Saturday, January 2, 2021

Why are contract assets not financial assets?

 


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A financial asset is any asset that is cash, an equity instrument of another entity or a contractual right to receive cash or another financial asset from another entity. The right to receive cash has no conditions attached, that is, the business is not expected to do anything or satisfy any future performance before being entitled to receive cash from the other party (customer, borrower, etc.)

Trade receivables: These are contractual rights to payment (to be paid) held by a business for goods supplied or services rendered that customers have ordered but not paid for. This meets the definition of a financial asset since it is a contractual right to receive cash. No conditions attached to the right.

Investment in equity: These are ordinary investments made by a business with the aim of receiving returns in the form of dividend or for capital appreciation. This meets the definition of a financial asset since the business holds an equity instrument of another entity. Note that this investment in equity is an asset in the books of the business. It is different from the business’ own equity. Also note that investment in associate, joint venture and subsidiary are not financial assets (ceteris paribus).

Loans and advances: These are funds carrying interest rate issued by a business (mostly banks) to customers or other entities for a specific purpose to be repayable after an agreed duration or over a period. This meets the definition of a financial asset since it is a contractual right to receive cash from the borrower.

Contract asset: This relates to an entity’s conditional right to consideration. The right is conditional when an entity must first satisfy another performance obligation in the contract before it is entitled to payment from the customer. If an entity has an unconditional right to receive consideration from the customer, the contract asset is accounted for as a trade receivable. A right is unconditional if nothing other than the passage of time is required before payment of that consideration is due. Hence, a contract asset is not a financial asset because the right  to receive cash has conditions, that is, asides from credit risk (which arises as a result of passage of time), there is a performance risk that the entity might not fulfil it’s remaining obligation that makes it entitled to receive cash from the customer. This right is conditioned on something other than the passage of time (the entity’s future performance). See post on Contract Assets to read more on contract assets. However, IFRS 15 requires Contract Assets to be assessed for impairment in accordance with IFRS 9, even though they are not financial assets. An impairment of a contract asset shall be measured, presented and disclosed on the same basis as a financial asset that is within the scope of IFRS 9.

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