Are your liabilities current or non-current?
The IASB has published amendments to IAS 1 which aim to clarify the classification of liabilities as either current or non-current and promote consistency between companies.
Companies will need to reconsider their loan agreements in light of new IFRS guidance on:
- When an entity should classify liabilities as either ‘current’ or ‘non-current’, and
- How an entity should classify liabilities which may be settled by conversion into equity.
The amendments to IAS 1 Presentation of Financial Statements aim to clarify apparent contradictions and address diversity in practice within existing requirements. The amendments are not intended to change the basic principles in this area. In practice, application of the new requirements may result in reclassification of some liabilities between current and non-current, which in turn could affect debt covenants.
Changes to the classification between current and non-current liabilities
Under the new rules, in order for a liability to be classified as non-current, an entity must have a right, at the end of the reporting period, to defer settlement of the liability, or roll over the obligation under an existing loan facility, for at least twelve months after the reporting period.
The previous requirement that this right should be ‘unconditional’ has been removed. Instead, the right to defer settlement of a liability must have substance. If the right is subject to specific conditions, then the right only exists if the entity complies with those conditions at the end of the reporting period, even if the lender does not test compliance until a later date.
The classification of a liability is not affected by management intentions. If an entity has a right to defer settlement of a liability at the end of a reporting period and, therefore, meets the criteria for classification as non-current, then the liability is classified as non-current regardless of whether management intends or expects to settle the liability within twelve months after the reporting period.
Also, classification is not affected if the liability is actually settled between the end of the reporting period and the date the financial statements are authorised. This would require disclosure as a non-adjusting event in accordance with IAS 10 Events after the Reporting Period.
Liabilities which may be settled by conversion into equity
Issuers of convertible debt should take note that the amendments to IAS 1 also address the classification when a liability, at the option of the lender, could result in its settlement by the transfer of the entity’s own equity.
Current requirements state that ‘the 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’. It has now been clarified that this applies only to liabilities that include a counterparty conversion option that meets the definition of an equity instrument and by applying IAS 32 Financial Instruments: Presentation, an entity recognises this option separately from the host liability as an equity component of a compound financial instrument. This means that:
- For a bond that the holder can convert to equity before maturity, assuming the conversion option is recognised as equity by applying IAS 32, the liability would be classified as current or non-current depending on the repayment terms of the bond without considering the possibility of earlier settlement by conversion to equity.
- For other situations, where the conversion option to equity is classified as a liability (for example, some foreign currency denominated convertible bonds) in accordance with IAS 32, the transfer of equity instruments would constitute the settlement of the liability for the purpose of classification as a current or non-current liability. Therefore, where the holder can elect to convert the debt at any point in time, all components of the convertible debt will be classified as current.
When are these changes effective?
An entity shall apply these amendments retrospectively for annual reporting periods beginning on or after 1 January 2022. Early adoption is permitted, and this must be disclosed.
The IASB expects to publish an exposure draft in May 2020 proposing the deferral of the effective date by one year to annual reporting periods beginning on or after 1 January 2023.
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