CFM16075 - Accounting for financial instruments: IAS 32 and IAS 39: meaning of financial asset and financial liability

Financial assets and liabilities - definitions

In very broad terms, financial assets will, or are likely to, lead to a company receiving cash in the future; financial liabilities will, or are likely to, lead to a company paying out cash in the future. But the cash may be received, or paid, via a whole chain of contractual rights or obligations – for example, a company may hold an option to acquire a convertible bond that can be converted into shares that can be sold for cash. So the definitions of financial asset and financial liability in IAS 32 are in general terms.

The principal things that are defined as being financial assets are:

• Cash
• An equity instrument of another entity, which is not a subsidiary – for example, ordinary shares in another company.
• A contractual right to receive cash or another financial asset from another entity. Loans and bank deposits are examples of assets where there is a contractual right to receive cash from another entity. And a company holding a convertible bond has a contractual right to receive another financial asset (shares, with cash as an alternative) from the issuer.
• A contractual right to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity. For example, an interest rate swap that is "in the money" will be a financial asset – the company has both a contractual obligation to pay, and a contractual right to receive, cash amounts, but over the remaining life of the swap expects to receive more than it will pay.
• The main categories of financial liability are
• a contractual obligation to deliver cash or another financial asset to another entity – for example, borrowings of all kinds or debt securities that the company has issued; or
• a contractual obligation to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable – for example, an out-of-the- money interest rate swap.

The definitions in IAS 32 also provide for certain certain contracts that will or may be settled in a company's own shares to be financial assets or financial liabilities. There is more about this in the discussion of the difference between debt and equity – see CFM16175.

CFM16075a provides further detail on what falls inside or outside of these definitions. CFM16075b deals with the status of lease obligations.