IFRS PRACTICAL IMPLEMENTATION GUIDE AND WORKBOOK

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Chapter 25 / Financial In struments: Recognition and Measurem ent (lAS 39 )

Dr 111vestment ill shares ofEntity B

110,000

Cr Cash

/00,000

Cr Derivative asset $/0 ,000 (To record exercise and derecognition of call options and receipt ofshares)

7.0.5 As discussed previously, there is an exce ption to the requiremen t to meas ure derivatives at fair value for derivatives that are linked to and must be settled by an inves tment in an unquoted equity instrument that cannot be reliably measured at fair value, For instance, an option to buy shares in a start-up entity that is not publicly traded may qualify for this exception, If the fair value can not be reliabl y meas ured, such a derivative would be measured at cost instead of fair value (i.e, close to zero in many cases), Case Study 12 On January 1, 20X6, Entit y A enters into a forward contract to purc hase on January I, 20X8, a specified number of barrel s of oil at a fixed price. Entity A is speculating that the price of oil will increase and plans to net settle the contrac t if the price increases. Entity A doe s not pay anything to enter into the for– ward contract on January 1, 20X6. Entity A does not designa te the forward co ntract as a hedging instru– ment. At the end of 20X6 , the fair value of the forward contrac t has increase d to $400,000. At the end of 20X7 , the fair value of the forward contrac t has declin ed to $350,000. Required Prepare the appropriate journal entrie s on Janu ary I, 20X6, December 3 1, 20X6. and December 3 1. 20X7 . So lution The journal entries are l alll/ary I 20X6 No entry is required. December 31 20X6 Dr Derivative asset CrGain December 31 20X7 Dr Loss Cr Derivative asset 50,000 50,000 7.1 Embedded Derivatives 7.1.1 Sometimes derivatives are embedded in other types of contracts. For instance, one or more derivative feature s may be embedded in a loan. bond . share, lease, insurance contract, or purchase or sale contract. When a derivative feature is embedded in a nonderivative contract, the derivative is referre d to as an embedded derivative and the contract in which it is embedded is referred to as a host contract. Example An entity may issue a bond with interest or principal payments that are indexed to the price of gold (e.g., the interest payments increase and decrease with the price of gold). Such a bond is a contract that combines a host debt instrument and an embedded derivative on the price of gold. 7.1.2 To achieve consistency in the accounting for derivatives (whether embedded or not) and to prevent entities from circumventing the recognition and measurement requirements for derivatives merely by embedding them in other types of contrac ts, entities are required to identi fy any embed– ded derivatives and account for them separately from their hosts contracts if these three condition s are met: ( I) On a stand-alone basis, the embedded feature meets the definition of a derivative. (2) The combined (hybrid) contract is not measured at fair value with changes in fair value recogni zed in profit or loss (i.e., if the comb ined contr act is already accounted for similar to a derivative, there is no need to separate the embedded feature). (3) The economic characteristics and risks of the embedded feature are not closely relat ed to the economic characteristics and risks of the host contract. 400,000 400,000 This case illustrates how to account for derivatives. Facts