Non-current liabilities with covenants – you’re going too far!

As we covered here, 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.

The proposals would amend the current guidance on determining whether an entity has a right to defer settlement of a liability for at least twelve months. They also propose that non-current liabilities subject to conditions that could affect their classification 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 it contradicts the principle-based nature of IFRS Standards.

Based on my highly incomplete review of the comment letters received, many respondents agree with the dissenters on that point. This is from the Dutch Accounting Standards Board:

  • The DASB considers that this will not result in more useful information as we expect that many liabilities will be captured in this category as most liabilities contain specified conditions. In our opinion, a separate presentation of a small group of non-current liabilities that would not be subject to specific conditions will not be useful for investors and it creates a risk of obscuring relevant information. The DASB prefers classification based on the generic classification of current and non-current liabilities combined with sufficient disclosure requirements instead of a separate presentation.
  • The DASB could sympathize with a proposal to present some liabilities separately. However, given the aforementioned concerns, the requirement should be further elaborated. For example, perhaps for liabilities with financial and/or non-financial conditions of which there is a reasonable uncertainty that the entity is not able to meet the conditions. Then this separate line item in the balance sheet would provide information to users and function as a highlight to encourage users of the financial statements to read the disclosures..

This is from the Institute of Chartered Accountants in England and Wales:

  • Creating a new line item on face of the statement of financial position highlighting such items could potentially be misleading as it may suggest to users that there is cause for additional concern when in fact there is none, because the risks of non-compliance may be negligible. Moreover, doing so will provide users with no useful information about the risks of non-compliance.
  • …We are concerned that the proposals would result in significant numbers of non-current liabilities being captured by this requirement as many loans will contain covenants that are tested on annual basis. The requirements are therefore likely to be onerous for preparers, with the costs outweighing the benefits.

The Canadian firm MNP commented:For entities where there is no material risk of non-compliance with conditions, presenting these liabilities separately could be misinterpreted as suggesting that the liquidity risk is greater than for other entities where the liabilities are not subject to specified conditions within twelve months after the reporting period.” The Brazilian Accounting Pronouncements Committee argued that such a requirement: “could also raise the question on whether other terms and conditions that typically apply to such financing liabilities could be deemed equally or more significant to users of financial statements to the point of also deeming separate presentation (bearing in mind that the entities may have different profile of primary users with different concerns that may value one aspect or another relating to debt, such as different interest rates, currency on which the financial liability is denominated, guarantees, among others)…” The European Securities and Markets Authority also expressed doubt about the proposal, adding: “Should the IASB deem it appropriate to retain the requirement for separate presentation, ESMA recommends refining the criteria for separate presentation to ensure the relevance of the information provided.”

Some others, such as the Australian Accounting Standards Board, expressed their disagreement very concisely, simply saying that they agreed with the views of the dissenting Board members. Although I don’t really disagree with all these views, they seem to me to illustrate a somewhat immature and rigid aspect of financial reporting. If it’s true in a specific case that the proposed separate presentation would, as set out above, be potentially misleading and provide no useful information, then it shouldn’t be a problem if it were omitted on the grounds of immateriality. And it’s a bit disheartening that at this advanced technological stage of our history, we’re still fussing around with how best to summarize a complex organization on one or two sheets of paper, and worrying about the implications of doing that imperfectly. If the proposals (which are hardly earth shattering) run such a risk of overwhelming a human user, then all the more reason perhaps to assign the task of analyzing an entity’s financial information to an AI user instead…

The opinions expressed are solely those of the author.

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