Current liabilities

A current liability is:

1. a liability that the entity expects to settle in its normal operating cycle;
2. a liability held primarily for trading;
3. a liability due to be settled within 12 months after the reporting period; or
4. a liability whose settlement the entity does not have an unconditional right to defer for at least 12 months after the reporting period.

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. This means that conversion features that are at the holder’s discretion do not impact the classification of the liability component of a convertible instrument. All other liabilities are non-current.

Change of control agreements Some loan agreements include a change of control clause, under which a loan becomes repayable if there is a change of control event. An entity is unable to prevent a controlling shareholder from selling its shares to a third party, even if there is no expectation that a change of control might happen within 12 months. A change of control clause does not result in classification as a current liability if there has been no change of control event at the end of the reporting period. In this respect, a change of control clause is similar in substance to a loan covenant. IAS 1 requires classification as a current liability if there is an actual breach at the balance sheet date, but not if there is only a potential breach. A borrowing is classified as non-current if the counter-party does not have a right as of the balance sheet date to demand repayment within 12 months of that date.

Material adverse change and subjective acceleration clauses Many loan agreements include either a ‘material adverse change clause’ (MAC) or a ‘subjective acceleration clause’ (SAC), under which the lender can call the borrowing based on subjective criteria. Each clause should be analyzed individually as of the balance sheet date. If the lender has the right at the balance sheet date, based on the application of the MAC or SAC clause, to call the loan within 12 months after the balance sheet date, the loan should be classified as current. In other words, if the lender has such a right, at the balance sheet date, the borrower does not have an unconditional right to defer the settlement of the loan for at least 12 months after the balance sheet date. On the other hand, the loan should be classified as non-current if the lender does not have the right, at the balance sheet date, to call the loan for at least 12 months, based on the terms and conditions of the loan arrangements at the balance sheet date. A current liability is not necessarily one that the entity expects to settle within 12 months of the reporting period. A liability that will be settled within an entity’s normal operating cycle is classified as current, even if, at the end of the reporting period, the entity has the right to defer payment until a later date. For example, trade payables some accruals for employees and other operating costs are operating liabilities incurred as part of the business’ normal operating cycle. This operating cycle might be longer than 12 months. Other liabilities that, as of the end of the reporting period, are due to be settled within 12 months of the reporting period are shown as current liabilities.

A current liability is not necessarily one that the entity expects to settle within 12 months of the reporting period.

A liability that will be settled within an entity’s normal operating cycle is classified as current, even if, at the end of the reporting period, the entity has the right to defer payment until a later date.

For example, trade payables some accruals for employees and other operating costs are operating liabilities incurred as part of the business’ normal operating cycle. This operating cycle might be longer than 12 months.

Other liabilities that, as of the end of the reporting period, are due to be settled within 12 months of the reporting period are shown as current liabilities.

Classification of warranty and environmental provisions How should an entity classify the following liabilities and provisions in its balance sheet? a.      Warranty provisions – The classification will depend on the warranty’s terms. Warranties that guarantee product performance for 12 months are classified as current liabilities. The provision for a warranty that covers a longer period should be split into its current and non-current elements, considering the length of the normal operating cycle. b.      Provision for environmental liabilities – This type of provision is unlikely to be part of a single operating cycle. It should be split into its current and non-current elements, depending on the likely timing of the expenditure to meet the environmental obligation.

Borrowings and covenant compliance

An entity classifies a financial liability as current if it is due to be settled within 12 months after the year-end. This is the case, even if an agreement to refinance, or to reschedule payments, on a long-term basis is completed after the year-end before the financial statements are authorized for issue.

An entity classifies a liability as current if it does not have the unconditional right to defer its settlement for at least 12 months after the end of the reporting period. A liability is classified as current where a liability is not scheduled for repayment within 12 months of the end of the reporting period but can be called by the lender at any time without cause.

A post-year-end rescheduling or refinancing of debt that is at the discretion of the lender is a non-adjusting post-balance sheet event. It does not affect the current/non-current classification of the debt at the balance sheet date.

A refinancing or rescheduling might be fully at the discretion of the borrowing entity, with the entity being able to and intending to roll over the debt for at least a further year. The debt can be classified as non-current. The entity must have full discretion to roll the obligation over; the potential for refinancing alone would not be sufficient to classify an obligation as non-current.

Classification of bank debt An entity has an outstanding borrowing under a term loan facility with a bank. The loan is due to be repaid six months after the end of the reporting period. Before the end of the reporting period, the entity and the lender agree on a new facility that expires in three years, and into which the entity can roll the existing loan. The entity intends to roll over the existing loan into the new loan facility when the loan matures and to maintain the outstanding balance of the new facility for the duration of the new facility. (a)   How should this loan be shown in the entity’s balance sheet? The loan should be classified as non-current. The entity has the ability and intent to roll this obligation over into the new loan facility even though the loan is due for repayment within six months after the end of the reporting period, the debt does not have to be settled until the new three-year committed facility expires. (b)   Would the answer be different if the existing loan and new facility were with different banks? Yes. Refinancing of the loan in this situation would require its settlement (in substance and fact) concurrently with a new borrowing. The new borrowing could not be viewed as an extension of the existing loan. The loan should be classified as current in the entity’s balance sheet but the circumstances and availability of the new facility should be disclosed.

Classification of liability from debt factoring arrangement An entity might enter into a factoring arrangement, which involves it transferring its rights to cash to be collected from receivables to a third party (the factor) in exchange for an upfront cash payment. The finance received from the factor is recorded as a liability where the entity continues to recognize the factored receivables. The terms of the factoring arrangement need to be considered, to determine how the liability should be classified in the balance sheet. Consider whether a factoring obligation in respect of receivables is presented as current or non-current in two scenarios: Scenario 1: Entity A enters into a five-year debtor factoring facility, where it can sell eligible debtors each period. The credit terms of the debtors are 30 days. Eligible debtors are legally valid debtors that do not exceed 90 days outstanding. The debtors are not de-recognised, on the basis that the entity remains exposed to substantially all of the risks and rewards. Collections can be netted against draw-downs for the sale of new debtors in the same period. As a result, the net cash inflow and outflow each period would be small. Debtors not paid within 90 days are ‘sold’ back to the entity and included in the net settlement of each period. Scenario 2: Entity B enters into a five-year term loan facility, whereby funds can be drawn down each period, provided that the principal outstanding does not exceed eligible debtors. The entity is only required to repay the shortfall if there is any breach of the covenant (that is if borrowings exceed eligible debtors). Loan balances and cash flows would be identical in all periods for the scenarios. In scenario 1, the entity cannot avoid settling whatever liability arises in each period. In scenario 2 the factoring arrangement has been structured as a term loan. However, the entity does not have the right to defer payment to the factor, because the cash flows with the bank during the next period, depend on actual payments (and missed payments) from customers and future sales. An entity classifies a liability as current if it does not have the unconditional right to defer its settlement for at least 12 months after the end of the reporting period. The liability is classified as current if an entity does not have the discretion to refinance or roll over liability for at least 12 months after the balance sheet date under an existing loan facility (in this case, the factoring arrangement). The borrowings that arise under both factoring arrangements above should be presented as current liabilities in the balance sheet.

Financial institutions often include borrowing covenants in loan contracts. The assessment of breaches of borrowing covenants focuses on the legal rights of the entity. However, the entity’s expectations on the timing of settlement also affect the liability’s classification where the entity has the discretion to roll over or refinance loans.

Under some borrowing covenants, a loan, which would otherwise be long-term in nature, becomes immediately repayable if certain items related to the borrower’s financial condition or performance are breached.

These items are often measures of liquidity or solvency based on ratios derived from the entity’s financial statements. Some borrowings include ‘cross-default’ clauses, such that the terms of the borrowing are assessed, at least in part, against compliance with the covenants of another borrowing.

Once the related borrowing covenant is breached, the borrowing with the ‘cross default’ clause, and any similarly linked borrowings, might become immediately repayable and classified as a current liability.

Borrowings should be classified as a current liability if these types of breaches occur before the end of a reporting period unless a sufficient waiver of the covenant is granted by the lender, such that the borrowing does not become immediately repayable.

The lender might agree, after the reporting period but before authorization of the financial statements, not to require immediate repayment of the loan. The lender’s agreement is generally regarded as a non-adjusting post-balance sheet event.

The lender’s agreement had not been obtained at the end of the reporting period, and the condition of the borrowing at that time was that it was immediately repayable.

Covenant breach reported after period end An entity has a long-term loan with a bank. The terms of the loan require quarterly testing of certain covenant ratios. The bank requires the entity to file covenant compliance certificates within 60 days of the measurement date of the covenants. The entity’s year-end is 31 December 20X0. The entity was within the acceptable parameters based on the calculation of the ratios for the third quarter – that is, on 30 September 20X0. The covenant testing date in the fourth quarter is 31 December 20X0. The financial results were finalized in January 20X1. Based on these, the entity was in breach of its covenants on 31 December 20X0. The entity is due to file the covenant compliance certificates on 2 March 20X1, which will show the breach. The entity believes that the breach of the covenant does not occur until the filing date, as this is the date at which the bank would call the loan, in the absence of any remedy. How should the loan balance be classified at year-end? The entity was, in effect, in breach of its covenants on 31 December 20X0 even though reporting of the breach was not required until after the end of the reporting period. This is the case, even though the reported financial figures were not finalized until January. The entity did not have the unconditional right to defer settlement of the loan for at least 12 months after the end of the reporting period; the loan should, therefore, be classified as current.

Lenders sometimes agree to a period of grace during which the borrower can rectify the breach following a breach of a borrowing covenant that results in a loan being repayable immediately. The lender agrees not to demand repayment during this time but, if the breach is not rectified, the debt becomes immediately repayable at the end of the period of grace.

If, before the balance sheet date, the lender has agreed to such a period of grace and that period ends at least 12 months after the balance sheet date, the liability should be shown as non-current.

The borrowing agreement includes a period of grace A term loan agreement includes a provision that the borrower must sell a foreign branch of its operations by 31 December 20X0. However, the agreement states that the borrower is permitted an additional two months to complete the sale if he is not able to sell the branch by that date. The borrower has not been able to find a buyer by 31 December 20X0.  In its financial statements for the period ended 31 December 20X0, how will the borrowings be classified? The entity should continue to classify the loan balance as non-current. The borrower does not lose the unconditional right to defer payment of the liability until the additional period has expired. In this case, where the breach does not occur until this later date, the entity continues to present the borrowings as non-current until the later date. The entity should consider the impact of the potential breach and the appropriateness of including disclosure on this item in the financial statements.

The liability is shown as non-current if the breach of the borrowing covenant occurs after the balance sheet date. The presentation of the loan is dictated by the condition of the loan as of the balance sheet date.

Events after that date might give evidence of that condition, but they do not change it. A serious breach could however affect the entity’s assessment about its ability to continue as a going concern.

Events after the reporting period do not alter a liability’s classification but they might require disclosure as a non-adjusting event. An entity should disclose the following events as non-adjusting events, by IAS 10, if they occur between the end of the reporting period and the date of authorization of the financial statements:

• Refinancing on a long-term basis.
• Rectification of a breach of a long-term loan agreement.
• The granting by the lender of a period of grace to rectify a breach of a long-term loan agreement ending at least 12 months after the reporting period.

IAS 1 does not specify any disclosures for non-adjusting post-balance sheet events for non-current loans. If such events are material (such that non-disclosure could influence the economic decisions that users make based on the financial statements), an entity should disclose the following in respect of each such event:

1. the nature of the event; and
2. an estimate of its financial effect, or a statement that such an estimate cannot be made.

Tax liabilities

Deferred tax liabilities should be classified as non-current, regardless of the period over which the temporary differences are expected to reverse.

Other tax liabilities should be classified as current where they are due to be settled within 12 months of the end of the reporting period; otherwise, they should be shown as non-current liabilities.

Notes to the statement of financial position

An entity discloses, either on the face of the balance sheet or in the notes, further sub-classifications of the line items presented, classified in a manner appropriate to the entity’s operations.

The level of this sub-classification depends on the size, nature, and function of the items involved and on any specific requirements in other standards and interpretations. Examples of items that require sub-classification are:

• Property, plant, and equipment should be shown by class.
• Trade receivables, receivables from related parties, pre-payments, and other amounts should be shown separately.
• Inventories should be shown by class.
• Common classifications are merchandise, production supplies, materials, work in progress, and finished goods.
• Provisions for employee benefits should be shown separately from other provisions.
• Equity capital and reserves should be disaggregated into classes, such as paid-in capital, share premium, and reserves.

Specific disclosures are required concerning each class of share capital and the nature and purpose of each reserve within equity. Disclosures are also required about how an entity manages its capital resources.

An entity, such as a partnership or trust, that does not have share capital, should disclose, for each category of equity interest, information equivalent to that required by IAS 1 for share capital.

An entity might reclassify certain items between financial liabilities and equity. It should disclose the amounts reclassified into and out of each category (financial liabilities or equity) and the timing and reason for that classification. These disclosures apply to the following types of instruments:

• a puttable financial instrument classified as an equity instrument; or
• an instrument that imposes on the entity an obligation to deliver to another party a pro-rata share of the net assets of the entity only on liquidation and classified as an equity instrument (For example, some shares issued by limited-life entities).

General requirement to present further sub-classifications of line items

Further sub-classifications of the line items presented should be disclosed either in the statement of financial position or in the notes, classified in a manner that is appropriate to the entity’s operations.

The details provided depend on the requirements of IFRS Standards and the size, nature, and function of the amounts involved. The factors set out in IAS 1 are also used to decide based on sub-classifications. IAS 1 gives the following examples:

• items of property, plant, and equipment are disaggregated into classes by IAS 16;
• receivables are disaggregated into amounts receivable from trade customers, receivables from related parties, prepayments, and other amounts;
• inventories are sub-classified, by IAS 2, into classifications such as merchandise, production supplies, materials, work in progress, and finished goods;
• provisions are disaggregated into provisions for employee benefits and other items; and
• equity capital and reserves are disaggregated into various classes, such as paid-in capital, share premium, and reserves.

Share capital and reserves

Presentation of share capital and reserves when ‘legal’ share capital is classified as liabilities

IAS 1 requires several disclosures about share capital and reserves.

In straightforward cases, these disclosures will be made in respect of the amounts included in the statement of financial position caption ‘issued capital and reserves attributable to owners of the parent’.

However, this will not always be the case, because amounts that are legally share capital will sometimes be presented, in whole or in part, as liabilities in the statement of financial position by IAS 32.

There are several ways in which the requirements of IAS 1 can be met.

For example, it is generally acceptable to present a single line item on the face of the statement of financial position for ‘issued share capital and reserves attributable to owners of the parent’. When this approach is taken, the amount presented on the face of the statement of financial position is the ‘net’ amount (i.e., excluding amounts that are legally shared capital but presented as financial liabilities).

Further details (e.g., analyzing legal share capital between amounts classified as equity and liabilities) can be shown in the notes. This approach may not be appropriate in some jurisdictions; regulatory requirements or general practice may be such that entities present greater detail on the face of the statement of financial position (e.g., share capital, share premium, and specified reserves).

When an expanded analysis of equity items is shown on the face of the statement of financial position (either because this is a regulatory requirement or because the entity wishes to present more detail on the face of the statement of financial position), the question arises as to which line items should be reduced by the amounts presented as liabilities.

When the amounts presented as liabilities represent the proceeds of the issue of a class (or classes) of shares, the most common approach is that the amounts presented as ‘share capital’ and ‘share premium’ on the face of the statement of financial position exclude those amounts (i.e., they relate to equity shares only).

Alternatively, the gross amounts for ‘share capital’ and ‘share premium’ may be presented on the face of the statement of financial position, with amounts classified as liabilities shown as a separate deduction.

In such circumstances, the supplementary disclosures required by IAS 1 regarding share capital can be presented separately in the relevant notes for the ‘equity’ and ‘liability’ classes of shares.

Alternatively, details about all classes of share capital may be presented in a single note, but distinguishing separately those classes and amounts that have been presented as liabilities.

The position is more complicated when a class of shares (e.g., redeemable convertible preference shares) is accounted for as a compound financial instrument with both equity and liability components. There are several possibilities for presentation in such circumstances, including:

• the share capital and share premium could be shown on the face of the statement of financial position at their ‘legal’ amounts, with a separate negative reserve equal to the liability recognized; or
• the share capital and share premium could be shown on the face of the statement of financial position as those amounts that relate to equity shares, with a separate line item such as ‘equity component of preference shares’; or
• the deduction for the liability might be made first from the share premium and then from share capital; or
• the deduction for the liability might be made from share capital and share premium in proportion to the allocation of the original proceeds of issue between those captions.

All of these are acceptable provided that adequate explanation is provided and that all of IAS 1’s disclosure requirements are met. The key point is that the total amount presented as equity is unaffected by these choices.

Analysis of reserves

There are some specific instances when IFRS Standards require a separate component of equity to be maintained.

For example, IAS 21 requires specified exchange differences to be accumulated in a separate component of equity and IAS 16 requires a surplus on revaluation of an asset to be recognized in other comprehensive income and accumulated in equity under the heading of revaluation surplus.

Subject to these (and other) specific requirements, there is some flexibility about which items are accounted for as separate components within equity.

Meaning of ‘retained earnings’

When IFRS Standards require amounts to be accumulated in equity, in the absence of specific requirements in IFRS Standards, and subject to local regulatory requirements, it is generally acceptable for these amounts to be included within retained earnings.

For example, the credit to equity required by IFRS 2 for equity-settled share-based payments may either be credited to a separate reserve or retained earnings.

Disclosures about share capital

For each class of share capital, the following should be disclosed, either in the statement of financial position or the notes: [IAS 1:79(a)]

• the number of shares authorized;
• the number of shares issued and fully paid;
• the number of shares issued but not fully paid;
• the par value per share, or the fact that the shares have no par value;
• a reconciliation of the number of shares outstanding at the beginning and the end of the period;
• the rights, preferences, and restrictions attaching to that class including restrictions on distributions of dividends and the repayment of capital;
• shares in the entity held by the entity or by its subsidiaries or associates; and
• shares reserved for issue under options and contracts for the sale of shares, including the terms and amounts.

Disclosure of shares in the entity held by the entity or by its subsidiaries or associates

By IAS 32, all or part of the amounts recognized for shares in the statement of financial position may be classified as liabilities. The above disclosure requirements apply irrespective of whether the shares are classified as equity debt or a combination of the two.

It is unclear whether the requirement to disclose ‘shares in the entity held by the entity or by its subsidiaries or associates’ refers to the number of shares held or the amount of the deduction from equity in respect of such holdings.

In the context of the other disclosures required by IAS 1, the text appears to refer to the number of shares. This would be appropriate for all of the types of holding referred to in IAS 1, including shares held by associates of the entity which are not deducted from equity as is required for shares held by the entity and its subsidiaries under IAS 32.

However, IAS 32 states that “the amount of treasury shares held is disclosed separately either in the statement of financial position or in the notes, by IAS 1”.

This text refers to the ‘amount’ of treasury shares rather than their number, but it appears to be a reminder of the disclosure requirement in IAS 1 rather than an additional requirement.

Because of the uncertainty regarding this disclosure requirement, it is recommended that both of the following be disclosed:

(1) the number of shares held by the entity and by its subsidiaries and associates, and

(2) when relevant, the amount of any deduction from equity in respect of treasury shares.

Some entities such as partnerships or trusts do not have share capital. In such cases, information equivalent to that described above for share capital should be disclosed, showing changes during the period in each category of equity interest and the rights, preferences, and restrictions attached to each category of equity interest.

If an entity has reclassified:

• a puttable instrument classified as an equity instrument, or
• an instrument that imposes on the entity an obligation to deliver to another party a pro-rata share of the net assets of the entity only on liquidation and that is classified as an equity instrument, between financial liabilities and equity, the amount reclassified into and out of each category (financial liabilities or equity), and the timing and reason for that reclassification, should be disclosed.

The terms used in the two bullet points above have the meaning specified in IAS 32.

Disclosures about reserves

Entities are required to describe the nature and purpose of each reserve within equity, either in the statement of financial position or in the notes.

Description of the nature and purpose of each reserve within equity

While IAS 1 requires financial statements to include additional information as to the nature and purpose of each reserve, it does not provide any further clarification regarding what information is needed.

By allowing this information to be disclosed in the statement of financial position, the Board has indicated that the required information might be sufficiently disclosed by the precise wording of the name of the reserve.

Thus, for reserves that are commonly encountered (revaluation reserves on property, plant and equipment, share premium account, translation reserves in respect of foreign operations, etc.), no further explanation is necessary for investors to understand the nature and purpose of the reserves.

However, if, for example, the entity wishes to designate special reserves within equity that are not familiar to users of financial statements, supplementary information should be provided regarding the purpose of the reserve, and how it will be utilized.

Statement of profit or loss and other comprehensive income

An entity that presents a separate statement of profit or loss does not present the profit or loss section in the statement presenting comprehensive income. The separate statement of comprehensive income begins with the profit for the period.

‘Profit or loss’ is the total income less expenses, excluding the components of other comprehensive income.

‘Other comprehensive income’ is the total of income and expenses that are not recognized in profit or loss as required or permitted by IFRS.

‘Total comprehensive income’ is the change in equity resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners.

The implementation guidance accompanying IAS 1 gives examples of the statement of profit or loss and other comprehensive income. It shows the statement of comprehensive income as a single statement, and it sets out the alternative approach showing two statements:

• the statement of profit or loss; and
• a separate statement of other comprehensive income.

Line items to be presented in profit or loss

In addition to items required by other IFRS Standards, the profit or loss section or the statement of profit or loss is required to present the following line items:

• revenue;
• finance costs;
• share of the profit or loss of associates and joint ventures accounted for using the equity method;
• tax expense; and
• a single amount for the total of discontinued operations.

Entities that have adopted IFRS 9 are also required to present:

• interest revenue calculated using the effective interest method separately from other revenue;
• gains and losses arising from the derecognition of financial assets measured at amortized cost;
• impairment losses (including reversals of impairment losses or impairment gains) determined by IFRS 9;
• if a financial asset is reclassified out of the amortized cost measurement category so that it is measured at fair value through profit or loss, any gain or loss arising from a difference between the previous amortized cost of the financial asset and its fair value at the reclassification date; and
• if a financial asset is reclassified out of the fair value through other comprehensive income measurement categories so that it is measured at fair value through profit or loss, any cumulative gain or loss previously recognized in other comprehensive income that is reclassified to profit or loss.

Entities that have adopted IFRS 17 are also required to present:

• insurance revenue separately from other revenue;
• insurance service expenses from contracts issued within the scope of IFRS 17;
• income or expenses from reinsurance contracts held;
• insurance finance income or expenses from contracts issued within the scope of IFRS 17; and
• finance income or expenses from reinsurance contracts held.

Income and expenses are to be recognized in profit or loss unless an IFRS requires or permits otherwise

All items of income or expense recognized in a period are recognized in profit or loss unless an IFRS requires or permits otherwise.

Some IFRS Standards specify circumstances in which particular items are recognized outside profit or loss. IAS 8 deals with two such circumstances – the correction of errors and changes in accounting policies.

Other IFRS Standards require or permit components of other comprehensive income that meet the definition of income or expense in the Conceptual Framework to be excluded from profit or loss.

Prohibition on ‘extraordinary items’

IAS 1 states that items of income and expense should not be presented as ‘extraordinary items’ in the statement(s) presenting profit or loss and other comprehensive income, or in the notes.

This may appear to be a slightly odd requirement in that IAS 1 does not define what is meant by ‘extraordinary items’ or say how such items might be presented if they were not prohibited.

To understand the requirements of IAS 1, it is necessary to be aware that a previous version of IAS 8 included a definition of extraordinary items as “income and expenses that arise from events or transactions that are distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly”.

It required such items to be disclosed on the face of the income statement separately from the profit or loss on ordinary activities (normally as a single net-of-tax number after profit from ordinary activities and before net profit).

As part of the revisions of IAS 1 and IAS 8 in 2003, the Board decided to prohibit the presentation of extraordinary items because they result from the normal business risks faced by an entity and do not warrant presentation in a separate component of the income statement.