The International Accounting Standards Board (IASB) recently issued narrow-scope amendments to IAS 1 that clarify the existing requirements for classifying liabilities as current or non-current. In practice, the amendments could affect, for example, the classification of rollover facilities, with some becoming non-current, and convertible instruments, with some becoming current.
Even though the amendments are only effective for reporting periods beginning 1 January 2022 (with early application permitted), if you are about to sign for a new facility or are subject to covenants on your current loans, you may want to read on!
What’s the current status?
Under the existing standard (IAS 1.69), an entity classifies a liability as current when:
- It expects to settle it in the normal operating cycle;
- It holds the liability for trading purposes;
- The settlement is due within 12 months after the reporting period;
- It does not have an unconditional right to defer settlement for at least 12 months after the reporting period. Terms of liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification.
Liabilities that do not meet the above criteria are classified as non-current.
The amendments only address the last IAS 1 condition mentioned above. The unconditional right to defer settlement requirement was removed and replaced by the right to defer payment, which must exist at the end of the reporting period and must have substance.
That year-end existence requirement could affect the classification of rollover facilities. Let’s take, for example, a facility whose rollover is contingent on passing the covenant test. Under the current IAS 1, the entity does not have an unconditional right to defer the settlement, therefore, the facility is classified as current. Under the new version, the entity only assesses its right to roll over at a future date. In case this right exists and has substance, and the entity meets covenants at the reporting date, the liability is classified as non-current.
There is little guidance surrounding the substance qualification, so the assessment will require management to exercise judgement.
There are also changes related to the settlement of instruments convertible at the option of the holder. The amendments clarify that the settlement can be done by transferring the company’s own equity instruments to the counterparty. Consequently, this affects the classification of convertible bonds whose conversion option is classified as a liability. Here, the question is the same: Does the company have the right to defer the transfer of its own equity instrument for at least 12 months? If the entity cannot defer the payment because, for example, the holder can exercise the option to convert at any time, the instrument will be classified as a current liability.
A final point: management’s intentions or expectations regarding whether the entity is going to exercise the right to defer settlements does not affect the classification. Only the hard facts matter!
Although the amendments will not be effective until 2022, remember that companies must disclose the impacts of those changes on their next financial statements, in line with IAS 8.30-31. So, prepare to embrace this new challenge, which is child’s play after all you have been thought this year (IFRS 16 ring any bells?).
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