In the recently published KPMG Corporate Treasury Newsletter, our colleague Felix Wacker-Kijewski used the example of refinancing to show that the accounting treatment of financial liabilities is an evergreen issue for all treasury accountants.
For financial years beginning on or after 1 January 2024, an amendment to IAS 1 provides for an adjustment to the classification requirements for liabilities as current or non-current. In addition to the clarification of recognition rules, the amendment also includes new disclosure requirements. These are aimed in particular at providing information on the nature and extent of any covenants agreed as part of the liabilities. For companies, the amendments to IAS 1 not only have an impact on external reporting, but also on internal performance indicators such as key performance indicators (KPIs), for which the treasury department is sometimes responsible.
In the past, IAS 1 stipulated that a liability was to be recognised as current if, among other things, the company did not have the unrestricted right to defer settlement of the liability for a period of at least 12 months after the balance sheet date (IAS 1.69). However, the aforementioned condition was modified by the IASB. Accordingly, it is now sufficient for recognition as a non-current liability if the right described above has "substance" and exists at the end of the financial year (IAS 1.72A). The existence of an unconditional right is no longer necessary.
The actual existence of this right may be influenced by the obligation to fulfil contractual conditions (covenants). When analysing the disclosure issue, only those conditions that are to be fulfilled by the reporting entity before or on the balance sheet date are to be used (IAS 1.72B). This applies regardless of whether compliance with the covenant is only recognised after this date. Conditions that are not to be met by a reporting entity until after the balance sheet date are not to be included in the analysis with regard to current or non-current recognition of the liability. For example, a contractual condition that relates to the financial position of the reporting entity 6 months after the reporting date is not relevant for the assessment of presentation as at the reporting date.
If an entity classifies a liability as non-current on the basis of an existing right to defer settlement that is dependent on covenants, the amendment to IAS 1 requires additional disclosures to be made in the notes. Accordingly, information must be disclosed about the risk of non-fulfilment of the covenants and thus a short-term repayment obligation (IAS 1.76ZA). For example, the type and nature of the covenants and the carrying amount of the liabilities concerned must be presented separately. Furthermore, in addition to actual covenant breaches, any indications of potential future breaches must also be disclosed.
In addition, the classification as current or non-current must now be made independently of any estimates by management regarding the repayment of the respective liabilities. Previously, recognition as a current liability was also possible if management did not expect the unrestricted right to defer settlement to be utilised within 12 months. However, the newly introduced IAS 1.75A defines that a substantial right to defer settlement existing at the end of the financial year requires long-term recognition regardless of management's expectation or intention. Nevertheless, in such a case, additional disclosures in the notes may be required to provide users of financial statements with information about the expected, shorter-term fulfilment.
In addition to external financial reporting, the amendment to IAS 1 and the adjusted disclosure rules can also have an impact on internal reporting systems and performance indicators. The differentiated consideration of current and non-current liabilities influences some important balance sheet ratios, KPIs or even covenants agreed in financing agreements.
Working capital, for example, a relevant parameter for the liquidity available within the operating business, is calculated from the difference or the ratio of current assets and current liabilities. Depending on the definition, the purely balance sheet-driven shift in the reported maturity structure of IAS 1 therefore causes a change in this key figure even without significant changes in the operating business.
The same applies to liquidity ratios I to III (also known as current, quick and cash ratios). These measures also aim to measure the ability to settle current liabilities using various aggregations on the assets side. An adjusted disclosure of previously current liabilities as non-current can again lead to a synthetic improvement in these key figures without the actual scope of action having changed.
Inversely, control parameters for long-term corporate financing can also be influenced. Similar to other leverage ratios such as debt-to-equity, the long-term debt-to-capitalisation ratio measures the proportion of existing capital or assets that is refinanced by long-term debt. The ratio is calculated as the quotient of long-term liabilities and the sum of long-term liabilities and equity. Similar to the liquidity ratios, the adjusted disclosure rules of IAS 1 can therefore lead to a synthetic change in the leverage KPIs. Against this backdrop, companies should analyse whether such a change in internal performance indicators, which is not based on actual economic developments, is considered sensible and desirable.
In view of the diverse effects of the amendment to IAS 1, both with regard to external financial reporting and the influence on internal performance indicators, further detailed questions arise that need to be analysed for each individual case. The Finance and Treasury Management team will be happy to support you in answering these questions and is available for a practical exchange and further discussion.
Source: KPMG Corporate Treasury News, Issue 146, August 2024
Authors:
Ralph Schilling, CFA, Partner, Head of Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Jan-Philipp Wallis, Senior Manager, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Christopher Wilksen, Assistant Manager, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
