When in a financial field, one frequently comes across the terms financial assets and liabilities. According to an entity's business strategy and the nature of the cash flows resulting from its financial assets, the classification of its financial assets is established. However, there's a lot more confusion regarding both terms. So, let's delve into this post to have a more clear view of it.
What is meant by the terms financial assets and liabilities?
All financial claims, equity, and the gold bullion portion of monetary gold are considered financial assets and also called economic assets. These assets are stores of value that indicate a benefit or sequence of benefits that the economic owner will achieve over time due to retaining or employing the assets.
For your information, financial assets are a means of carrying or holding forward value from one accounting period to the next. On the other hand, financial liabilities are created when debtors are required to make a payment or a series of payments to creditors.
Financial assets and liabilities are categorized the same way as financial transactions. Financial assets and liabilities are evaluated at market value as negotiable financial instruments. However, commissions, fees, and taxes are excluded from these values. Also, the non-negotiable financial instruments are valued at nominal value.
How are financial assets classified?
According to an entity's business strategy and the nature of the cash flows resulting from its financial assets, the classification of its financial assets is established. The way a company manages its financial assets to produce cash flows is known as its business model. An entity or company may have more than one business model. However, the business model doesn't rely on management's intentions for a certain instrument.
How are financial liabilities classified?
Almost all financial liabilities are classified at amortized cost, with the following exceptions:
●Financial liabilities at a clear or fair value through profit or loss (designated as it is or meant for trading).
●Contingent liabilities that result from the application of the ongoing involvement method or the non-derecognition of a transfer of a financial asset;
●Financial liabilities develop when a flow of a financial asset doesn't meet or qualifies for derecognition or when the continuous involvement approach occurs.
●Financial guarantee contracts.
●Loan commitments to avail of loans at below-market interest rates
Financial liabilities retained for trading are those held at fair value through profit or loss. An entity may choose a financial liability at fair value through profit or loss if this action results in much relevant information. This designation is irreversible and must be made at the time of initial recognition.
Conclusion
Knowing to classify financial assets and liabilities can be of great advantage. One can put effort into understanding these terms, which can pave the way to better financing. This piece of the article was a brief yet detailed overview of the classification of financial assets and liabilities. And we are sure that it was helpful in a positive manner.
