The accounting for financial instruments includes the treatment of swaps, hedges, options and other sophisticated forms of investing. Most non-profit organizations are restricted by statutes, internal regulations, and a good night’s sleep as to the investments they take on, and generally they only deal with primary instruments like stocks, bonds and investment certificates, as well as accounts receivable and accounts payable.
For this reason we have chosen to simplify the recommendations for financial instruments, section 3856, to cover the instruments 99.9% of NPO’s deal with.
Financial Assets and Liabilities Defined
For simplicities sake, we will define financial assets as: cash; the contractual right to receive cash or another financial asset; an equity instrument of another entity, a share held. And we will define a financial liability as a contractual obligation to deliver cash or another financial asset.
A financial asset could be cash, an account receivable, a loan to an outside party, bonds, stocks or investment certificates held. It could not be a prepaid expense, because that is the right to a service and not cash, nor could it be inventory or a capital asset because these are not the right to cash. A financial liability could be an account payable, or debt issued. A financial liability could not be GST payable, or income tax withheld because those are statutory and not contractual obligations. Nor could a financial liability be unearned revenue or deferred contributions because they represent the future provision of goods or services, not cash.
Recognition and Measurement of Financial Assets and Liabilities
A financial assets or liability, traded in an active market, and obtained through an arm’s length contract would be recognized and measured at fair value according to the arrangement of the contract. (3856.06,.07) In subsequent reporting periods, the instrument would be revalued to market value.(3856.12) If the active market ceases, the entity may elect to continue to value the instrument at fair value. (3856.13) All transactions costs, interest, dividends, gains and losses would be recognized in income. (3856.15)
If the asset or liability is not traded in an active market, or is a derivative offset by an instrument not traded in an active market, then the instrument would be carried at cost and adjusted by any financing fees or transcation costs. (3856.11,.12) For such an instrument, the NPO section on related party transactions does not address the method of valuing related party transactions, however, the for-profit section 3840 generally requires that such transactions would be made at carrying value. (3856.08, 3840.08) If a financial instrument carried at cost experiences a significant negative adverse change, it would be written down, and revalued if the situation improves.(3856.16-.19) The fair value of any financial assets or liabilities carired at cost would need to be disclosed. (3856.38)
Offsetting Financial Assets and Liabilities
A financial asset should be offset against a financial liability when there is a legal right to do so and there is an intention to settle the amounts simultaneously. The most common example of this is the settlement of an account receivable and payable to the same entity. (3856.24)
Derecognition of Receivables and Financial Liabilities
A receivable transferred to another organization would only be derecognized when control is surrendered. (3856.25) A financial liability would only be removed when the obligation is extinguished. (3856.26)
The organization should disclose any significant risks arising from financial instruments, and significant concentrations of risk. (3856.53, .54)