IFRS PRACTICAL IMPLEMENTATION GUIDE AND WORKBOOK

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Wiley IFR S: Practica l Implementation Guide and Workbook

7.1.3 When any of these three conditions is not met, the embedded derivative is not separated

(i.e., only if all conditions are met is an embedded derivative separated) . When all of these condi–

tions are met, the embedded derivative is separated (i.e. , bifurcated) from the host contract and ac–

counted for like any other deri vative. The host instrument is accounted for under the accounting

requirements that app ly to the host instrument as if it had no embedded deri vative .

7.1.4 The flowchart illustrates these three conditions.

On a stand-alone basis, would the

embedded feature meet the definition of a

derivative?

Yes

Is the combined contract measured at fair

Yes

value with changes in fair value recognized

in profit or loss?

Is the embedded derivative closely related

Yes

to the host contract?

The embedded derivative feature should be

The embedded derivative fe ature should

separated fro m the host contract and

not be separated from the host contract.

accounted for as a derivative.

Example

A convertible bond is an instrument that combines both a host debt instrument and an equity con–

version option (i.e., an option that enables the holder [investor] to convert the bond into a predeter–

mined number of shares on specified conditions). In this case, the investor usually would be re–

quired to separate the equity conversion option from the investment in the host debt instrument and

account fo r the equity conversion option separate ly as a derivative.

7.1. 5 To help in the eval uation of whether an embedded fea ture is closely related-s-condition (3)

above-lAS 39 provides examples of when the economic characteri stics and risks would be con–

sidered to be clo sely related or not. Generally, for an embedded feature in a host debt contract to be

considered closely related, the embedded feature must have primarily debt characteristics.

Example

Features that would be considered not closely related to the host contract are

• An equity conversion option embedded in a convertible bond instrument that allows the

holder to convert the instrument into shares ofthe issuer

• A call option embedded in an investment in an equity instrument that allows the issuer to

repurchase the instrument

• A bond that has a principal amount or interest payments that varies based on a commodity or

equity price index

• A credit derivative embedded in a debt instrument that reduces the principal amount of the

bond

a third party defaults

• Sales or purchase contracts that require payments in a fo reign currency other than (a) the

f unctional currency of any substantial party to the contract, (b) the currency in which the re–

lated good or service

routinely denominated (i.e., U.S. dollars fo r crude oil), or (c) a cur-