Classifying liabilities – all about the rights

The IASB has issued Classification of Liabilities, an exposure draft of proposed amendments to IAS 1, with comments to be received by June 10, 2015.

The proposals are intended to clarify “that classification of liabilities as either current or non-current is based on the rights that are in existence at the end of the reporting period.” Since this general principle is already pretty clear, the amendments would just provide incremental tweaks to what presently exists. The first of these relates to IAS 1.69, which currently says that an entity classifies a liability as current when (among other things) it doesn’t have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period. The Board observes now however “that rights to defer settlement are rarely unconditional, because such rights are often conditional on compliance in future periods with covenants made by the borrower.” To address this, it’s proposing to remove that notion, referring only to a “right at the end of the reporting period.”

The Board also focused on the phrase “settlement of the liability,” proposing the following new language: “For the purposes of classification as current or non-current, settlement of a liability refers to the transfer to the counterparty of cash, equity instruments, other assets or services that results in the extinguishment of the liability.” This should stamp out any doubt about whether the classification principles vary based on the circumstances in which the liability arose. The standard will continue to state though, as at present, 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” – I wonder if some commenters will find the proposed juxtaposition of the two references to equity instruments rather confusing…

IAS 1.73 currently says that if an entity expects, and has the discretion, to refinance or roll over an obligation for at least twelve months after the reporting period under an existing loan facility, it classifies the obligation as non-current, even if it would otherwise be due within a shorter period. The IASB now proposes tightening this wording, much like the above, to refer simply to a right to roll over an obligation for at least that period. Conversely, the amended standard would specify that “when the entity does not have the right to roll over the obligation (because, for example, there is no arrangement in place at the end of the reporting period for rolling over the obligation), the entity does not consider the potential to refinance the obligation and classifies the obligation as current.” The Exposure Draft of Annual Improvements 2010–2012 had proposed including a reference to “same lender” here, but the Board received feedback that this wasn’t practical, given the different ways in which lender consortia can be structured.

IAS 1 already specifies that if events such as refinancings or rectifications of breaches of agreements occur between the end of the reporting period and the date the financial statements are authorized for issue, those events are disclosed as non-adjusting events in accordance with IAS 10. The IASB proposes adding, for the avoidance of any doubt, that these events don’t affect classification at the end of the reporting period. According to the basis for conclusions, the Board did consider whether and how management’s expectations about events after the end of the reporting period should affect classification, but ended up not taking that train of thought anywhere.

Preparers continue to be drawn occasionally to the premise that such expectations should sometimes matter – for example, if a long-term debt is classified as current at the end of the reporting period only because of a covenant breach, and the issuer obtains a waiver before the statements are authorized for issue, it might be appealing to argue that long-term classification provides the most meaningful predictive value in the light of subsequent negotiations. Old Canadian GAAP, of course, did allow taking exactly this backward-looking approach, and so did IAS 1 when it first appeared in 1997 – the present approach dates back to an exposure draft from 2002. Some comment letters back then disagreed: “They advocated classifying a liability as current or non-current according to whether it is expected to use current assets of the entity, rather than strictly on the basis of its date of maturity and whether it is callable at the end of the reporting period. In their view, this would provide more relevant information about the liability’s future effect on the timing of the entity’s resource flows.” But the IASB was persuaded instead to focus more sharply on rights and obligations as they exist at the end of the reporting period, and it’s not likely to wander away from that now.

Anyway, the amendments – which also include a bit of reorganization to group similar examples together – would be applied retrospectively, with earlier adoption permitted. Presumably they’ll be finalized more or less as written, perhaps with a bit more fine-tuning here and there…

The comments expressed are solely those of the author

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