able to adopt hedge accounting in respect of any instrument taken out as a hedge of the
instrument (e.g. a receive fixed, pay floating interest rate swap taken out to hedge a fixed
rate discretionary dividend on non-redeemable shares). This is because IFRS 9 or IAS 39
– Financial Instruments: Recognition and Measurement – if applicable, does not
recognise a hedge of own equity as a valid hedging relationship (see Chapter 49).
Accordingly, if an issuer of an equity instrument bearing a fixed-rate discretionary
coupon or dividend enters into an interest rate swap to hedge its cash outflows, the swap
will be accounted for under the normal rules for derivatives not forming part of a
hedging relationship – i.e. at fair value with all value changes recognised in profit or loss
(see Chapters 44 and 45). Although, economically speaking, any such gains and losses
are offset by equal gains and losses (due to interest rate movements) on the shares, the
latter, like all movements in the fair value of own equity, are ignored for financial
reporting purposes under IFRS.
11
DERIVATIVES OVER OWN EQUITY INSTRUMENTS
IAS 32 provides a number of detailed examples of the accounting treatment required,
under the provisions of revised IAS 32 and IFRS 9, to be adopted by an entity for
derivative contracts over its own equity instruments. Examples are given of each of the
main possible permutations, namely:
• a forward purchase (see 11.1.1 below);
• a forward sale (see 11.1.2 below);
• 'back-to-back' forward contracts (see 11.1.3 below);
• a purchased call option (see 11.2.1 below);
• a written call option (see 11.2.2 below);
• a purchased put option (see 11.3.1 below); and
• a written put option (see 11.3.2 below).
All such contracts can be either:
(a) net cash-settled (i.e. the contract provides that the parties will compare the fair
value of the shares to be delivered by the seller to the amount of cash payable by
the buyer and make a cash payment between themselves for the difference);
(b) net share-settled (i.e. the contract provides that the parties will compare the fair
value of the shares to be delivered by the seller to the amount of cash payable by
the buyer and make a transfer between themselves of as many of the entity’s shares
as have a fair value equal to the difference);
(c) gross settled (i.e. the contract provides that the seller will deliver shares to the
buyer in exchange for cash); or
(d) subject to various settlement options, whereby the manner of settlement is not
predetermined, and instead one or other party can choose the manner of
settlement (i.e. gross, net cash or net shares).
Financial instruments: Financial liabilities and equity 3571
The examples consider the above settlement options in turn for the main possible
permutations of derivatives over own equity instruments.
All derivative contracts over own equity, where settlement is not exclusively by an
exchange of a fixed number of shares for a fixed amount of cash, do not meet the
definition of equity instruments in IAS 32 and are, in general, treated as derivative
financial assets or liabilities (see 5.2.8 above). IFRS 9, requires such contracts to be
accounted for at fair value through profit or loss (see Chapter 45). Exemption to this rule
applies to forward purchases and written put options with an option to settle gross
(see 11.1.1 and 11.3.2 below).
11.1 Forward
contracts
11.1.1 Forward
purchase
In a forward purchase transaction, the entity and a counterparty agree that on a given
future date the counterparty will sell a given number of the entity’s shares to the entity.
Such a contract is illustrated in Example 43.16 below. [IAS 32.IE2-6].
Example 43.16: Forward purchase of shares
The reporting entity (A), which has a functional currency of Euro and a year end of 31 December, and another
party (B) enter into a forward contract for the purchase of A’s shares by A, for which the following are the
major assumptions.
Contract date
1 February 2019
Maturity date
31 January 2020
Fixed forward price to be paid on 31 January 2020
€104
Present value of forward price on 1 February 2019
€100
Number of shares under contract 1,000
Market price per share on 1 February 2019
€100
Market price per share on 31 December 2019
€110
Market price per share on 31 January 2020
€106
Fair value of forward to A on 1 February 2019
€0
Fair value of forward to A on 31 December 2019
€6,300
Fair value of forward to A on 31 January 2020
€2,000
For simplicity, it is assumed that no dividends are paid on the underlying shares (i.e. 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. At settlement date this is €2,000 representing 1,000 shares at €2,
being the difference between the market price of €106 and the contract price of €104.
A Net
cash
settlement
If the contract is entered into as net cash-settled on 1 February 2019, settlement on 31 January 2020 will
take the form of receipt or delivery by A of a cash payment for the difference between the fair value of
1,000 of A’s own shares, at 31 January 2020, and €104,000 (i.e. 1,000 shares at the forward price of €104
per share). Since 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:
3572 Chapter 43
€
€
1 February 2019
No entry is required because the fair value of the contract is zero
at inception and no cash is paid or received
31 December 2019
Forward contract (statement of financial position)
6,300
Gain on forward (profit or loss)
6,300
To record movement in fair value of forward from zero to €6,300
31 January 2020
Loss on forward (profit or loss)
4,300
Forward contract (statement of financial position)
4,300
To record movement in fair value of forward from €6,300 to €2,000
Cash 2,000
Forward contract (statement of financial position)
2,000
To record settlement of forward by payment of €2,000 by B to A
B
Net share settlement
If the contract is entered into as net share-settled on 1 February 2019, settlement on 31 January 2020 will take
the form of receipt or delivery by A of as many of A’s shares as have a fair value equal to the difference
between the fair value, at 31 January 2020, of 1,000 of A’s own shares and €104,000 (i.e. 1,000 shares at the
forward price of €104 per share). Because 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 and no cash is paid or received
31 December 2019
Forward contract (statement of financial position)
6,300
Gain on forward (profit or loss)
6,300
To record movement in fair value of forward from zero to €6,300
31 January 2020
Loss on forward (profit or loss)
4,300
Forward contract (statement of financial position)
4,300
To record movement in fair value of forward from €6,300 to €2,000
Equity 2,000
Forward contract (statement of financial position)
2,000
To record net settlement of forward by transfer of €2,000 worth of A’s
shares (€2000/106=18.9 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).
Financial instruments: Financial liabilities and equity 3573
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 receipt of 1,000 own shares by A in exchange for a payment of €104,000 to B. IAS 32 classifies
this derivative contract as an equity instrument giving rise to a financial liability for the present value of the
purchase price amount payable in one year’s time (see 5.3 above). On the assumption that A accounts for this
liability under the effective interest method in IFRS 9, A records the following accounting entries:
€
€
1 February 2019
Equity 100,000
Liability for forward contract (statement of financial position)
100,000
To record net present value of liability on forward contract
31 December 2019
Interest expense
3,660
Liability for forward contract (statement of financial position)
3,660
To accrue interest, under the effective interest rate method, on the
liability to settle forward contract
31 January 2020
Interest expense
340
Liability for forward contract (statement of financial position)
340
To accrue further interest, under the effective interest rate method, on the
liability to settle forward contract
Liability for forward contract (statement of financial position)
104,000
Cash
104,000
To record settlement of the liability in cash
D Settlement
options
If there are settlement options (such as net in cash, net in shares or by an exchange of a fixed amount of cash
for a fixed number of shares), the forward contract is a financial asset or a financial liability – see 5.2.7 above.
The contract does not meet the definition of an equity instrument, because it can be settled otherwise than by
delivery of a fixed amount of cash for a fixed number of equity instruments. If one of the settlement
alternatives is gross settlement by an exchange of cash for shares, A recognises a liability for the obligation
to deliver cash. Otherwise, A accounts for the forward contract as a derivative.
The implementation guidance to IAS 32 states that A should recognise a liability ‘if one of the settlement
alternatives is to exchange cash for shares’. As drafted, this applies whether the choice of settlement rests
with A or B. This seems curious since, where A has the choice of settlement, there would be no obligation
for A to settle gross. We assume that the example is written on the presumption that the choice of settlement
would normally rest with the counterparty rather than the entity. Paragraph 23 in the main body of the
standard is clear that an equity contract gives rise to a liability for the purchase price of the shares only where
there is an obligation for the entity to purchase its own equity. Accordingly, in our view, where the choice of
settlement rests only with the entity, it is acceptable to record no liability, and to account for the contract as
a derivative.
11.1.2 Forward
sale
In a forward sale transaction, the entity and a counterparty agree that on a given future
date the entity will sell (or issue) a given number of the entity’s shares to the
counterparty. Such a contract is illustrated in Example 43.17 below. [IAS 32.IE7-11].
3574 Chapter 43
Example 43.17: Forward sale of shares
The reporting entity (A), which has a functional currency of Euro and a year end of 31 December, and another
party (B) enter into a forward contract for the purchase of A’s shares by B, for which the following are the
major assumptions.
Contract date
1 February 2019
Maturity date
31 January 2020
Fixed forward price to be paid on 31 January 2020
€104
Present value of forward price on 1 February 2019
€100
Number of shares under contract 1,000
Market price per share on 1 February 2019
€100
Market price per share on 31 December 2019
€110
Market price per share on 31 January 2020
€106
Fair value of forward to A on 1 February 2019
€0
Fair value of forward to A on 31 December 2019
€(6,300)
Fair value of forward to A on 31 January 2020
€(2,000)
For simplicity, it is assumed that no dividends are paid on the underlying shares (i.e. 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. At settlement date this is negative €2,000
representing 1,000 shares at €2, being the difference between the market price of €106 and the contract
price of €104.
A Net
cash
settlement
If the contract is entered into as net cash-settled on 1 February 2019, settlement on 31 January 2020 will
take the form of receipt or delivery by A of a cash payment for the difference between the fair value of
1,000 of A’s own shares, at 31 January 2020, and €104,000 (i.e. 1,000 shares at the forward price of €104
per share). Since 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 and no cash is paid or received.
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
Cash
2,000
To record net settlement of forward by payment of €2,000 cash by A to B
Financial instruments: Financial liabilities and equity 3575
B
Net share settlement
If the contract is entered into as net share-settled on 1 February 2019, settlement on 31 January 2020 will take
the form of receipt or delivery by A of a payment of as many of A’s shares as have a fair value equal to the
difference between the fair value, at 31 January 2020, of 1,000 of A’s own shares and €104,000 (i.e.
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 706
