Many people think that the day they buy financial instruments (whether equity shares, preference shares, bonds, debentures, commercial paper, promissory notes, loans, etc.) is the day they will receive them. The reality is that the date a contract for the purchase of a financial instrument is entered into may not necessarily be the actual date they are delivered to the buyer. To understand trade date and settlement date accounting, we need first to understand what trade date and settlement date are.

Trade Date: This is when two parties enter a contract (in this case, an agreement to buy or sell financial instruments). It is the day the investor places a buy order in the capital market or an Exchange. On this date, the parties involved in the contract (i.e., buyer and seller) agree on the price of the security, the face value, coupon rate, maturity, discount, transaction fees etc.

Settlement date: The settlement date is the date when the legal transfer of the securities is executed between the buyer and seller. It is the date the assets are delivered to the holder by the issuer of the instrument.

Consider this example, Mr Tom enters a contract to buy 100 Tesla shares on 20 July 2021 when the share price was USD 770. The transaction was finalised two days later (i.e., T+2), on 22 July 2021, and Mr Tom received 100 Tesla’s shares when the prevailing share price was USD 770.7. How should this transaction be reported in the books of Mr Tom upon initial recognition?

In accounting for the above equity investment transaction, which fair value should be adopted? Should we use the trade date fair value or the settlement date fair value? IFRS9 makes it a matter of accounting policy for an entity because it presumes that there will not be a material difference in fair value between the two dates.

In the above question, the fair value on the trade date, 20 July 2021, was USD 770, while the fair value on the settlement date, 22 July 2021, was USD 770.7.

Upon Initial recognition:

a) If trade date is accounting is adopted, Mr Tom will record the transaction in its books at initial recognition (on 20 July 2021) as thus:

Debit: Equity Investment by $77,000 USD (i.e., 100 shares X $770 USD)

Credit: Bank (or other modes of payment) by $77,000 USD (i.e., 100 shares X $770 USD)b)

If the settlement date accounting is adopted, Mr Tom will record the transaction in its books at initial recognition (on 20 July 2021) as thus:

Debit: Equity Investment by $77,070 USD (i.e., 100 shares X $770.7 USD)

Credit: Bank (or other modes of payment) by $77,000 USD (i.e., 100 shares X $770 USD)

Credit: Profit or Loss by $70 USD (i.e., 100 shares X $0.7 USD)

Note, when the settlement date accounting is adopted, a Day 1 loss must be rIf settlement date accounting is adopted, a gain will be recorded in profit or loss (or other comprehensive income if classification of the equity investment is at fair value through OCI) at initial recognition. This is because by substance, Mr Tom has assumed ownership of those shares (even though delivery is yet to be made); hence, any flunction in share price of the instrument would not affect the issuer but the holder. Therefore, the increase in fair value of shares will be recognised as a gain on settlement date and credited to profit or loss. Conversely, fair value loss at initial recognition could arise if the share price drops before the settlement date.

It is instructive to note that the industry favours more of trade date accounting than settlement date accounting. However, the standard makes it an accounting policy option concerning adopting a fair value of financial instruments at initial recognition.