From the IFRS Institute – September 9, 2022
Debt arrangements often contain creditor protective clauses, such as quantitative debt covenant clauses, material adverse change clauses1, subjective acceleration clauses2, or change in control clauses. The treatment of these features in classifying debt as current/noncurrent on the balance sheet can result in significant differences between IFRS Standards and US GAAP, affecting a company’s working capital and liquidity profile.
IFRS Standards requirements in a nutshell
IAS 13 governs the classification of assets and liabilities as current or noncurrent. Liabilities are considered current when they are expected to be settled as part of the normal operating cycle, held for trading, due for settlement within 12 months from the reporting date, or when the debtor does not have an unconditional right to defer settlement for at least 12 months from the reporting date.
These are two common instances in which debt (or a portion thereof) is classified as current at the reporting date.
- The debt is maturing within 12 months or is payable on demand and, at the reporting date, the debtor does not have an unconditional right to defer settlement or roll over the obligation for at least 12 months after the reporting date.
- The creditor has the right to call the debt at the reporting date because a covenant has been breached and no waiver has been received, a material adverse change has occurred, or a subjective acceleration clause has been activated.
In this assessment, IAS 1 focuses on the conditions (e.g. contract breaches and waivers) existing at the reporting date, and disregards potential remediations or breaches occurring after the reporting date but before the financial statements are issued4. However, if at the reporting date a debtor expects and is able – solely at its own discretion – to refinance or roll over a loan for at least 12 months after the reporting date under an existing facility, then it classifies it as non-current even if the loan otherwise would be current.
IFRS Standards compared to US GAAP
The following are the key differences that exist between IAS 1 and ASC 4705 when classifying financial liabilities as current or noncurrent.
1. Ability to refinance on a long-term basis obtained after the reporting date
Generally, under both IFRS Standards and US GAAP, debt (or a portion thereof) that is due within 12 months from the reporting date, or is payable on demand, is classified as current.
However, under US GAAP, unlike IFRS Standards, a debtor classifies a short-term obligation as noncurrent if it demonstrates its intent and ability to refinance the obligation on a long-term basis after the reporting date but before the financial statements are issued.4 The debtor can demonstrate the intent and ability to refinance by completing either of the following after the reporting date:
- issuing a long-term obligation or equity securities to replace the short-term obligation; or
- entering into a finance agreement that permits the debtor to refinance the short-term obligation on a long-term basis on terms that are readily determinable. In addition, all of the following conditions must be met:
- the financing agreement does not expire within 12 months (or operating cycle, if applicable) from the reporting date and during that period, it is not cancellable or callable by the creditor, except for violation of a provision with which compliance is objectively determinable or measurable;
- the debtor is not in violation of any provision in the financing agreement at the reporting date; no violation has occurred before the financial statements are issued4; and the debtor expects to comply with all provisions of the financing agreement during the year following the reporting date;
- if a violation exists at the reporting date or occurs thereafter before the financial statements are issued4, the debtor must either cure the violation or obtain a waiver from the creditor before the financial statements are issued4; and
- the creditor or the prospective creditor is financially capable of honoring the agreement.
2. Breached conditions at the reporting date remedied after the reporting date
Under IFRS Standards, a loan with breached conditions at the reporting date is also classified as current, if the breach renders the loan repayable immediately. This is true even if the lender agrees, after the reporting date but before the financial statements are issued4, not to demand repayment as a result of the breach.
Under US GAAP, unlike IFRS Standards, a debt repayable on demand as a result of a covenant violation is not classified as current if, after the reporting date but before the financial statements are issued:4
- the lender waived or lost its right to demand repayment for more than 12 months from the reporting date and it is not probable that the debtor will violate any provision of the debt instrument within 12 months from the reporting date; or
- for a long term-obligation with grace periods for which breaches may be remedied, it is probable that the violation will be cured within that grace period and it is not probable that the debtor will violate any provision of the debt instrument within 12 months from the reporting date.
3. Subjective acceleration clauses
Under IFRS Standards, no specific guidance exists when an otherwise noncurrent debt obligation includes a subjective acceleration clause. Classification of the liability is based on whether the debtor has an unconditional right to defer settlement of the liability at the reporting date. As such, subjective acceleration clauses may require greater judgement to determine whether the terms of the agreement have been breached at the reporting date, and classification of the debt as current is required.
Unlike IFRS Standards, US GAAP provides specific guidance on current/noncurrent classification when an otherwise long-term debt agreement includes a subjective acceleration clause. Classification of debt is based on the likelihood (remote, reasonably possible or probable) that the creditor will accelerate repayment of the liability, as follows:
- remote: the debtor is neither required to classify the debt as current nor required to disclose the existence of the subjective acceleration clause.
- reasonably possible: the debtor evaluates the facts and circumstances to determine the proper classification and appropriate disclosures.
- probable: the debt is classified as current and the debtor discloses the nature and terms of the subjective acceleration clause, the amount that may be due within 12 months from the reporting date, and the debt’s due date assuming acceleration.
Under IFRS Standards, the likelihood that the creditor will accelerate repayment of the liability is disregarded.
In 2020, the International Accounting Standards Board (IASB® Board) introduced revised guidance for classifying liabilities as current or noncurrent. The amendments – which are effective for annual periods beginning on or after January 1, 2023 and could result in changes in classification – clarify that:
- classification is based solely on the debtor’s substantive right to defer settlement at the reporting date; and
- the transfer of the debtor’s own equity instruments is regarded as settlement of a liability, unless it results from the exercise of a conversion option that meets the definition of an equity instrument.
To address questions raised about applying these amendments to debt with covenants, the IASB Board published further proposals, including to defer the effective date of the 2020 amendments to January 1, 2024. The proposed amendments would require that only covenants with which a debtor must comply on or before the reporting date would affect the liability’s classification. Covenants which a debtor must comply within 12 months from the reporting date would not affect classification of a liability as current or noncurrent. Instead, debtors would present separately, and disclose information about, noncurrent liabilities subject to such covenants. These proposals are being redeliberated, with final amendments expected to be issued in the last quarter of 2022.
The current and noncurrent classification of liabilities was not converged between IFRS Standards and US GAAP before the amendments to IAS 1. In April 2021, the FASB removed from its technical agenda a project that was intended to bring US GAAP closer to IFRS Standards. We expect differences will still exist once the amendments are finalized and effective.
Differences continue to exist between IAS 1 and ASC 470, due to the different treatments of debt classification under both standards. Preparers with significant debt, or debt with complex terms, should assess the effect of the 2020 amendments, as well as monitor the IASB Board’s proposals for any further changes.
To learn more about the differences between IFRS Standards and US GAAP, take a look at our publication: IFRS compared to US GAAP.