Accounting for corporate finance: key concepts: financial instrument, financial assets, financial liabilities: examples of contracts
A flour milling company enters into a forward contract to buy 1,000 tonnes of wheat in 6 months’ time, at an agreed price. The contract can either be settled by delivery of wheat to the company’s mill, or by a cash payment representing the difference between the forward price and the spot price of the wheat on the delivery date.
If the milling company has entered into the contract as part of its normal trading arrangements for buying raw materials, and the purchase is in line with its normal usage requirements, the contract will be outside the scope of IAS 39 and Sections 12 of FRS 102.
A company speculating in commodities enters into a forward contract to buy wheat, on similar terms to that under example 1 above, with the settlement date being on 1 September 20x6. The company takes delivery of the wheat, but on 4 September 20x6 it sells the wheat to a third party. The company has entered into the contract for the purpose of realising a profit from short-term fluctuations in price; the contract is a derivative within the scope of IAS 39 and Section 12 of FRS 102.
A farming company grants an option to a builder in return for a premium. The option gives the builder the right to buy an area of farmland for £1.5 million at any time within the next two years. However, on exercise of the option the builder may choose not to have the land conveyed to him, but to receive a cash amount related to the difference between the strike price and the open market value of the land. The farming company cannot say that it has written the option in order to dispose of land, because it has no control over whether it will part with the land or not. The contract is a derivative within the scope of IAS 39 and Section 12 of FRS 102.