Financial Instruments
Financial Instruments
Financial Instruments
Ordinary shares (that cannot be put back to the issuer by the holder)
Preference shares (that cannot be redeemed by the holder or provide for
nondiscretionary dividends
Warrants or written call options (that allow the holder to subscribe foror purchase
a
fixed number of nonputtable ordinary shares in exchange for a fixed amount of cash
or another financial asset)
The definition of an equity instrument is brief and succinct, but the definitions of
financial asset and financial liability are more complex.
Cash;
An equity instrument of another entity;
A contractual right to receive cash or another financial asset from another entity, or to
exchange financial assets or financial liabilities with another entity under conditions
that are potentially favorable to the entity; or
A contract that may or will be settled in the entitys own equity instrument and is not
classified as an equity instrument of the entity (discussed below).
Cash, above
Investment in shares or other equity instrument issued by other entities, see (b) above
Investments in bonds and other debt instruments issued by other entities, see (c) above
Issued bonds and other debt instruments issued by the entity, see (a) above
Obligations to deliver own shares worth a fixed amount of cash, see (b) above
It follows from the definitions that these assets and liabilities are not financial
instruments:
Physical assets (e.g., inventories, property, plant, and equipment). Control of physical
assets creates an opportunity to generate a cash inflow but does not give rise to a
present right to receive cash or another financial asset.
Intangible assets (e.g., patents and trademarks). Control of intangible assets creates
an opportunity to generate a cash inflow but does not give rise to a present right to
receive cash or another financial asset.
Prepaid expenses. Such assets are associated with the receipt of goods or services.
They do not give rise to a present right to receive cash or another financial asset.
Deferred revenue. Such liabilities are associated with the future delivery of goods or
services. They do not give rise to a contractual obligation to pay cash or another
financial asset.
Warranty obligations. Such liabilities are associated with the future delivery of
goods or services. They do not give rise to a contractual obligation to pay cash or
another financial asset.
Income tax liabilities (or assets). Such liabilities (or assets) are not contractual but
are imposed by statutory requirements.
Apart from items that meet the definition of financial instruments, IAS 32, IAS 39, and IFRS
7 also apply to some contracts that do not meet the definition of a financial instrument but
have characteristics similar to derivative financial instruments. This expands the scope of IAS
32, IAS 39, and IFRS 7 to contracts to purchase or sell nonfinancial items (e.g., gold,
electricity, or gas) at a future date when, and only when, a contract has both of these two
characteristics: (a) it can be settled net in cash or some other financial instrument, and (b) it is
not for receipt or delivery of the nonfinancial item in accordance with the entitys expected
purchase, sale, or usage requirements.
Unlike IAS 39, IAS 32 has no scope exception for an entitys issued equity instruments
that are classified in the equity section of the balance sheet (e.g., an entitys share capital).
Case Example
This case illustrates how to apply the definition of a financial instrument and the scope
of IAS 32.
Company A is evaluating whether each of these items is a financial instrument and whether it
should be accounted for under IAS 32:
(a) Cash deposited in banks
(b) Gold bullion deposited in banks
(c) Trade accounts receivable
(d) Investments in debt instruments
(e) Investments in equity instruments, where Company A does not have significant influence
over the investee
(f) Investments in equity instruments, where Company A has significant influence over the
investee
(g) Prepaid expenses
(h) Finance lease receivables or payables
(i) Deferred revenue
(j) Statutory tax liabilities
(k) Provision for estimated litigation losses
(l) An electricity purchase contract that can be net settled in cash
(m) Issued debt instruments
(n) Issued equity instruments
Required:
Help Company A to determine (1) which of the above items meet the definition of a financial
instrument and (2) which of the above items fall within the scope of IAS 32.
Solution:
(a) Yes, cash deposited in a bank is a financial instrument. If an entity deposits cash in a
bank, it is a financial asset of the entity and a financial liability of the bank, because the bank
has a contractual obligation to repay the cash to the entity. It falls within the scope of IAS 32.
(b) No, gold is not a financial instrument. It is a commodity. It is outside the scope of IAS
32.
(c) Yes, a trade accounts receivable is a financial instrument. Trade accounts receivable is
a financial asset because the holder has a contractual right to receive cash. It falls within the
scope of IAS 32.
(d) Yes, an investment in a debt instrument is a financial instrument. Investments in debt
instruments are financial assets because the investor has a contractual right to receive cash. It
falls within the scope of IAS 32.
(e) Yes, an investment in an equity instrument is a financial instrument. Investments in
equity instruments are financial assets because the investor holds an equity instrument
issued by another entity. It falls within the scope of IAS 32.
(f) While an investment in an equity instrument is a financial instrument (a financial
asset), if the investor has significant influence, joint control or control over the investee, the
investment generally is scoped out of IAS 32 and instead accounted for as an investment in
an associate, joint venture, or subsidiary.
(g) No, prepaid expenses are not financial instruments because they will not result in the
delivery or exchange of cash or other financial instruments. They are outside the scope of
IAS 32.
(h) Yes, finance lease receivables or payables are financial instruments. They are within
the scope of IAS 32. (However, they are scoped out of IAS 39 except for recognition and
measurement of impairment of finance lease receivables.)
(i) No, deferred revenue does not meet the definition of a financial instrument. Deferred
revenue is outside the scope of IAS 32.
(j) No, deferred taxes do not meet the definition of a financial instrument, because they
do not arise from contractual rights or obligations, but from statutory requirements.
They are outside the scope of IAS 32.
(k) No, provisions do not meet the definition of a financial instrument, because they do
not arise as a result of contractual rights or obligations. They are outside the scope of IAS
32.
(l) Even though an electricity purchase contract does not meet the definition of a
financial instrument, it is included in the scope of IAS 32 (and IAS 39) if it can be settled
net in cash unless it will be settled by delivery to meet the entitys normal purchase, sale, or
usage requirements.
(m) Yes, an issued debt instrument meets the definition of a financial liability. It is within
the scope of IAS 32.
(n) Yes, an issued equity instrument is a financial instrument that falls within the scope
of IAS 32. However, although an issued equity instrument meets the definition of a financial
instrument, there is a specific scope exception for issued equity instruments in IAS 39.