In November 2021, the International Accounting Standards Board (IASB) published an Exposure Draft proposing amendments to IAS 1 Presentation of Financial Statements. It is intended to improve the information companies provide about liabilities with covenants and address stakeholder concerns about how a company determines whether such liabilities should be classified as current or non-current.
Why is a new approach needed?
IAS 1 currently requires a company to classify a liability as non-current only if the company has a right to defer settlement of the liability for at least 12 months after the reporting date. However, such a right is often subject to the company complying with covenants after the reporting date. For example, a company might have long-term debt that could become repayable within 12 months if the company fails to comply with covenants after the reporting date.
The proposed amendments specify that, in such a situation, covenants would not affect the classification of a liability as current or non-current at the reporting date. Instead, a company would:
(a) present non-current liabilities with covenants separately in its balance sheet; and
(b) disclose information in the notes about the covenants with which it must comply within 12 months after the reporting date.
The aim of these proposals is to improve the information a company provides about non-current liabilities with covenants by enabling investors to assess whether such liabilities could become repayable within 12 months.
The proposals also address feedback from stakeholders about the classification of debt as current or non-current when applying requirements introduced in 2020 that are not yet effective.
ICAEW’s views on the proposals
ICAEW’s comment letter raises concerns about the proposals to require preparers to present non-current liabilities subject to covenants separately. One concern is that creating a new line item highlighting such things could potentially be misleading. It may suggest to users that there is cause for additional concern when in fact there is none because the risks of non-compliance may be negligible. Moreover, ICAEW believes that doing so will provide users with no useful information about the risks of non-compliance.
Marianne Mau, ICAEW’s Head of Corporate Reporting Strategy, says: “We are pleased that the Board has listened to stakeholder concerns about the 2020 amendments. We were always uncomfortable with them as, in some circumstances, they would have required a company to classify a liability as current even when, at the reporting date, it had no contractual obligation to repay the liability within 12 months. We do not, however, believe that the proposals provide an appropriate solution.”
The comment letter also highlights concerns about the proposed new disclosure requirements. When liabilities are subject to covenants, ICAEW agrees that it may be helpful to provide users of the financial statements with information about the possible risk of future non-compliance and the consequences of such a breach.
However, the concern is that the proposals as drafted are too wide ranging and may result in excessively detailed disclosures and unnecessary clutter in the financial statements, particularly for entities with multiple sources of debt finance.
Notwithstanding these concerns, the comment letter goes on to say that it is imperative that the IASB issues an amendment updating its guidance specifically dealing with classification of liabilities as current and non-current as soon as possible. This is because, it says, the extant version of IAS 1 incorporating the 2020 amendments urgently needs fixing before it comes into effect.
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