Problem:
Holder Ltd purchased a option contract for issuer Ltd that gave Holder Ltd the right to acquire 100,000 options in Torquay Ltd for a price (exercise price) of $10,000 per share. When the contract was exchanged, the price of Torquay Ltd shares were $9 each. The option entitles Holder Ltd to exercise the options and buy the shares anytime within the next six months. If the options are not exercised within the six month period, the options will expire.
Required:
Determine whether a financial liability or financial asset exists from the perspective of Holder Ltd and Issuer Ltd. Further, if the price of shares in Torquay Ltd falls to $5 (with the results that it is improbable that Holder Ltd will ever exercise the option) will this change the classification of the options as either financial assets or financial liabilities? Why?