Governments around the globe are taking increasingly stringent steps to help contain or delay the spread of the COVID-19. Those steps may result in significant disruptions to your business operations. Like many other companies you may be in negotiations regarding existing or new loans in order to secure sufficient liquidity to pull through the situation. But have you already analyzed the impact of the new requirements in IFRS1 regarding the balance sheet classification of liabilities as current or non-current? If you are talking to your lenders, you should consider those impacts. Depending on your individual situation, you may not want to wait until 2022 to apply the new requirements and/or to amend loan agreements.
What are the new requirements for classifying a liability as current?
A liability is classified as current when:
- settlement is expected in the normal operating cycle or due within twelve months after the reporting period,
- the liability is primarily held for trading purposes, or
- the company does not have the right at the end of the reporting period to defer settlement for at least twelve months after the reporting period.
Any other liability is classified as non-current.
That sounds familiar. What has changed compared to the existing requirements?
The changes relate to the last criterion (mentioned above) for classifying a liability as current.
Under the existing requirements, the right to defer settlement has to be unconditional. However, such rights are rarely unconditional in practice. Typically, compliance with covenants is required in order to defer settlement. Changing the criterion to "the right to defer settlement must have substance and exist at the end of the reporting period" will therefore result in more liabilities being classified as non-current.
Another change relates to options to settle an existing liability with the borrower’s own equity instruments. Under the new requirements, the terms of this conversion option will have an impact on classification. Consequently, this change can result in fewer liabilities being classified as non-current.
Which liabilities will be impacted by the changes?
Impacts are primarily expected for rollover loans and convertible liabilities.
What changes for rollover loans?
A rollover loan is a loan which is renewed when it is not repaid in full within the predefined loan term. Therefore, if the remaining loan term is less than twelve months, the question arises whether such a loan should be classified as current (i.e. no renewal is assumed) or non-current (i.e. renewal is assumed).
The answer depends on the conditions of the right to renew. When the right to renew is subject to compliance with covenants, those need to be met at the end of the reporting period. Compliance at the end of the reporting period is required regardless of whether the lender tests compliance at this or only at a later date.
But what does that mean in practice? Some rollover loans will be reclassified from current to non-current liabilities. Let’s illustrate this with the following example:
- Existing rollover loan with a term of three months.
- Automatic renewal every quarter if certain covenants are met at the end of the quarter.
- Covenants are met at the end of the reporting period (31 December 2020).
- Rollover facility has a remaining term of four years, i.e. automatic and consecutive renewals are available until 31 December 2024.
How is this rollover loan classified at 31 December 2020? In this example, there is no unconditional right to defer settlement and, hence, the liability is classified as current under the existing requirements. Applying the new requirements, the loan is generally classified as non-current, because the covenants are met as of the reporting date and settlement can be deferred until 31 December 2024 by way of consecutive renewals.