ED: Non-current Debts with Covenants - First of Many Questions

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exIFRS
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ED: Non-current Debts with Covenants - First of Many Questions

Post by exIFRS »

I have a lot of thoughts and questions on the new ED: Non-current Debts with Covenants.

The first question I would be interested to hear views on is:

The new paragraphs effectively say (among other things) (they are self referential so I have tried to pull them together):
When an entity classifies liabilities subject to the conditions described in paragraph 72B(b) [that is they include conditions that the entity is required to comply with within the next twelve months or the debt becomes current] the entity shall present such liabilities separately in its statement of financial position.
Are there many non-current liabilities that don't include at least some condition that could make them current in the next 12 months? A missed payment, a change in circumstances, etc?

The second question is how do people feel about creating an entirely new category of liability on the face of the Statement of Financial Position. Does this feel like a proportionate response to the issue of covenants?

Thoughts?
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Re: ED: Non-current Debts with Covenants - First of Many Questions

Post by JRSB »

I had not spotted this so, thanks, I will review!
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Re: ED: Non-current Debts with Covenants - First of Many Questions

Post by exIFRS »

Here is the ED if anyone is interested: https://www.ifrs.org/content/dam/ifrs/p ... -nclwc.pdf
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Re: ED: Non-current Debts with Covenants - First of Many Questions

Post by Marek Muc »

I do feel that creating an additional line on the face of SoFP as per ED is an overkill. From my experience, a missed payment is almost always a contractual breach triggering lender's right to require immediate full repayment of the loan. On the other hand, I wonder whether such condition (i.e. not missing payments) is considered to be a 'covenant' by finance professionals. ED kind of defines the term 'covenants' as 'complying with specified conditions' (para 72B) but I think that this definition is too broad.

I think that the approach outlined as one of the alternatives would be much more useful (ED.BC22)
specifically requiring separate presentation only for liabilities with conditions with which an entity would not have complied based on its circumstances at the reporting date. Some Board members favoured this alternative because separate presentation of a more limited set of liabilities may highlight liabilities at a greater risk of becoming repayable within twelve months. In contrast, the Board’s proposal would apply to a broader set of liabilities, thus reducing signalling benefits. However, this alternative might require the Board to specify how an entity assesses compliance with non-financial conditions or financial performance conditions for the purposes of that separate presentation, which would introduce complexity.
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Re: ED: Non-current Debts with Covenants - First of Many Questions

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Yeah this is another of my concerns, I think the word covenant is a red herring, the ED talks about conditions and specific conditions, and I don't know how to put limits around that. I am also partial to the "Alternative View".
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Re: ED: Non-current Debts with Covenants - First of Many Questions

Post by Marek Muc »

PS. Shouldn't our concerns be alleviated by the materiality concept? I mean, typical terms, such as making payments when due, would not trigger separate presentation due to immateriality. I like this example from Practice Statement 2 which is perfect for this discussion (PS2 par. 81-83)
Example P—assessing whether information about covenants is material
Background
An entity has rapidly grown over the past five years and recently suffered some liquidity problems. A long-term loan was granted to the entity in the current reporting period. The loan agreement includes a clause that requires the entity to maintain a ratio of debt to equity below a specified threshold, to be measured at each reporting date (the covenant). According to the loan agreement, the debt-to-equity ratio has to be calculated on the basis of debt and equity figures as presented in the entity’s IFRS financial statements. If the entity breaches the covenant, the entire loan becomes payable on demand.
[...]
In the preparation of its financial statements, the entity assesses whether information about the existence of the covenant and its terms is material information, considering both the consequences [Refer: paragraph 82(a)] and the likelihood of a breach occurring. [Refer: paragraph 82(b)]
[...]
Scenario 2—the lender defined the covenant threshold on the basis of the three-year business plan prepared by the entity, adding a 200 per cent tolerance to the forecast figures

In this scenario, the entity assessed the likelihood of a breach occurring as remote, on the basis of its historical track record of meeting its past business plans and the magnitude of the tolerance included in the covenant threshold. Therefore, although the consequences of the covenant breach would affect the entity’s financial position and cash flows in a way that could reasonably be expected to influence primary users’ decisions, the entity concluded that information about the existence of the covenant and its terms was not material.
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Re: ED: Non-current Debts with Covenants - First of Many Questions

Post by exIFRS »

This is an interesting issue, and I am not sure it is clear cut, I mean we can always play the "it's not material" card :-). But I am not sure the example you provide, which is about disclosure of specific terms in the notes (which I agree with) applies in this situation, and if it did, wouldn't that really mean these proposals are unnecessary? Instead, would the question not be, do I have a material amount of liabilities subject to conditions? Paragraph BC26 of the ED only muddies the water I think, because it addresses this issue, but specifically in the context of "disclosure" and "information", if materiality was meat to apply to presentation in this way why is it not specifically addressed?

I don't know the answer by the way, I am trying to think it through too.
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Re: ED: Non-current Debts with Covenants - First of Many Questions

Post by Marek Muc »

Materiality applies to PFS as well. For example, you don't need to separately present items listed in IAS 1.54 if they are immaterial (say you're a car manufacturer but due to some quirk you've got some immaterial biological assets -> you can present them together with other assets despite para IAS 1.54f)

Coming back to ED: it's not a question of whether the amount of liability is material, but whether the "covenants" are material. For example, you've got a debt of material amount and:

Scenario 1: covenants are just the regular ones, e.g. pay on time, don't move your HQ abroad etc.
Scenario 2: maintain your financial ratio below X at 30 June 20X2, it's 31 December 20X1 and you are above X but expect to get below X by 30 June 20X2

Scenario 1: you don't need to disclose anything nor present the debt in a separate line (as per ED)
Scenario 2: you need to present this debt in a separate line as per ED
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Re: ED: Non-current Debts with Covenants - First of Many Questions

Post by exIFRS »

Like I say I don't disagree with the value argument, so let's put that aside.

I hear what you are saying about the materiality of a covenant. But then I wonder how we ended up where we are, there was already a requirement to disclose material covenants, as demonstrated by the Practice Statement Quoted. If the intention is to have them presented on the face of the financial statements why not just say, debt with material covenants must be separately presented. Why this weird dance, and why do they specifically get a whole new class of liability? I'd rather worry about internally generated intangible assets for example.
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Re: ED: Non-current Debts with Covenants - First of Many Questions

Post by JRSB »

I wonder what the impact is in terms of going concern, ie if there is a specific IFRS opportunity to make a potential going concern factor more prevalent in the primary statement, then an auditor who is facing ever more pressure on going concern (and revised ISAs in that regard) will tend towards requiring the separation because of the risk of not having done so should a covenant breach send it under...
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Re: ED: Non-current Debts with Covenants - First of Many Questions

Post by Marek Muc »

exIFRS wrote: 26 Nov 2021, 18:19 If the intention is to have them presented on the face of the financial statements why not just say, debt with material covenants must be separately presented. Why this weird dance, and why do they specifically get a whole new class of liability?
Well, this is what the ED effectively says, except that the classification as non-current has a 12-month horizon.

I agree that this has been a weird dance, probably they didn't sufficiently analyse practical consequences of the 2020 amendment
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Re: ED: Non-current Debts with Covenants - First of Many Questions

Post by exIFRS »

I am still curious what people think about the creation of a whole new category of liabilities on the face of the Statement of Financial Position.
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