You’ll recall that following amendments to IAS 1 in 2022, an entity classifies a liability as current when, among other things, 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 specifies that 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. Classification of a liability is unaffected by the likelihood that the entity will exercise its right to defer settlement of the liability for at least twelve months after the reporting period.

Against that backdrop, Canada’s IFRS Accounting Standards Discussion Group recently discussed a particular (rather peculiar-sounding) form of term loan arrangement. The loan has a remaining maturity of three years as at the borrower’s December 31, 20X0 reporting date; however, the loan arrangement includes a provision that the entity must sell a foreign branch of its operations by December 31, 20X0. The terms allow the entity an additional two months to complete the sale if it is not able to sell the branch by the specified date; otherwise, the entity may demand repayment of the loan on February 28, 20X1. As of December 31, 20X0, the entity has not sold the branch. The meeting notes analyze the situation as follows:

• The classification of the loan as current or non-current depends on whether the entity was granted a period of grace. Since IAS 1 does not define “period of grace,” an entity must apply judgment to determine if a period of grace was provided.
• In this fact pattern, the original contractual provisions allow the sale of the foreign branch to be completed by February 28, 20X1. Therefore, a period of grace was not required on December 31 to avoid a covenant breach. The entity can continue to classify the loan as non-current at the reporting date because the covenant does not affect the entity’s right to defer payment of the liability at the end of the reporting period.
• If, however, the contractual provisions had required the entity to sell the foreign branch by December 31, or obtain written approval from the lender to defer this requirement until February 28, this would be considered a period of grace. In this case, the entity would be required to classify the term loan as current at the balance sheet date because the period of grace would have been less than 12 months after the balance sheet date.

This may seem awfully close to privileging legal form over economic substance, and may also strike some as being counter-intuitive: if the entity knows at the date of preparing its statements (in March 20X1 say) that the covenant was in fact breached and that repayment of the loan was demanded, then it might certainly seem that current classification as at the end of December 20X0 would provide more relevant information. As such it’s the flipside of the common situation in which a loan is classified as current on the basis of contractual facts and circumstances even though subsequent events provide assurance that settlement won’t actually be demanded within twelve months. This leads of course to the importance of the revised disclosure requirements, under which the entity provides information enabling users of financial statements to understand the risk that the liabilities could become repayable within twelve months after the reporting period, including information about the covenants (including their nature and when the entity is required to comply with them) and any facts and circumstances indicating the entity may have difficulty complying with the covenants—for example, the entity having acted during or after the reporting period to avoid or mitigate a potential breach. This includes disclosing when applicable that the entity wouldn’t have complied with the covenants if they had been assessed at the end of the reporting period.

It’s perhaps a little regrettable that recent amendments made for the sake of clarity and consistency should contain so many ambiguities – as indicated above, the amendments don’t define “period of grace” (nor, as noted in a subsequent meeting, “waiver”) and another portion of the group’s discussion rests on the fact of “covenant” not being defined either. In another fact pattern discussed by the group, members expressed different views on whether a particular arrangement “is economically similar to one where there was a covenant breach, and an entity is granted a three-month period of grace to rectify that breach because the requirement to comply with the future covenant is intrinsically linked to the entity’s waived covenant at year-end,” or whether the situation involved “a future covenant that should not impact the classification of the loan as current or non-current at year-end.” Maybe we should classify the IASB’s upgrade to this area as being, at best, an “incomplete”…

The opinions expressed are solely those of the author.