Updated July 15, 2023
Introduction of Financial Assets
Financial assets are those of an entity that derives their value from the contractual rights or an underlying asset. It includes only those assets with some worth to exchange the same to settle financial obligations or to settle an entity’s equity instruments or a right to receive a financial asset from another entity, or it may include cash.
Explanation
- Before knowing what “financial asset” means, let’s understand a financial instrument’s meaning. A financial instrument is a contract that results in the financial asset for one entity and a financial liability or an equity instrument for another entity (so it goes vice versa). For example, Mr. A Is a debtor for Apple inc; likewise, apple inc is the creditor for Mr. A. Mr. John is an investor in Domino. From the point of view of Mr. A, he holds the financial asset of Domino, and from the point of view of Domino’s, Mr. A is a shareholder holding an equity instrument.
- Financial assets are liquid assets such as stocks, bonds, cash balance, bank balance, deposits with banks, mutual fund investments, investments in equity instruments of another company, etc.
- Financial Assets may or may not have a physical form. Like in the case of bank balance, it is not in physical form, but in cash, it has a physical form.
- Even though few financial assets have no physical form, IRS requires reporting both financial & real assets as tangible assets only from a tax perspective.
Examples of Financial Assets
As EXPLAINED ABOVe, We will take different examples to cover the different aspects of financial assets.
Example #1
Say a company has entered into an agreement to purchase a financial asset for $ 1200, which is the fair value as of the date of agreement I.E. 30th December 2019. The balance sheet date falls on 31st December 2019, at which the fair value is $ 1240. The payment same is made on 4th January 2020. We will record the financial asset at amortized cost.
Solution:
| Date | Particulars | Amt ($) |
| 30-12-2019 | Financial Asset (Debit) | 1,200 |
| Trade Payables (Credit) | 1,200 | |
| 31-12-2019 | No entry to be passed at amortized cost | |
| 4/1/2020 | Trade Payables (Debit) | 1,200 |
| Cash (Credit) | 1,200 |
Explanation
- Amortized Cost Means the Present Value of Future Cash Flows. Since the Future Cashflows Are Just a Few Days Ahead, the Amortised Cost of $ 40 Here Is the Same as Balance Sheet Date.
- Thus, No Adjusting Entry Is Required at the Close of the Accounting Year Under Amortised Cost. The Real Amount Payable Is Settled on 4Th January of Next Year.
Example #2
Say a company has entered into an agreement to purchase a financial asset for $ 2000, which is the fair value as of the date of agreement I.E. 30th December 2019. the balance sheet date falls on 31st December 2019, with a fair value of $ 2150.The payment same is made on 4th January, 2020and the fair value was $ 2180.we will record the financial asset using ftvoci
| Date | Particulars | Amt ($) |
| 30-12-2019 | Financial Asset (Debit) | 2,000 |
| Trade Payables (Credit) | 2,000 | |
| 31-12-2019 | Financial Asset (Debit) | 150 |
| OCI (Credit) | 150 | |
| 4/1/2020 | Trade Payables (Debit) | 2,000 |
| Cash (Credit) | 2,000 |
Explanation
- The Accounting Policy Followed Here Is the Valuation of Financial Assets at Fair Value Through Other Comprehensive Income (oci). Oct Is part of the comprehensive income statement of the entity. The Gain/loss from Oci Is directly transferred to the owner’s equity & not transferred to the profit & loss statement (i.e. the first part of the comprehensive income statement).
- The amount of Oci $ 150 is transferred to the fair value reserve account, a balance sheet item grouped under “reserves & surplus”.
- As of the balance sheet date, the financial asset is recognized at $ 2150. the gain amount of $ 150 is transferred to oci. The actual amount is payable at the rate of $2000 only and not at the fair value.
Example #3
Say a company has entered into an agreement to purchase a financial asset for $ 5000, which is the fair value as of the date of agreement I.E. 30th December 2019. The balance sheet date falls on 31st December 2019, with a fair value of $ 5540. The Payment was made on 4th January 2020, and the fair value was $ 5590.we will record the financial asset using fvtpl
| Date | Particulars | Amt ($) |
| 30-12-2019 | Financial Asset (Debit) | 5,000 |
| Trade Payables (Credit) | 5,000 | |
| 31-12-2019 | Financial Asset (Debit) | 540 |
| Profit & Loss (Credit) | 540 | |
| 4/1/2020 | Financial Asset (Debit) | 50 |
| Profit & Loss (Credit) | 50 | |
| 4/1/2020 | Trade Payables (Debit) | 5,000 |
| Cash (Credit) | 5,000 |
Explanation:
- In Example 3, We see that the profit or loss is recorded at each change.
- The difference is transferred to the Profit & Loss Account. It means that Fvtpl assumes that the Profit or Loss is a realized gain or loss & hence, It allows a direct effect on the profit & loss of the entity.
Example #4
On 1st March 2019, Alpha Inc acquired 15000 shares in Beta Inc for $ 500,000. This holding is reflected in 30% of total shares issued by beta inc. thus, Alpha inc is treated as an associate entity of beta inc. For the year-end 2019, beta inc earns $ 750,000 as net income from its business operations. Further, on 15th January 2020, beta inc paid a dividend of to alpha inc of $ 15000.We will record the investment in equity instruments using the equity method as below:
| Date | Particulars | Amt ($) |
| 1/3/2019 | Investment in Beta Inc (Debit) | 5,00,000 |
| Bank (Credit) | 5,00,000 | |
| 31-12-2019 | Investment in Beta Inc (Debit) | 2,25,000 |
| Investment Income (OCI) (Credit) | 2,25,000 | |
| 15-01-2020 | Bank (Debit) | 15,000 |
| Investment in Beta Inc (Credit) | 15,000 |
Explanation
- Since Alpha Inc is an associated entity with 30% shareholding, the proportionate profits of Beta Inc are allowed to be treated as income of Alpha Inc.
- The investment income of $ 225,000 is treated as the “other Comprehensive Income” of the entity.
- Receiving the dividend should reduce the number of receivables from Beta Inc; hence, the account is debited when the dividend is received.
- Investment in Beta Inc is shown as financial assets in the balance sheet of Alpha Inc at the value of $ 725,000 on December 31, 2020. the Oci is increased by $ 225,000, which increases the reserves of the entity.
Conclusion
The financial assets are recognized based on the asset’s characteristics and the intention behind holding the asset. The recognition criteria are used for initial recognition. The subsequent recognition of financial assets requires the financial asset to be recognized under the same principles. This ensures consistency in the measurement of financial assets.
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