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  • Accounting - All you need to know for classifying entity's liabilities as current or non-current under IFRS!
Article:

Accounting - All you need to know for classifying entity's liabilities as current or non-current under IFRS!

09 November 2020

What criteria is the entity required to follow for determining classification of liabilities as current or non-current?

IAS 1 Presentation of Financial Statements (‘IAS 1’) requires a liability to be classified as current when it satisfies any of the following criteria, with all other liabilities classified as non-current. 

The criteria for classifying a liability as current are: 

  • It is expected to be settled in the entity’s normal operating cycle;
  • It is held primarily for the purpose of trading; 
  • It is due to be settled within twelve months after the end of the reporting period; or 
  • The entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the end of the reporting period. 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.  

This article is focused to review criteria (4) in more detail.

Please provide an instance of an unconditional right to defer settlement of the liability for at least twelve months after the end of the reporting period.

In an agenda decision of November 2010, the Interpretations Committee clarified by stating that a debt scheduled for repayment after more than a year which is, however, payable on demand of the lender is a current liability as the entity does not have unconditional right to defer settlement.

Are there any additional references from IAS 1 on assessment for classification to consider?

A liability is classified as current:

  • When it is due to be settled within twelve months after the end of the reporting period, even if: 
  • The original term was for a period longer than twelve months; and 
  • An agreement is concluded to refinance, or to reschedule payments, on a long-term basis after the period end and before the financial statements are authorised for issue (Will require subsequent event disclosure for refinancing); or 
  • An entity breaches a provision of a long-term loan arrangement, on or before the period end, with the effect that the liability becomes payable on demand. Liability is classified as current even if the lender agreed, after the period end and before the authorisation of the financial statements for issue, not to demand payment as a consequence of the breach (Subsequent events note would disclose the post-period end agreement). The standard explains that the liability should be classified as current because, at the period end, the entity does not have an unconditional right to defer its settlement for at least twelve months after that date. 

As per provisions above, assessment of liability as current or non-current liability requires diligent assessment and only qualifying liabilities are classified as non-current liabilities.

Certain practical scenarios in case an entity breaches covenants for a long-term borrowing

Does the entity have an unconditional right to defer the settlement of the liability for at least 12 months?

Scenarios

Classification

Testing of debt covenants are required on or before the reporting date, and an entity breaches the debt covenants on or before reporting date.

Current

Testing of debt covenants are required on or before the reporting date, and an entity breached the debt covenants on or before reporting date. However, the lender agreed not to demand repayment because of breach at or before the reporting date.

Non-current

Assessment of debt covenants after the reporting date but the related tests for covenant compliance are based on financial information as at or before the reporting, and an entity breached the debt covenants.

Current

Testing of debt covenants are required on or before the reporting date, and an entity breached the debt covenants on or before reporting date. However, lender agreed not to demand repayment because of breach after reporting date but before financial statement are authorised for issue

Non-current

The entity has complied with debt covenants on or before reporting date and debts is due in more than 12 months. However, circumstances changed significantly, and an entity breached debt covenants after reporting period end but before the financial statements are authorised for issue.

Non-current

 

Are there amendments considered for classification of liabilities by the International Accounting Standards Board (‘IASB’ or the ‘Board’)?

Yes, On 23 January 2020, IASB has issued amendments to paragraphs 69 to 76 of IAS 1 Presentation of Financial Statements (the amendments) to specify the requirements for classifying liabilities as current or non-current.

What does amendments clarify? 

The amendments clarify: 

  1. What is meant by a right to defer settlement? 
  2. A right to defer must exist at the end of the reporting period. 
  3. That classification is unaffected by the likelihood that an entity will exercise its deferral right. 
  4. If a liability has any conversion options that involve a transfer of the company’s equity instruments, these would affect its classification as current or non-current. The Board has now clarified that – when classifying liabilities as current or non-current – a company cannot ignore those conversion options that are recognised as liabilities. 

From amendments listed above one point to highlight here is clarification for a right to defer settlement - the Board addressed the clarification by removing ‘unconditional’ in the fourth criterion in paragraph 69 (as stated at point (4) in the first section), which states that a liability is current if an entity ‘does not have an unconditional right to defer settlement of the liability for at least twelve months’. The Board explained that a right to defer settlement is rarely unconditional, as such rights often are conditional on compliance with covenants. Therefore, the Board decided that if an entity’s right to defer settlement of a liability is subject to the entity complying with specified conditions, the entity has a right to defer settlement of the liability at the end of the reporting period if it complies with those conditions at that date.

From when these amendments are effective? 

The amendments to IAS 1 are applicable for annual periods beginning on or after 1 January 2022. Retrospective application of the amendments are required as per IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Earlier application is permitted, however, in May 2020 proposed deferral of the effective date to 1 January 2023.

Reason for deferral effective date? 

The Board discussed the effect of the covid-19 pandemic on financial reporting. The Board noted that the pandemic had created pressures that could delay the implementation of any changes in classification resulting from the application of these amendments. It could also delay the start and extend the duration of the renegotiation of loan covenants.

Are there any further changes to previously notified amendments? 

No, the Board is not proposing any changes to the Classification of Liabilities as Current or Non-current amendments issued in January 2020 other than the deferral of the effective date. Earlier application of the amendments will continue to be permitted.