Are your borrowings classified correctly as current or non-current liabilities?

IAS 1 Presentation of Financial Statements requires entities that prepare a classified statement of financial position to present liabilities as either current or non-current. IAS 1, paragraph 69 requires a liability to be classified as current if any one of the following criteria are met:

  • It expects to settle the liability in its normal operating cycle
  • It holds the liability primarily for the purpose of trading
  • The liability is due to be settled within twelve months after the reporting period, or
  • It does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period (see paragraph 73). Terms of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification.

If any of these criteria are met, the liability must be classified as current. 

COVID-19 has resulted in significant financial difficulties for many entities, including significant liquidity constraints. These effects have highlighted the importance of classifying liabilities correctly, as doing so provides users with important information about liabilities that will or may require settlement in the next 12 months.

BDO’s latest International Financial Reporting Bulletin IFRB 2021 06 Classification of Liabilities as Current or Non-Current: FAQs explains the requirements of IAS 1, paragraph 69 (including related guidance) through frequently asked questions (FAQs), which BDO has encountered commonly in practice. The table below includes a brief summary of these FAQs. Please read the whole publication for complete answers.

FAQ

Question topic

Summary answer

1.1

Scope

Which liabilities do the classification requirements of IAS 1.69 apply to?

Applies to all types of liabilities, e.g. bank borrowings, corporate bonds, lease liabilities, contract liabilities and accounts payable.

Does not apply to deferred tax liabilities, which are always presented as non-current.

2.1

Split presentation

Are liabilities divided into a current and non-current portion?

Yes.

Amortising bank borrowings and lease liabilities are split into:

  • Current portion – payments contractually due within 12 months, and
  • Non-current portion – payments due more than 12 months after reporting date.

3.1

Effects of covenants on classification – general matters

Requirement to maintain a specified financial ratio at each year-end. If the financial ratio is not met, bank has the right to demand repayment of the loan immediately. Entity meets the specified financial ratio at year-end (31 December 2020).

How is the loan classified at reporting date?

Non-current.

Entity has an unconditional right to defer settlement of the liability for at least 12 months after reporting date (31 December 2020).

3.2

Effects of covenants on classification – general matters

Same facts at FAQ 3.1. above, except that financial ratio is not met at reporting date (31 December 2020).

Subsequent to reporting date, on 15 February 2021, before the financial statements are authorised for issue, Entity receives a waiver from the bank whereby the bank will not demand repayment for 12 months.

How is the loan classified at reporting date?

Current.

At reporting date, Entity does not have an unconditional right to defer settlement of the liability for at least 12 months after reporting date.

IAS 1, paragraph 74 specifically deals with this issue.

3.3

Effects of covenants on classification – general matters

Same facts at FAQ 3.1. above, except that Entity is concerned it will not meet its financial ratio on 31 December 2020, so discusses the matter with its bank in November 2020.

On 15 December 2020, the bank agrees to waive the covenants at 31 December 2020. Entity does not need to comply with the covenant at 31 December 2020 but needs to comply at future reporting dates.

How is the loan classified at reporting date?

Non-current.

Entity has an unconditional right to defer settlement of the liability for at least 12 months after reporting date (31 December 2020).

IAS 1, paragraph 74 specifically deals with this issue.

3.4

Effects of covenants on classification – general matters

Same facts at FAQ 3.1. above, except that the banking agreement states compliance with covenants will be based on audited financial statements once they are approved and released (expected March 2021).

Entity violates its covenants based on 31 December 2020 audited financial statements.

How is the loan classified at reporting date?

Current.

Even though the audited financial statements were not available at 31 December 2020 to test the covenant, the loan is classified as current because the condition that led to the breach already existed at reporting date, and the audited financial statements merely provide evidence of that breach.

At reporting date, Entity does not have an unconditional right to defer settlement of the liability for at least 12 months after reporting date.

IAS 1, paragraph 74 specifically deals with this issue.

3.5

Effects of covenants on classification – quarterly testing

Entity has a long-term loan with a bank. Entity is required to maintain a specified financial ratio at the end of each quarter. If the financial ratio is not met, bank has the right to demand repayment of the loan immediately.

Entity has met the financial ratio at its reporting date, 31 December 2020.

How is the loan classified at reporting date?

Non-current.

Even though compliance will be tested again in less than 12 months, i.e. at the end of the next quarter, 31 March 2021, Entity complied with the covenant at reporting date and therefore has an unconditional right to defer settlement of the liability for at least 12 months after reporting date (31 December 2020).

Future covenants will be tested at future dates, which do not affect conditions at 31 December 2020.

3.6

Effects of covenants on classification – quarterly testing

Same facts as FAQ 3.5, except that the financial statements for 31 December 2020 are only completed in April 2021.

Entity met its covenant at 31 December 2020 but did not meet its covenant at 31 March 2021.

How is the loan classified at reporting date, 31 December 2020?

Non-current.

Entity complied with the covenant at reporting date (31 December 2020) and therefore has an unconditional right to defer settlement of the liability for at least 12 months after reporting date (31 December 2020).

Breach of the covenants at 31 March 2021 should be disclosed in the 31 December 2020 financial statements as a non-adjusting subsequent event (refer IAS 10, paragraph 21).

4.1

Rollovers and modifications of existing loans

Entity has a loan due for repayment to the bank within 12 months of reporting date. Entity has an option to roll over the loan for another 12 months, with the rollover conditional upon Entity passing a financial test.

How is the loan classified at reporting date if the rollover has not taken place?

 

Depends on facts and circumstances.

Non-current

The loan is classified as non-current if the entity expects, and has discretion, to refinance or roll over an obligation for at least 12 months after reporting date (IAS 1, paragraph 73). Entity might have discretion in respect of the financial test if they expect to pass the test.

 

Current

The loan is classified as current if management does not intend to roll over the loan.

Refer to FAQ 4.1 for more details.

4.2

Rollovers and modifications of existing loans

Entity has a loan due for repayment to the bank within 12 months of reporting date. Before year-end, Entity enters into an agreement with a new bank whereby the new bank will ‘roll over’ the old loan into a new loan, repayable in five years’ time.

How is the loan classified at reporting date?

Current.

At reporting date, Entity does not have an unconditional right to defer settlement of its existing liability for at least 12 months after reporting date.

5.1

Classification of contract liabilities

Entity has a contract liability for future discounts to be provided to customers as a result of loyalty points earned.

Entity has strong historical data to support that only 50-55% of points earned in a given calendar year will be redeemed within 12 months of reporting date. This is because many customers prefer to accumulate their points for a larger purchase.

How is the contract liability relating to points classified at reporting date?

Current.

At reporting date, Entity does not have an unconditional right to defer settlement of its contract liability for at least 12 months after reporting date.

Technically every customer could decide to redeem all their points in the next 12 months. However, IAS 1, paragraph 69(d) is based on contractual rights and obligations.

6.1

Classification of trade payables

Is a trade payable due to be paid more than 12 months after reporting date classified as a current or a non-current liability?  

Current if payable within the normal operating cycle.

IAS 1, paragraph 70 states that trade payables form part of the working capital used in an entity’s normal operating cycle. These are  classified as current liabilities even though they are due to be settled more than 12 months after reporting date (refer IAS 1, paragraph 69(a).

7.1

Classification of convertible notes

Entity issues a $1,000 convertible note with a maturity of three years from date of issue. At maturity, the holder has an option to receive $1,000 cash or 10,000 of Entity’s shares (i.e. a European-style option that can only be exercised at maturity).

The note is accounted for as a compound financial instrument under IAS 32 Financial Instruments: Presentation and entitity therefore recognises an equity component as well as a financial liability.

How is the liability component of the convertible note classified at issue date?

Non-current.

Entity has an unconditional right to defer settlement of the liability for three years from issue date.

7.2

Classification of convertible notes

Same facts as FAQ 7.1, except that the conversion feature can be exercised by the holder at any time (i.e. an American-style option).

How is the liability component of the convertible note classified at issue date?

Non-current.

Even though the holder could exercise its option to convert the notes (liability) into equity at any time, IAS 1, paragraph 69(d) states that ‘...terms of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification...’

Beware – IAS 1 is changing

It should be noted that answers to the above FAQs may change when the IASB amendments to the classification requirements become effective for periods beginning on or after 1 January 2023. For information on the revised classification requirements for liabilities, please refer to our International Financial Reporting Bulletin IFRB 2020/01 IASB issues amendments to IAS 1 – Classification of Liabilities as Current or Non-Current.

This publication has been carefully prepared, but is general commentary only. This publication is not legal or financial advice and should not be relied upon as such. The information in this publication is subject to change at any time and therefore we give no assurance or warranty that the information is current when read. The publication cannot be relied upon to cover any specific situation and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact the BDO member firms in Australia to discuss these matters in the context of your particular circumstances.

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