FASB has issued a proposed Accounting Standards Update, or ASU, intended to improve guidance used to determine whether debt should be classified as a current or noncurrent liability in a classified balance sheet.
The amendments in this proposed ASU would introduce a principle for determining whether debt or other instruments within the scope of the proposed amendments would be classified as a noncurrent liability as of the balance sheet date. According to that principle, an entity would classify an instrument as noncurrent 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.
The amendments in this proposed ASU would continue to require that an entity classify debt as a noncurrent liability when:
- there has been a debt covenant violation, and
- the entity receives a waiver of or a forbearance agreement for that violation that meets certain conditions before the financial statements are issued (or are available to be issued).
The amendments in this proposed ASU also would require more comprehensive disclosures about defaults resulting from violations of a loan covenant, grace periods within which a debtor may cure a violation, and triggers of a subjective acceleration clause.
According to the proposed ASU:
The amendments in the proposed ASU could shift classification of certain debt arrangements between noncurrent liabilities and current liabilities as compared with current guidance. The existing classification guidance would be superseded by a principle that may result in a classification that differs from the classification produced under existing rules.
An example of one of the most significant changes to the classification would be short-term debt that is refinanced on a long-term basis after the balance sheet date. Current guidance requires that short-term debt (at the balance sheet date) that is refinanced on a long-term basis (after the balance sheet date but before the financial statements are issued or are available to be issued) be classified as a noncurrent liability. Consistent with the accounting for other subsequent events, the amendments in this proposed ASU would prohibit an entity from considering a subsequent refinancing when determining the classification of debt as of the balance sheet date. A subsequent refinancing provides evidence about conditions that did not exist at the date of the balance sheet but arose after that date (that is, a nonrecognized subsequent event). Similarly, under the proposed amendments a subsequent refinancing of short-term debt with the issuance of equity securities no longer would affect the classification of debt as of the balance sheet date. Therefore, those debt arrangements would be classified as current liabilities.
Another example of a change in the classification would be short-term debt that has an associated long-term financing arrangement. Under current GAAP, short term debt is classified as a noncurrent liability if an entity enters into a financing arrangement and meets certain conditions. The amendments in this proposed ASU would preclude an entity from considering other financing arrangements (such as letters or lines of credit) in determining the classification of the debt.
An additional example of a change in the classification would result from debt that contains subjective acceleration clauses or material adverse change clauses. Current GAAP requires that an entity consider the likelihood of acceleration of the due date when determining noncurrent or current classification. The amendments in this proposed ASU would remove that probability assessment, and, instead, the subjective acceleration clause would affect the classification of debt when it is triggered. However, when there is debt subject to a covenant violation as of the balance sheet date, an entity would be required to assess whether it is probable that the subjective acceleration clause would be violated within 12 months from the balance sheet date.
There also could be a change in classification when a borrower violates a provision of a long-term debt arrangement and the debt arrangement provides a specified grace period. Current GAAP requires that an entity classify that debt as a current liability unless it is probable that the violation will be cured within the period, which would prevent the debt from becoming callable. The amendments in this proposed ASU would require that the principle be applied in that scenario, which would result in a noncurrent liability classification if either of the criteria in the principle is met as of the balance sheet date.
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