What is a Financial instrument?

What is a Financial instrument?

A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. The following financial instruments do not fall within the scope of Ind AS 32:

Financial asset

A financial asset is any asset that is:

1. cash;
2. an equity instrument of another entity;
3. a contractual right:
4. to receive cash or another financial asset from another entity; or
5. to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or
6. a contract that will or may be settled in the entity’s own equity instruments and is:
7. a non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments; or
8. a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments.

The definition of financial asset includes a reference to financial asset which should not be taken as a circular reference. The contractual right to receive cash or another financial asset should end with the receipt of cash or other financial asset ultimately. Thus, a chain of contractual rights or contractual obligations meets the definition of a financial instrument if it will ultimately lead to the receipt or payment of cash or to the acquisition or issue of an equity instrument.

The rights and obligations of financial assets and financial liabilities are the result of certain contractual provisions underlying these. An entity’s tax liability, for example, does not meet the ‘contractual basis’ test and hence is not a financial instrument. Cash, even though is not formed out of a contractual basis, is still a financial asset as it represents the medium of exchange and is therefore the basis on which all transactions are measured and recognised in financial statements. Inventories, plant and machinery, properties and other intangible assets are examples of non-financial assets that are not financial instruments. Such assets even if it is held as an investment (as opposed to stock-in-trade) are not regarded as financial instruments.

Common examples of financial assets representing a contractual right to receive cash in the future and corresponding financial liabilities representing a contractual obligation to deliver cash in the future are:

1. trade accounts receivable and payable;
2. notes receivable and payable;
3. loans receivable and payable; and
4. bonds receivable and payable.

In each case, one party’s contractual right to receive (or obligation to pay) cash is matched by the other party’s corresponding obligation to pay (or right to receive).

Financial liability

A financial liability is any liability that is:

1. a contractual obligation:
2. to deliver cash or another financial asset to another entity; or
3. to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or
4. a contract that will or may be settled in the entity’s own equity instruments and is:
5. a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or
6. a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments.

Here again the definition of financial liability includes a reference to financial liability which should not be taken as a circular reference. The contractual obligation to deliver cash or another financial asset should end with the delivery of cash or other financial asset ultimately.

Ind AS Accounting Standards