What are the various Financial Instruments? | Ind AS 32, Ind AS 109 and Ind AS 107

3. Financial Asset

The following definitions are given in Ind AS 32.

A financial asset is any asset that is:

(a)  cash;

Analysis: Currency /Cash is a financial instrument because it is a medium of exchange of transactions and is therefore the basis on which all transactions are measured and recognized in the 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 obtains cash from the bank.

(b)  an equity instrument of another entity;

Analysis: Investment in equity shares of other entity;

Read the word carefully – It is “Equity” instrument not just ‘equity share capital’. We will be discussing it below

(c)  a contractual right:

(i)  to receive cash or another financial asset from another entity; or

Examples: Trade receivables, Bills receivables, loan and advance (given).

In these cases, the entity has either a right to receive cash or other financial asset (i.e., equity instrument of any entity);

(ii)  to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity (Profit making); or

Examples: A Ltd. holds a call option to purchase equity share in listed company X Ltd for ` 50 per share at the end of 60 days period and if value of the share on exercise day is more than 50 Say 75 (This is called “In the money” in financial management terms). As you know, A Ltd. is called “Holder of the option” and X Ltd. is called “Writer of the option”

 As it is potentially favourable, it is a financial asset and A Ltd. recognises the same by debiting -Option asset & Crediting – Other income for ` 25.

Try to understand, when it is potentially favourable to A Ltd., obviously it is the other side of the coin for X Ltd, i.e., potentially unfavourable to X Ltd and hence, it is an obligation to settle for X Ltd. Hence, it should recognise the financial liability by debiting – Expense/loss & Crediting – Financial liability for ` 25.

(d)  a contract that will or may be settled in the entity’s own equity instruments and is:

(i)  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

 (ii)  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. For this purpose, the entity’s own equity instruments DO NOT INCLUDE:

• • • • • Puttable financial instruments classified as equity instruments,
        • Instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments; or
        • Instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.

Important note:

As per the Companies Act, 2013 – a company cannot hold its own shares; hence Point (d) is not applicable in India. It leads to buy back of shares and it should satisfy the provisions of the Companies Act, 2013.

Outside India, as per the laws of that country, a company can hold its own shares. Such shares are called “Treasury stock” – Accounting of treasury stock is discussed in the later part to this chapter.

4. Financial liability (FL)

Financial liability is any liability that is:

(a)  a contractual obligation:

(i)  to deliver cash or another financial asset to another entity; or

Examples: Trade payables, Loan taken wherein the entity should settle by paying either cash or by transferring any other financial asset;

(ii)  to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity(loss making); or

Example: Refer the point in financial asset.

(b)  a contract that will or may be settled in the entity’s own equity instruments and is

(i)  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

E.g., A convertible debenture, which will be converted into equity shares based on the market value of the shares on the date of conversion. (Variable number of own shares – based on market value) (See below concept capsule)

(ii)  A DERIVATIVE that will or may be settled for OTHER THAN

• • • • • By exchange of a fixed amount of cash (i.e., payable in variable amount is FL); or
        • Another financial asset for a fixed number of the entity’s own equity instruments;

Based on the above definition the following are NOT financial liabilities but are equity instruments:

• • • For this purpose, rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers rights, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments. (Example: a contract to issue right shares, Share warrants, etc., are not financial liability).
    • Apart from the aforesaid, the equity conversion option embedded in a convertible bond denominated in foreign currency to acquire a fixed number of the entity’s own equity instruments is an equity instrument if the exercise price is fixed in any currency.

In the above two cases – entity’s own equity instruments do not include Puttable instruments (discussed part of “equity”).

5. Equity Instrument

It is defined in two ways:

Definition 1

It is a contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities;

It means equity instrument holder is the owner and who is ready to accept the remaining money after clearing all the liabilities of the entity. Remaining amount may be positive or nil.

Definition 2

Equity instrument is the one which is NOT a financial liability. This is elaborated like this:
An instrument is equity instrument if it satisfies following both of the following conditions-

a. The instrument includes NO contractual obligation to either (i) to deliver cash or another financial asset to another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the issuer;

b. If the instrument will or may be settled in the issuer’s own equity instruments, it is:

• • • • • a non-derivative that includes NO contractual obligation for the issuer to deliver a variable number of its own equity instruments; or
        • a derivative that will be settled only by the issuer exchanging a fixed amount of cash or another financial asset for a fixed number of its own equity instruments.

To classify an instrument correctly whether as a liability or equity – One should NOT look at the nomenclature of the instrument BUT to observe the terms and conditions attached to it.