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Financial instruments and leases
Published on March 29, 2017 17 min
Other Talks in the Series: Analysing Financial Statements
Hi and welcome to part six Financial Instruments and Leases in this HSTalks lecture series on Analyzing Financial Statements. My name is David Bond. Given it's a big topic, I'm going to jump right in. We'll start with financial instruments before moving on to leases.
Financial instruments range from the relatively simple to the incredibly complex. Not surprisingly, the accounting for financial instruments can be a little convoluted at times. It is also controversial. The use of fair values, or sometimes termed mark-to-market accounting, was argued to be an exacerbating factor during the GFC. Given that this is an introduction to financial instruments, I'm going to first look at what financial instruments are and then provide an overview of the main ways in which they get accounted for so you can get a feel as to what is going on.
So what are financial instruments? According to the standards, a financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. Looking at that definition, a couple of things are important. First, a financial instrument is a contractual relationship between two parties. Second, one party will end up with a financial asset whilst the other will end up with either a financial liability or an equity instrument. Before we move into an example to explain this, let's define financial asset, financial liability, and equity instrument.
The following definitions are somewhat simplified from the standards, but they'll suit our purposes. A financial asset is any asset that is cash and equity instrument of another entity or the contractual right to receive cash or another financial asset from another entity. A financial liability is any liability that is a contractual obligation to deliver cash or another financial asset to another entity and an equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. Now that we've defined them, let's use an example to see them in action.