CFM24220 - Accounting for corporate finance: derivative contracts and IAS: examples of derivatives that are not financial instruments within IAS 39

Derivatives that are not financial instruments

Many contracts that meet the definition of a derivative will be also be financial instruments, constituting a financial asset of one party and a financial liability of the other. Consider, for example, a call option over foreign currency. This is a financial instrument because

• the option holder, in return for a premium, has a right to exchange one financial asset (cash) for another (foreign currency) under conditions that are potentially favourable, and
• the option writer has a contractual obligation to exchange financial assets under conditions that are potentially unfavourable.

Some instruments embody both a right and an obligation to make an exchange. Since the terms of the exchange are determined on inception of the derivative those terms may become either favourable or unfavourable as prices in financial markets change.

But some derivatives are not financial instruments, and therefore are not within the scope of IAS 39. An example of a derivative that is not a financial instrument is an option to buy or sell an asset other than a financial asset (such as a commodity, or a building or similar fixed asset) that cannot be settled net in cash or another financial instrument. Such an option does not give rise to a financial asset or financial liability because, although one party parts with cash (or some other financial instrument), they do not receive a financial instrument in exchange.

Similarly, a forward contract to buy goods of any kind, where there is no possibility of net settlement in cash, will not be within the scope of IAS 39.