The general guideline set forth in IAS 1.60 mandates entities to divide assets and liabilities into current and non-current within the statement of financial position. This classification enhances the understanding of a company’s financial standing. For instance, identifying the balance between current and non-current assets and liabilities is vital for effective liquidity management. It is crucial for management to ensure they possess sufficient current assets to settle current liabilities, such as accounts payable, accrued liabilities, and short-term debts, thereby averting liquidity crises. Moreover, the classification as current and non-current enables investors and other external stakeholders to conduct ratio analyses, including the current ratio (current assets divided by current liabilities) or quick ratio. These ratios may offer valuable insights into a company’s financial health and risk profile.
Let’s delve deeper into the classification criteria as laid out in IAS 1.
Classifying liabilities as current or non-current
Under IAS 1.69, an entity classifies a liability as current if:
- It anticipates settling the liability within its normal operating cycle;
- It primarily holds the liability for trading purposes;
- The liability is due for settlement within twelve months after the reporting period; or
- It does not have a right to defer the settlement of the liability for a minimum of twelve months after the reporting period.
Should none of these conditions be satisfied, the liability is classified as non-current.
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Amendments to IAS 1
In 2020 and 2022, the IASB published amendments to IAS 1 to clarify the rules for classifying liabilities as current or non-current. These amendments are effective from 1 January 2024. Further details about these amendments are discussed in subsequent sections.
Defining settlement
The IAS 1 amendments clarified the concept of ‘settlement’ for classifying a liability as current or non-current. Settlement refers to the transfer of economic resources or own equity instruments to the counterparty, which results in the extinguishment of the liability (IAS 1.76A).
A right to defer settlement of the liability
According to IAS 1.69(d), a liability is classified as current if an entity lacks a right to defer the settlement of the liability for at least twelve months after the reporting period. Therefore, unlike assets, the classification of liabilities as current or non-current isn’t determined by the entity’s expectations but by the lack of a right to defer the settlement for at least a year. This makes provisions for claims and litigation typically current, as entities typically lack such rights, even if the legal proceedings are projected to last several years.
Conversely, if an entity plans to settle a liability within a year of the reporting date (before the contractual due date), but retains the right to defer the settlement, the liability is classified as non-current. The recent amendments to IAS 1 further clarified this approach (IAS 1.75A, BC48C(b)). Furthermore, these amendments eliminated the reference to the ‘unconditional’ right to defer settlement, reflecting the reality that various conditions often apply to loans (e.g., compliance with covenants). IAS 1.75A, introduced by the amendments, clarified that the classification of a liability remains unaffected by the likelihood of the entity exercising its right to postpone the settlement for at least twelve months following the reporting period. This means that a liability settled after the end of the reporting period but before the financial statements are authorised may still qualify as non-current as of the reporting date.
Example – Revolving credit facility
Let’s consider Entity A that arranges a revolving credit facility (RCF) with a bank on 1 June 20X1. The RCF permits Entity A to draw down up to $2 million anytime, repayable at any time. The RCF is valid for five years, assuming that Entity A maintains a debt to EBITDA ratio below 3.
On 10 November 20X1, Entity A draws down $1.5 million for higher marketing expenses expected in December 20X1. This amount remains outstanding at the annual reporting date of 31 December 20X1, and Entity A plans to repay it in the first quarter of 20X2. The debt to EBITDA ratio stays below 3 as of 31 December 20X1. Despite intending to repay the outstanding amount within three months, Entity A classifies the $1.5 million as a non-current liability at 31 December 20X1 because it possesses a right to delay settlement for at least twelve months after the reporting period.
Rollovers
A rollover refers to the renewal of a loan. Instead of repaying the debt at maturity, an entity ‘rolls it over’ into a new loan. When an entity has the right to roll over an obligation under an existing loan facility for at least twelve months after the reporting period, the liability is classified as non-current according to IAS 1.73.
Covenants
Many financing agreements contain covenants. The presence of covenants doesn’t automatically necessitate the classification of a liability as current. A liability is only classified as current if the covenants are breached at the reporting date, causing the liability to become payable within the next 12 months.
Recent amendments to IAS 1 clarified the impact of covenants (IAS 1.72B) on liability classification as follows:
- A covenant affects whether the right to defer settlement exists at the end of the reporting period if an entity is required to comply with the covenant on or before the end of the reporting period. This effect holds true even if compliance with the covenant is assessed only after the reporting period. For example, a covenant might be based on the entity’s financial position at the end of the reporting period but assessed for compliance only after the reporting period.
- A covenant does not affect the right to defer settlement at the end of the reporting period if an entity is required to comply with the covenant only after the reporting period. For instance, a covenant might be based on the entity’s financial position six months after the end of the reporting period.
Additionally, the amendments added paragraph IAS 1.76ZA that requires further disclosures relating to covenants.
Conversion of a liability to equity
The fact that a liability can be converted into equity at the discretion of the counterparty does not automatically classify this liability as current, as long as the conversion option is recognised separately from the liability component in equity (refer to IAS 1.69(d) before amendments or IAS 76B after amendments).
Impact of events after the end of the reporting period
Any events concerning a liability that occur after the balance sheet date do not affect the current/non-current classification at the balance sheet date. For more discussion on this, refer to paragraphs IAS 1.74-76.
Classifying assets as current or non-current
An asset is classified as current when (IAS 1.66):
- The entity expects to realise the asset, or intends to sell or consume it, within its normal operating cycle;
- The asset is primarily held for trading purposes;
- The entity anticipates realising the asset within twelve months after the reporting period; or
- The asset is cash or a cash equivalent, unless usage of the asset is restricted for at least twelve months after the reporting period.
If none of the aforementioned criteria are met, the asset is classified as non-current.
Assets acquired for resale
Assets typically classified as non-current cannot be reclassified as current unless they fulfil the criteria for being classified as held for sale in accordance with IFRS 5. A similar restriction applies to assets of a class normally regarded as non-current that are purchased solely for resale (IFRS 5.3,11).
Deferred tax
Deferred tax assets or liabilities should never be classified as current (IAS 1.56). Instead, entities are required to disclose in the accompanying notes the portion of the deferred tax balance expected to be recovered within/beyond 12 months (IAS 1.61).
Operating cycle
An entity’s operating cycle is the time interval between the acquisition of assets for processing and their conversion into cash. If the entity’s normal operating cycle is not clearly identifiable, it is presumed to be twelve months (IAS 1.68). All assets used/sold, or liabilities settled, within an operating cycle are classified as current, even if this exceeds 12 months. Inventories and trade receivables are typical assets used or sold within one operating cycle. Trade payables and short-term employee benefits are examples of liabilities settled as part of the normal operating cycle. Conversely, all kinds of borrowings and bank overdrafts are not considered liabilities settled as part of the normal operating cycle (IAS 1.71). The same operating cycle applies to the classification of an entity’s assets and liabilities (IAS 1.70).
Current and non-current portions of a single asset or liability
Financial assets and liabilities of a long-term nature are divided into current/non-current portions based on the maturity of cash flows (IAS 1.68, 72). For other assets and liabilities, when a balance sheet line combines amounts expected to be recovered within and beyond 12 months (e.g., trade receivables/payables, deferred tax assets/liabilities, inventories), an entity is required to separately disclose amounts expected to be recovered or settled within or beyond 12 months (IAS 1.61). This disclosure is intended to facilitate the evaluation of an entity’s liquidity and solvency.
Presentation based on liquidity
As an exception to the current/non-current classification, IAS 1.60 permits presentation based on liquidity if it provides a more relevant understanding of the financial position of the entity. This method is mainly utilised by financial institutions. A mixed approach is permitted when an entity has diverse operations (IAS 1.64).