IAS 1, Presentation of Financial Statements covers a variety of presentation issues, including classification of liabilities as current or non-current. Originally issued in 1997, it has remained relatively consistent in the ensuing years with only a few amendments along the way. So why then the recent need to amend its guidance on classification of liabilities as current or non-current? The answer is to address potential diversity in practice specifically related to potential contradictions between some of the language. It is important to note that the IASB believes these amendments to be more clarifications than actual changes to the guidance, and as a result requires the new guidance to be applied retrospectively. In recent IFRS Update courses taught by GAAP Dynamics, this has been one of the most popular and most debated issues!
The amendments clarify one of the criteria in IAS 1 for classifying a liability as non-current and that is the requirement that an entity have the “right to defer settlement of the liability for at least twelve months after the reporting period”. In addition, the amendments:
- Require that an entity’s right to defer settlement exists at the end of the reporting period
- Clarify that management’s intentions about settlement or the exercise of the right to defer settlement does not impact classification
- Clarify how lending conditions should be considered in determining classification
- Clarify the meaning of the term settlement, particularly as it applies to settlement via the entity’s equity shares
Let’s take a closer look at the criterion that was amended. The following is paragraph 69 of IAS 1, marked with the changes:
- An entity shall 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 an unconditional the right at the end of the reporting period 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.
- An entity shall classify all other liabilities as non-current.
In addition to the changes to this main paragraph, other supporting paragraphs that provide guidance on current vs. non-current were also added or amended. Now let’s look at an example that will illustrate some of the amendments.
So, is the classification on December 31, 20X1 correct? The answer is no, assuming that noncompliance with the covenant will result in the loan becoming payable on demand. 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 will not be assessed until March of the following year. MMI must calculate its debt to equity ratio as of December 31 and classify the loan appropriately based on the outcome. If it violates the covenant, which it appears might be a possibility, the loan will be classified as current assuming that noncompliance will result in the loan becoming payable on demand.
The amendments to IFRS added a paragraph which clarifies that an entity’s right to defer settlement of a liability for at least 12 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.
You may be wondering, what if the lender waives the violation and does not demand payment as a result of the breach? The effect of a waiver depends on when it is received. If the lender provides the waiver before the end of the reporting period, then the loan is classified as non-current because the entity now has the right, at the end of the reporting period, to defer settlement for a period of at least 12 months from the end of the reporting period. However, if the waiver is received after the end of the reporting period but before the issuance of the financial statements, the loan is classified as current. This is because, at the end of the reporting period, the entity does not have the right to defer settlement for at least 12 months after that date. In this case, the entity should consider disclosing the waiver as a non-adjusting subsequent event under the guidance in IAS 10.
The amendments to IAS 1 were deferred as a result of the COVID-19 pandemic and are now effective for annual reporting periods beginning on or after January 1, 2023. Interestingly, the issue of classification has also been addressed recently by the IFRS Interpretations Committee (IFRIC) in a recent tentative agenda decision (premium subscription may be required to access) and by the European Securities Market Authority in a recent enforcement decision. Do you want to learn more about this topic and other recently issued guidance by the IASB?
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