Financial instrument - What is a financial instrument?
Financial instruments are documents detailing the issuing of assets that can be traded and are considered binding
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Financial instruments represent the issuing of investments in the form of financial assets and liabilities, as well as equity. The issuing of financial instruments affects the buying and selling parties differently when it comes to recording the activity.
A financial instrument is considered a contract between the two parties involved, so technically, a financial instrument is a piece of paper or a virtual document with monetary value that can be printed.
Stocks, bonds, securities, futures - essentially any form of capital that can be packaged and traded can be considered a financial instrument.
Types of financial instruments
Different types of financial instruments can be involved in a transaction. There are generally two types: cash and derivative. As far as cash financial instruments are concerned, they can be again separated into three categories:
Debt: as financial instrument, debts mean a loan that is provided to the owner of an asset by an investor. Debt can also be categorised into short-term or long-term.
Equity (capital): if a financial instrument involves company capital, then it falls under equity.
Foreign-exchange: a unique type of financial instrument that involves an exchange rate as the asset addressed in the contract. They are not considered debt-based nor equity-based so they have their own category of financial instruments.
Some financial instruments, such as bonds, provide the holder with additional rights such as a say in company activities involving shares.
How to record financial instruments
On the accounting side, financial instruments can get a bit complicated. How they are recorded depends on whether a business is buying or issuing and is of course related to the type of financial instrument as discussed above.
When financial instruments involve investments such as stocks, bonds, sales on credit (receivables), then these are considered financial assets. When financial instruments involve a balance in accounts payable or a long-term loan, they are considered financial liabilities.
In accounting, bonds and receivables are considered assets, long-term loans and receivables are considered liabilities, and capital is considered equity. Derivatives are also financial instruments.
Issuing financial instruments
When a business issues financial instruments, this transaction is recorded as an asset in the accounts receivable.
Buying financial instruments
When a business or party is on the purchasing side of a transaction involving financial instruments, this is recorded as a liability in the accounts payable. The transactions involving financial instruments can be anonymous, so the buyer and seller are unknown to one another.
