Introduction

‘Financial instruments’ is a broad term, encompassing a wide range of financial assets and liabilities as well as a company's own equity. These terms are defined below. Financial assets include shares and debt instruments held by an investor. By contrast, debt instruments, in the financial statements of the issuer of the debt, are financial liabilities. Although a company's own equity (that is, where it issues its own shares) is excluded from the definition of financial liabilities, it is nevertheless a financial instrument and is discussed below. Financial assets and liabilities also include derivatives and more straightforward instruments such as cash, receivables (debtors) and payables (creditors). Accounting for financial instruments has been one of the most complex and controversial aspects of accounting. The requirement that some financial instruments are stated at fair value is a major source of complexity. The fair value requirement is also controversial, especially where changes in fair values are reported in the income statement, giving rise to earnings volatility. However, there are other problematic aspects, including when and how to use ‘hedge accounting’ and how debt and equity should be distinguished.

The term ‘capital instruments’ has been used historically in the UK. This represents all instruments issued by an entity as a means of raising finance, comprising the entity's equity instruments, together with debt instruments such as loans and debentures. However, the term ‘capital instruments’ is not used in IFRS.

Background

The IFRS requirements relating to accounting for financial instruments are set out in IAS 32 ‘Financial instruments: presentation’ and IAS 39 ‘Financial instruments: recognition and measurement’.

IAS 32 deals with classification of issued instruments into debt and equity; the classification is, in principle, based on the substance of the instrument, not its legal form.