Financial instruments are contracts that give rise to both a financial asset of one company and a financial liability of another company. Financial instruments come in a variety of forms which include derivatives, hedges, and marketable securities.
Measured at fair market value:
Financial assets:
- Financial assets held for trading.
- Available-for-sale financial assets.
- Derivatives (whether stand-alone or embedded in non-derivative instruments).
- Non-derivative instruments with fair value exposures hedged by derivatives.
Financial liabilities:
- Derivatives.
- Financial liabilities held for trading.
- Non-derivative instruments with fair value exposures hedged by derivatives.
Measured at cost or amortized cost:
Financial assets:
- Unlisted instruments (there is no reliable valuation measure).
- Held-to-maturity investments (bonds).
- Loans and receivables.
Financial liabilities:
- All other liabilities (such as bonds payable or notes payable).
Accounting for Gains and Losses on Marketable Securities
- Held-to-maturity securities. Debt securities that management intends to hold to their maturity dates. At year-end, they are reported at cost adjusted for the effect of interest (debit the securities account and credit the interest income account) and unrealized holding gains and losses are not recognized.
- Trading securities. Debt and equity securities bought and held mainly for sale in the short term to generate income on price changes. At year-end, they are reported at their fair market value. Any unrealized holding gains or losses are recognized on the company's income statement as part of net income. When they are sold, the realized gains or losses will also appear on the income statement. Realized gains and losses are not affected by any unrealized gains or losses recognized before.
- Available-for-sale securities. Debt and equity securities not classified as held-to-maturity or trading securities. Unrealized gains and losses are reported as part of other comprehensive income (in contrast, the unrealized gains or losses of trading securities are reported in the income statement as part of net income). Other than that, they are accounted for in the same way as trading securities.