| What are financial instruments? |
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Preparers often misclassify assets and liabilities as financial instruments. There are three basic points to consider in deciding whether you have a financial instrument or not… - The arrangement is contractual rather than statutory.
- One party to the transaction has a financial asset, and the other party to the transaction has either a financial liability or a residual interest (‘equity’).
- The transaction is settled in cash or another financial instrument.
By applying these three basic points to arrangements, preparers will be able to analyse transactions and conclude whether they are contractual or statutory.
Contractual versus statutory arrangements
Assets and liabilities are accounted for differently depending on whether they are contractual or statutory. The table outlines the key differences: | Contractual arrangements | Statutory arrangements | | Governed by law of contracts. | Governed by legislation, regulation or similar means. | | Willing parties to the transaction. | Compulsory transaction. | | Rights and obligations for parties to the arrangement. The rights and obligations need not be equal. | Same as contractual arrangements. | | Rights and obligations are enforceable. | Same as contractual arrangements. |
Financial asset, financial liability or residual interest
For a financial instrument to exist, one party to the arrangement has a financial asset, and the other party has a financial liability or a residual interest.
Typical examples include the following: - An entity sells goods on credit. In this instance the entity selling the goods has a financial asset, while the other party has a financial liability to pay for the goods received.
- An entity receives goods on credit. In this instance, the entity receiving the goods has a financial liability and the other party has a financial asset to receive payment.
- An entity (investor) invests in the ordinary shares of another entity. The shares are a residual interest as they entitle the investor to a portion of the other entity’s net assets. The investor has a financial asset, and the other entity has transferred a residual interest in it to the investor.
Settled in cash
Because of the requirement to have a financial asset in one entity and a financial liability or residual interest in another, financial instruments are settled in cash. Transactions or balances that are settled through the provision of goods or services are not financial liabilities. To illustrate: Prepaid insurance will be settled through the provision of insurance services rather than through the return of cash.
Find guidance on financial instruments
In response to the changes to GRAP 104, the Secretariat issued Fact Sheets to assist entities to apply the changes.
One of the Fact Sheets deals with applying the definition of financial instruments. As the definition between the old and the new versions of GRAP 104 is unchanged, the Fact Sheet can be applied regardless of the version of GRAP 104 being applied.
Access the Fact Sheet here. |
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