Know Your Rights!!

How-to distinguish source of funds as a   Debt or Equity? Let’s begin reading this article by knowing the definition of Financial Instruments. A financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. The essence of the definition lies in contract which we generally understand as a transaction having all the three characteristics: agreement between two or more parties; for an economic consideration and legally enforceable. The definition then highlights financial assets, financial liabilities and equity instrument. Assets, liabilities, equity instrument reminds us of the balance sheet. For example, in credit sales transaction, the entity which sold the goods has a financial asset – trade receivable – while the purchaser has to account for a financial liability – trade payable. Another example is when the entity sources finance by issuing ordinary equity shares. The e...

Because investors rely on accounting information to make their investment decisions, it is important for accounting information to present items according to their substance, and not merely their legal form. Some financial instruments have the legal form of equity but are in substance, liabilities. Under IFRS the issuer should classify the instrument, or its component parts, as a financial liability or equity in accordance with the ‘substance’ of contractual arrangement on initial recognition, and the definitions of financial liability and an equity instrument . The classification is made at the date of issue and is not revised later. The critical feature in differentiating a financial liability from an equity instrument is the existence of a contractual obligation on one party to the financial instrument (the issuer) either to deliver cash or another financial asset to the other party (the holder) or to exchange another financial instrument with the holder under potentially unf...