In a previous newsletter, we discussed the importance of financial covenants for the categorisation of financial liabilities as current or non-current. In this article, we would like to go into more detail about the required disclosures in the notes in the upcoming annual reports.
Financial covenants are contractual agreements between lenders and borrowers that define specific financial ratios that the company must meet in order to fulfil the loan conditions. These ratios often relate to aspects such as debt, liquidity or profitability.
These covenants not only serve to protect lenders, but also promote responsible corporate governance. By defining certain key performance indicators, they enable risks to be identified at an early stage and help to keep the company on track. Non-compliance can have consequences such as higher interest rates or, in the worst case, immediate repayment of the loan.
The disclosures in the notes on financial covenants previously resulted primarily from the requirements to present the liquidity risk appropriately. This is because IFRS 7.B10A(a) requires disclosures in the notes if the cash flows presented in the liquidity analysis could fall due significantly earlier than presented. In particular, covenants that could lead to the early repayment of a loan and whose non-compliance is not unlikely already had to be explained here.
Companies are now subject to further disclosure requirements. IAS 1.76ZA contains new disclosures for financial years beginning on or after 1 January 2024.
The following information must be provided in future:
- Information on covenants (type, agreed date of fulfilment),
- Carrying amount of the associated liabilities
- Facts and circumstances that indicate difficulties in fulfilling the covenants (for example, measures taken to prevent a future breach)
Are constellations nevertheless conceivable in which companies can dispense with the disclosure of financial covenants? A look at IFRS Practice Statement 2, "Making Materiality Judgements", is helpful here. According to this statement, disclosures that are relevant to the reader of the financial statements must be made in the notes. According to paragraphs 81-83, companies must assess the relevance of disclosures on financial covenants from the following perspectives:
- What consequences would a breach of the covenants have for the company's net assets, financial position, results of operations or cash flow?
- How likely is such a scenario?
Accordingly, it is only permissible not to describe covenants in the notes if the impact is either minor or the probability of an impact is to be classified as "remote".
As the end of the financial year is approaching, all financing agreements should be analysed now to determine whether they need to be clarified with regard to covenants.
Those: KPMG Corporate Treasury News, Ausgabe 148, Oktober 2024
Authors:
Ralph Schilling, CFA, Partner, Head of Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Andrea Monthofer, Senior Managerin, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
