ACC711: ADVANCED ACCOUNTING PRACTICE & REPORTING II
Tutorial 1: Accounting for Financial Instrument
1. Define financial instrument
Financial instrument is any contract that gives rise to both a financial asset of one entity and
a financial liability or equity instrument of another entity.
2. What is a primary instrument? Give example
Primary financial instruments generate rights and obligations between the parties directly
involved in the underlying transaction. Examples of primary financial instruments would
include receivables, payables and equity securities, such as shares.
3. What is a derivative financial instrument? Give example.
Derivative financial instruments create rights and obligations that have the effect of
transferring between the parties to the instrument one or more of the financial risks inherent
in an underlying primary financial instrument. Examples would include financial options,
futures, forward contracts, and interest rate or currency swaps.
4. What factors influence the value of a derivative financial instrument, and how should
changes in the value of derivatives be from an accounting perspective?
The value of a derivative changes in response to the change in a specified interest rate,
financial instrument price, commodity price, foreign exchange rate, index of prices or rates,
credit rating or credit index, or other variable, provided in the case of a non-financial
variable that the variable is not specific to a party to the contract (sometimes called the
‘underlying’). From an accounting perspective all derivatives are required to be recognized
and measured at fair value. Gains and losses on the financial instrument would generally go
directly to profit or loss.
5. Would physical assets (such as inventories, property, plant and equipment) be considered to
be financial assets? Why?
Inventories, plant and equipment would not be considered to be financial assets as they don’t
satisfy the above requirements. As paragraph AG10 of AASB 132 states:
Physical assets (such as inventories, property, plant and equipment), leased assets, and
intangible assets (such as patents and trademarks) are not financial assets. Control of such
physical and intangible assets creates an opportunity to generate an inflow of cash or
another financial asset, but it does not give rise to a present right to receive cash or another
financial asset.
6. What is a compound financial instrument? Provide some examples
A compound financial instrument is a financial instrument that contains both a financial
liability, and an equity element.
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A common form of compound financial instrument is a debt instrument with an embedded
conversion option, such as a bond convertible into ordinary shares of the issuer, and without
any other embedded derivative features.
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