Financial instruments are contracts or agreements between two parties that have financial value and can be traded or used for investment purposes. They can take many forms, including stocks, bonds, derivatives, currencies, and commodities.
Financial instruments are used for a variety of purposes, including hedging risk, raising capital, and investing for the purpose of generating a return.
Financial instruments can be divided into two main categories: debt instruments and equity instruments. Debt instruments, such as bonds, represent a promise to repay a fixed amount of money at a specified time and typically pay periodic interest.
Equity instruments, such as stocks, represent ownership in a company and give the holder a right to a portion of the company’s profits and assets.
Financial instruments can be traded on financial markets, such as stock exchanges or over-the-counter markets, and their value is determined by supply and demand.
The price of financial instruments can be influenced by a variety of factors, including changes in interest rates, economic conditions, and market sentiment.
Definition of Financial instruments under IFRS 9
Under International Financial Reporting Standards (IFRS) 9, financial instruments are defined as any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. This definition includes a wide range of financial instruments, including loans, bonds, equities, derivatives, and many others.
IFRS 9 provides a framework for the classification and measurement of financial instruments, with the goal of ensuring that the financial statements accurately reflect the risks and characteristics of each financial instrument.
Under IFRS 9, financial instruments are classified into one of three categories: amortized cost, fair value through other comprehensive income (FVTOCI), and fair value through profit or loss (FVTPL).
The classification of a financial instrument under IFRS 9 is based on its contractual cash flows and the entity’s business model for managing the financial asset or liability. The appropriate classification and measurement category for a financial instrument will impact the financial statements and affect the recognition of gains and losses over time.
Overall, IFRS 9 provides a comprehensive framework for the reporting and analysis of financial instruments, and helps to ensure that financial statements provide a fair and accurate picture of an entity’s financial position and performance.
List of assets that are not considered financial instruments:
- Physical assets such as real estate, equipment, machinery, and vehicles
- Raw materials, semi-finished goods, and finished goods held in inventory
- Natural resources such as minerals, oil, and gas reserves
- Intellectual property such as patents, trademarks, and copyrights
- Artwork and collectibles
- Land, buildings, and infrastructure
- Reputation and brand value
- Employee skills and knowledge
- Customer relationships and goodwill
- Government grants and subsidies.
- Tax receivable
Note that these are just examples and the definition of a financial instrument can vary based on the specific context and jurisdiction.
Here is an explanation for why each of the assets listed above is not considered a financial instrument:
- Physical assets such as real estate, equipment, machinery, and vehicles are not financial instruments because they do not represent a contractual agreement or promise to deliver cash or another financial asset. They are tangible assets that provide value through their use or ownership.
- Raw materials, semi-finished goods, and finished goods held in inventory are not financial instruments because they are physical assets that are used in the production process or sold as goods. They do not represent a financial obligation or right to receive cash or another financial asset.
- Natural resources such as minerals, oil, and gas reserves are not financial instruments because they are tangible assets that provide value through their extraction and sale. They do not represent a financial obligation or right to receive cash or another financial asset.
- Intellectual property such as patents, trademarks, and copyrights are not financial instruments because they represent the legal rights to use a particular invention, name, or creative work, but do not represent a financial obligation or right to receive cash or another financial asset.
- Artwork and collectibles are not financial instruments because they are physical assets that provide value through their rarity, historical significance, or aesthetic appeal. They do not represent a financial obligation or right to receive cash or another financial asset.
- Land, buildings, and infrastructure are not financial instruments because they are tangible assets that provide value through their use or ownership. They do not represent a financial obligation or right to receive cash or another financial asset.
- Reputation and brand value are not financial instruments because they represent intangible assets that provide value through consumer perception and trust. They do not represent a financial obligation or right to receive cash or another financial asset.
- Employee skills and knowledge are not financial instruments because they represent intangible assets that provide value through the ability to perform work. They do not represent a financial obligation or right to receive cash or another financial asset.
- Customer relationships and goodwill are not financial instruments because they represent intangible assets that provide value through the ability to attract and retain customers. They do not represent a financial obligation or right to receive cash or another financial asset.
- Government grants and subsidies are not financial instruments because they represent non-repayable transfers from a government to an individual or organization, rather than a financial obligation or right to receive cash or another financial asset.
- Tax receivable: tax receivable is not typically considered to be a financial instrument. A financial instrument is defined as a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. Tax receivable refers to the right to receive a payment from a government or other tax authority for taxes that have been paid in excess of the amount owed. While tax receivable can have financial value and impact a company’s cash flows, it does not meet the criteria for a financial instrument as defined under International Financial Reporting Standards (IFRS). Instead, tax receivable is typically accounted for as a non-financial asset, such as a receivable or deferred tax asset, and is recognized in the financial statements based on the accounting principles applicable to that asset class.