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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Accounting for corporate finance: derivative contracts: examples of derivatives that are not financial instruments

This guidance applies for IFRS, New UK GAAP and FRS 26 under Old UK GAAP.

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.

Some contracts relating to the purchase or sale of non financial items will not give rise to derivatives - or will not be accounted for as derivatives. For example, contracts to buy or sell a non financial item (e.g. a commodity- copper, oil, coffee) that are held for an entity’s purchase, sale, or usage requirements, will not be accounted for as derivatives.

However, some contracts to buy or sell a non financial item will be accounted for as derivatives, if they are not held for such purposes, and if, for example:

  • the contract can be settled net in cash;
  • the contract may not provide for net settlement, but the entity has a past practice of settling such contracts net;
  • the entity has a past practice of taking delivery of the physical item, and immediately selling it for the purposes of generating a profit from price fluctuations or a dealer’s margin; or
  • when the non financial item is readily convertible to cash.

Note: the final three bullet points above are not referred to by FRS102, which only refers to contracts which can be settled net.