New rules for classifying liabilities from 1 January 2024
On 31 October 2022, the International Accounting Standards Board (IASB) published its second-round changes to the requirements for classifying liabilities as current or non-current. This follows the initial changes proposed in 2020 (Classification of Liabilities as Current or Non-current). At the time of writing, these second-round changes have not been approved by the New Zealand Accounting Standards Board but are expected to be approved in due course.
What changes were made to IAS 1?
Some of the 2020 changes were superseded by changes made in 2022. It is therefore easier for entities to apply the results of both amendments together. This article summarises the final changes resulting from a combination of the 2020 and 2022 amendments, which relate to:
- The right to defer settlement
- Classification based on rights to defer settlement rather than intention
- Liabilities settled by transferring the entity’s own equity instruments prior to maturity
- Additional disclosures regarding compliance with covenants after reporting date
These are discussed further below.
If none of the criteria in IAS 1, paragraphs 69(a) to (c) are satisfied, paragraph 69(d), as amended, only requires a liability be classified as a non-current liability if at the end of the reporting period the entity has a right to defer settlement of the liability for at least twelve months after the reporting period. This means that:
- The right to defer settlement must exist at the end of the reporting period
- The right no longer needs to be unconditional.
New paragraph 72A then confirms that the right to defer settlement must have substance and must exist at the end of the reporting period.
An entity’s right to defer settlement is rarely ‘unconditional’ because most loan arrangements contain conditions, or covenants, that it must meet in order to continue deferring settlement beyond twelve months of reporting date. The 2022 final amendments clarify whether a right to defer settlement exists at the end of the reporting period. This is illustrated in the diagram below.
As the diagram above shows, new paragraph 72B clarifies that if an entity is required to comply with a covenant:
- On or before the end of the reporting period - this will affect whether the entity has a right to defer settlement at the end of the reporting period. Such covenants affect whether the right exists at the end of the reporting period, even if compliance is assessed only after the reporting date.
- Only after the end of the reporting period - for example, based on the entity’s financial position six months after reporting date - such covenants will not affect whether the entity has a right to defer settlement at the end of the reporting period.
Example 1 – Affects right to defer settlement
Entity A has a 31 December 20X2 year-end. It has a long-term bank loan from Bank, repayable in five years. Bank can demand repayment immediately if a specified debt: equity ratio is not maintained at each year-end. The covenant is tested based on audited financial statements which are signed on 31 March 20X3.
Entity A must comply with the debt: equity ratio at 31 December 20X2, even though it is only tested after year-end. It will recognise the bank loan as a NON-CURRENT LIABILITY if it meets the debt: equity ratio at 31 December 20X2, and a CURRENT LIABILITY if it does not.
Example 2 – Does not affect right to defer settlement
Entity B has a 31 December 20X2 year-end. It has a long-term bank loan from Bank, repayable in five years. The loan arrangement is subject to covenants. Entity B must maintain a working capital ratio as follows:
- At least 1.0 at 31 December 20X2
- At least 1.1 at 30 June 20X3.
At 31 December 20X2, Entity B’s working capital ratio was 1.05. Management expects to comply with the 1.1 ratio on 30 June 20X3.
At 31 December 20X2, Entity B does not yet meet the 30 June 20X3 covenant test. However, IAS 1, paragraph 72B(b) only requires Entity B to comply with the 30 June 20X3 covenant after end of the reporting period. The 30 June 20X3 covenant therefore does not affect whether Entity B has a right, at 31 December 20X2, to defer settlement.
Entity B therefore classifies the liability for the loan arrangement as a NON-CURRENT LIABILITY at 31 December 20X2.
Currently, IAS 1, paragraph 73 requires an entity that expects, and has discretion, to refinance or roll over an obligation under an existing loan facility for at least twelve months after reporting date to classify the liability as non-current, even if it would otherwise be due within twelve months.The amendments remove intention from this assessment, which is now based only on whether the entity has a right to roll over an obligation for at least twelve months under an existing loan facility.
Entity C has a loan facility with Bank expiring on 31 March 20X3. Its year-end is 31 December 20X2. Entity C has a right to roll over its loan with Bank at 31 December 20X2 for a further twelve months (until 31 March 20X4) because the rollover was approved by Bank prior to 31 December 20X2.
At 31 December 20X2, Entity C intends to repay the bank loan on 31 March 20X3.
The 31 December 20X2 financial statements were authorised for issue on 30 April 20X3.
Under the current IAS 1 requirements, Entity C classifies the loan as a CURRENT LIABILITY because it does not expect to roll over loan for a further twelve months. However, the amendments require this loan to be classified as a NON-CURRENT LIABILITY because Entity C has a right to defer payment beyond twelve months, even though it does not intend to do so.
In this scenario, Entity C repays the loan to Bank on 31 March 20X3, which is before the financial statements were authorised for issue on 30 April 20X3. This should be disclosed as a non-adjusting subsequent event in Entity C’s 31 December 20X2 financial statements.
Currently, a liability arising from a convertible note that can be settled prior to maturity by issuing an entity’s own equity instruments is classified as current or non-current according to terms of the convertible note, not the possibility that it could be settled earlier via the issue of equity instruments. For example, if the convertible note is repayable in cash in three years’ time but could be converted by the holder at any time into equity instruments, it is classified as a non-current liability because the note is only repayable in cash in three years’ time.The amendments change these requirements. The classification of the instrument’s conversion feature will now impact the current/non-current classification of the instrument. If the conversion feature is classified as a liability or a derivative liability, the entity must consider the early conversion option for current/non-current classification.
Entity D issues a $1 million note payable with an ‘American-style’ conversion option, which is exercisable at any time over the life of the note. Once exercised, the note will convert into 1 million ordinary shares of Entity D. If the note is not converted into shares, it is repayable, plus interest, in five years’ time.
The note is quoted in NZD, but the functional currency of Entity D is not NZD.
Because the conversion feature is classified as a derivative financial liability, and not as an equity instrument under IAS 32 Financial Instruments: Presentation, the early conversion option must be considered when classifying the financial liability. Because the note can be converted at any time, the debt portion is classified as a CURRENT LIABILITY.
The amendments also introduce more disclosures about liabilities classified as non-current where the right to defer settlement is subject to the entity complying with loan covenants in the next twelve months.Entities must disclose information in the notes to enable users of financial statements to understand the risk that non-current liabilities could become repayable within twelve months of reporting date.
Disclosures should include:
- Details of the nature of the covenant
- When the entity is required to comply with the covenants
- The carrying amount of liabilities affected by the covenants
- Facts and circumstances, if any, that indicate that the entity may have difficulty complying with the covenants (e.g., if the entity has acted during or after reporting period to avoid mitigating a potential breach)
- If applicable, the fact that the entity would not have complied with the covenants if they were to be assessed for compliance based on the entity’s circumstances at reporting date.
A proposal to require separate presentation in the statement of financial position of non-current liabilities subject to covenants was not included in the final amendments. However, as noted above, the notes to the financial statements must disclose the carrying amount of non-current liabilities that could become payable within twelve months after reporting date if covenants tested during that period are not met.
When do these changes apply?
This new application date aligns with the 2022 amendments, which is also 1 January 2024. If you adopt the 2020 amendments early, you must also early adopt the 2022 amendments, and vice versa. The 2020 amendments were initially applicable to annual periods beginning or after 1 January 2022 and have been deferred twice: firstly, to 1 January 2023; and now to 1 January 2024.
Do comparatives need to be restated?
Yes. If the amendments result in a material reclassification of your liabilities from current to non-current or vice versa, you will need to restate your:
- Comparative statement of financial position at the end of the preceding period
- Opening statement of financial position at the beginning of the preceding period.
The following table shows which statement of financial position will be affected when these new classification requirements are first applied.
Statement of financial position
|First time application
|Opening statement of financial position
|31 December 2024
|31 December 2023
|1 January 2023
|31 March 2025
|31 March 2024
|1 April 2023
|30 June 2025
|30 June 2024
|1 July 2023
|30 September 2025
|30 September 2024
|1 October 2023
Please refer to our International Financial Reporting Bulletin for more information on these latest changes to IAS 1.
Please contact our IFRS Advisory team if you require assistance navigating these amendments to determine how they could affect the classification of your liabilities, and any flow-on effects for your loan covenants.
For more on the above, please contact your local BDO representative.
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