Accounting updates

In January 2020, the International Accounting Standards Board (IASB) issued amendments to International Accounting Standard (IAS) 1, Presentation of Financial Statements, thereby clarifying how an entity classifies its debt and other financial liabilities as current or non-current in certain circumstances (2020 amendments). This amendment was applicable from 1 January 2023.

However, stakeholders raised concerns regarding 2020 amendments and IASB reviewed those amendments. To improve the information provided by companies regarding a long-term debt (with attached covenants) undertaken by companies, IASB issued additional amendments to IAS 1 in October 2022 (2022 amendments). Some of the key changes introduced in the 2022 amendments include:

a. Liabilities with covenants – Classification criteria: Under the existing requirements of IAS 1, companies classify a liability as current when they do not have an unconditional right to defer settlement for at least 12 months after the reporting date. Through the 2022 amendments, IASB has now removed the requirement for a right to be unconditional, i.e., a liability would be classified as non-current, even if the right to defer settlement is subject to some underlying conditions (covenants).

However, such right must exist at the reporting date and have substance.

It has also been clarified that only such covenants with which a company must comply on or before the reporting date would affect the classification of a liability as current or non-current. Any covenants with which the company must comply after the reporting date (i.e., future covenants) would not affect a liability’s classification at that date. The same can be explained with the help of an example below:

Example: Company ABC Ltd. (the company) has a loan which is repayable in five years. Other facts of the case are:

• Loan is subject to a covenant which requires the company to maintain an EBITDA of at least 10 per cent on 31 December 20X2 and 14 per cent on 30 June 20X3 respectively. The loan becomes repayable on demand if the target EBITDA is not met on any of the specified dates
• The company is preparing its annual financial statements for the year ending 31 December 20X2. The EBITDA is 11 per cent as on 31 December 20X2. Also, the company expects an EBITDA of 12.5 per cent as on 30 June 20X3.

b. Additional disclosure requirements: When non-current liabilities are subject to future covenants, a company would be required to disclose appropriate information for helping the users of financial information understand the risk that those liabilities could become repayable within 12 months after the reporting date

c. Clarification on convertible liability: The amendments have also provided a clarification on classification of a convertible liability – e.g., convertible debt. When a liability comprises of a conversion option, involving transfer of a company’s own equity instruments, the conversion option is recognised as either equity or a liability separately from the host liability under IAS 32, Financial Instruments: Presentation.

In this regard, the IASB has now clarified that when a company classifies the host liability as current or non-current, it can ignore only those conversion options that are recognised as equity. In simple terms, if the conversion option is recognised as a liability under IAS 32, the same would affect current or non-current classification of the host liability.

Effective date: The amendments would apply retrospectively for annual reporting periods beginning on or after 1 January 2024, with early application permitted. They also specify the transition requirements for companies that may have early-adopted the previously issued but not yet effective 2020 amendments.

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To access the text of the IASB announcement, please click here