SolvedCFM24030 | Accounting for corporate finance: derivative contracts: what is a financial instrument?
From HM Revenue & Customs · Corporate Finance Manual
The definitions below are essentially the same as those used by all entities preparing accounts under IFRS, New UK GAAP or Old UK GAAP..
A financial instrument is ‘any contract that gives rise to both a financial asset and a financial liability or equity instrument of another entity’, where:
A financial asset is ‘any asset that is:
cash;
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 favourable to the entity; or
a contract that will or may be settled in the entity’s own equity instruments and is
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
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
A financial liability is ‘any liability that is:
a contractual obligation
to deliver cash or another financial asset to another entity’ or
to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entitly; or
a contract that will or may be settled in the entity’s own equity instruments and is
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
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…’
An equity instrument is ‘any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.’
A financial instrument must be a contractual asset or liability
A financial instrument must arise from a contractual right. For example, tax liabilities, because these stem from a statutory provision and not from a contract, are not financial liabilities.
Contractual rights and contractual obligations include those that are contingent on the occurrence of future events (e.g. those arising under a financial guarantee).
Note that, for an accountant, the term ‘contract’ has a precise meaning. Although an agreement to purchase an item of plant or machinery is legally a contract, this is initially an unperformed, or executory, contract, which gives rights and obligations to exchange a physical asset for a financial asset. It is only once the item is delivered that a debtor/creditor relationship is brought into existence. This is the point at which the assets and liabilities are recognised.