BACKGROUND
The Australian Accounting Standards Board (AASB) has clarified presentation as current or non-current of loan arrangements subject to covenants by amending AASB 101 (Presentation of Financial Statements) through the issuance of AASB 2022-6 Amendments to Australian Accounting Standards – Non-current Liabilities with Covenants. The amendments, which are effective for years commencing on or after 1 January 2024, do not affect any aspects of recognition or measurement of the liabilities, which are addressed by the relevant Australian Accounting standard applicable to the nature of the loan arrangement.
As currently issued, AASB 101 is unclear as to whether breaches of covenants, or expected breaches of covenants that occur subsequent to reporting date, require the reporting entity to present loan arrangements as current. The amendment establishes clearer guidance for this determination and introduces mandatory minimum disclosure.
The AASB noted that rights to defer settlement of loan arrangements are rarely unconditional — they are often conditional on compliance with covenants. The AASB has therefore clarified AASB 101 such that if an entity’s right to defer settlement of a liability is subject to the entity complying with specified covenants, the presentation of a loan arrangement as current or non-current is dependent on whether the entity has a right to defer settlement of the liability at the end of the reporting period. Any covenants measured using information subsequent to the reporting period are considered from a perspective of disclosure only – and do not impact presentation as current or non-current.
DISCUSSION - PRESENTATION
AASB 2022-6 clarifies that only covenants with which an entity is required to comply on or before the reporting date affect the classification of a liability as current or non-current.
This recognises that there are covenants that broadly fall into two categories: those which relate to information available at reporting date (e.g. a financial ratio as-at, or prior-to period end), and those which are assessed based on information relating to a period or date after the reporting period (e.g. a financial ratio measured as of a date subsequent to period end).
Covenants with which an entity is required to comply on-or before-the reporting date affect the classification of a liability as current or non-current, even if compliance with the covenant is assessed subsequent to the reporting date. This is because the right to defer settlement arises from compliance status of the entity on or before the reporting date.
Compliance with covenants measured as of a date subsequent to reporting date does not affect the classification of a liability as current or non-current.
DISCUSSION - DISCLOSURE
The amendment includes certain specific additional disclosure requirements:
If classification of the loan arrangement as non-current is subject to compliance with covenants within twelve months of period end, the entity must disclose information in the notes to the financial statements that enables users of financial statements to understand the risk that non-current liabilities with covenants could become repayable within twelve months.
The information required for disclosure includes:
- Information about the nature of the covenants, the timing of when the entity is required to comply with the covenant and the carrying amount of the related liability;
- Any facts or circumstances that indicate that the entity may have difficulty complying with the covenants. Examples may include but are not limited to:
- The entity taking action during or after the reporting period to avoid or mitigate a potential breach; and
- Whether the entity would have complied with the covenant had they been assessed at the end of the reporting period.
Scenario 1
Entity ABC holds a $10M principal loan with a five year maturity and has a reporting date of 30 June 20X0.
- Loan covenants require that Entity ABC maintains a minimum current ratio of 2.5 at the end of the reporting period;
- ‘Current ratio’ is defined in the loan agreement;
- Covenant compliance is required to be reported to the bank on or before 31 July;
- A covenant breach will result in the lender’s right to call the full amount of the loan;
- At 30 June, Entity ABC has a current ratio of 2.1 which is reported to the bank on 30 July. The covenant breach was rectified on 10 July via a capital contribution from shareholders;
- The bank agreed to not call the loan and waived the covenant breach on 1 August.
Question: How should the loan be presented at 30 June 20X0?
Answer: As Entity ABC does not have the right to defer settlement for at least 12 months, the loan is classified as a current liability.
In the notes to the financial statements Entity ABC would also be required to disclose:
- That the $10M loan was subject to a current ratio covenant with compliance date 30 June and every quarter thereafter;
- that the entity was not compliant with the covenant at 30 June;
- steps taken by management to rectify the breach; and
- that subsequent to reporting date a waiver of the breach was received.
Scenario 2
Entity ABC holds a $10M principal loan with a five year maturity and has a reporting date of 30 June 20X0.
- Loan covenants require that Entity ABC maintains a minimum current ratio of 2.5 thirty days subsequent to reporting date;
- Current ratio’ is defined in the loan agreement;
- Covenant compliance is required to be reported to the bank on or before 31 August;
- A covenant breach will result in the lender’s right to call the full amount of the loan;
- At 30 July, Entity ABC has a current ratio of 2.1 which is reported to the bank on 30 July. The covenant breach was rectified on 10 July via a capital contribution from shareholders;
- The bank agreed to not call the loan and waived the covenant breach on 1 August.
Question: How should the loan be presented at 30 June?
Answer: As the compliance date for the covenant is after the reporting date, the covenant breach at 30 July does not affect the classification of the liability as of 30 June. The loan is presented as a non-current liability.
In the notes to the financial statements Entity ABC would also be required to disclose:
- that the $10M loan was subject to a current ratio covenant with compliance date 30 July;
- that had the covenant been assessed as at 30 June, the entity would not have been in compliance; and
- that subsequent to reporting date they had taken steps to mitigate the risk of non-compliance with the breach (i.e. injection of additional cash into the business).
APPLICATION
The amendments are applied fully retrospectively (applying IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors).
EFFECTIVE DATE
The amendments are effective for annual reporting periods beginning on or after 1 January 2024. Earlier application is permitted.
FURTHER INFORMATION
If you wish to discuss any of the information included in this Technical Accounting Alert, please get in touch with your local Grant Thornton Australia contact or a member of the National Assurance Quality Team at national.assurance.quality@au.gt.com.
