Should Loans be Classified as Current or Non-Current?

Issue

Loans that are in breach of covenants often pose difficult accounting considerations as to whether they should be classified as either current or non-current in the Statement of Financial Position.
This publication will highlight the key factors you should consider when deciding whether a loan should be classified as either current or non-current.

Guidance

All loans should be classified as current unless there is an unconditional right to defer settlement of the liability for at least twelve months after the reporting period (AASB 101.69(d))[1].  This assessment needs to be made at reporting date.

So, for instance, if an entity breaches a loan covenant after reporting date this will be a non-adjusting event and the loan remains as non-current but with the additional disclosures of AASB 110.21.  One of the critical issues to be considered is, when did the breach occur?

Example:

X Ltd has a year end 30 June 2019 with a $1m loan subject to a Debt/Equity covenant which must be calculated at year end.  Based on the 30 June 2019 financial statements X Ltd has breached this covenant but this was not reported to the lender until 31 July 2019.

The loan will be classified as current as the breach occurred prior to the end of the reporting period and X Ltd did not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period.  The date the breach is reported is irrelevant for this analysis.

It is common for a breach to occur prior to the end of the reporting period and the lender to waive this breach after year end but prior to the financial report being authorised for issue.  As per AASB 101.74 the loan still remains current unless the waiver was received from the lender prior to the end of the reporting period.

Another interesting situation is where a breach occurs prior to year end and is dealt with (waived) by the lender, prior to the end of the reporting period, but as part of this waiver the lender imposes an additional covenant check within the next months. This additional requirement will not cause the loan to be classified as current since it relates to a future condition of the loan.

Where a default or breach of a loan has occurred during the period then certain additional disclosures are required by AASB 7.18-19 which include:

• details of any defaults;
• the carrying amount of the loans payable in default at the end of the reporting period; and
• whether the default was remedied, or the terms of the loans payable were renegotiated, before the financial statements were authorised for issue.

Accounting standard references

AASB 101 Presentation of Financial Statements

Current liabilities

69 An entity shall classify a liability as current when:

• it expects to settle the liability in its normal operating cycle;
• it holds the liability primarily for the purpose of trading;
• the liability is due to be settled within twelve months after the reporting period; or
• it does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period (see paragraph 73). 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.

An entity shall classify all other liabilities as non-current

74 When an entity breaches a provision of a long-term loan arrangement on or before the end of the reporting period with the effect that the liability becomes payable on demand, it classifies the liability as current, even if the lender agreed, after the reporting period and before the authorisation of the financial statements for issue, not to demand payment as a consequence of the breach. An entity classifies the liability as current because, at the end of the reporting period, it does not have an unconditional right to defer its settlement for at least twelve months after that date.

75 However, an entity classifies the liability as non-current if the lender agreed by the end of the reporting period to provide a period of grace ending at least twelve months after the reporting period, within which the entity can rectify the breach and during which the lender cannot demand immediate repayment.
76 In respect of loans classified as current liabilities, if the following events occur between the end of the reporting period and the date the financial statements are authorised for issue, those events are disclosed as non-adjusting events in accordance with AASB 110 Events after the Reporting Period:

• refinancing on a long-term basis;
• rectification of a breach of a long-term loan arrangement; and
• the granting by the lender of a period of grace to rectify a breach of a long-term loan arrangement ending at least twelve months after the reporting period.

 AASB 110 Events after the Reporting Period

21 If non-adjusting events after the reporting period are material, non-disclosure could influence the economic decisions that users make on the basis of the financial statements. Accordingly, an entity shall disclose the following for each material category of non-adjusting event after the reporting period:

• the nature of the event; and
• an estimate of its financial effect, or a statement that such an estimate cannot be made.

AASB 7 Financial Instruments: Disclosures

Defaults and breaches
18 For loans payable recognised at the end of the reporting period, an entity shall disclose:

• details of any defaults during the period of principal, interest, sinking fund, or redemption terms of those loans payable;
• the carrying amount of the loans payable in default at the end of the reporting period; and
• whether the default was remedied, or the terms of the loans payable were renegotiated, before the financial statements were authorised for issue.

19 If, during the period, there were breaches of loan agreement terms other than those described in paragraph 18, an entity shall disclose the same information as required by paragraph 18 if those breaches permitted the lender to demand accelerated repayment (unless the breaches were remedied, or the terms of the loan were renegotiated, on or before the end of the reporting period).

For more information, please contact your local firm, details can be found here.