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• A forward contract to sell a fixed number of equity instruments (e.g., 1,000 shares) of the entity to another entity for a fixed exercise price at a future
date (e.g., $100). If the forward is entered into at a zero fair value, no journal entry is required until settlement of the transaction.
If, however, there is any variability in the amount of cash or own equity instruments that will be received or delivered under such a contract (e.g., based on the share
price, the price of gold, or some other variable), the contract is a financial asset or financial liability, as applicable.
Example
Examples of instruments that are classified as financial liabilities are
• A contract that requires the entity to deliver as many of the entity’s own equity instruments as are equal in value to $100,000 on a future date
• A contract that requires the entity to deliver as many of the entity’s own equity instruments as are equal in value to the value of 100 ounces of gold on a
future date
• A contract that requires the entity to deliver a fixed number of the entity’s own equity instruments in return for an amount of cash calculated to equal the
value of 100 ounces of gold on a future date
If a financial instrument requires the issuer to repurchase its own issued equity instruments for cash or other financial assets, there is a financial liability for the
present value of the repurchase price (redemption amount). The liability is recognized by reclassifying the amount of the liability from equity. Subsequently, the
liability is accounted for under IAS 39. If it is classified as a financial liability measured at amortized cost, the difference between the repurchase price and the present
value of the repurchase price is amortized to profit or loss as an adjustment to interest expense using the effective interest rate method.
Example
On January 1, 20X7, Entity A enters into a forward contract that requires the entity to repurchase 1,000 shares for $60,000 on December 31, 20X7. No
consideration is paid or received at inception of the contract. The market interest rate is 10%, such that the present value of the payment is $54,545 [= 60,000/(1
+ 10%)]. Therefore, the entity makes this journal entry on initial recognition to recognize its liability for the repurchase price:
Equity 54,545
Liability 54,545
On December 31, 20X7, Entity A makes this entry to recognize the amortization in accordance with the effective interest method:
Interest expense 6,565
Liability 6,565
Finally, on December 31, 20X7, Entity A settles the forward contract and makes this journal entry:
Liability 60,000
Cash 60,000
If a derivative financial instrument gives one party a choice over how it is settled, it is a financial asset or financial liability unless all of the settlement alternatives
would result in it being an equity instrument.
Example
One example of a contract that would be classified as a financial liability because it provides for a choice of settlement is a written call option on own equity
that the entity can decide to settle by either of the following:
1. By issuing a fixed number of own equity instruments in return for a fixed amount of cash.
2. Net in cash, in an amount equal to the difference between (a) the value of a fixed number of own equity instruments and (b) a fixed amount.
Such a financial liability would be accounted for as a derivative at fair value.
If the contract had not included a net settlement alternative (2 in the preceding list), it would have been classified as an equity instrument because it would not
have contained any variability in the amount of cash or the number of equity instruments that would have been exchanged.
Treasury Shares
Treasury shares are shares that are not currently outstanding. When an entity reacquires an outstanding share or other equity instrument, the consideration paid is
deducted from equity. No gain or loss is recognized in profit or loss even if the reacquisition price differs from the amount at which the equity instrument was
originally issued. Similarly, if the entity subsequently resells the treasury share, no gain or loss is recognized in profit or loss even if the proceeds at reissuance differ
from the consideration paid when the treasury shares were reacquired previously. The amount of treasury shares is disclosed separately either in the notes or on the
face of the balance sheet.
Example