The section: accounting and audit

Department of accounting and audit

Margarita Zholaeva A.

 

Almaty, the University of International Business (UIB)

 

The Account of Financial Instruments: Challenges and Solutions

 

The dynamic development of international financial markets had lead to the appearance of various financial instruments such as traditional, which include debt obligations, and production instruments. The expansion of capital markets and new opportunities for investments defined not only the development of industrial financial instruments but created some problems, connected with the influence of different risks on the results of companies’ activities.

As Kazakhstan made its step toward the market relations, it is also began the mastering the experience of the developed states. In particular, this was concerned to the development of the fund markets. However, despite the development of market environment, the majority of Kazakhstan and Russian economic textbooks did not give the simple definition of the notion of the “financial instrument”; moreover it was not mentioned there at all.  In particular, we can find only the definition of some separate types of financial instrument in the financial dictionaries that are:  security paper, warrant, stocks, bill and others. In the English –Russian dictionary of the monetary and credit terms there are several definitions of the term of “financial instrument”:

1.      “Currency, paper holdings, deposits”.

2.      “An instrument”:

a.       an instrument of the monetary and credit or economic politics (discount rate and central bank activities, reserve requirements, etc);

b.      legally issued document;

c.       financial asset or obligation, which is the object of trade on the market (security paper, deposits, contracts, etc).[1]

Kovalev V.V. gives the following definition in the Russian textbook on the economy – “the term of financial instruments can explain different forms of short - term and long – term investments operating on the financial markets. They include financial resources, security paper, options, forward contracts, futures and swaps.”

The western economic textbooks contain several definitions of “financial instruments”. For example the definition of financial instrument can be used according to the International Financial Reporting Standards ¹ 32 (IFRS 32). It describes financial instrument as any contract, which as a result provides one company with the financial assets and obligations or the other with the equity.”

According to the article 6 of the IFRS 32, a contract is the legal agreement between two or more sides, which has a certain economic consequences for them. The IFRS also describes the possibility of contract absence, which is the cause of the same operations of financial instruments. In particular, in the single transactions on the purchase and sell of international currency (spot, swap - transactions), the legal documentary registration is based on the general agreement. This agreement is reached between the participants before the activities on the currency market start. Today most of the investments companies and banks working on the currency markets present the conditions for the transactions on the purchase and sell of the currency in the form of offer for the sides, which are interested in it. For example, Money garden Corporation offers the contracts on currency operations for individuals through the internet communications. The definition of the financial instrument given in IFRS 32 based on the recognition of the basic elements that construct a financial instrument in the frame of the contract that has the following required requisites:

There are a lot of definitions of the “financial instrument” today, which reveals only its separate types. In particular, we are facing now with the appearance of the definition of the real financial instrument; “the instruments that are correcting themselves to the inflation temp, and counting in a real dollars. As a result the real interest rate is used to convert them in future to the nominal dollars after the calculations committed between the transaction members.”

The specific attention should be given to the definition of the “off-balance sheet risks”. According to the GAAP USA, “a financial instrument has the off – balance risk in the case of book loss. It can happen if the loss amount exceeds the amount of financial asset; or if the obligations on the financial instrument can exceed the amount of that, which is regarded as the obligation of the accounting balance – sheet.” According to the BTA Bank experts, “the existing financial instruments with the off – balance risks can be divided into two groups. The first group includes the financial derivative products and currency forward contracts; the second group regards the legal requirements for the particular companies. Theses requirements are the credits, and the guaranties on these credits within the established limits.”

The given division is explained by the different types of the financial risks that are peculiar to such instruments as the price risks, which are included to the first group, and the credit risks from the second group. The money flows connected with the off – balance instruments is characterized by their indefinite feature, and the company does not have an owner right for the operations results with such instruments. Based on this point the ….

At the same time it is important to mention that instrument with the off –balance risks can be mentioned in the notes of the accountant report according to the IFRS 32, which include the following data:

-         the main sum (principal) of financial asset or obligation;

-         the date of payment or of its termination;

-         the possibility to end the financial instrument activity by the moment of its performance according to the contract, and  to mention the possible price for it. The example of it is the option for the financial exchange of an instrument. 

-         the sum and the temporary periods of future money receipts and payments of the basic sum (principal) of the instrument, including periodic pay, and the sinking funds.

-         in case if money flow for the financial instrument is expressed in currency, that is different from the  accounts of an economic subject, it is necessary to show the currency type, in which the receipts and payments are going to be.

According to the legislation of the Republic of Kazakhstan the rights and obligations of the sides on the off – balance instruments are defined by the transaction conditions, which is allowed by the article 157 of the Civil jurisdiction of the Republic of Kazakhstan; or it is happen when the company do not have a property right on the results of the financial instrument operation. Here we are talking about the contingent rights and obligations that are usually exist in the case of options and guarantees. The contingent rights and obligations on the options can be found on the off – balance counts 008 that is the “Guarantees on obligations and the received payments”, and 009 that is the “Guarantees on obligations and the given payments”. The inclusion of the off – balance count to the side of the contract can be explained by the fact that it is  a condition for option performance with underlying asset (the contract object). Even the huge possibility of the option performance can not guarantee its off – balance expression. In such a case the evaluation of some articles in the account balance will be distorted.

Any decision concerning the expression of non monetary and off – balance instruments in the balance should be based on the principles of importance and liability to the financial risks. In this research it is interesting to present the opinion of Rudanov A.P., who denied the off – balance count. This point of view can be justified by the fact while commercial banks are using the off - balance counts for the expression of the performed guarantees on loans it can decrease the quality of the account analysis.  As an example, we can look at the situation that happened to the commercial banks in South East Asian states during the crisis of 1997. The problem was connected with the big amount of non paid credits and loans, which as a result made the situation, worsen after the disappearance of foreign currency in the region.  Another interesting research conducted by the Frederick Choe makes conclusion that the relations of the company debts to its assets in Japan is higher than it is in Europe and USA. Another research shows that the relatively low coefficient does not mean its validity degree and the company’s paying capacity but in contrast, it shows its inability to take credits from the banks.

As a matter of fact, the following can be applied to the financial instruments:

1.                           Bank deposits (according to the bank deposit contract, only  a client have a right to receive money, and bank in their turn are obliged to return money based on the contract condition).

2.                           The sum of receivable and payable except the wage advance, which is paid for future goods delivery (or services).

3.                           Notes receivable and note payable.

4.                           Company security paper.

5.                           Governmental paper holdings.

6.                           Types of financial guarantees. A financial guarantee is the contractual right of the money lender who can get money from the guarantor.

7.                           Received and given money.

8.                           Derivative, which underlying assets can not be considered as goods.

Financial instruments include not only the well known instruments like security paper, but other instruments too; they are derivatives, which are financial options, futures, forwards, interests and currency swaps. Financial instruments include contracts as well, which present non financial assets and obligations. The IFRS 32 gives the oil obligation as an example. Oil obligation gives its holder a right to get the fixed sum of interests and the nominal price after his payment.

One of the types of financial instruments is also the so called substitutes of the paper holdings. The substitute of the paper holdings is the financial instrument, which has a function and the features of any security  paper, but does not accepted as such by the legislation or tradition, does not regulated by the government.

Financial instruments also include the factoring debt activities. It is the mechanism by which a company gets money from Factor Company in exchange of obligations to collect debts from the debtors.

The sphere of activities and the types of financial instruments in Kazakhstan are not as wide as they are in the Western countries. The most popular financial instruments here are the derivatives. At first, they are well spread among the other financial instruments (the world’s trade over with derivatives is about 1.5 billion $. As a result the turnover of currency markets of derivatives is 8 – 10 times more than the world’s GDP rate). Secondly, they include all the challenges connected with the count of financial instruments.

 

Leturature:

1.       Ïåïåëÿåâ Ñ., Õàìåíóøåíêî È. Ôîðâàðäíûå è ôüþ÷åðñíûå ñäåëêè. Ôèíàíñîâî-ïðàâîâûå àñïåêòû.// Ýêîíîìèêà è æèçíü. ÑÏá.ñêèé ðåãèîíàëüíûé âûïóñê. - 1996.-¹14.-Ñ.17.

2.        Ïðîèçâîäíûå öåííûå áóìàãè: äîïîëíèòåëüíûå âîçìîæíîñòè óâåëè÷åíèÿ
ïðèáûëè// Ïåòåðáóðãñêèé ôèíàíñîâûé âåñòíèê.-1996.-¹6(142).-Ñ. 14-15.

3.       Áèðæè ïðîèçâîäíûõ: Ðóêîâîäñòâî ïî îðãàíèçàöèè, óïðàâëåíèþ è ïîëèòèêå// Know-How Fund, Financial Research Associates, 1995.

 

 

 


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