Understanding financial instruments involves dissecting the term into two parts: "financial" and "instruments." Firstly, the term "financial" delves into items found on a balance sheet, encompassing both monetary and non-monetary assets and liabilities. While often associated with money, "financial" extends beyond mere currency, including items like accounts receivable and payable, which are expected to be settled at their stated values. Notably, assets like property, plant, and equipment do not fall under the monetary category but are considered non-monetary.
Moreover, certain non-monetary items also fall under the umbrella of "financial," notably investments in other entities' debt or equity securities. These investments, though not strictly monetary, hold financial significance due to their potential impact on an entity's financial position.
Moving on to the term "instruments," it commonly refers to written agreements or documents outlining various financial arrangements. In the realm of financial instruments, this term emphasizes the contractual nature of monetary items. Essentially, any monetary items arising from agreements—such as loans, bonds, or stocks—are recognized as financial instruments. Conversely, monetary items like statutory payments to governments, which lack contractual agreements, do not qualify as financial instruments.
In summary, financial instruments encompass financial assets of an entity, along with corresponding financial liabilities or equity of another entity, arising from contractual agreements. This nuanced understanding emphasizes the dual significance of both the financial nature of assets and liabilities and the contractual agreements that govern them.
