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10.4 Derivatives on own shares—settlement models
Publication date: 14 Oct 2019
us IFRS & US GAAP guide
Entities will need to consider how derivative contracts on an entity’s own shares will be settled. Many of these contracts that are classified as equity under US GAAP (e.g., warrants that will be net share settled or those where the issuer has settlement options) will be classified as derivatives under IFRS. Derivative classification will create additional volatility in the income statement.
US GAAP
| IFRS
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Derivative contracts that are in the scope of ASC 815-40 and either (1) require physical settlement or net share settlement, or (2) give the issuer a choice of net cash settlement or settlement in its own shares are considered equity instruments, provided they meet the criteria set forth within the literature.
| Contracts that are net settled (net cash or net shares) are classified as liabilities or assets. This is also the case even if the settlement method is at the issuer’s discretion.
Gross physical settlement is required to achieve equity classification.
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Analysis of a contract’s terms is necessary to determine whether the contract meets the qualifying criteria, some of which can be difficult to meet in practice.
Similar to IFRS, derivative contracts that require net cash settlement are assets or liabilities.
Contracts that give the counterparty a choice of net cash settlement or settlement in shares (physical or net settlement) result in derivative classification. However, if the issuer has a choice of net cash settlement or share settlement, the contract can still be considered an equity instrument.
| Unlike US GAAP, under IFRS, a derivative contract that gives one party (either the holder or the issuer) a choice over how it is settled (net in cash, net in shares, or by gross delivery) is a derivative asset/liability unless all of the settlement alternatives would result in the contract being an equity instrument.
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