Accounting for income taxes is dealt with in more detail in another standard, IAS 12 –
Income Taxes (see Chapter 29), while levies are covered by IFRIC 21 – Levies (see
Chapter 27).
Similarly, constructive obligations as defined in IAS 37 – Provisions, Contingent
Liabilities and Contingent Assets (see Chapter 27 at 3.1.1) do not arise from contracts
and are therefore not financial liabilities. [IAS 32.AG12].
3414 Chapter 41
2.2.2
Simple financial instruments
Currency (or cash) is a financial asset because it represents the medium of exchange
and is therefore the basis on which all transactions are measured and recognised in
financial statements. A deposit of cash with a bank or similar financial institution is a
financial asset because it represents the contractual right of the depositor to obtain cash
from the institution or to draw a cheque or similar instrument against the balance in
favour of a creditor in payment of a financial liability. [IAS 32.AG3].
The following common financial instruments give rise to 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:
(a) trade accounts receivable and payable;
(b) notes receivable and payable;
(c) loans receivable and payable; and
(d) 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).
[IAS 32.AG4].
Another type of financial instrument is one for which the economic benefit to be
received or given up is a financial asset other than cash. For example, a note payable in
government bonds gives the holder the contractual right to receive, and the issuer the
contractual obligation to deliver, government bonds, not cash. The bonds are financial
assets because they represent obligations of the issuing government to pay cash. The
note is, therefore, a financial asset of the note holder and a financial liability of the note
issuer. [IAS 32.AG5].
Perpetual debt instruments (such as perpetual bonds, debentures and capital notes)
normally provide the holder with the contractual right to receive payments on account
of interest at fixed dates extending indefinitely, either with no right to receive a return
of principal or a right to a return of principal under terms that make it very unlikely or
very far in the future. For example, an entity may issue a financial instrument requiring
it to make annual payments in perpetuity equal to a stated interest rate of 8% applied to
a stated par or principal amount of $1,000. Assuming 8% is the market rate of interest
for the instrument when issued, the issuer assumes a contractual obligation to make a
stream of future interest payments having a net present value (or fair value) of $1,000
on initial recognition. The holder and issuer of the instrument have a financial asset and
a financial liability, respectively. [IAS 32.AG6].
2.2.3
Contingent rights and obligations
The ability to exercise a contractual right or the requirement to satisfy a contractual
obligation may be absolute (as in the examples at 2.2.2 above), or it may be contingent
on the occurrence of a future event. A contingent right or obligation, e.g. to receive or
deliver cash, meets the definition of a financial asset or a financial liability. [IAS 32.AG8].
For example, a financial guarantee is a contractual right of the lender to receive cash
from the guarantor, and a corresponding contractual obligation of the guarantor to pay
Financial instruments: Definitions and scope 3415
the lender, if the borrower defaults. The contractual right and obligation exist because
of a past transaction or event (the assumption of the guarantee), even though the
lender’s ability to exercise its right and the requirement for the guarantor to perform
under its obligation are both contingent on a future act of default by the borrower.
[IAS 32.AG8].
However, even though contingent rights and obligations can meet the definition of a
financial instrument, they are not always recognised in the financial statements as such.
For example, contingent rights and obligations may be insurance contracts within the
scope of IFRS 4 – Insurance Contracts (see Chapter 51 at 3.3) or IFRS 17 – Insurance
Contracts (see Chapter 52 at 3.3) or may otherwise be excluded from the scope of
IFRS 9 (see 3 below). [IAS 32.AG8].
2.2.4 Leases
A lease typically creates an entitlement of the lessor to receive, and an obligation of the
lessee to make, a stream of payments that are substantially the same as blended
payments of principal and interest under a loan agreement. The lessor accounts for its
investment in the amount receivable under a finance lease rather than the underlying
asset itself. Accordingly, a lessor regards a finance lease as a financial instrument.
[IAS 32.AG9]. The lessee accounts for its obligation to make payments to the lessor (in
addition to the leased asset) and also regards it as a financial instrument.
In contrast, a lessor does not recognise its entitlement to receive lease payments under
an operating lease. The lessor continues to account for the underlying asset itself rather
than any amount receivable in the future under the contract. Accordingly, a lessor does
not regard an operating lease as a financial instrument, except as regards individual
payments currently due and payable by the lessee. [IAS 32.AG9].
Similarly, a lessee does not recognise its obligation to make lease payments under an
operating lease under IAS 17 – Leases, and does not regard an operating lease as a
financial instrument, except as regards individual payments currently due and payable
to the lessor. However, when applied, IFRS 16 – Leases – requires a lessee to recognise
a lease liability, with corresponding right-of-use asset, at the commencement date at
the present value of the lease payments that are not paid at that date. [IFRS 16.22, 26].
Accordingly, under IFRS 16, a lessee regards a lease as giving rise to a financial liability.
Nevertheless, as discussed in more detail at 3.2 below, financial instruments arising
from leases are not always accounted for under IFRS 9.
The standards do not explicitly address whether an accrued liability (or receivable)
under an operating lease meets the definition of a financial liability (or financial asset)
before the due date for payment. However, the guidance on accounting for service
concession arrangements (see 2.2.6 below) suggests that such accruals should be
considered financial instruments.
2.2.5
Non-financial assets and liabilities and contracts thereon
Physical assets (such as inventories, property, plant and equipment), right-of-use assets
and intangible assets (such as patents and trademarks) are not financial assets. Control
of such physical assets, right-of-use assets and intangible assets creates an opportunity
to generate an inflow of cash or another financial asset, but it does not give rise to a
3416 Chapter 41
present right to receive cash or another fina
ncial asset. [IAS 32.AG10]. For example, whilst
gold bullion is highly liquid (and perhaps more liquid than many financial instruments),
it gives no contractual right to receive cash or another financial asset, and so is therefore
a commodity, not a financial asset. [IFRS 9.B.1].
Assets such as prepaid expenses, for which the future economic benefit is the receipt
of goods or services rather than the right to receive cash or another financial asset, are
not financial assets. Similarly, items such as deferred revenue and most warranty
obligations are not financial liabilities because the outflow of economic benefits
associated with them is the delivery of goods and services rather than a contractual
obligation to pay cash or another financial asset. [IAS 32.AG11].
Contracts to buy or sell non-financial items do not meet the definition of a financial
instrument because the contractual right of one party to receive a non-financial asset
or service and the corresponding obligation of the other party do not establish a present
right or obligation of either party to receive, deliver or exchange a financial asset. For
example, contracts that provide for settlement only by the receipt or delivery of a non-
financial item (e.g. an option, future or forward contract on silver and many similar
commodity contracts) are not financial instruments. However, as set out at 4 below,
certain contracts to buy or sell non-financial items that can be settled net or by
exchanging financial instruments, or in which the non-financial item is readily
convertible into cash are included within the scope of IAS 32 and IFRS 9, essentially
because they exhibit similar characteristics to financial instruments. [IAS 32.AG20].
In some industries, e.g. brewing and heating gas, entities distribute their products in
returnable containers. Often, these entities will collect a cash deposit for each container
delivered which they have an obligation to refund on return of the container. The
Interpretations Committee found itself in November 2007 addressing the classification of
these obligations, in particular whether they met the definition of a financial instrument.2 It
is easy to jump to the conclusion (as the Interpretations Committee did initially)3 that such
an arrangement represents a contract to exchange a non-financial item (the container) for
cash and is therefore outside the scope of IFRS 9. However, the Interpretations Committee
recognised that this analysis holds true only if, in accounting terms, the container ceases to
be an asset of the entity when the sale is made, i.e. it is derecognised. If the container is not
derecognised, the entity cannot be regarded as receiving the non-financial asset because
the accounting treatment regards the entity as retaining the asset. Instead, the deposit simply
represents an obligation to transfer cash and is therefore a financial liability.4
Some contracts are commodity-linked, but do not involve settlement through the
physical receipt or delivery of a commodity. Instead they specify settlement through
cash payments that are determined according to a formula in the contract. For example,
the principal amount of a bond may be calculated by applying the market price of oil
prevailing at the maturity of the bond to a fixed quantity of oil, but is settled only in
cash. Such a contract constitutes a financial instrument. [IAS 32.AG22].
Financial instruments also include contracts that give rise to a non-financial asset or
non-financial liability in addition to a financial asset or financial liability. Such
arrangements often give one party an option to exchange a financial asset for a non-
financial asset. For example, an oil-linked bond may give the holder the right to receive
Financial instruments: Definitions and scope 3417
a stream of fixed periodic interest payments and a fixed amount of cash on maturity,
with the option to exchange the principal amount for a fixed quantity of oil. The
desirability of exercising this option will vary over time depending on the fair value of
oil relative to the exchange ratio of cash for oil (the exchange price) inherent in the
bond, but the intentions of the bondholder do not affect the substance of the
component assets. The financial asset of the holder and the financial liability of the
issuer make the bond a financial instrument, regardless of the other types of assets and
liabilities also created. [IAS 32.AG23].
2.2.6
Payments for goods and services
Where payment on a contract involving the receipt or delivery of physical assets is
deferred past the date of transfer of the asset, a financial instrument arises at the date
of delivery. In other words, the sale or purchase of goods on trade credit gives rise to a
financial asset (a trade receivable) and a financial liability (a trade payable) when the
goods are transferred. [IAS 32.AG21]. This is the case even if an invoice is not issued at the
time of delivery.
IAS 32 does not explain whether the same logic should apply to the delivery of other,
less tangible, non-financial items, e.g. construction or other services. IFRIC 12 – Service
Concession Arrangements – provides guidance on how operators of service
concessions over public infrastructure assets should account for these arrangements.
Where an operator obtains an unconditional contractual right to receive cash from the
grantor in exchange for construction or other services, the accrued revenue represents
a financial asset. This is the case even if payment is not due immediately and even if it
is contingent on the operator ensuring that the underlying infrastructure meets
specified quality or efficiency requirements (see Chapter 26 at 4.2). [IFRIC 12.16].
2.2.7 Equity
instruments
Equity instruments include non-puttable ordinary shares, some puttable and similar
instruments, some types of preference shares and warrants or written call options that
allow the holder to subscribe for or purchase a fixed number of non-puttable ordinary
shares in the issuing entity, in exchange for a fixed amount of cash or another financial
asset. [IAS 32.AG13]. The definition of equity instruments is considered in more detail in
Chapter 43 at 3.
2.2.8
Derivative financial instruments
In addition to primary instruments such as receivables, payables and equity instruments,
financial instruments also include derivatives such as financial options, futures and
forwards, interest rate swaps and currency swaps. Derivatives normally transfer one or
more of the financial risks inherent in an underlying primary instrument between the
contracting parties without any need to transfer the underlying instruments themselves
(either at inception of the contract or even, where cash settled, on termination).
[IAS 32.AG15, AG16].
There are important accounting consequences for financial instruments that are
considered to be derivatives, and the defining characteristics of derivatives are covered
in more detail in Chapter 42 at 2.
3418 Chapter 41
As noted at 2.2.5 above, certain derivative contracts on non-financial items are included
within the scope of IAS 32 and IFRS 9, even though they are not, strictly, financial
instruments as defined. These contracts are covered in more detai
l at 4 below.
On inception, the terms of a derivative financial instrument generally give one party a
contractual right (or obligation) to exchange financial assets or financial liabilities with
another party under conditions that are potentially favourable (or unfavourable). Some
instruments embody both a right and an obligation to make an exchange and, as prices
in financial markets change, those terms may become either favourable
or unfavourable. [IAS 32.AG16].
A put or call option to exchange financial assets or financial liabilities gives the holder
a right to obtain potential future economic benefits associated with changes in the fair
value of the underlying instrument. Conversely, the writer of an option assumes an
obligation to forgo such potential future economic benefits or bear potential losses
associated with the underlying instrument. The contractual right (or obligation) of the
holder (or writer) meets the definition of a financial asset (or liability). The financial
instrument underlying an option contract may be any financial asset, including shares
in other entities and interest-bearing instruments. An option may require the writer
to issue a debt instrument, rather than transfer a financial asset, but the instrument
underlying the option would constitute a financial asset of the holder if the option
were exercised. The option-holder’s right (or writer’s obligation) to exchange the
financial asset under potentially favourable (or unfavourable) conditions is distinct
from the underlying financial asset to be exchanged upon exercise of the option. The
nature of the holder’s right and of the writer’s obligation (which characterises such
contracts as a financial instrument) are not affected by the likelihood that the option
will be exercised. [IAS 32.AG17].
Another common type of derivative is a forward contract. For example, consider a
contract in which two parties (the seller and the purchaser) promise in six months’ time
to exchange $1,000 cash (the purchaser will pay cash) for $1,000 face amount of fixed
rate government bonds (the seller will deliver the bonds). During those six months, both
parties have a contractual right and a contractual obligation to exchange financial
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