IAS 1: Classification of Liabilities
IAS 1, Presentation of Financial Statements covers a variety of presentation issues, including classification of liabilities as current or noncurrent. Recently, the IASB issued clarifying amendments to the classification of liabilities guidance, which this post will summarize.
Classify a liability as current
Based on the revisions made, IAS 1.69 requires an entity to classify a liability as current when:
- 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 the right at the end of the reporting period to defer settlement of the liability for at least twelve months after the reporting period.
If none of these criterion are met, an entity must classify a liability as noncurrent.
Management’s intentions
Consider the following scenario:
Savage Inc. has a long-term borrowing containing a debt covenant (e.g., staying below a maximum debt to equity ratio). The specific requirements in the debt covenant have to be met as of the end of each fiscal year end (December 31). If they are not met at the end of the year, the agreement provides Savage with a three-month grace period to rectify the breach, or the debt becomes payable on demand.
As of December 31, Savage determines that it is NOT in compliance with the covenant, but does not foresee any issues with returning to compliance in the next three months.
Classification conclusion
In accordance with IAS 1, this borrowing should be classified as current. IAS 1 requires entities to comply with any conditions that would affect classification as of the end of the reporting period, in this example, December 31. This requirement exists regardless of the fact that the covenant may be rectified in the subsequent periods after year end to avoid becoming due.
Savage must consider the state of its compliance with the covenant as of December 31 and its ability at that time, based on the conditions that exist on that date, to prevent the loan from potentially being due within the next twelve months and classify the loan appropriately based on the outcome. If the covenant has been violated at this date, which is the case, the loan will be classified as current, even if future actions may change this classification at a later date.
IAS 1 added a paragraph which clarifies that an entity’s right to defer settlement of a liability for at least twelve months after the reporting period must exist at the end of the reporting period. If the right to defer settlement is dependent on specific conditions (e.g., covenants), then that right exists at the end of the reporting period only if the entity complies with those conditions at the end of the reporting period, regardless of when compliance is required to be tested or if actions can be taken after the balance sheet date to fix the violation.
Lending conditions
Maybe you’re wondering, what if the lender waives the violation and does not demand payment as a result of the breach?
Assume that Savage quickly contacts its lender and receives a signed waiver on January 31 that forgives the breach for the year, requiring that Savage return to compliance by December 31 of the next year. Savage’s financial statements aren’t due to be issued until March 1.
Considering this additional information, the borrowing should still be classified as current as of December 31! IAS 1 requires entities to comply with any conditions that would affect classification as of the end of the reporting period, in this example, December 31. This requirement exists regardless of the fact that subsequent to year end, Savage is able to obtain a waiver to extend it debt for at least another year.
This is because the condition that EXISTED at year end was that the borrowing was not in compliance with the covenant and subject to immediate repayment. Only if the waiver was obtained as of, or before, December 31, would it impact the classification and allow noncurrent classification at December 31. However, subsequent events disclosure would likely be appropriate in this scenario.
Final thoughts
We hope you found this blog post to be helpful in summarizing the most recent guidance for IAS 1 relating to the classification of liabilities! We have a full IFRS library, including our most recent update courses where we summarize all of the various changes to guidance during the year. Check it out and let us know what you think!
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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.
