Classification of Liabilities as Current or Non-Current (Amendments to IAS 1)

Background

The Exposure Draft Classification of Liabilities published in February 2015 (Exposure Draft) proposed amendments to the requirements in IAS 1 Presentation of Financial Statements. Those requirements relate to the classification of liabilities as current or non-current.

The papers for this meeting discuss two remaining issues in relation to the proposal that an entity should classify a liability as non-current only if it has a right at the end of the reporting period to defer settlement of the liability for at least twelve months. The two issues are:

• (a) Classification of liabilities with equity-settlement features
• (b) Classification of loans for which the right to defer settlement is subject to lending conditions that will not be tested until after the end of the reporting period

Liabilities with equity-settlement features (Agenda Paper 29A)

Staff analysis

The Exposure Draft proposed to clarify that settlement ‘refers to the transfer to the counterparty of cash, equity instruments, other assets or services that results in the extinguishment of the liability’.

Respondents to the Exposure Draft raised two concerns about including a reference to equity instruments in the clarification of settlement:

• (a) Some respondents disagreed that issuing equity instruments should be viewed as ‘settlement’ of a liability for the purpose of classifying the liability as current or non-current
• (b) Many respondents asked for more clarification. In particular, they questioned how the proposed new reference to equity instruments would interact with a statement in IAS 1:69(d) that:

“Terms of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification”. Some respondents suggested the proposed new reference is incompatible with that existing statement.

The staff’s analysis worked through these potential issues in detail and concluded that the Exposure Draft proposals are compatible with existing IAS 1 requirements on the following bases:

• (a) the proposed new reference to equity instruments applies to an obligation to transfer equity instruments that does not meet the definition of equity and so is classified as a liability. The proposed new reference means that the transfer of the entity’s own equity instruments is regarded as settlement of that liability for the purpose of classifying it as current or non-current.
• (b) the existing statement in IAS 1:69(d) applies only if a convertible bond or similar financial instrument includes a holder conversion option that meets the definition of an equity instrument and is recognised separately as an equity component of a compound financial instrument applying IAS 32 Financial Instruments: Presentation. The statement in IAS 1:69(d) means that the terms of the equity component do not affect the classification of the liability component as current or non-current.

Staff recommendations

The staff recommended refinements to the Exposure Draft proposals to clarify both the existing IAS 1 requirements and the proposed amendments. This includes stating more explicitly when IAS 1:69(d) applies, clarifying that a settlement can be in the entity’s own equity instruments and aligning terminology by referring to ‘transfer’, rather than ‘issue’ in IAS 1:69(d).

These refinements are not considered fundamental and the staff do not recommend that there is a need to re-expose the Exposure Draft.

Board Discussion

All Board members agreed with the proposals.

One Board member commented that they were satisfied with the proposals as the objective of classification was to provide information relating to duration. It was noted that there were other views on the objective of classification that differ from this, including the views of the FASB, however, the proposals align with the IASB’s view.

One Board member suggested that the proposals could be simplified and one underlying principle be included within the Standard. The principle would be that the terms that matter in determining the classification are those relating to the instrument classified as a liability under accounting standards not the terms of the instrument that is classified as equity. This received mixed views from other Board members and was not added to the proposals.

Staff added that their next steps would be to present a paper to IFRS Interpretations Committee members to ensure there were no practical implications that staff may have missed.

Board Decisions

The Board voted unanimously in favour of the proposals.

Lending conditions tested after the reporting period (Agenda Paper 29B)

Staff analysis

In February 2016, the Board tentatively decided to clarify that, in assessing an entity’s right to defer settlement of a liability, compliance with any conditions in a lending agreement should be assessed as at the reporting date—even if the lender will not test the entity’s compliance until a later date.  The staff had recommended this approach on the basis that the purpose of the condition is to protect the lender’s interests and, to be effective, such protection must be in place continuously.  So the entity’s right to defer settlement is implicitly conditional on continuous compliance, even if the lender tests compliance only from time to time.

At the November 2018 meeting it was suggested that this may be difficult to implement if the conditions are based on an entity’s financial performance to a certain date, e.g. operating profits or a ratio of EBITDA to net interest-bearing debt.

The staff have suggested alternatives to assessing, at the reporting date, whether financial performance conditions have been met, where only part of the year to which the condition relates has occurred. Staff have used an example where, at the reporting date, nine months of the year to which the conditions are being assessed has occurred. The alternatives were:

• (a) Include the full year to the reporting date, including three months of actual results
• (b) Include the full year to the assessment date, including three months of forecast results
• (c) Compare nine months of the assessment year to a pro-rated balance of the assessment condition

The staff recommendation below is to require the use of alternative (a) above.

Staff recommendations

The Board has tentatively decided to clarify that, in assessing an entity’s right to defer settlement of a liability, compliance with any conditions in a lending agreement should be assessed as at the reporting date—even if the lender will not test the entity’s compliance until a later date.

The staff recommended adding that, if a condition relates to a measure of financial performance for a period extending beyond the reporting date, an entity would be judged to comply with the condition as at the reporting date if its financial performance for a period of equal length ending on the reporting date indicates it is complying with the condition.

Board Discussion

Initially a number of the Board members agreed with the direction of the proposals. However, there was disagreement around what the proposals meant. In particular, some interpreted the wording as meaning that using alternative (a) was the only method whereas others saw (a) as one way of doing the assessment but not as the only way.

Given that it was not clear some Board members suggested that this assessment was an estimate like any other and that perhaps further guidance was not required.

Board Decisions

10 Board members voted in favour of including no further guidance on this judgement in the Standard.