Current or non-current loan

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exIFRS
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Current or non-current loan

Post by exIFRS »

Any thoughts?
An entity has a loan with the following contractual terms:
(a) the loan is repayable in five years (ie at 31 December 20X6).
(b) however, the loan requires a working capital ratio above 1.0 at 31 December 20X1 and above 1.1 at 30 June 20X2 (and at each 30 June thereafter). The loan becomes repayable on demand if the ratio is not met at any of these testing dates.
(c) the entity’s working capital ratio at 31 December 20X1 is 1.05. The entity expects the working capital ratio to be above 1.1 at 30 June 20X2.
Should the loan be classified as current or non-current in the financial statements?
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Re: Current or non-current loan

Post by JRSB »

It seems the covenants are not breached so it's NC?
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Marek Muc
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Re: Current or non-current loan

Post by Marek Muc »

tricky one :)

I'm looking at para 72A of IAS 1 as recently amended:
The entity must comply with the conditions at the end of the reporting period even if the lender does not test compliance until a later date.
so a current liability it seems?
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Re: Current or non-current loan

Post by exIFRS »

Thanks JRSB and Marek for your views! Before I share my view I would be interested to hear if anyone else has any thoughts.
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Re: Current or non-current loan

Post by Marek Muc »

yep, let's build some tension ;)
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Re: Current or non-current loan

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PS I took it to mean 'equal to or above'
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Re: Current or non-current loan

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hm, but it doesn't really matter in this scenario, does it?
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Re: Current or non-current loan

Post by Jonny »

Looks like the ratio is not above at the date of reporting. current. We had a similar case. Ratio non respected a 31.12.x1 Waived in January x2. The loan was considered current.
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Re: Current or non-current loan

Post by Marek Muc »

are you sure this was a similar case? did you have different ratios at different dates and you complied with the one required at the reporting date?
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Re: Current or non-current loan

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I think the key thing is we are in compliance at 31 December, I we believe we will be in compliance at 30 June.

I will post later today some relevant documents, but Marek, a question on Para 72A.

If the loan (as many do) states that: interest must be paid quarterly, or else the loan becomes current.

At 31 December X1 I have just paid my latest amount of interest. But I haven't paid the interest due in March X2, therefore I have not yet complied with a condition that will be tested on 31 March therefore the loan is current?

I would read 72A to be more akin to: your 31 December X1 annual report must show Assets to Liabilities of 2:1. But because it won't be published until March that's when we (the Bank) test. But you know when you are producing the annual report that it is not going to comply, therefore the debt should be reported as current at 31 December in your report.
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Re: Current or non-current loan

Post by Marek Muc »

I will think it over and post back :)
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Re: Current or non-current loan

Post by DJP »

Hello everyone,

The covenants seem to have not been breached at the reporting date. The loan should therefore classify as non-current as there is no obligation to repay the loan within 12 months from the reporting date.
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Re: Current or non-current loan

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Grant Thornton think the anticipated future breach does not affect classification..

https://www.grantthornton.global/global ... enants.pdf
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Re: Current or non-current loan

Post by DJP »

Which makes sense. The IASB has made it clear that it is the conditions observable at the reporting date that matter. For the same reason that expected covenants-breach remedies cannot be considered (Jonny's example), the expectation of a future breach should not be considered as well.
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Re: Current or non-current loan

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So I agree very strongly with JRSB and DJP on this one. This is what the staff paper going to the IFRS Interpretations Committee has to say on the exact facts I outlined above:
"The entity's right to defer settlement of the loan for at least twelve months after the reporting period is subject to the entity complying with two specified conditions-a working capital ratio above 1.0 at 31 December 20X1 and a working capital ratio above 1.1 at 30 June 20X2.

Paragraph 72A of IAS 1 states that 'if the right to defer settlement is subject to the entity complying with specified conditions, the right exists at the end of the reporting period only if the entity complies with those conditions at the end of the reporting period. The entity must comply with the conditions at the end of the reporting period even if the lender does not test compliance until a later date'. The entity has a working capital ratio of 1.05 at 31 December 20X1. Therefore the entity complies with the condition tested at that date (a working capital ratio above 1.0) but does not comply with the condition that will be tested at 30 June 20X2 (a working capital ratio above 1.1).

Accordingly, the Committee concluded that the entity does not have the right at the end of the reporting period to defer settlement of the loan for at least twelve months after the reporting period."
And I just don't think that is right. The paper can be found here, and if anyone reads it and thinks I have missed something fundamental I would be really interested: https://cdn.ifrs.org/-/media/feature/me ... -ias-1.pdf

The IFRIC Meeting is happening next week and I'll update you on what happens.
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Re: Current or non-current loan

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That's very interesting!
exIFRS wrote: 27 Nov 2020, 10:00I would read 72A to be more akin to: your 31 December X1 annual report must show Assets to Liabilities of 2:1. But because it won't be published until March that's when we (the Bank) test. But you know when you are producing the annual report that it is not going to comply, therefore the debt should be reported as current at 31 December in your report.
I don't share this view. The facts at the reporting date matter, not when the repercussion will happen in the future - this a overarching concept across IFRS, so I don't think this is what IASB had in mind when they drafted this specific requirement.

I had another scenario in mind before I read your last post:

Entity A takes out a loan on 1 June 20X1. A covenant requires the Entity to keep its working capital ratio above 1.1, but this will be tested on 30 June 20X2 for the first time. It's 31 December 20X1 and the capital ratio stands at 1.05 but the Entity expects it to rise to above 1.1 until 30 June 20X2. The loan should be a current one IMO even though the bank will not test it at 31 Dec 20X1

I know it's not exactly the same case as in IC paper, which covers a corner case because there are two different ratios.
exIFRS wrote: 27 Nov 2020, 10:00 If the loan (as many do) states that: interest must be paid quarterly, or else the loan becomes current.
At 31 December X1 I have just paid my latest amount of interest. But I haven't paid the interest due in March X2, therefore I have not yet complied with a condition that will be tested on 31 March therefore the loan is current?
This can be put another way: you cannot default on any interest payments. At 31 Dec 20X1, you satisfied this condition therefore you can keep the loan as non-current
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Re: Current or non-current loan

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I don't share this view. The facts at the reporting date matter, not when the repercussion will happen in the future - this a overarching concept across IFRS, so I don't think this is what IASB had in mind when they drafted this specific requirement.
I think you have missed what I am trying to say, often at the actual report date we don't know whether we are in compliance or not, the year hasn't been closed out etc. So often the contract with the bank states that compliance will be tested at a later date (when the financial statements are available). Paragraph 72A is saying even though compliance is only tested at a later date, because it was based on circumstances at 30 December for the financial statements prepared for the year ended 30 December the covenant is breached even though contractually the test occurs later. "The entity must comply with the conditions at the end of the reporting period even if the lender does not test compliance until a later date."

This can be put another way: you cannot default on any interest payments. At 31 Dec 20X1, you satisfied this condition therefore you can keep the loan as non-current
I don't think your alternative formulation of the interest default scenario changes anything. On that logic I would rephrase the covenant as: "you cannot fail to meet a working capital ratio test as detailed in this contract". At 31 Dec 20X1, you have not yet failed a test so you satisfied this condition therefore you can keep the loan as non-current.
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Re: Current or non-current loan

Post by Marek Muc »

I think it's important to distinguish between 'testing date' and 'compliance date'. We need to comply at the reporting date irrespective of the testing date.

In the interest payment example, you complied with all requirements at 31 Dec X1, so classification as non-current.

In my example (previous post) you failed to comply at 31 Dec X1, so classification as current, even though it was not a testing date. BTW, how would you classify the loan from my example?

In the IC example, well that's tough one and I admit that I'm not fully convinced because it's the same criterion but at different levels depending on testing date. On one hand, the company does not comply with the 1.1 ratio at the reporting date (to be tested in 6 months), but on the other hand there is a lower level of the same ratio applicable at the reporting date. I'm sympathetic with both sides in this particular scenario ;)
JRSB wrote: 27 Nov 2020, 14:28 Grant Thornton think the anticipated future breach does not affect classification..
https://www.grantthornton.global/global ... enants.pdf
But they write that the company complies with the covenant at the reporting date, but expects to breach it in the future, so it's an easier case to assess IMO
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Re: Current or non-current loan

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Entity A takes out a loan on 1 June 20X1. A covenant requires the Entity to keep its working capital ratio above 1.1, but this will be tested on 30 June 20X2 for the first time. It's 31 December 20X1 and the capital ratio stands at 1.05 but the Entity expects it to rise to above 1.1 until 30 June 20X2. The loan should be a current one IMO even though the bank will not test it at 31 Dec 20X1
I mean I agree with your conclusion on this one the contract is clear "A covenant requires the Entity to keep its working capital ratio above 1.1" as soon as your ratio drops below you have breached. But the example in the Tentative Agenda Decision is completely different. I have only breached if my working capital ratio is not above 1.1 at 30 June.
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Re: Current or non-current loan

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my example was obviously easier to conclude on :)

so let's wait for the IC meeting ...
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Re: Current or non-current loan

Post by Marek Muc »

PS. In the IC scenario, what is your opinion on classification at 31 Dec 20X2 if the ratio is below 1.1 at that date, but the next testing date is on 30 June 20X3 (i.e. no testing at 31 Dec 20X2)?
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Re: Current or non-current loan

Post by DJP »

I may have changed my opinion due to that last sentence in paragraph 72A...

I guess if indeed as per 30 June X2 the covenant changes, then the liability may have to be classified as current on 31 December X1 because at that date the entity does not comply with the conditions to avoid settlement of the liability for at least 12 months.
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Re: Current or non-current loan

Post by Marek Muc »

What a great discussion we're having here! :)

In the meantime, we must remember that these amendments to IAS 1 are not effective until 2023. On the other hand, the IASB stated that these amendments clarify, but do not change, requirements of IAS 1, so they kind of apply under IAS 1 as currently effective :roll:
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Re: Current or non-current loan

Post by marea »

A few months ago, I attended a webinar, and this topic was briefly discussed. It was said that we should only consider the actual situation as on the reporting date. In the case that the covenants were breached on the reporting date, the liability would be classified as current, if not it would be classified as non-current.
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Re: Current or non-current loan

Post by DJP »

Correct, but that's assuming that the covenant will not change in the coming 12 months. In the case in analysis, as at 31 December the actual situation is not compliant with a covenant that needs to be verified in 6 month's time. Therefore, the entity cannot state at 31 December that it can defer settlement for more than 12 months given that if all stays the same, the covenant will be breached in June.
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Re: Current or non-current loan

Post by marea »

To me such classification is in line with the interpretation in the publication issued by Grant Thornton that JRSb shared. "anticipated outcome of future
covenant tests (based on financial conditions existing after the end of the current reporting period) does not influence the classification of a loan at the reporting date. This is true even when the borrower believes it is likely that it will ‘fail’ the future tests"
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Re: Current or non-current loan

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But in the Grant Thorton publication, the entity satisfied at reporting date all the covenants that will be tested in next 12 months, so it's a substantially different scenario
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Re: Current or non-current loan

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Marek Muc wrote: 27 Nov 2020, 09:42 are you sure this was a similar case? did you have different ratios at different dates and you complied with the one required at the reporting date?
no, you are right, it isn’t.

In the scenario Case 2 of the staff paper:
"the fact pattern is the same as Case 1 except: (a) instead of the condition described the loan requires a working capital ratio above 1.0 at each 31 March (ie the ratio is tested only once a year at 31 March). The loan becomes repayable on demand if the ratio is not met at any of these testing dates. (b) the entity’s working capital ratio at 31 December 20X1 is 0.9. The entity expects the working capital ratio to be above 1.0 at 31 March 20X2."

Would it be current also under IAS 1 as currently effective?
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Re: Current or non-current loan

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Jonny wrote: 28 Nov 2020, 14:42 Would it be current also under IAS 1 as currently effective?
viewtopic.php?p=2985#p2985
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Re: Current or non-current loan

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I guess we should take heart from the fact the question is going to the IFRIC, as this indicates that there is not a clear answer, otherwise it would not have got as far as an agenda paper. Personally I think it feels wrong to classify as a current liability, this seems to me to misrepresent the underlying economic substance of the transaction. If the staff interpretation stands I think it will surprise a lot of organisations (I can tell you the paper has surprised every technical staff person I have spoken to across a number of large accounting firms).

The arguments remind me of an example the IFRS staff used to use when discussing the new definition of a liability under the new (2018) Conceptual Framework. The question went something like, "in October 20X1 the government mandates that all factories must install smoke detectors by 30 June 20X2. The expected cost is CU100,000. If detectors are not installed the organisation faces a CU1Million fine. At report date, 31 December 20x1, no action has been taken. What should the organisation recognise in it's financial statements?".

The logic being applied to covenants would seem to be akin to arguing that a liability of CU1 Million should be recognised, because, unless the organisation undertakes specific action, that is currently how much they currently stand to lose. Unsurprisingly this was not the approach advocated in the CF disucssion.
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