What are financial assets and how are they initially recognized?

One side of the balance sheet is called ‘assets’ and they consist of various types of assets – there are inventories, accounts receivables, cash, fixed and immaterial assets etc. When some are physical and touchable sort of speak, then others are without any physical substance. Financial instruments considered also as financial assets are those without any physical substance obviously and are defined as contractual right for an asset. Essentially they form a part of assets.

Financial instruments on the asset side of the balance sheet are for example cash, deposits, bank accounts, commercial papers and bills, accounts and notes receivable, bonds, investments into shares etc. Those are all immaterial assets which arise more or less from contractual agreements.

When a mentioned instrument is initially recognized, it is measured at the transaction price including all transactions costs. However, if the arrangement constitutes in effect a financing transaction (i.e. in the form that for sale of goods or services the payment is deferred beyond normal business terms), this instrument is measured at the present value of future payments discounted at a market rate of interest for a similar debt instrument.

For example, a long term loan is recognized at the present value of the cash receivable but a receivable for goods sold on short-term credit is recognized at the undiscounted amount of cash receivable (invoice price). If the credit term is longer however and yet doesn’t bear any interest, the receivable is recognized at the current cash sale price.

Obviously this is to simplify things and as always there are exceptions to the rule, but we will cover them more in-depth later on.