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 has 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 to 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 the right at the end of the reporting period to defer settlement of the liability for at least twelve months after the reporting period.
- 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, should the borrowing be classified as current or non-current as of December 31? The answer is 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 12 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.
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 or if actions can be taken after the balance sheet date to fix the violation.
You may be wondering, what if the lender waives the violation and does not demand payment as a result of the breach? Let’s return to our example. 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, should the borrowing be classified as current or non-current as of December 31? The answer is still current. Remember, 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.
The amendments to IAS 1 are effective for annual reporting periods beginning on or after January 1, 2023. Do you want to learn more about this topic and other recently issued guidance by the IASB? Check out our IFRS Update (2022) eLearning course available now!
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