Debt and the classification of debt on classified balance sheets has been scrutinized and analyzed over the years and is currently based on rules based guidance provided by Accounting Standards Codification (ASC) Topic 470, Debt. The Financial Accounting Standards Board (FASB) is proposing to replace the old rules based guidance that does not cover all debt scenarios with a proposal issued on January 10, 2017 of principle based guidance called “simplifying the classification of debt in a classified balance sheet (current versus noncurrent)” through Accounting Standards Update (ASU) No. 2016-200 Debt (Topic 470).
The proposal is part of the FASB’s simplification initiative and was released to improve and reduce some complexities relating to the classification of debt and to make the new proposed presentation more meaningful to the users of the financial statements.
The proposal introduces a principle for determining whether a debt arrangement (or other arrangement within the scope) should be classified as a noncurrent liability on a classified balance sheet. This principle is that an entity should 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, or
The entity has a contractual right to defer settlement of the liability for at least one year (or operating cycle, if longer) after the balance sheet date.
If an entity has violated a debt covenant and receives a waiver of that violation before the financial statements are issued (or are available to be issued) the entity can continue to classify the debt arrangement as a noncurrent liability. The waiver must meet certain conditions as stated in ASC 470-10-45-23 so that the debt can be classified as noncurrent. This “rule” is an exception to the principle above and is similar to current Generally Accepted Accounting Principles (GAAP).
The previous paragraph is one “rule” that was maintained, however this proposal may modify other presentations of debt between current and noncurrent liabilities. One of the significant changes based on this proposal is short-term (current) debt that is refinanced on a long-term (noncurrent) basis after the balance sheet date would no longer be classified as a noncurrent liability. Even though the debt was refinanced subsequent to the balance sheet date and it is known to be long-term (noncurrent) before the financial statements have been issued (or are available to be issued) this proposal states that the liability should be presented as a short-term (current) liability. The FASB wrote “a subsequent refinancing provides evidence about conditions that did not exist at the date of the balance sheet but arose after that date.”
Another change is entities do not have to assess the likelihood of subjective acceleration clauses in a debt arrangement when trying to determine whether the debt is a current or noncurrent liability. The classification should be based on the principles set forth above and subjective acceleration clauses should not be taken into account.
As many CPA’s and Accountant’s struggle with different debt arrangements and the proper classification of those debt arrangements, the principle based criteria above does define the classification based on the contractual arrangement but I am sure some aspects including the first significant change above will be responded to in depth.
The FASB is seeking comments on this debt classification proposal by May 5, 2017.