Do the proposed clarifications to IAS 1 Presentation of Financial Statements hit the mark?
Under IFRS, most companies present a balance sheet that classifies liabilities as either current or non-current.
This split has traditionally been helpful in understanding a company’s ability to meet its liabilities in the short term, although the introduction of enhanced disclosure of maturity and liquidity risk has reduced its relevance.
Even so, companies and users have long struggled with the application of these classification requirements, particularly for loans.
It has become a very emotive issue because of the inconsistency between existing requirements, which has caused much debate and confusion in practice.
The proposals confirm that the classification as current/non-current is based on facts and circumstances at the reporting date, and that the probability of continuing to meet conditions is irrelevant.
However, potential confusion remains with the proposals to modify the existing classification criteria. In particular, under the proposals:
These changes have the potential to create diversity in practice, such that reasonable people may reach different conclusions for the same fact patterns.
The example provided in our In the Headlines compares the treatment of a term loan and a rollover facility under the current and proposed requirements.
The conclusion reached in this scenario to classify the rollover facility as non-current may feel appropriate because of the analogy to an economically equivalent term loan. However, there may be an alternative view. This then prompts the question: when is a right not quite a right?
For example, should the borrowing still be classified as non-current if the ‘right’ is conditional on meeting some other future financial test, or on the condition that there are no ‘material adverse changes’ in the prospective borrower’s financial position? These are both common scenarios. Or, what if the ‘right’ amounted to little more than a right to apply for a loan at a future date, to be considered consistent with the bank’s lending criteria?
These are all ‘rights’, albeit with future conditions, none of which are breached at the reporting date, but all of which are fundamental to whether the company will be able to exercise any right to roll over the facility in the future. Ultimately, a question arises as to whether a ‘right’ that you can’t exercise until a future date, which is based on conditions that are uncertain to be met at that date, is in fact a right at all.
So, the risk is that the IASB’s proposal to delete the word ‘unconditional’ and refer only to the existence of a ‘right’ will simply raise a new problem: when is a right not quite a right? Unless clarified, significant diversity in practice may result, risking a new expectation gap between preparers and users.
“We are concerned that the proposals may not bring clarity, and so might risk continued diversity in practice. A broader rethink may be needed.”
If the IASB pursues a clarification of this relatively narrow issue, then we would welcome a clarification as to what is meant by a ‘right’; preparers and users would then know what a requirements means and users could not misinterpret a company’s rights as more than they are.
In addition, we suggest that the IASB might go further and ask users whether a current/non-current classification continues to be relevant given that separate disclosures now exist on liquidity risk and contractual maturity, and then put forward proposals that respond to users’ needs.
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