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Financial Asset Definition and Liquid vs. Illiquid Types
Financial Asset Definition and Liquid vs. Illiquid Types
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Table of Contents
What Is a Financial Asset?
Understanding a Financial Asset
Common Types of Financial Assets
Pros and Cons of Highly Liquid Financial Assets
Illiquid Assets Pros and Cons
Real-World Example of Financial Assets
Corporate Finance
Accounting
Financial Asset Definition and Liquid vs. Illiquid Types
By
James Chen
Full Bio
James Chen, CMT is an expert trader, investment adviser, and global market strategist.
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editorial policies
Updated March 20, 2021
Reviewed by
Margaret James
Fact checked by
Katrina Munichiello
Fact checked by
Katrina Munichiello
Full Bio
Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.
Learn about our
editorial policies
What Is a Financial Asset?
A financial asset is a liquid asset that gets its value from a contractual right or ownership claim. Cash, stocks, bonds, mutual funds, and bank deposits are all are examples of financial assets. Unlike land, property, commodities, or other tangible physical assets, financial assets do not necessarily have inherent physical worth or even a physical form. Rather, their value reflects factors of supply and demand in the marketplace in which they trade, as well as the degree of risk they carry.
Investopedia / Mira Norian
Understanding a Financial Asset
Most assets are categorized as either real, financial, or intangible. Real assets are physical assets that draw their value from substances or properties, such as precious metals, land, real estate, and commodities like soybeans, wheat, oil, and iron.
Intangible assets are the valuable property that is not physical in nature. They include patents, trademarks, and intellectual property.
Financial assets are in-between the other two assets. Financial assets may seem intangible—non-physical—with only the stated value on a piece of paper such as a dollar bill or a listing on a computer screen. What that paper or listing represents, though, is a claim of ownership of an entity, like a public company, or contractual rights to payments—say, the interest income from a bond. Financial assets derive their value from a contractual claim on an underlying asset.
This underlying asset may be either real or intangible. Commodities, for example, are the real, underlying assets that are pinned to such financial assets as commodity futures, contracts, or some exchange-traded funds (ETFs). Likewise, real estate is the real asset associated with shares of real estate investment trusts (REITs). REITs are financial assets and are publicly traded entities that own a portfolio of properties.
The Internal Revenue Service (IRS) requires businesses to report financial and real assets together as tangible assets for tax purposes. The grouping of tangible assets is separate from intangible assets.
key takeaways
A financial asset is a liquid asset that represents—and derives value from—a claim of ownership of an entity or contractual rights to future payments from an entity.A financial asset's worth may be based on an underlying tangible or real asset, but market supply and demand influence its value as well.Stocks, bonds, cash, CDs, and bank deposits are examples of financial assets.
Common Types of Financial Assets
According to the commonly cited definition from the International Financial Reporting Standards (IFRS), financial assets include:
CashEquity instruments of an entity—for example a share certificateA contractual right to receive a financial asset from another entity—known as a receivableThe contractual right to exchange financial assets or liabilities with another entity under favorable conditionsA contract that will settle in an entity's own equity instruments
In addition to stocks and receivables, the above definition comprises financial derivatives, bonds, money market or other account holdings, and equity stakes. Many of these financial assets do not have a set monetary value until they are converted into cash, especially in the case of stocks where their value and price fluctuate.
Aside from cash, the more common types of financial assets that investors encounter are:
Stocks are financial assets with no set ending or expiration date. An investor buying stocks becomes part-owner of a company and shares in its profits and losses. Stocks may be held indefinitely or sold to other investors.
Bonds are one way that companies or governments finance short-term projects. The bondholder is the lender, and the bonds state how much money is owed, the interest rate being paid, and the bond's maturity date.
A certificate of deposit (CD) allows an investor to deposit an amount of money at a bank for a specified period with a guaranteed interest rate. A CD pays monthly interest and can typically be held between three months to five years depending on the contract.
Pros and Cons of Highly Liquid Financial Assets
The purest form of financial assets is cash and cash equivalents—checking accounts, savings accounts, and money market accounts. Liquid accounts are easily turned into funds for paying bills and covering financial emergencies or pressing demands.
Other varieties of financial assets might not be as liquid. Liquidity is the ability to change a financial asset into cash quickly. For stocks, it is the ability of an investor to buy or sell holdings from a ready market. Liquid markets are those where there are plenty of buyers and plenty of sellers and no extended lag-time in trying to execute a trade.
In the case of equities like stocks and bonds, an investor has to sell and wait for the settlement date to receive their money—usually two business days. Other financial assets have varying lengths of settlement.
Maintaining funds in liquid financial assets can result in greater preservation of capital. Money in bank checking, savings, and CD accounts are insured against loss of up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) for credit union accounts. If for some reason the bank fails, your account has dollar-for-dollar coverage up to $250,000. However, since FDIC covers each financial institution individually, an investor with brokered CDs totaling over $250,000 in one bank faces losses if the bank becomes insolvent.
Liquid assets like checking and savings accounts have a limited return on investment (ROI) capability. ROI is the profit you receive from an asset divided by the cost of owning that asset. In checking and savings accounts the ROI is minimal. They may provide modest interest income but, unlike equities, they offer little appreciation. Also, CDs and money market accounts restrict withdrawals for months or years. When interest rates fall, callable CDs are often called, and investors end up moving their money to potentially lower-income investments.
Pros
Liquid financial assets convert into cash easily.
Some financial assets have the ability to appreciate in value.
The FDIC and NCUA insure accounts up to $250,000.
Cons
Highly liquid financial assets have little appreciation
Illiquid financial assets may be hard to convert to cash.
The value of a financial asset is only as strong as the underlying entity.
Illiquid Assets Pros and Cons
The opposite of a liquid asset is an illiquid asset. Real estate and fine antiques are examples of illiquid financial assets. These items have value but cannot convert into cash quickly.
Another example of an illiquid financial asset are stocks that do not have a high volume of trading on the markets. Often these are investments like penny stocks or high-yield, speculative investments where there may not be a ready buyer when you are ready to sell.
Keeping too much money tied up in illiquid investments has drawbacks—even in ordinary situations. Doing so may result in an individual using a high-interest credit card to cover bills, increasing debt and negatively affecting retirement and other investment goals.
Real-World Example of Financial Assets
Businesses, as well as individuals, hold financial assets. In the case of an investment or asset management company, the financial assets include the money in the portfolios firm handles for clients, called assets under management (AUM). For example, BlackRock Inc. is the largest investment manager in the U.S. and in the world, judging by its $6.84 trillion in AUM (as of June 30, 2019).
In the case of banks, financial assets include the worth of the outstanding loans it has made to customers. Capital One, the 10th largest bank in the U.S., reported $373,191 million in total assets on its first-quarter 2019 financial statement; of that, $240,273 million were from real estate-secured, commercial, and industrial loans.
Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our
editorial policy.
Internal Revenue Service. "Publication 551 (12/2018), Basis of Assets." Accessed Aug. 13, 2020.
Internal Revenue Service. "Part 1. Organization, Finance, and Management. Chapter 35. Financial Accounting. Section 6. Property and Equipment Accounting." Accessed Aug. 13, 2020.
IAS Plus. "IAS 32 — Financial Instruments: Presentation." Accessed Aug. 13, 2020.
Federal Deposit Insurance Corporation. "Deposit Insurance FAQs." Accessed Aug. 13, 2020.
BlackRock. "History." Accessed Aug. 13, 2020.
BlackRock. "Introduction to BlackRock." Accessed Aug. 13, 2020.
CapitalOne Financial Corporation. "Q1 2019 Quarterly Results," Pages 2, Accessed Aug.13, 2020.
Related Terms
What Is a Liquid Asset, and What Are Some Examples?
A liquid asset is an asset that can easily be converted into cash within a short amount of time.
more
Cash and Cash Equivalents (CCE) Definition: Types and Examples
Cash and cash equivalents are company assets that are either cash or can be converted into cash immediately.
more
What Are Real Assets vs. Other Asset Types?
A real asset is a tangible investment, such as gold, real estate, or oil, that has an intrinsic value due to its substance and physical properties.
more
Understanding Liquidity and How to Measure It
Liquidity refers to the ease with which an asset, or security, can be converted into ready cash without affecting its market price.
more
What Are Alternative Investments? Definition and Examples
An alternative investment is a financial asset that does not fall into one of the conventional investment categories which are stocks, bonds or cash.
more
Nonfinancial Asset: Definition, How It's Valued, and Examples
A nonfinancial asset is an asset with a physical value such as real estate and equipment. It can also include intellectual property.
more
Related Articles
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What Investments Are Considered Liquid Assets?
Cash and Cash Equivalents (CCE) Definition: Types and Examples
Are stocks real assets?
What Are Real Assets vs. Other Asset Types?
Understanding Liquidity and How to Measure It
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Financial Assets - Definition, Measure, Classification
Financial Assets - Definition, Measure, Classification
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Financial Assets
Contractual agreements on future cash flows Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
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What are Financial Assets?
Financial assets refer to assets that arise from contractual agreements on future cash flows or from owning equity instruments of another entity. Financial instruments refer to a contract that generates a financial asset to one of the parties involved, and an equity instrument or financial liability to the other entity.
A key difference between financial assets and PP&E assets – which typically include land, buildings, and machinery – is the existence of a counterparty. Financial assets can be categorized as either current or non-current assets on a company’s balance sheet.
Measurement of Financial Assets
The most important accounting issue for financial assets involves how to report the values on the balance sheet. Considering all financial assets, there is no single measurement technique that is suitable for all assets. When investments are relatively small, the current market price is a relevant measure. However, for a company that owns a majority of shares in another company, the market price is not particularly relevant because the investor doesn’t intend to sell its shares.
In fact, a key factor in the presentation of financial statements is the management’s intent for the investment. For example, the value of a company’s investment in another company’s shares would be shown differently if they were purchased with the intention to hold them for a while and then sell them (e.g., trading) vs. owning a significant percentage (75%) of the company.
The flexibility and uniqueness of different financial assets, however, do not mean that companies can choose any method they want to. Accounting standards specify general guidelines to account for different financial assets. A few guidelines set out by the IFRS are shown below.
Accounting Classification of Financial Assets under IFRS
Type of Financial InstrumentBusiness ModelAccounting ClassificationAccounting Treatment
EquityControlSubsidiaryConsolidation
EquityJoint control of assets and liabilitiesJoint operationsProportionate consolidation
EquityJoint control of net assetsJoint ventureEquity method
EquitySignificant influenceAssociateEquity method
Equity/DebtRealize changes in valueFair value through profit or loss (FVPL)Fair value, changes recorded through net income
DebtCollect contractual cash flowsAmortized cost Amortized cost method
Equity investments in the first four rows refer to strategic investments. The first row refers to investments wherein a company exercises control (i.e., normally owns >50% of the voting interest) of another company. The proper accounting treatment is to consolidate the financial statements of the investor and the subsidiary into a single set of financials.
In addition, joint control in rows 2 and 3 refer to any contractual arrangement between two or more companies. For joint operations, the appropriate treatment is proportionate consolidation wherein the financial statements are compiled depending on the percentage of ownership. Joint venture classifications and significant influence investments, on the other hand, follow the equity method.
The Equity Method
The Equity method is used for either joint ventures or significant influence investments (i.e., owning 20%-50% voting interest). It either increases or decreases the investment account based on income earnings and dividend payments. This is best illustrated through an example.
On January 1, 2017, XYZ Company acquired 10,000 shares of ABC Company, representing 30% of the shares of ABC, for $100,000. For the year ended December 31, 2017, ABC earns $300,000 of net income. On January 1, 2018, ABC declares and pays a dividend to XYZ company of $20,000.
January 1, 2017
DR Investment in ABC (significant influence) 100,000
CR Cash 100,000
December 31, 2017
DR Investment in ABC (significant influence) 90,000
CR Investment income 90,000
Because ABC is an associate of XYZ, XYZ can include its portion of the net income (300,000 * 30%) to its ledger.
January 1, 2018
DR Cash 20,000
CR Investment in ABC (significant influence)20,000
When dividend payments are received, the investment account is reduced.
Fair Value through Profit or Loss
The FVPL accounting treatment is used for all financial instruments that are intended to be held for sale and NOT to maintain ownership. When these assets are being held, they are always recorded at fair value on the balance sheet, and any changes in the fair value are recorded through the income statement, eventually affecting net income and not other comprehensive income (OCI). All transaction costs associated with the investment are expensed immediately.
Example: XYZ Company purchased an investment on November 1, 2016 for $1,000. At December 31, 2016, the fair value of the investment is $3,000. Transaction costs are 4% of purchases. What are the journal entries?
November 1, 2016
DR Investment (FVPL)1,000
CR Cash1,000
DR Transaction Expense40
CR Cash40
December 31, 2016
DR Investment (FVPL)2,000
CR Unrealized Gain 2,000
Amortized Cost Method
Finally, the amortized cost method is used to account for debt instruments. These financial assets are intended for collecting contractual cash flows until maturity. Debt instruments are different from FVPL investments because FVPL is intended to be held for a certain period and then sold.
The debt instrument is recorded at its acquisition cost; any premium or discount is amortized over the life of the investment using the effective interest rate method, and transaction costs, if any, are capitalized.
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What Are Financial Assets?
What Are Financial Assets?
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What Are Financial Assets?
By
Mike Price
Updated on November 30, 2021
Reviewed by
Robert C. Kelly
Reviewed by
Robert C. Kelly
Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital.
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In This Article
Definition and Examples of Financial Assets
How Financial Assets Work
Types of Financial Assets
Financial vs. Real vs. Intangible Assets
Photo: SolStock / Getty Images
Definition
Financial assets are liquid assets such as stock equity or bank deposits that assume their value from a contractual claim or ownership on an underlying asset.
Key Takeaways
Financial assets are liquid assets that derive their value from a contract or agreement.Financial assets are different from real assets because of their non-physical nature.The most common personal financial assets are checking accounts and retirement investments, as well as stocks and bonds for the average investor.
Definition and Examples of Financial Assets
Financial assets are liquid assets such as stock equity or bank deposits that assume their value from a contractual claim or ownership on an underlying asset. An underlying asset can be anything from a commodity to a piece of real estate. These real, often tangible assets are attached to financial assets, such as commodity futures or real estate investment trusts (REITs), respectively.
The most common type of personal financial assets are bank deposits and investment portfolios. In the U.S., according to recent data, the majority of personal financial assets are held specifically in checking accounts, with the second most-used financial asset being retirement accounts.
Note
Financial assets are considered liquid because they generally can be sold easily but can also lose value over time. If a company or individual has high liquidity, that means they have enough assets to meet financial obligations.
Businesses have financial assets as well, including those in the form of accounts receivable and notes receivable. This information is listed on a company’s balance sheet. To get a better understanding of what is classified as a financial asset, let’s take a look at Home Depot’s balance sheet as of May 2, 2021, per the U.S. Securities and Exchange Commission (SEC).
In this case, the two main financial assets are cash and cash equivalents as well as receivables. Cash is all of The Home Depot’s deposits, down to the store level, while cash equivalents are short-term investments that can be converted to cash in under three months, like a money market account. Receivables is any money customers and borrowers owe to The Home Depot.
The above-mentioned assets are financial assets because the value is derived from the lease contract.
Your personal balance sheet probably looks similar to The Home Depot’s, just less complicated. Cash and cash equivalents are your checking and savings accounts as well as any brokerage or retirement accounts. Receivables is any money you’ve loaned out to people.
How Financial Assets Work
As mentioned, financial assets are any assets that derive value from a contract or other claim. More specifically, according to the International Financial Reporting Standards (IFRS), a financial asset is any asset that is:
Cash
An equity instrument of an entity
A contractual right to receive cash or assets—known as accounts receivable—or exchange financial assets or liabilities with another entity
A contract that can be settled in the entity’s own equity instruments
To fully understand how financial assets work, it’s best to explain the types of financial assets in detail, as each one functions differently.
Types of Financial Assets
Below is a breakdown of the most common types of financial assets, specifically for investors.
Cash and Cash Equivalents
Cash and cash equivalents include any savings deposits, certificates of deposit (CDs), money market deposit accounts, and money market funds. These assets are considered safe, strong investments by the federal government. A CD, for example, is a type of savings account offered by banks and credit unions that typically earns interest at a fixed rate.
For deposit accounts, you sign an agreement with the financial institution and get monthly statements stating the value in the account. Accounts are generally insured up to $250,000 by the FDIC, and the type of deposit account is determined by how often funds can be withdrawn. For example, checking or demand deposit accounts can be used whenever you want, while CDs lock up your cash for a preset period.
Accounts Receivable
Generally, accounts receivable are short-term business assets where a customer signs a contract, guaranteeing they will pay for the service or product in less than a year. Unlike the other financial assets, the value of receivables is based on what is owed and the probability of payment. This type of asset is used in the balance sheets of many businesses as well as universities, including Cornell University.
Stocks
Stocks are often considered the riskiest financial assets, but they also offer the greatest potential for growth. Stocks represent ownership in a publicly traded company, which means when you buy a company’s stock, you become part owner of that business.
Bonds
Bonds are a type of fixed-income investment in which the bond issuer borrows money from an investor. They function similarly to loans in that the borrowing organization promises to pay the bond back at an agreed-upon date. They enable companies to finance short-term projects and tend to offer modest returns.
Financial Assets vs. Real Assets vs. Intangible Assets
The other two types of assets you’ll find on a personal or business balance sheet are called real assets and intangible assets. Real assets are assets that are tangible, or physically existing, such as real estate, commodities, or equipment. Intangible assets are things like patents, trademarks, or goodwill that do not have a physical substance or financial nature.
Note
When it comes to tax season, the IRS requires real and financial assets to be reported together as tangible assets.
As mentioned, financial assets are generally the most liquid of the three. For example, bank deposits and stocks can be converted to cash within a week in most cases, while real estate and equipment has to be listed before it can be sold.
The other thing that generally differentiates financial assets is how their value is derived. Real assets have some level of intrinsic value based on their nature as a physical asset. Intangible assets are generally recorded at cost. Financial asset values, then, can vary based on supply and demand in the marketplace where they trade.
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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
Federal Reserve Bank of St. Louis. "What Types of Financial Assets Do People Hold?"
U.S. Securities Exchange Commission. "Part I – Financial Information. Item 1. Financial Statements. The Home Depot, Inc. Consolidated Balance Sheets (Unaudited)."
PWC. "Financial Instruments Under IFRS: A Guide Through the Maze." Page 36.
U.S. Securities and Exchange Commission. "Beginners’ Guide to Asset Allocation, Diversification, and Rebalancing."
FDIC. "Consumer Assistance Topics: Deposit Accounts."
Cornell University. "Diversity of Financial Affairs Accounting: Accounts Receivable."
IRS. "Publication 551 (12/2018), Basis of Assets."
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From Wikipedia, the free encyclopedia
Intangible asset that derives value because of a contractual claim
A financial asset is a non-physical asset whose value is derived from a contractual claim, such as bank deposits, bonds, and participations in companies' share capital. Financial assets are usually more liquid than tangible assets, such as commodities or real estate.[1][2][3]
The opposite of financial assets is non-financial assets, which include both tangible property (sometimes also called real assets) such as land, real estate or commodities, and intangible assets such as intellectual property, including copyrights, patents, trademarks and data.
Types[edit]
According to the International Financial Reporting Standards (IFRS), a financial asset can be:
Cash or cash equivalent,
Equity instruments of another entity,
Contractual right to receive cash or another financial asset from another entity or to exchange financial assets or financial liabilities with another entity under conditions that are potentially favorable to the entity,
A contract that will or may be settled in the entity's own equity instruments and is either a non-derivative for which the entity is or may be obliged to receive a variable number of the entity's own equity instruments, or a derivative that will or may be settled other than by exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments.[4][5]
Treatment of financial assets under IFRS[edit]
Under IFRS, financial assets are classified into four broad categories which determine the way in which they are measured and reported:
Financial assets "held for trading" — i.e., which were acquired or incurred principally for the purpose of selling, or are part of a portfolio with evidence of short-term profit-taking, or are derivatives — are measured at fair value through profit or loss.
Financial assets with fixed or with determinable payments and fixed maturity which the company has to be willing and able to hold till maturity are classified as "held-to-maturity" investments. Held-to-maturity investments are either measured at fair value through profit or loss by designation, or determined to be financial assets available for sale by designation.
Financial assets with fixed or determinable payments which are not listed in an active market are considered to be "loans and receivables". Loans and receivables are also either measured at fair value through profit or loss by designation or determined to be financial assets available for sale by designation.
All other financial assets are categorized as financial assets "available for sale" and are measured at fair value through profit or loss by designation.[6]
For financial assets to be measured at fair value through profit or loss by designation, designation is only possible at the amount the asset was initially recognized at. Moreover, designation is not possible for equity instruments which are not traded in an active market and the fair value of which cannot be reliably determined. Further (alternative) requirements for designation are e.g. at least a clear diminution of a "mismatch" with other financial assets or liabilities,[7] an internal valuation and reporting and steering at fair value,[8] or a combined contract with an embedded derivative which is not immaterial and which may be separated.[9] Regarding financial assets available for sale by designation, designation is only possible at the amount the asset was initially recognised at as well. However, there are no further restrictions or requirements.
See also[edit]
Security (finance)
Financial accounting
Financial statements
References[edit]
^ Chen, James (20 November 2003). "Financial Asset". Investopedia. Dotdash. Retrieved 2 December 2016.
^ "What are Financial Assets?". The Balance. Dotdash. Archived from the original on 4 March 2016. Retrieved 2 December 2016.
^ "Financial assets". The Free Dictionary. Retrieved 2 December 2016.
^ International Accounting Standard (IAS) 32.11
^ Property Financial Report Guide
^ International Accounting Standard (IAS) 32.9
^ International Accounting Standard (IAS) 32.9b i
^ International Accounting Standard (IAS) 32.9b ii
^ International Accounting Standard (IAS) 32.11a
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Classification of Financial Assets & Liabilities (IFRS 9) - IFRScommunity.com
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Classification of Financial Assets and Financial Liabilities (IFRS 9)
Last updated: 24 January 2024
The way financial assets and liabilities are classified determines how they are accounted for in financial statements, particularly how these financial instruments are measured following their initial recognition. Now, let’s dive deeper into the details.
Classification of financial assets
The following decision tree summarises the classification of financial assets according to IFRS 9.
Decision tree for classification of financial assets under IFRS 9
--Are you tired of the constant stream of IFRS updates? I know it's tough. That's why I've created Reporting Period – a once-a-month digest for professional accountants. It consolidates all essential IFRS developments and Big 4 insights into one concise, readable email. I personally curate every issue to ensure it's packed with the most relevant information, delivered straight to your inbox. Subscribe for free, enjoy a spam-free experience, and remember, you can opt out anytime with a single click.
Categories of financial assets under IFRS 9
Financial assets are classified into one of the following measurement categories:
Amortised cost.
Fair value through other comprehensive income with recycling to P/L (‘FVOCI with recycling’).
Fair value through other comprehensive income without recycling to P/L (‘FVOCI no recycling’).
Fair value through profit or loss (‘FVTPL’).
These two factors are pivotal to classifying financial assets (IFRS 9.4.1.1):
The entity’s business model for managing financial assets, and
The contractual cash flow characteristics of the financial asset.
A financial asset should be measured at amortised cost if it satisfies both of the following conditions outlined in IFRS 9.4.1.2:
The financial asset is held within a business model whose objective is to hold financial assets to collect contractual cash flows.
The contractual terms of the financial asset generate cash flows on specified dates that solely constitute payments of principal and interest on the outstanding principal amount (‘SPPI’ test).
However, if a financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets, it is measured at fair value through other comprehensive income, with cumulative gains or losses recycled to P/L upon derecognition – a category referred to as ‘FVOCI with recycling’ (IFRS 9.4.1.2A). This is of course true if the SPPI test (point 2) is met. The order in which these two criteria (i.e. SPPI test and business model) are assessed is not particularly important, as we discussed in this forums topic.
If a financial asset does not fit into either of the two categories discussed above, it is measured at fair value through profit or loss – ‘FVTPL’ (IFRS 9.4.1.4). However, for equity instruments that are not held for trading or do not form part of a contingent consideration relating to business combination, an entity can irrevocably elect, at initial recognition, to present changes in their fair value in other comprehensive income without recycling to P/L upon derecognition – ‘FVOCI no recycling’ category (IFRS 9.4.1.4; 5.7.5).
Finally, IFRS 9 permits an entity, at initial recognition, to irrevocably designate a financial asset to the FVTPL category if this would eliminate or significantly decrease an inconsistency (‘accounting mismatch‘) in measurement or recognition (IFRS 9.4.1.5).
Business model for managing financial assets
An entity’s business model is determined at a level that reflects how groups of financial assets are managed together to achieve a business objective. This model is not based on intentions for individual instruments, but rather on a broader aggregation level, allowing for different business models within a single entity. For example, an entity might manage one portfolio for collecting contractual cash flows and another for trading to realise fair value changes.
The business model’s essence lies in its approach to generating cash flows, whether through collecting contractual flows, selling assets, or a combination of both. This assessment excludes unlikely scenarios like ‘worst case’ situations. Importantly, deviations in realising cash flows from previous expectations do not constitute prior period errors nor alter the classification of remaining financial assets, as long as the original assessment considered all relevant information.
The assessment of an entity’s business model for managing financial assets is a fact-based exercise, not merely an assertion. This assessment is evident through the activities conducted to meet the business model’s objectives and requires judgment. An entity must consider all relevant evidence available at the time of assessment. Such evidence includes how the business model and its financial assets’ performance are reported to key management, how risks affecting the model and assets are managed, and the basis of managers’ compensation (IFRS 9.B4.1.1-B4.1.2B).
Collecting contractual cash flows
A business model whose objective is to hold assets in order to collect contractual cash flows emphasises managing assets primarily for the collection of their contractual cash flows over their life, rather than for overall portfolio returns through both holding and selling. In assessing whether a business model is oriented towards collecting these cash flows, it’s crucial to consider the historical pattern of sales – their frequency, value, timing, and the reasons behind them – in conjunction with expectations about future sales activities. Thus, an entity must evaluate past sales in light of the reasons for these sales and the conditions at that time, comparing them with the present conditions.
Furthermore, the presence of sales in a portfolio does not negate a business model aimed at collecting contractual cash flows. For instance, sales triggered by an increase in the credit risk of financial assets, regardless of their frequency or value, align with the model’s objective. This is because managing credit risk is integral to ensuring the collection of contractual cash flows.
Sales for other reasons, like managing credit concentration risk without an increase in credit risk, can still be consistent with this model, provided these sales are infrequent or insignificant in value, individually and in aggregate. It’s essential for entities to assess the consistency of such sales with their objective of collecting cash flows. Furthermore, sales made close to maturity that approximate the collection of the remaining contractual cash flows also align with this business model’s objective.
Collecting contractual cash flows and selling assets
In a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets, the management recognises that this dual approach is essential to achieving the model’s objectives. These objectives may vary, encompassing the management of daily liquidity needs, maintaining a specific interest yield profile, or aligning the duration of financial assets with the liabilities they fund. Unlike models focused solely on holding assets for cash flow collection, this approach typically involves a higher frequency and volume of sales, given that selling assets is a core component of the strategy, not merely incidental. Notably, there is no predefined threshold for sales frequency or volume in this model, as both collecting cash flows and selling assets are fundamental to achieving its intended goals (IFRS 9.B4.1.4A-C).
Example: Investing funds for future capital expenditure
Consider an entity that prepares for future capital expenditure and plans to invest its excess cash in both short and long-term financial assets. This strategy is tailored to fund the anticipated expenditure by balancing the collection of contractual cash flows with the opportunistic selling of financial assets. As many of these assets have contractual lives extending beyond the entity’s expected investment period, the entity’s business model is designed to maximise returns by deciding, on an ongoing basis, whether to collect cash flows or sell assets for reinvestment in higher-return options.
This approach, which involves both collecting cash flows and selling assets, contrasts with a different business model where an entity facing a similar capital expenditure timeline invests exclusively in short-term financial assets. In this alternative model, the entity continuously reinvests in new short-term assets until the need for capital arises, primarily focusing on holding assets to collect contractual cash flows, with only minor sales before maturity.
This comparison highlights two business models in financial asset management: one that balances collecting contractual cash flows and selling assets, and another that prioritises holding assets for their contractual cash flows.
Other business models
Financial assets that do not align with either of the two business models are measured at fair value through profit or loss. This measurement applies, for instance, to a business model where the primary objective is to realise cash flows through the active buying and selling of assets. In such a model, the collection of contractual cash flows occurs, but it is incidental, not integral, to achieving the business model’s objective.
This approach is also exemplified by portfolios managed and evaluated on a fair value basis, as outlined in IFRS 9.4.2.2(b), where the focus is solely on fair value for assessing performance and making decisions. Similarly, portfolios that meet the definition of being held for trading fall under this category, as their management is not aimed at collecting contractual cash flows but primarily on realising fair value (IFRS 9.B4.1.5-6).
Contractual cash flow characteristics (‘SPPI test’)
The SPPI (Solely Payments of Principal and Interest) test assesses whether the cash flows from a financial asset are solely payments of principal and interest on the outstanding principal amount, as expected in a basic lending arrangement. If a financial asset fails this test, it must be measured at fair value through profit or loss (FVTPL). This is because, as stated by the IASB in IFRS 9.BC4.158, the amortised cost measurement only provides relevant and useful information for financial assets with ‘simple’ contractual cash flows. More complex cash flows require a fair value overlay to contractual cash flows to ensure that the reported financial information provides useful information (IFRS 9.BC4.172).
Examples of financial assets that pass the SPPI test include (IFRS 9.B4.1.13):
A bond denominated in Euros, with a specified maturity date. The payments, consisting of principal and interest on the outstanding principal, are indexed to Eurozone inflation. This inflation linkage is not leveraged.
A variable interest rate loan, also with a defined maturity date, which allows the borrower to select the applicable market interest rate at regular intervals. For instance, at each rate reset date, the borrower may choose either the three-month SONIA benchmark rate for a three-month period or the one-month SONIA rate for a one-month period.
A bond with a predetermined maturity date that offers a variable market interest rate, subject to a maximum cap.
In contrast, examples of financial assets that do not pass the SPPI test include (IFRS 9.B4.1.14):
A bond with a specified maturity date, where payments of principal and/or interest on the outstanding principal amount are tied to the issuer’s revenue growth.
A convertible bond that can be exchanged for a fixed number of the issuer’s equity instruments.
A loan featuring an inverse floating interest rate, meaning the interest rate moves inversely to market interest rates.
A perpetual bond which the issuer has the option to redeem at any time, paying the holder the face value plus any accrued interest. In this case, deferred interest does not accumulate additional interest.
Principal
‘Principal’ in the context of the SPPI test refers to the fair value of the financial asset at initial recognition. Naturally, the principal amount may change over the life of the financial asset, for instance, if there are repayments of principal (IFRS 9.4.1.3(a); B4.1.7B). It is critical to note that ‘principal’ in this context does not equate to the face value of an instrument. However, in practical terms, the terms ‘principal’ and ‘face value’ are often used interchangeably. Consider the following example:
Example: Principal vs face value in the SPPI test
Entity A purchases a bond with a face value of $1,000 and an annual coupon of 5%. Due to falling market interest rates, the bond trades at $1,020, which is the amount Entity A pays for the bond (i.e., its fair value). In this context, the bond’s principal for Entity A is $1,020.
Interest
‘Interest’ is considered in IFRS 9.4.1.3(b) as the compensation for:
The time value of money,
Credit risk associated with the outstanding principal amount,
Other basic lending risks and costs, and
Profit margin.
However, if contractual terms introduce exposure to risks or volatility unrelated to a basic lending arrangement, such as exposure to changes in equity prices or commodity prices, the SPPI test is not met because the contractual cash flows are not solely payments of principal and interest (IFRS 9. B4.1.7A).
Generally, the market in which the transaction occurs is relevant to the assessment of the time value of money element. For instance, in the UK, it is common to reference interest rates to SONIA benchmark. If the time value of money element is modified (deemed ‘imperfect’), such as when the interest rate resets every month to a one-year rate, an additional assessment is needed to determine if the SPPI test is met, as described in IFRS 9.B4.1.9A-E.
Prepayable financial assets
For financial assets that are prepayable, IFRS 9.B4.1.12 offers an exception to the general criteria, allowing certain instruments with contractual prepayment features to pass the SPPI test. This exception applies to many purchased credit-impaired financial assets and financial assets originated at below-market interest rates (IFRS 9.BC4.193-195), among others.
Option to designate a financial asset at FVTPL
IFRS 9.4.1.5 states that an entity may, upon initial recognition, irrevocably designate a financial asset as measured at FVTPL if this classification significantly reduces or eliminates a measurement or recognition inconsistency, commonly known as ‘accounting mismatch’.
Understanding accounting mismatch
The concept of an accounting mismatch involves two ideas. Firstly, certain assets and liabilities of an entity are measured, or gains and losses are recognised, inconsistently. Secondly, there exists a perceived economic relationship between these assets and liabilities. For instance, a liability may be perceived as related to an asset if they share a risk that causes opposite changes in fair value that typically offset each other, or when the entity considers the liability as funding for the asset (IFRS 9.BCZ4.61). IFRS 9.B4.1.30 provides examples when these conditions could be met. For practical reasons, the entity doesn’t have to enter into all the assets and liabilities creating the accounting mismatch simultaneously (IFRS 9.B4.1.31).
It’s permissible to designate only a portion of a set of similar financial assets or liabilities if this results in a greater reduction of the accounting mismatch. However, IFRS 9.B4.1.32 prohibits to designate only a component of a financial instrument (such as a specific risk) or a proportion of it.
Hybrid contract with non-financial asset as a host
IFRS 9 also provides a fair value option for hybrid contracts that contain embedded derivatives with a non-financial asset as the host (IFRS 9.4.3.5). IFRS 9.B4.3.9 points out that measuring an entire hybrid contract at FVTPL can be simpler than separating embedded derivatives. However, this option is not permitted if any of the conditions outlined in IFRS 9.4.3.5 are applicable (refer to IFRS 9.BCZ4.70 for further discussion).
Option to designate an equity instrument at FVOCI (no recycling)
Upon initial recognition, an entity may irrevocably elect to present subsequent changes in the fair value of an investment in an equity instrument within the scope of IFRS 9 in OCI, provided the instrument is neither held for trading nor contingent consideration recognised by an acquirer in a business combination (IFRS 9.5.7.5). This election is made on an instrument-by-instrument basis (i.e., share-by-share) (IFRS 9.B5.7.1).
The definition of equity instruments can be found in IAS 32. It should be noted that the specific treatment of certain puttable instruments (for example, investment funds), which can be classified as equity by the issuer, does not apply to the option available for the holder discussed here (IFRS 9.BC5.21 and this agenda decision). Hence, the FVOCI (no recycling) option cannot be employed in accounting for investments in mutual or hedge funds. This forums topic discusses this further.
Hybrid contracts
The criteria for the classification of financial assets should be applied to the entire hybrid contract, that is, both the host and the embedded derivative together (IFRS 9.4.3.2).
Reclassification of financial assets
Reclassification criteria
An entity should reclassify all impacted financial assets only when there is a change in its business model for managing these assets (IFRS 9.4.4.1). Changes in the business model are inherently infrequent and significant to the entity’s operations. They stem from internal or external factors, are approved by senior management, and must be apparent to external parties (IFRS 9.B4.4.1).
A change in business model can be exemplified by scenarios such as an entity shifting from holding commercial loans for short-term sale to acquiring them for long-term cash flow collection. This is seen when an entity acquires a company that manages loans differently, leading to a strategic shift in managing their loan portfolio. Another instance is a financial services firm closing its retail mortgage sector, ceasing new business and actively selling its mortgage loan portfolio. However, mere changes in intentions towards specific financial assets, reactions to market condition fluctuations, the temporary loss of a market, or transfers of assets between different business models within an entity do not qualify as changes in the business model (IFRS 9.B4.4.1-3).
Measurement implications
The reclassification is accounted for prospectively from the reclassification date, defined as the first day of the first reporting period following the business model change. As a result, previously recognised gains, losses (including impairments), or interest are not restated (IFRS 9.5.6.1). Guidance on accounting for reclassifications between specific categories is given in IFRS 9.5.6.2-7 and IFRS 9.B5.6.1-2, with accompanying illustrations in Example 15 to IFRS 9.
Disclosure
IFRS 7.12B-D detail the disclosure requirements relating to the reclassification of financial assets.
Financial assets and liabilities held for trading
A financial asset or liability is classified as ‘held for trading’ if it fulfils, as per IFRS 9 Appendix A, at least one of the following criteria:
It is primarily acquired or incurred for selling or repurchasing in the near future.
Upon initial recognition, it’s part of a portfolio of identified financial instruments managed together and showing evidence of a recent pattern of short-term profit-taking (refer to IFRS 9.IG.B.11).
It is a derivative, excluding a derivative that is a financial guarantee contract or a designated and effective hedging instrument.
IFRS 9 further elaborates that ‘held for trading’ usually indicates active and frequent buying and selling. Financial instruments under this classification are generally used to generate profit from short-term price fluctuations or dealer’s margin (IFRS 9.BA.6). Examples of financial liabilities held for trading are provided in IFRS 9.BA.7. When classified as ‘held for trading’, a financial asset or liability is measured at fair value through profit or loss (FVTPL).
Classification of financial liabilities
Categories of financial liabilities under IFRS 9
Financial liabilities are classified into one of the following categories (IFRS 9.4.2.1):
Measured at amortised cost.
Measured at fair value through profit or loss (FVTPL).
Designated at fair value through profit or loss (FVTPL).
Generally, a liability is measured at amortised cost, unless it is a financial liability held for trading or designated at FVTPL. In addition, specific measurement requirements are given for:
Financial guarantee contracts,
Commitments to provide a loan at below-market interest rate,
Contingent consideration recognised by an acquirer in a business combination; and
Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies (IFRS 9.4.2.1).
Liabilities designated at FVTPL
At initial recognition, an entity may irrevocably designate a financial liability to be measured at FVTPL when:
it contains embedded derivatives (subject to conditions outlined in IFRS 9.4.3.5),
doing so eliminates an accounting mismatch, or
when a group of financial liabilities or financial assets and financial liabilities is managed and evaluated on a fair value basis (IFRS 9.4.2.2).
Financial liability managed on a fair value basis
This option to designate financial liabilities to be measured at FVTPL applies when an entity manages a group of financial liabilities or financial assets and financial liabilities in a manner that results in more relevant information if the group is measured at FVTPL. The emphasis here is on how the entity manages and evaluates performance, rather than the nature of its financial instruments (IFRS 9.B4.1.33).
To use this option (IFRS 9.4.2.2(b)), an entity must:
Have a documented risk management or investment strategy (refer also to IFRS 9. B4.1.36); and
Provide information about the group of financial liabilities (and financial assets, if relevant) internally to its key management personnel on that basis.
Although this option is not explicitly available for financial assets, there’s no need for it as financial assets managed on a fair value basis would fall into the FVTPL category based on the business model criterion.
Reclassification of financial liabilities
Reclassification of financial liabilities is prohibited as per IFRS 9.4.4.2.
More about financial instruments
See other pages relating to financial instruments:
Scope of IFRS 9 and Initial Recognition of Financial Instruments
Scope of IAS 32
Financial Instruments: Definitions
Derivatives and Embedded Derivatives: Definitions and Characteristics
Classification of Financial Assets and Financial Liabilities
Measurement of Financial Instruments
Amortised Cost and Effective Interest Rate
Impairment of Financial Assets
Derecognition of Financial Assets
Derecognition of Financial Liabilities
Factoring
Interest-Free Loans or Loans at Below-Market Interest Rate
Offsetting of Financial Instruments
Hedge Accounting
Financial Liabilities vs Equity
IFRS 7 Financial Instruments: Disclosures
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ContentsClassification of financial assetsCategories of financial assets under IFRS 9Business model for managing financial assetsCollecting contractual cash flowsCollecting contractual cash flows and selling assetsOther business modelsContractual cash flow characteristics (‘SPPI test’)PrincipalInterestPrepayable financial assetsOption to designate a financial asset at FVTPLUnderstanding accounting mismatchHybrid contract with non-financial asset as a hostOption to designate an equity instrument at FVOCI (no recycling)Hybrid contractsReclassification of financial assetsReclassification criteriaMeasurement implicationsDisclosureFinancial assets and liabilities held for tradingClassification of financial liabilitiesCategories of financial liabilities under IFRS 9Liabilities designated at FVTPLFinancial liability managed on a fair value basisReclassification of financial liabilitiesMore about financial instruments
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Table of Contents
What Is an Asset?
Understanding Assets
Types
Asset FAQs
Corporate Finance
Financial statements: Balance, income, cash flow, and equity
What Is an Asset? Definition, Types, and Examples
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What Is an Asset?
An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.
Assets are reported on a company's balance sheet. They're classified as current, fixed, financial, and intangible. They are bought or created to increase a firm's value or benefit the firm's operations.
An asset can be thought of as something that, in the future, can generate cash flow, reduce expenses, or improve sales, regardless of whether it's manufacturing equipment or a patent.
Key Takeaways
An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.Assets are reported on a company's balance sheet.They are bought or created to increase a firm's value or benefit the firm's operations.An asset is something that may generate cash flow, reduce expenses or improve sales, regardless of whether it's manufacturing equipment or a patent.Assets can be classified as current, fixed, financial, or intangible.
Investopedia / Nez Riaz
Understanding Assets
An asset represents an economic resource owned or controlled by, for example, a company. An economic resource is something that may be scarce and has the ability to produce economic benefit by generating cash inflows or decreasing cash outflows.
An asset can also represent access that other individuals or firms do not have. Furthermore, a right or other type of access can be legally enforceable, which means economic resources can be used at a company's discretion. Their use can be precluded or limited by an owner.
For something to be considered an asset, a company must possess a right to it as of the date of the company's financial statements.
Assets can be broadly categorized into current (or short-term) assets, fixed assets, financial investments, and intangible assets.
Types of Assets
Current Assets
In accounting, some assets are referred to as current. Current assets are short-term economic resources that are expected to be converted into cash or consumed within one year. Current assets include cash and cash equivalents, accounts receivable, inventory, and various prepaid expenses.
While cash is easy to value, accountants periodically reassess the recoverability of inventory and accounts receivable. If there is evidence that a receivable might be uncollectible, it'll be classified as impaired. Or if inventory becomes obsolete, companies may write off these assets.
Some assets are recorded on companies' balance sheets using the concept of historical cost. Historical cost represents the original cost of the asset when purchased by a company. Historical cost can also include costs (such as delivery and set up) incurred to incorporate an asset into the company's operations.
Fixed Assets
Fixed assets are resources with an expected life of greater than a year, such as plants, equipment, and buildings. An accounting adjustment called depreciation is made for fixed assets as they age. It allocates the cost of the asset over time. Depreciation may or may not reflect the fixed asset's loss of earning power.
Generally accepted accounting principles (GAAP) allow depreciation under several methods. The straight-line method assumes that a fixed asset loses its value in proportion to its useful life, while the accelerated method assumes that the asset loses its value faster in its first years of use.
Financial Assets
Financial assets represent investments in the assets and securities of other institutions. Financial assets include stocks, sovereign and corporate bonds, preferred equity, and other, hybrid securities. Financial assets are valued according to the underlying security and market supply and demand.
Intangible Assets
Intangible assets are economic resources that have no physical presence. They include patents, trademarks, copyrights, and goodwill. Accounting for intangible assets differs depending on the type of asset. They can be either amortized or tested for impairment each year.
While an asset is something with economic value that's owned or controlled by a person or company, a liability is something that is owed by a person or company. A liability could be a loan, taxes payable, or accounts payable.
What Is Considered an Asset?
When looking at an asset definition, you'll typically find that it is something that provides a current, future, or potential economic benefit for an individual or company. An asset is, therefore, something that is owned by you or something that is owed to you. A $10 bill, a desktop computer, a chair, and a car are all assets. If you loaned money to someone, that loan is also an asset because you are owed that amount. For the person who owes it, the loan is a liability.
What Are Examples of Assets?
Personal assets can include a home, land, financial securities, jewelry, artwork, gold and silver, or your checking account. Business assets can include such things as motor vehicles, buildings, machinery, equipment, cash, and accounts receivable.
What Are Non-Physical Assets?
Non-physical or intangible assets provide an economic benefit even though you cannot physically touch them. They are an important class of assets that include things like intellectual property (e.g., patents or trademarks), contractual obligations, royalties, and goodwill. Brand equity and reputation are also examples of non-physical or intangible assets that can be quite valuable.
Is Labor an Asset?
No. Labor is the work carried out by human beings, for which they are paid in wages or a salary. Labor is distinct from assets, which are considered to be capital.
How Are Current Assets Different From Fixed (Noncurrent) Assets?
In accounting, assets are categorized by their time horizon of use. Current assets are expected to be sold or used within one year. Fixed assets, also known as noncurrent assets, are expected to be in use for longer than one year. Fixed assets are not easily liquidated. As a result, unlike current assets, fixed assets undergo depreciation.
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Internal Revenue Service. "Publication 946 (2021), How to Depreciate Property."
Internal Revenue Service. "Intangibles."
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Guide to Accounting
Accounting Explained With Brief History and Modern Job Requirements
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Financial Assets
What are Financial Assets? Definition & Meaning
Updated: February 28, 2023
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Do you own anything that has some type of financial value? It could be a vehicle, a house, a lawn mower, or a piece of land, for example. What about stocks or other types of investments? There can be a lot of terms thrown around when speaking about assets and it can sometimes be confusing.
The good news? We put together this guide to break down financial assets and what they mean. Keep reading to learn more about how financial assets work, the different types, and some of the biggest advantages.
Table of Contents
KEY TAKEAWAYS
Financial assets are mainly assets that are tied to having ownership or contractual claims to an underlying tangible asset.
Financial assets are considered high liquidity. They’re able to be sold easily but they also have the potential to lose value over extended periods.
Cash, certificates of deposit, bonds, stock equity investments, mutual funds, and accounts receivable are all considered to be financial assets.
What Is a Financial Asset?
When you think of an asset, the first thing that comes to mind is likely a physical form of possession like property, inventory, or land. Because the traditional definition of an asset is an item of value that you own. Those types of assets have inherent value tied to them.
In comparison, financial assets aren’t always tangible. They’re mainly assets that are tied to having ownership or contractual claims to an underlying tangible asset. Instead of having inherent value, their value is tied to the supply and demand of the market and how much risk is associated with them. These types of assets might include:
Investment portfolios
Stock equity
Bank deposits
Accounts receivable
The most common type of financial assets are retirement investments and demand deposit accounts. Simply put, a financial asset consists of ownership rights or contractual rights to an underlying asset like a company, real estate, or commodity.
How Financial Assets Work
To understand how a financial asset works, it’s helpful to understand what the other types of assets are along with what’s considered a financial asset. There are multiple types of assets and a financial asset is just one of them. An asset falls into one of three categories:
Real
Intangible
Financial
Real assets are physical possessions like land, real estate, or commodities. It’s the one most people are familiar with. Intangible assets would be valuable possessions that aren’t physical such as your intellectual property, a trademark, copyright, or patent. Although they aren’t physical, they still hold value and ownership can be established. Financial assets are almost a combination of the two.
Financial assets get their value from a contract or other agreement that establishes an ownership claim over a real asset. Most of these assets don’t have a set value until they’re liquidated and turned into cash. They come in several forms and each comes with certain advantages and disadvantages.
Cash and cash equivalents: Cash and its equivalents are considered the safest asset. The accounts the cash is stored in are backed by the FDIC and the value is consistent. It could be within a certificate of deposit, money market account, or savings account. Each one provides monthly statements that confirm the value no matter the type of deposit account.
Stocks: Owning stocks of a company makes you part owner of that company. Your percentage of ownership is determined by how many shares of the stock you own compared to how many shares were issued. Depending on the type of stocks you may also be entitled to dividend payments. These are considered high risk, but there’s potential for high reward.
Bonds: Bonds are an investment that entitles the owner to the repayment of the bond plus interest once the bond reaches its maturity date. It’s similar to a loan granted to a company from an individual.
Accounts receivable: Accounts receivable are considered an asset based on the amount of money expected to be received by a company.
The commonality between all of the above-mentioned assets is that they would be considered a high liquidity financial instrument. They all gain value from an established contractual claim. Although these liquid assets aren’t tangible, the value attached to the financial instrument is still very real.
Advantages of Financial Assets
Financial assets come with several advantages that you won’t find with real or intangible assets.
High liquidity makes it easy to convert the asset into cash when an emergency hits.
Bank deposits are protected by the FDIC by up to $250,000 in case the bank fails.
Some financial assets can increase in value. Stock prices might rise, or money market deposit accounts gain interest from the bank or financial institution.
In comparison, a physical asset like land or property is considered an illiquid asset. If you were interested in liquidating a piece of real estate it must be listed, contracted, and then sold. That could take months. Meanwhile, trading in stock equity might take up to two business days.
Disadvantages of Financial Assets
Holding liquid assets allows for some flexibility, better control of assets, and added protection. There may even be a slight return on your investment funds. However, there are downsides to keeping financial assets as well. They include:
The price you pay for high liquidity is often a lower return on investment. Checking accounts, money market accounts, and savings accounts offer minimal amounts of interest on your deposit.
Keeping bank deposits amounts above $250,000 in one bank could mean there’s a potential for loss if the bank fails.
High liquidity doesn’t apply to investments with low demand such as penny stocks or specialty stocks.
Financial asset values are dependent on the supply and demand of the market it’s based in. For example, if you’ve invested in stocks for the oil and gas industry, but the oil and gas market crashes then you might take a loss on your investment.
Summary
Overall, financial assets are useful when including high liquidity assets as part of your strategic investments plan. Several monetary instruments are considered liquid assets including cash, equity instrument, bonds, and receivables. They aren’t physical assets but they have a value that’s closely tied to real assets through a claim of ownership or contracts. The value of financial assets depends on the supply and demand that influence investments and affects the price of the underlying asset it’s tied to.
Written by
Grant Gullekson
Grant Gullekson is a CPA with over a decade of experience working with small owner/operated corporations, entrepreneurs, and tradespeople. He specializes in transitioning traditional bookkeeping into an efficient online platform that makes preparing financial statements and filing tax returns a breeze. In his freetime, you’ll find Grant hiking and sailing in beautiful British Columbia. Learn more about Grant’s services at viccityaccountant.com.
Written by
Grant Gullekson
Grant Gullekson is a CPA with over a decade of experience working with small owner/operated corporations, entrepreneurs, and tradespeople. He specializes in transitioning traditional bookkeeping into an efficient online platform that makes preparing financial statements and filing tax returns a breeze. In his freetime, you’ll find Grant hiking and sailing in beautiful British Columbia. Learn more about Grant’s services at viccityaccountant.com.
Financial Asset FAQs
Why are financial assets important?
Financial assets are important because they allow for faster cash conversion compared to real or intangible assets which are more illiquid investments. This provides a financial cushion in the event of an emergency or pressing financial needs. Assets that are less liquid such as real estate require a longer time frame for funds to become available.
Are financial assets investments?
They can be. Financial assets such as stocks, retirement accounts, and bonds would be considered investments. Cash and some of its equivalents would not.
Which financial assets are the safest?
Cash is considered to be the safest financial asset for the average investor.
What is the difference between a financial asset and a tangible asset?
A tangible asset holds intrinsic value and is a physical possession. Financial assets are non-physical and their value comes from the contracts and agreements that grant a form of ownership over a tangible asset.
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