Amendments to IAS 1 – Classification of financial liabilities

Date recorded:

The project manager noted that in October 2013, the Board had tentatively decided to remove ‘unconditional’ from ‘unconditional rights’ in paragraph 69(d) of IAS 1. She asked the Board members to confirm that they still agreed with that decision. The Board members confirmed that they still agreed with that decision.

The project manager noted that the Board had also agreed in October 2013 to make it explicit that settlement for the purposes of classification related to the transfer of cash or other assets. She noted that in the paper, the staff had recommended extending that wording to also include the transfer of services. This was in anticipation of the new revenue standard when liabilities with respect to performance obligations would also apply. She asked the Board members whether they agreed with this clarification to the wording in paragraph 69(d) of IAS 1.

A Board member wondered whether the proposed change was really needed and asked how frequently a financial liability was settled by rendering services. He also asked whether this was an amendment resulting from the proposed revenue recognition standard. The project manager responded that in the future there would be some liabilities that would be settled through the provision of services. She added that, currently, there were liabilities that were effectively based on performance obligations, for example, where amounts had been invoiced and services had not yet been performed, so there were existing liabilities that were being extinguished by services. The Board member asked whether this was not in effect an amendment to the revenue recognition standard and wondered if the Board would have to address whether a performance obligation could be classified as current and not current.

Another Board member asked a question regarding paragraph 24 of the paper, which referred to situations (such as convertible bonds) when an entity might, or would, settle a liability by issuing its own equity; an issue that had been raised at the previous meeting. The project manager responded, noting that the staff had consulted with the financial instruments team regarding this issue, who noted that this issue had been addressed in the previous amendments to IAS 1 (paragraph 69(d)). She added that, in most cases, the convertible loan would be covered by paragraph 69(c). She further noted that it could be made absolutely explicit in the standard by including the transfer of cash, other assets, the issuer’s own shares or services – but the staff didn’t think this was required, and accordingly, did not include this in the proposal. The project manager added that the staff believed this issue had been addressed in the previous amendments to IAS 1. In response to the above discussion, the Director of Implementation Activities clarified that paragraph 69(d) stated that where the counterparty had the option of demanding settlement, that did not affect the classification of the liability. He noted that in the case of a convertible, an entity would stick with cash settlement requirements in terms of classification.

The project manager then asked the Board members whether they affirmed the decisions made in October, which was to amend paragraph 73 to replace the word 'discretion' with 'right' and to specify that the arrangement had to be with the same lender or a consortium of lenders. A Board member highlighted the fact that paragraphs 69(d) and 73 did not talk about the same thing. She noted that paragraph 69(d) talked about the terms of a particular liability with optional prepayment or extension features, and paragraph 73 talked about a new liability that might replace the first liability. She expressed her concern that the extension introduced by paragraph 73 would result in an entity using liabilities it was not accounting for yet to classify whether a currently held liability was current or non-current. She further noted that she did not agree with including 'consortium' in the wording of the standard because there could be situations where there was a very different group of lenders. She saw little difference between such a situation and the situation where an entity had a loan that was due to be repaid within the next 12 months and had a completely different bank lined up to refinance the loan. The project manager noted that the staff had tried to make paragraph 73 as specific as possible to ring-fence such situations. Staff had introduced 'consortium' into the wording because when this had been published for comment two years ago, the staff had received feedback from a number of parties saying that there was no point talking about same or similar lenders unless consortia were taken into account because that was a common structure.

The Board member further commented on the staff’s proposal to replace 'discretion' with 'right'. She believed that discretion was stronger than right as, with a right, the other party might have the ability to say no and there might be conditions attached. The Director of Implementation Activities noted that the staff had seen a right as being stronger and clearer than discretion, which had been the reason for the staff’s proposal. The Board member didn’t agree with the proposal, noting that there must have been a reason in the past for requiring an 'unconditional right'. She added that an entity might have a right to ask, but might have to satisfy certain conditions. She expressed concerns that using the term ‘right’ did not make it clear that the ability to refinance was wholly within the entity’s control and certain enough that she would be comfortable going beyond looking at the terms of the liability the entity currently had to a new financing if there was any uncertainty whether the entity could access that financing.

Another Board member noted that he didn’t agree with softening the language in IAS 1. He noted that the Board needed to be strict on what was considered current, adding that, if the Board wanted to develop accounting in this area, this should be through better disclosures about capital structure and the ability to refinance etc. He shared similar concerns regarding the inclusion of 'consortium' as the first Board member, noting that he saw no difference between a similar but slightly different consortium and a completely different lender.

A further Board member shared the above concerns with regards to opening this issue up to consortia. She noted that if an entity was dealing with the same lender, then this would be an exception, adding that the Board should not expand the wording to include consortia, even if a number of comments were received on this matter.

Another Board member noted that it would be extremely rare that a credit agreement was completely unconditional – such that the borrower had the unconditional right to refinance or roll over a loan. He noted that there were always covenants that would make these rights conditional. Accordingly, if the current language was retained, an entity would always have to classify liabilities under such agreements as current. He noted that the proposed amendment (regarding the removal of 'unconditional') was a reasonable way of dealing with the language in credit agreements, and accordingly supported the staff’s recommendation. With respect to the issue of including a specific reference to consortium, he noted that instead of saying that it would be management’s discretion to determine whether or not the consortium should be considered the same after changes to its membership, this should be determined based on whether a majority of the lenders in the consortium, including the leader, had changed.

There was further discussion around the issue of including a specific reference to consortium in paragraph 73, with various Board members participating in the discussion.

One Board member raised the question whether in a situation where the lead decision-making bank had remained the same it did matter if one or two banks in the background had changed and at what stage changes did become significant enough that the consortium was not considered the same lender. Another Board member noted the distinction between a scenario where an entity had a contract with a lead arranger who was channelling funds vs. a scenario where the entity had a direct relationship with five banks. Another Board member raised the issue of the language in paragraph 73, noting that the current wording 'under an existing loan facility' was different from 'under the same loan'. He suggested that changing the wording in paragraph 73 to 'under the existing facility' would reduce tension on the consortium aspect because it would be clear that the paragraph was referring to the same loan. He noted that in the discussion thus far, the Board had been focusing on whether the lender was the same, not on whether the loan was the same. He further noted that given this was an exception, the guidance should be as strict as possible, and suggested that the Board concentrate on the loan itself, to reduce tension on the lender aspect.

The Director of Research raised the issue of whether, in the case of a consortium where there were some continuing members, a distinction would need to be made for the portion of the loan attributable to continuing members vs. non-continuing members, and raised the question how this be split would be determined.

Another Board member raised the point that the reason for the distinction between current and non-current liabilities was to provide important information to users regarding the amount of cash a company would have to pay out in the upcoming year. She noted that in the situation where a company was rolling over a loan with the same lender, then the company would not need to come up with the cash to repay the loan. However, if there was a new lender, then the company would need to come up with cash to pay off the old loan, and as there was more risk involved in this situation, users would want to see this loan classified as current. She further noted that in the case of consortia, to provide useful information to lenders the company would need to identify situation where there was some risk that the company would have to come up with cash in the next 12 months. Accordingly, it would seem that under an agreement where the company could refinance with same consortium – and the same lead bank – without having to come up with cash to repay the old loan, there was little risk, and therefore, in this situation, the loan would be classified as non-current.

Another Board member agreed with the comments made by the previous Board member and noted that if the Board decided to extend the guidance to consortiums, the logic for this decision should be explained in the basis for conclusions. The logic was that there was no cash flow risk because the company would be dealing with the same counterparty. She added that adding this logic would be important as not every consortium would work the same. In response to the comment made by the previous Board member, another Board member noted that he was concerned that if a new principle of 'no cash flow risk' was added, this potentially opened up the exception even further. The Director of Implementation Activities noted that, in relation to the principle of 'same lender', the question the staff had received from the last outreach performed was how one would apply the concept of same lender when there was a consortium? In response to the above, a Board member suggested that the Board could say 'same lender' in the standard, and in the basis for conclusions describe that in certain circumstances, a consortium agreement might lead to situations where, in effect, an entity was dealing with the same lender. The Director of Implementation Activities suggested including the above wording in the standard rather than in the basis for conclusions because the basis for conclusions was not authoritative.

The project manager noted that, based on the above discussions, there were 3 possible options:

  1. No revision to the existing standard [with the exception of changing 'an' to 'the' – per a comment raised by a Board member in the paragraph below];
  2. Add additional guidance to state that it must be with the same lender; or
  3. Say 'same lender' and refer to 'consortium'

A board member highlighted the comment raised earlier in the discussion that tension was being created by the existing wording in paragraph 73 and suggested that the wording should be amended to say the existing facility, not an existing facility (as it was currently), because this would clarify that the Board were talking about that specific loan, adding that 'an' existing facility could be any facility to renew or roll over. He further noted that using the wording 'the' existing loan would define that the loan would have to be with the same lender/consortium – putting the tension on the loan being carried over, rather than the counterparty.

Thirteen Board members voted in favour of option 1.

The Director of Implementation Activities reminded the Board that they still needed to decide on whether or not to replace the word 'discretion' with 'right'. The Chairman said he was confused as the Board seemed to have turned over decisions made in the October 2013 meeting. He asked why the paper was brought back to the Board. The project manager responded, noting that, when the staff brought the paper to the Board in October, everything was worded in terms of 'does the entity have a right to postpone settlement for at least 12 months?' She noted that it was pointed out to the staff that the standard defined what the criteria were from a current perspective. Staff believed that in practice the same answer would be arrived at regardless of whether the assessment was performed from a current or non-current perspective (because they were mirror images of each other). Accordingly, the staff had brought back this paper to put the argument in terms of paragraph 69, which was the principle in the standard. The Board agreed to replace 'discretion' with 'right'.

The project manager noted that Question 3 in the paper had been superseded by the previous decisions by the Board. The Board members agreed with the staff recommendation to make explicit in the standard that only rights in place at the reporting date affected the classification of liabilities (Question 4 in the paper).

The project manager then asked the Board members if they agreed that management’s expectation about events after the end of the reporting period that prevented the application of rights to defer settlement should affect the classification of liabilities (Question 5 in the paper). A number of Board members noted that they disagreed with the proposal, as they believed that entities should not be accounting for intentions/expectations at the reporting date. The Director of Implementation Activities noted that paragraph 69(a) of IAS 1 talked about classification as current when the entity expected to settle the liability in its normal operating cycle, which the staff had brought into the analysis to say that, if an entity was planning to settle the liability within 12 months then a current classification would be proposed, which would provide information to users of financial statements that there would be an outflow of cash sooner than expected.

A Board member said that he would not interpret paragraph 69(a) in such a way. Another Board member noted that even if she accepted the basic premise of intent being factored in, she had concerns with the Board continuing to open up expectations, because this could create a very significant and new obligation when doing classification to almost go into the same projections as would be required when assessing going concern. She noted that if intent was factored in (which included expectation), the Board would need to look very carefully at whether this created a big change that should be a wording change. The project manager noted that this point was included because, at the October 2013 meeting, a number of Board members had been concerned that at the year-end an entity might have a right to defer settlement, but that management might know that things would deteriorate after the reporting date and the entity would have to repay the loan early because they the entity would be in breach. Another Board member noted that there appeared to be two different issues that were being discussed, these issues being 1) Intention – what did management think it would do; and 2) what did management think might happen to the entity (that would trigger repayment)? He noted that in the latter situation where management expectation was that the entity would be forced to repay, that would be useful information to provide to users.

The project manager provided a summary of the discussion, noting that the Board members had agreed with the following:

  • Deletion of 'unconditional' from paragraph 69(d)
  • Replacement of 'discretion' with 'right' in paragraph 73
  • Linkage of settlement of the liability with the transfer of cash, other assets or services
  • No changes to paragraph 73 to include same lender or to deal with consortium
  • Accordingly, no discussion regarding 'similar terms'
  • Only rights in place at the reporting date should affect the classification of a liability
  • No other changes that prevent the application of the right subsequent to the reporting date
  • Accordingly, no consideration of whether to take information up to the date that the financial statements are authorised for issue.

The project manager drew the Board members’ attention to the fact that in the draft proposal, the staff had reorganised the existing requirements so that similar types of examples were grouped together. There were no objections to the reorganisation of the paragraphs from the Board members.

A Board member raised a question regarding exposure. The project manager responded noting that this would be exposed as a narrow focus amendment to IAS 1.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.