Corporate Financial Reporting · Accounting of Financial Instruments

Financial Instruments: Definition and Scope under Ind AS 32, 107 and 109

Updated 11 October 2026 · Fact-checked

A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another. To solve questions, test the contract: does it give a right to receive cash, an obligation to pay cash, or a residual interest? Then check scope exclusions before applying Ind AS 109.

Understand Introduction to Financial Instruments

A financial instrument is a contract. One side of the contract holds a financial asset. The other side holds a financial liability or an equity instrument. A trade receivable in your books is a financial asset. The same amount in the customer's books is a financial liability.

Three terms matter. A financial asset is cash, an equity instrument of another entity, a contractual right to receive cash or another financial asset, or a contractual right to exchange financial instruments on favourable terms. A financial liability is a contractual obligation to deliver cash or another financial asset, or to exchange financial instruments on unfavourable terms. An equity instrument is a contract that shows a residual interest in the assets of an entity after deducting all its liabilities.

The word contractual is the key. Items that arise from statute, such as income tax payable or GST dues, are not financial instruments. Prepaid expenses and advances for goods or services are also not financial assets, because the benefit is goods or services, not cash. Deferred revenue is not a financial liability for the same reason.

Three standards work together. Ind AS 32 deals with presentation: definitions, and the split between liability and equity. Ind AS 109 deals with recognition, classification, measurement, impairment, derecognition and hedge accounting. Ind AS 107 deals with disclosures.

Scope matters in exams. Ind AS 109 applies to all entities and all types of financial instruments, except items covered by other standards. Examples from the standard: interests in subsidiaries, associates and joint ventures accounted under Ind AS 110, Ind AS 27 or Ind AS 28; lease rights and obligations under Ind AS 116; employer rights and obligations under Ind AS 19; the entity's own equity instruments under Ind AS 32; and insurance contracts under Ind AS 117. Some exceptions have exceptions, so read each one fully.

Key rules to remember

Financial instrument: Financial instrument = contract → financial asset (one entity) + financial liability or equity instrument (another entity); No contract, no financial instrument. Statutory dues fail this test.
Financial asset test: Cash | equity instrument of another entity | contractual right to receive cash or another financial asset | contractual right to exchange on favourable terms; Prepayments for goods or services are not financial assets.
Financial liability test: Contractual obligation to deliver cash or another financial asset, or to exchange on unfavourable terms; Obligations settled by delivering goods or services are not financial liabilities.
Equity instrument test: Residual interest = assets − all liabilities; Ind AS 32 decides liability versus equity. Ind AS 109 does not apply to the issuer's own equity.
Equity issued to extinguish a liability: Gain or loss in profit or loss = carrying amount of liability extinguished − consideration paid (equity instruments measured at the extinguishment date); If the fair value of equity cannot be reliably measured, measure the equity to reflect the fair value of the liability extinguished. This does not apply where the creditor acts as an existing shareholder, where creditor and entity are under common control and the substance is a distribution or contribution, or where the original terms provide for settlement in equity shares.
Role of each standard: Ind AS 32 = presentation | Ind AS 109 = recognition and measurement | Ind AS 107 = disclosure; Name the correct standard in your answer.

How to solve Introduction to Financial Instruments questions

Use this sequence for any classification or scope question on financial instruments.

1Identify the item and the counterparty. Ask what the contract is.
2Check that a contract exists. If the item arises from law, such as tax, it is not a financial instrument.
3Ask what the settlement is. Cash or another financial asset points to a financial asset or liability. Goods or services do not.
4Decide the side. A right to receive is an asset. An obligation to pay is a liability. A residual interest after all liabilities is equity.
5Check the scope exclusions in Ind AS 109 (subsidiaries, leases, employee benefits, own equity, insurance contracts) and note any carve-backs.
6Name the standard that governs the next step: Ind AS 32 for presentation, Ind AS 109 for measurement, Ind AS 107 for disclosure.
7Write a one-line conclusion with the reason.

Quickest way: Contract, settlement, side

When to use it: For MCQs asking whether an item is a financial asset, financial liability or neither.

Is it contractual? If not, reject.
Is settlement in cash or a financial asset? If goods or services, reject.
Pick the side: receive is asset, pay is liability, residual is equity.
For scope MCQs, recall the exclusion list and check for a carve-back.

Common mistakes in Introduction to Financial Instruments

Treating income tax payable or GST payable as a financial liability.
It is a cash payment obligation, so it looks like a liability.
Fix: Check for a contract. Statutory obligations are not contractual, so they fall outside the financial instrument definition.
Treating advances paid to suppliers or prepaid expenses as financial assets.
Cash has left the business, so students assume a financial asset.
Fix: The future benefit is goods or services, not cash. These are not financial assets.
Calling deferred revenue a financial liability.
It sits under liabilities in the balance sheet.
Fix: It is settled by delivering goods or services, so it is not a financial liability.
Applying Ind AS 109 to the entity's own equity shares.
Equity shares are financial instruments, so the scope seems obvious.
Fix: Own equity instruments are excluded from Ind AS 109 for the issuer. The holder, however, applies Ind AS 109 to them unless an Ind AS 110, 27 or 28 exception applies.
Mixing up the roles of Ind AS 32, 107 and 109.
All three deal with financial instruments and names are similar.
Fix: Remember: 32 presents, 109 measures, 107 discloses.
Applying the equity-for-debt appendix to a creditor who is also a shareholder acting as shareholder.
Students see equity issued against a liability and apply the gain or loss rule mechanically.
Fix: Check the three scope exclusions first: creditor acting as shareholder, common control with distribution or contribution in substance, and settlement in equity under the original terms.

Worked examples

Example 1

Arvind Textiles Ltd has the following items at year end: (a) trade receivable from Sharma Traders, (b) advance paid to a supplier for raw material, (c) GST payable to the government, (d) loan taken from a bank. State with reasons which are financial assets or financial liabilities.

Show the solution

(a) The trade receivable is a contractual right to receive cash. It is a financial asset.
(b) The advance will be settled by receiving raw material, not cash. It is not a financial asset.
(c) GST payable arises from law, not a contract. It is not a financial liability.
(d) The bank loan is a contractual obligation to pay cash. It is a financial liability.

Answer: (a) financial asset; (b) not a financial asset; (c) not a financial liability; (d) financial liability.

Example 2

Which of the following is outside the scope of Ind AS 109? (A) Trade receivable of a manufacturer (B) Lease liability of a lessee, in respect of its initial recognition and measurement (C) Investment in a debenture of another company (D) Loan given to an employee by an employer under a loan agreement

Show the solution

Option A: a trade receivable is a financial asset and is within scope.
Option C: a debenture investment is a financial asset and is within scope.
Option D: a loan agreement is a contract giving a right to receive cash. It is within scope.
Option B: rights and obligations under leases fall under Ind AS 116 and are excluded from Ind AS 109. However, lease liabilities are subject to the derecognition requirements of Ind AS 109.
So the item excluded from Ind AS 109 for recognition and measurement is B.

Answer: B. Lease liability recognition and measurement is governed by Ind AS 116, though Ind AS 109 derecognition rules apply to it.

Exam tips

In MCQs, the trap is usually a non-contractual item (tax, statutory dues) or a prepayment or deferred income. Test for a contract and cash settlement first.
Memorise the Ind AS 109 exclusion list and its carve-backs, such as lessor receivables and lessee derecognition.
State the standard by number in written answers. Examiners reward the correct link between topic and standard.
For equity-for-debt questions, check the scope exclusions before computing the gain or loss.
Give a one-line reason with every classification. A bare label earns fewer marks.

Practice questions from Accounting of Financial Instruments

Introduction to Financial Instruments in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Introduction to Financial Instruments: frequently asked questions

What is the difference between a financial asset, a financial liability and an equity instrument?

A financial asset is a contractual right to receive cash or another financial asset, or cash itself or another entity's equity instrument. A financial liability is a contractual obligation to deliver cash or another financial asset. An equity instrument is a residual interest in the assets after deducting all liabilities.

Is deferred revenue a financial liability?

No. It is settled by delivering goods or services, not cash or another financial asset. So it does not meet the definition of a financial liability.

Which standard covers what for financial instruments?

Ind AS 32 covers presentation, including liability versus equity. Ind AS 109 covers recognition, classification, measurement, impairment, derecognition and hedge accounting. Ind AS 107 covers disclosures.

Does Ind AS 109 apply to investments in subsidiaries?

Generally no. Interests in subsidiaries, associates and joint ventures accounted under Ind AS 110, Ind AS 27 or Ind AS 28 are excluded. Those standards may sometimes require or permit parts of Ind AS 109 to be used, and derivatives on such interests are generally within Ind AS 109.