Debt covenants and liability classification Debt covenants and liability classification

2020 has been a challenging year for everyone. There have been many things to consider, and debt covenants should definitely be on your priority list. Have you experienced significant financial impacts that could result in covenant breaches? If so, it's time to act now.

Debt covenants are clauses in the loan agreement with which the borrower guarantees to comply. Typical examples are
 

• equity or leverage ratios;
• interest coverage ratios; or
• material adverse change clauses.
  

When a company breaches a covenant on or before the reporting date, the respective liability will normally become repayable on demand. If this is the case, the liability will need to be presented as current on the balance sheet even if it is a long-term liability.

Yes, if the lender agrees by a certain date to provide a grace period ending at least twelve months after the reporting date, the liability continues to be classified as non-current. Please note that the timing of the lender’s agreement is key (see next question).

The answer depends on the applicable accounting framework:
 

• IFRS: No. The lender needs to provide its agreement by the end of the reporting period. Therefore, the liability must be presented as current if the lender’s agreement is received after the reporting date.
• Swiss GAAP FER and Swiss Code of Obligations: Yes. Provided that the lender’s agreement is obtained before the financial statements are approved, the liability may be presented as non-current.
  

No. It is necessary that the lender cannot require repayment of the liability for at least twelve months from the reporting date.

Covenant breaches need to be considered as part of management’s assessment of the going concern assumption as they may have a severe impact on liquidity. In addition, the impact on the company’s disclosures should be assessed.

• Review covenant clauses and assess whether a breach has occurred or is likely to occur on the reporting date.
• If a breach has occurred or is likely to occur, think about obtaining a waiver from the lender that provides a grace period of at least twelve months from the reporting date. Remember that for IFRS the lender’s agreement is required until the reporting date.
• Renegotiate covenants if financial impacts are to remain and thus future covenant breaches are likely to occur.

More information on accounting consequences under the current challenging circumstances can be found in our FAQ: Accounting implications of COVID-19 (PDF)