(c) Cash for shares ('gross physical settlement')
IE20. Assume the same facts as in (a) except that settlement will be made by delivering a fixed number of shares and receiving a fixed amount of cash, if Entity B exercises the option. Similarly to (a) and (b) above, the exercise price per share is fixed at CU102. Accordingly, Entity B has a right to receive 1,000 of Entity A's own outstanding shares in exchange for CU102,000 (CU102 × 1,000) in cash, if Entity B exercises its option. Entity A records the following journal entries.
1 February 2002          
Dr    Cash    CU5,000    
Cr    Equity         CU5,000
To record the cash received in exchange for the obligation to deliver a fixed number of Entity A's own shares in one year for a fixed price. The premium received is recognised in equity. Upon exercise, the call would result in the issue of a fixed number of shares in exchange for a fixed amount of cash.
31 December 2002
No entry is made on 31 December because no cash is paid or received and a contract to deliver a fixed number of Entity A's own shares in exchange for a fixed amount of cash meets the definition of an equity instrument of the entity.
31 January 2003
Entity B exercises the call option and the contract is settled gross. Entity A has an obligation to deliver 1,000 shares in exchange for CU102,000 in cash.
Dr    Cash    CU102,000    
Cr    Equity         CU102,000
To record the settlement of the option contract.

(b) Shares for shares ('net share settlement')
IE19. Assume the same facts as in (a) except that settlement will be made net in shares instead of net in cash. Entity A's journal entries are the same as those shown in (a), except for recording the settlement of the option contract, as follows:
31 January 2003
Entity B exercises the call option and the contract is settled net in shares. Entity A has an obligation to deliver CU104,000 (CU104 × 1,000) worth of Entity A's shares to Entity B in exchange for CU102,000 (CU102 × 1,000) worth of Entity A's shares. Thus, Entity A delivers the net amount of CU2,000 worth of shares to Entity B, ie 19.2 shares (CU2,000 / CU104).
Dr    Call option obligation    CU2,000    
Cr    Equity         CU2,000
To record the settlement of the option contract. The settlement is accounted for as an equity transaction.

(a) Cash for cash ('net cash settlement')
IE18. Assume the same facts as in Example 3(a) above except that Entity A has written a call option on its own shares instead of having purchased a call option on them. Accordingly, on 1 February 2002 Entity A enters into a contract with Entity B that gives Entity B the right to receive and Entity A the obligation to pay the fair value of 1,000 of Entity A's own ordinary shares as of 31 January 2003 in exchange for CU102,000 in cash (ie CU102 per share) on 31 January 2003, if Entity B exercises that right. The contract will be settled net in cash. If Entity B does not exercise its right, no payment will be made. Entity A records the following journal entries.
1 February 2002
Dr    Cash    CU5,000    
Cr    Call option obligation    CU5,000
To recognise the written call option.
31 December 2002
Dr    Call option obligation    CU2,000    
Cr    Gain         CU2,000
To record the decrease in the fair value of the call option.
31 January 2003
Dr    Call option obligation    CU1,000    
Cr    Gain         CU1,000
To record the decrease in the fair value of the option.
On the same day, Entity B exercises the call option and the contract is settled net in cash. Entity A has an obligation to deliver CU104,000 (CU104 × 1,000) to Entity B in exchange for CU102,000 (CU102 × 1,000) from Entity B, so Entity A pays a net amount of CU2,000.
Dr    Call option obligation    CU2,000    
Cr    Cash         CU2,000
To record the settlement of the option contract.

(d) Settlement options
IE16. The existence of settlement options (such as net in cash, net in shares or by an exchange of cash and shares) has the result that the call option is a financial asset. It does not meet the definition of an equity instrument because it can be settled otherwise than by Entity A repurchasing a fixed number of its own shares in exchange for paying a fixed amount of cash or another financial asset. Entity A recognises a derivative asset, as illustrated in (a) and (b) above. The accounting entry to be made on settlement depends on how the contract is actually settled.
Example 4: Written call option on shares
IE17. This example illustrates the journal entries for a written call option obligation on the entity's own shares that will be settled (a) net in cash, (b) net in shares or (c) by delivering cash in exchange for shares. It also discusses the effect of settlement options (see (d) below).
Assumptions:      
Contract date    1 February 2002
Exercise date    31 January 2003
(European terms, ie it can be exercised only at maturity)
Exercise right holder    Counterparty (Entity B)
Market price per share on 1 February 2002    CU100
Market price per share on 31 December 2002    CU104
Market price per share on 31 January 2003    CU104
Fixed exercise price to be received on 31 January 2003    CU102
Number of shares under option contract    1,000
Fair value of option on 1 February 2002    CU5,000
Fair value of option on 31 December 2002    CU3,000
Fair value of option on 31 January 2003    CU2,000

(c) Cash for shares ('gross physical settlement')
IE15. Assume the same facts as in (a) except that settlement will be made by receiving a fixed number of shares and paying a fixed amount of cash, if Entity A exercises the option. Similarly to (a) and (b) above, the exercise price per share is fixed at CU102. Accordingly, Entity A has a right to receive 1,000 of Entity A's own outstanding shares in exchange for CU102,000 (CU102 × 1,000) in cash, if Entity A exercises its option. Entity A records the following journal entries.
1 February 2002
Dr    Equity    CU5,000    
Cr    Cash         CU5,000
To record the cash paid in exchange for the right to receive Entity A's own shares in one year for a fixed price. The premium paid is recognised in equity.
31 December 2002
No entry is made on 31 December because no cash is paid or received and a contract that gives a right to receive a fixed number of Entity A's own shares in exchange for a fixed amount of cash meets the definition of an equity instrument of the entity.
31 January 2003
Entity A exercises the call option and the contract is settled gross. Entity B has an obligation to deliver 1,000 of Entity A's shares in exchange for CU102,000 in cash.
Dr    Equity    CU102,000    
Cr    Cash         CU102,000
To record the settlement of the option contract.

(b) Shares for shares ('net share settlement')
IE14. Assume the same facts as in (a) except that settlement will be made net in shares instead of net in cash. Entity A's journal entries are the same as those shown in (a) except for recording the settlement of the option contract as follows:
31 January 2003
Entity A exercises the call option and the contract is settled net in shares. Entity B has an obligation to deliver CU104,000 (CU104 × 1,000) worth of Entity A's shares to Entity A in exchange for CU102,000 (CU102 × 1,000) worth of Entity A's shares. Thus, Entity B delivers the net amount of CU2,000 worth of shares to Entity A, ie 19.2 shares (CU2,000 / CU104).
Dr    Equity    CU2,000    
Cr    Call option asset         CU2,000
To record the settlement of the option contract. The settlement is accounted for as a treasury share transaction (ie no gain or loss).

(a) Cash for cash ('net cash settlement')
IE13. On 1 February 2002, Entity A enters into a contract with Entity B that gives Entity B the obligation to deliver, and Entity A the right to receive the fair value of 1,000 of Entity A's own ordinary shares as of 31 January 2003 in exchange for CU102,000 in cash (ie CU102 per share) on 31 January 2003, if Entity A exercises that right. The contract will be settled net in cash. If Entity A does not exercise its right, no payment will be made. Entity A records the following journal entries.
1 February 2002
The price per share when the contract is agreed on 1 February 2002 is CU100. The initial fair value of the option contract on 1 February 2002 is CU5,000, which Entity A pays to Entity B in cash on that date. On that date, the option has no intrinsic value, only time value, because the exercise price of CU102 exceeds the market price per share of CU100 and it would therefore not be economic for Entity A to exercise the option. In other words, the call option is out of the money.
Dr    Call option asset    CU5,000    
Cr    Cash         CU5,000
To recognise the purchased call option.
31 December 2002
On 31 December 2002, the market price per share has increased to CU104. The fair value of the call option has decreased to CU3,000, of which CU2,000 is intrinsic value ([CU104 - CU102] × 1,000), and CU1,000 is the remaining time value.
Dr    Loss    CU2,000    
Cr    Call option asset         CU2,000
To record the decrease in the fair value of the call option.
31 January 2003
On 31 January 2003, the market price per share is still CU104. The fair value of the call option has decreased to CU2,000, which is all intrinsic value ([CU104 - CU102] × 1,000) because no time value remains.
Dr    Loss    CU1,000    
Cr    Call option asset         CU1,000
To record the decrease in the fair value of the call option.
On the same day, Entity A exercises the call option and the contract is settled net in cash. Entity B has an obligation to deliver CU104,000 (CU104 × 1,000) to Entity A in exchange for CU102,000 (CU102 × 1,000) from Entity A, so Entity A receives a net amount of CU2,000.
Dr    Cash    CU2,000    
Cr    Call option asset         CU2,000
To record the settlement of the option contract.

Example 3: Purchased call option on shares
IE12. This example illustrates the journal entries for a purchased call option right on the entity's own shares that will be settled (a) net in cash, (b) net in shares or (c) by delivering cash in exchange for the entity's own shares. It also discusses the effect of settlement options (see (d) below):
Assumptions:      
Contract date    1 February 2002
Exercise date    31 January 2003 (European terms, ie it can be exercised only at maturity)
Exercise right holder    Reporting entity (Entity A)
Market price per share on 1 February 2002    CU100
Market price per share on 31 December 2002    CU104
Market price per share on 31 January 2003    CU104
Fixed exercise price to be paid on 31 January 2003    CU102
Number of shares under option contract    1,000
Fair value of option on 1 February 2002    CU5,000
Fair value of option on 31 December 2002    CU3,000
Fair value of option on 31 January 2003    CU2,000

(d) Settlement options
IE11. The existence of settlement options (such as net in cash, net in shares or by an exchange of cash and shares) has the result that the forward contract is a financial asset or a financial liability. It does not meet the definition of an equity instrument because it can be settled otherwise than by Entity A repurchasing a fixed number of its own shares in exchange for paying a fixed amount of cash or another financial asset. Entity A recognises a derivative asset or liability, as illustrated in (a) and (b) above. The accounting entry to be made on settlement depends on how the contract is actually settled.

1 February 2002
No entry is made on 1 February. No cash is paid or received because the forward has an initial fair value of zero. A forward contract to deliver a fixed number of Entity A's own shares in exchange for a fixed amount of cash or another financial asset meets the definition of an equity instrument because it cannot be settled otherwise than through the delivery of shares in exchange for cash.
31 December 2002
No entry is made on 31 December because no cash is paid or received and a contract to deliver a fixed number of Entity A's own shares in exchange for a fixed amount of cash meets the definition of an equity instrument of the entity.
31 January 2003
On 31 January 2003, Entity A receives CU104,000 in cash and delivers 1,000 shares.
Dr    Cash    CU104,000    
Cr    Equity         CU104,000
To record the settlement of the forward contract.