Loan with breached covenants

The liabilities are classified as either current or non-current based on the rights existing at the end of the reporting period. Liabilities are classified as non-current if the entity has a substantive right to defer settlement for at least 12 months at the end of the reporting period. The amendment no longer refers to unconditional rights, since loans are rarely unconditional (for example, because the loan might contain covenants). The assessment determines whether a right exists, but it does not consider if the entity shall exercise the right. The right to defer only exists if the entity complies with relevant conditions at the reporting date.

The liability is classified as current if a condition is breached at or before the reporting date and a waiver is obtained after the reporting date.

In case, a covenant is breached after the reporting date, it is classified as non-current.

The standard IAS 1 Presentation of financial statements tells you when the liability is current:

• Either it is expected to be settled in its normal operating cycle,
• Then when the liability is held primarily for trading,
• The liability is due to be settled within 12 months after the reporting period
• The liability is current when the entity has no unconditional right to defer its settlement for at least 12 months after the reporting period.

Do we have an unconditional right to defer the settlement of the liability for at least 12 months after the reporting period?

If yes, then the liability is non-current.

If not, then the liability is current.

Let’s understand this under different scenarios

Scenario 1: Covenant breached after the end of a reporting period

If the company meets the covenants at the end of the reporting period, but after the end of the reporting period, the covenants are breached. Per the standards, we need to look at the status of the breach at the end of the reporting period, no breach, no need to change the classification of loan from non-current to current. The subsequent breach of covenants after the end of the reporting period is a non-adjusting event under IAS 10 Events after the Reporting Period, so just disclose the fact in the financial statements and no accounting.

Scenario 2: Management intends to repay the loan within 12 months

In case the covenants aren’t breached and the loan is non-current but the entity intends to repay the loan within the next 12 months, then the loan becomes current upon agreeing with the bank or if the repayment date is after 12 months but the entity can repay the loan at its own will, the loan becomes current. It is to be remembered that the mere intention to repay the loan is not enough, if the loan has a fixed date for repayment, and no agreement is made with the bank regarding an early repayment, the loan shall be classified as non-current.

Scenario 3: The covenants are breached but the bank doesn’t ask for early repayment

If the bank agreed before or at the end of the reporting period, then the loan is classified as non-current, because at the end of the reporting period the company has still unconditional right to defer settlement of the loan beyond 12 months after the reporting period.