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Chapter
25 /
Financial In struments: Recognition and Measurem ent (lAS 39 )
267
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
400,000
400,000
This case illustrates how to account for derivatives.
Facts
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.