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Classification of liabilities as current or non-current

Date recorded:

Cover Paper (Agenda Paper 29)

Background

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

The papers for this meeting discuss two remaining areas of the ED proposals. The two areas are:

  • a) Classification of liabilities with equity-settlement features (a focussed consultation on practical consequences of proposed clarifications).
  • b) Proposals for transition and early application.

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

Feedback on practical implications of proposed changes on classification of liabilities with equity settlement features

  • Respondents to the ED noted that in some jurisdictions where there is diversity in practice, the clarifications would reduce the diversity. At present some ignore a holder conversion option only if it is separately classified as an equity component of a compound instrument. Others currently ignore any holder conversion option, irrespective of its classification as equity or liability.
  • The staff also consulted with members of the IFRS Interpretations Committee. One Committee member noted that the clarifications would result in some entities reclassifying debt from non-current to current which could jeopardise compliance with loan covenants. As such, enough time should be given before the effective date to allow entities to re-negotiate covenants.
  • Committee Members noted a gap in the ED for holder conversion options, in particular those recognised as embedded derivatives.
  • Two Committee members felt there was no underlying principle behind the amendments. They suggested that without an underlying principle the amendments would not achieve the clarity the Board is aiming for, instead entrenching an existing inconsistency.

In summary there where mixed options on the tentative decisions. One member suggested the Board should consider re-exposing as the extent of comments on the current draft demonstrated that the concepts are generally not well understood.

Staff analysis

Staff analysis focused on responses to comments around the underlying principle of proposed clarifications and the comment around allowing enough time before the effective date to allow affected entities to re-negotiate covenants.

Underlying principle of the proposed amendments (and effect on embedded derivatives)

Staff think that the Board should clarify the requirements by making clear that IAS 1:69(d) applies only to counterparty conversion options recognised separately to the liability as an equity component. Any other feature (such as an embedded derivative) does not affect the classification of the liability as current/non-current.

Effect on covenants

Staff note these concerns and think the Board could address these by giving entities enough time to renegotiate covenants before implementing proposed amendments.

Staff recommendation

IAS 1:69(d) states 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 as current or non-current.

The staff recommend clarifying in IAS 1 that this statement applies only to a counterparty conversion option recognised separately from the liability as an equity component of a compound financial instrument. Otherwise, extinguishing a liability by transferring equity instruments to the counterparty constitutes settlement of the liability for the purpose of classifying it as current or non-current.

Board discussion

The agenda papers were discussed together. See discussion below.

Transition and early adoption (Agenda Paper 29B)

Feedback on proposed amendments

  • Most respondents to the ED agreed with the proposal to require retrospective application. Most stated that retrospective application would not require the use of hindsight as the requirement would be to classify liabilities by reference to the rights as at the reporting date and not management expectation of future events.
  • A few respondents questioned whether the benefits of retrospective application would be sufficient to justify the cost and effort. An accounting firm suggested the information obtained by retrospective application might not be relevant, particularly if a liability was reclassified as non-current at the end of the previous period and then settled during the current period (or reclassified as current and then not settled). One group representing users of financial statements said its members would not be very interested in the amounts classified as short-term in prior periods.
  • Some respondents disagreed with the analysis in the Basis for Conclusions to the ED. They disagreed that a change in classification resulting from initial application of the proposed amendments would be more in the nature of a change in an accounting estimate than a change in accounting policy.

Staff analysis and conclusion

Comments on the proposed transition arrangements are opinions on the relative costs and benefits of retrospective application. The balance of opinion supports the Board’s view that the benefits would exceed the costs. On this basis, the staff conclude that the Board should require retrospective application.

Staff think a reclassification resulting from the initial application of the proposed amendments would be the result of a change in accounting policy, not a change in accounting estimate, as a change in accounting estimate is defined within IAS 8 as a “an adjustment to the carrying amount of an asset of liability that results from new information or new developments”. The proposed amendments would not lead to any such adjustments.

Staff recommendation

The staff recommend that, as proposed in the ED, and for the reasons set out in the Basis for Conclusions on the ED, the Board should require entities to apply the amendments retrospectively in accordance with IAS 8.

The Board was asked:

  1. whether they agree that, as proposed in the ED, the Board should require entities to apply the amendments retrospectively in accordance with IAS 8
  2. whether they agree that, as proposed in the ED, the Board should provide no exemptions for entities adopting IFRS Standards for the first time
  3. whether they agree that, as proposed in the ED, the Board should permit early application, requiring entities that apply the amendments early to disclose that fact

Board discussion

The agenda papers were discussed together. A number of Board members agreed with the recommendations of the staff. Many Board members noted the principle of ‘less is more’ highlighting that this narrow-scope project should only look to provide further explanation of the current wording of IAS 1 and it is not intended to feed into the discussions on the Financial Instruments with Characteristics of Equity project in this area. One member noted that inclusion of the examples as set out in the paper would aid application in practise of the principal.

A Board member noted the importance of clarifying only what the Board intended when making the amendment to IAS 1, to make the distinction between instruments which have an equity derivative feature in accordance with the classification requirements in IAS 32, and not to provide other guidance on what settlement features should be ignored and which should be assessed. They felt the most important clarification point needed is that this only applies to the derivative components which are separated under IAS 32 and are classified as equity. This view was supported by other members of the Board.

Board decision

The Board agreed with the recommendations of the staff as stated above.

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