QUESTION 22 Illustration 12: Written put option on own equity instruments On 1 January 2018, Entity X writes a put option over 1,00,000 of its own equity shares for which it receives a premium of $ 5,00,000. Under the terms of the option, Entity X may be obliged to take delivery of 1,00,000 of its own shares in one year’s time and to pay the option exercise price of $ 22,000,000. The option can only be settled through physical delivery of the shares (gross physical settlement). Examine the nature of the financial instrument.
Solution
The financial instrument in this case is the written put option over 1,00,000 of Entity X's own equity shares.
Based on the information provided, the put option is a financial liability for Entity X, as it has a contractual obligation to deliver its own shares and receive the option exercise price of $22,000,000. The option premium of $5,00,000 received by Entity X represents a liability that will need to be offset against the liability arising from the put option.
Since the option can only be settled through physical delivery of the shares, it is classified as a liability measured at fair value through profit or loss under International Accounting Standards (IAS 32). This means that any changes in the fair value of the liability will be recognized in the income statement of Entity X.
Therefore, based on the information provided, the written put option over Entity X's own equity shares is a financial liability measured at fair value through profit or loss, as it represents a contractual obligation for Entity X to deliver its own shares in exchange for the option exercise price.
Here is a table summarizing the calculation for the financial instrument in Illustration 12:
Note that the fair value of the liability will need to be re-measured at the end of each reporting period, with any changes in fair value recognized in the income statement. The calculation of fair value will be based on market conditions and the probability of the option being exercised.