement of a dividend payable

Accounting for any difference

Presentation and disclosure

An entity must disclose:

There are two main parts to IFRS 7:

Statement of financial position disclosures

Statement of profit or loss disclosures

These risks typically include, but are not restricted to:

Market price per share on 1 February 20X2 CU100

Fixed forward price to be paid on 31 January 20X3 CU104

Fair value of forward on 1 February 20X2 CU0

Example 2: Forward to sell shares

Market price per share on 1 February 20X2 CU100

Fixed forward price to be paid on 31 January 20X3 CU104

Fair value of forward on 1 February 20X2 CU0

Market price per share on 1 February 20X2 CU100

Fixed exercise price to be paid on 31 January 20X3 CU102

Fair value of option on 1 February 20X2 CU5,000

Example 4: Written call option on shares

Market price per share on 1 February 20X2 CU100

Fixed exercise price to be paid on 31 January 20X3 CU102

Fair value of option on 1 February 20X2 CU5,000

Example 5: Purchased put option on shares

Fixed exercise price to be paid on 31 January 20X3 CU98

Fair value of option on 1 February 20X2 CU5,000

Example 6: Written put option on shares

Market price per share on 1 February 20X2 CU100

Fixed exercise price to be paid on 31 January 20X3 CU98

Fair value of option on 1 February 20X2 CU5,000

[ACCA SBR Kaplan Book]

[ACCA SBR BPP – Practice Kit]

1. Coasters – (Liabilities or equity)

Example 1: Forward to buy shares

Dr Forward asset CU6,300

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

c) Cash for shares (‘gross physical settlement’)

Example 2: Forward to sell shares

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

Example 3: Purchased call option on shares

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