The IASB has issued for comment Non-current Liabilities with Covenants, an exposure draft of proposed amendments to IAS 1, with comments to be received by March 21, 2022.
One of the situations in which an entity classifies a liability as current under IAS 1 arises when “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.” The standard in its current form (that is, following the most recent amendments, from 2020) comments: “If the right to defer settlement is subject to the entity complying with specified conditions, the right exists at the end of the reporting period only if the entity complies with those conditions at the end of the reporting period. The entity must comply with the conditions at the end of the reporting period even if the lender does not test compliance until a later date.” Among other problems though, this doesn’t take into account conditions negotiated to reflect an entity’s specific circumstances – for example a contract may specify different conditions at different dates to incorporate the expected effects of seasonality or the entity’s future performance
The exposure draft proposes replacing the above passage with the following:
- An entity’s right to defer settlement of a liability for at least twelve months after the reporting period may be subject to the entity complying with specified conditions (often referred to as ‘covenants’). For the purposes of applying (that requirement) such conditions:
- affect whether that right exists at the end of the reporting period…if an entity is required to comply with the condition on or before the end of the reporting period. This is the case even if compliance with the condition is assessed only after the reporting period (for example, a condition based on the entity’s financial position as of the end of the reporting period but assessed for compliance only after the reporting period).
- do not affect whether that right exists at the end of the reporting period if an entity is required to comply with the condition only within twelve months after the reporting period (for example, a condition based on the entity’s financial position six months after the end of the reporting period).
- An entity does not have the right to defer settlement of a liability for at least twelve months…if the liability could become repayable within twelve months after the reporting period:
- at the discretion of the counterparty or a third party—for example, when a loan is callable by the lender at any time without cause; or
- if an uncertain future event or outcome occurs (or does not occur) and its occurrence (or non-occurrence) is unaffected by the entity’s future actions—for example, when the liability is a financial guarantee or insurance contract liability. In such situations, the right to defer settlement is not subject to a condition with which the entity must comply as described (above).
Among other things the Board concluded that these proposals would avoid the seasonality problem pointed out above, and would make the requirements less complex overall. The exposure draft proposes that liabilities subject to such conditions should be presented separately in the balance sheet, with a description indicating that the non-current classification is subject to compliance with conditions within twelve months after the reporting period, and with information disclosed in the notes enabling users to assess the risk that the liability could become repayable within twelve months (including addressing whether and how the entity expects to comply with the conditions after the end of the reporting period). A couple of Board members dissented from this part of the exposure draft, stating in part that:
- this proposal contradicts the principle-based nature of IFRS Standards…To maintain the principle-based nature of IFRS Standards, the Board should set out rules only rarely. The proposed presentation requirement does not represent a compelling case to forgo a principle-based approach. Further, there is limited space in an entity’s statement of financial position. Under a principle-based approach, to provide the most relevant information to users of financial statements, an entity would apply principles to prioritize the information presented in the statement of financial position relative to disclosure in the notes (and) in deciding whether it is more appropriate to disclose such information in the statement of financial position or in the notes.
I must admit though that I can’t quite follow how this specific aspect crosses the “rare” line of setting out rules (the implementation of which should still be subject to materiality considerations). Not to mention that the “limited space” point belongs so heavily to the paper-based world that we should be trying to move beyond.
Anyway, the proposals wouldn’t be effective any earlier than January 1, 2024, with the exact date to be decided later, and would be applied retrospectively. I imagine there might be some lively feedback on the exposure draft, not least on those presentation and disclosure aspects…
The opinions expressed are solely those of the author