On September 12, 2019, the Financial Accounting Standards Board (FASB) issued a revised proposed Accounting Standards Update (ASU) intended to simplify the current versus noncurrent classification of debt on the balance sheet and provide more consistent and transparent information to financial statement users.
The FASB previously proposed amendments to the debt classification guidance in January 2017. The FASB decided to re-expose the 2017 proposed amendments to raise awareness of the revisions and to seek feedback on the changes. Changes from the 2017 proposed amendments include requirements to preclude the consideration of unused long-term financing arrangements and to allow the consideration of grace periods. The FASB didn’t make significant changes to the other aspects of the 2017 proposed amendments.
The proposed amendments would apply to all entities that enter into a debt arrangement and present a classified balance sheet. They would also apply to convertible debt instruments, liability-classified mandatorily redeemable financial instruments, and lease liabilities.
Comments on the revised proposed ASU are due by October 28, 2019.
The current guidance on determining whether debt should be classified as current or noncurrent in a classified balance sheet in Topic 470, Debt, is often viewed as overly complex because it focuses on certain narrow, fact-specific debt transactions. The purpose of the proposed amendments is to simplify the current versus noncurrent classification of debt and replace the current narrow-scope guidance with principles-based guidance.
Classification of Debt
Under the proposed amendments, a debt arrangement would be defined as an arrangement that provides a lender with a contractual right to receive consideration and a borrower with a contractual obligation to pay consideration on demand or on fixed or determinable dates.
The proposed amendments introduce a principle in which a debt arrangement would be classified as a noncurrent liability if either of the following criteria is met as of the balance sheet date:
- The liability is contractually due to be settled more than one year, or operating cycle, if longer, after the balance sheet date.
- The entity has a contractual right to defer settlement of the liability for a period greater than one year, or operating cycle, if longer, after the balance sheet date.
Current guidance requires short-term debt that is refinanced on a long-term basis after the balance sheet date but before the financial statements are issued to be classified as a noncurrent liability. In contrast, the proposed amendments focus on the legal rights at the balance sheet date and would prohibit an entity from considering a subsequent refinancing when determining the classification of debt as of the balance sheet date.
The proposed amendments clarify that entities aren’t allowed to consider their ability to refinance debt using separate, unused long-term financing arrangements—such as an unused line of credit—in determining the classification of a debt arrangement.
Grace Period for Covenant Violations
When a debt arrangement provides a grace period for the borrower to become compliant with a debt covenant that has been violated, the proposed amendments clarify that the debt should be classified as noncurrent if either of the above debt classification criteria is met.
Waivers of Covenant Violations
As an exception to the proposed debt classification principle, the proposed amendments would continue to require an entity to classify a debt arrangement as a noncurrent liability when a lender waives its right to demand payment arising from a covenant violation, as of a specific date, for a period greater than one year after the balance sheet date. All of the following conditions must exist for the debt to be classified as noncurrent:
- One of the above debt classification criteria would have been met absent the covenant violation.
- A waiver of violation has been obtained by the borrower prior to the date the financial statements are issued.
- The waiver is for a period greater than one year—or operating cycle, if longer—from the balance sheet date.
- The borrower determines it isn’t probable that any other covenants will be violated for 12 months—or operating cycle, if longer—from the balance sheet date.
This exception wouldn’t apply to covenant violation waivers that result in a modification that’s either accounted for as a troubled debt restructuring or debt extinguishment. The proposed amendments would require an entity to separately present the amount of debt in the balance sheet that is classified as noncurrent as a result of this exception.
Under the proposed amendments, events of default include violations of a loan covenant and triggers of a subjective acceleration clause. In the event of a default, the entity must disclose an explanation of the default, the amount of obligations subject to the default, and the terms of a waiver.
Additionally, the proposed amendments would require disclosures during the period in which an entity violates a provision of a long-term debt arrangement, and the debt arrangement provides a grace period that expires after the balance sheet date. In this scenario, the entity must disclose an explanation of the violation, the amount of obligations subject to the violation, and the terms of the grace period.
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