Classification of liabilities as current or non-current is expected to change: Are you ready?

Classification of liabilities as current or non-current is expected to change: Are you ready?

The International Accounting Standards Board (IASB) has issued two amendments to IAS 1 Presentation of Financial Statements (The Amendment), introducing important changes to the requirements for current vs. non-current classification of liabilities. Under IFRS Accounting Standards, these changes are applicable for annual periods beginning on or after 1 January 2024. Similar changes are expected to be made in Indian Accounting Standards (Ind AS) and will apply for financial years beginning on or after 1 April 2024.

For most entities engaged in manufacturing/ supply of goods or services, separate classification of current and non-current assets and liabilities in the balance sheet provides useful information by distinguishing the net assets that are continuously circulating as working capital from those used in the entity's long-term operations. It also highlights assets that are expected to be realized within the current operating cycle, and liabilities that are due for settlement within the same period. In practice, current vs. non-current classification of assets and liabilities also helps users of financial statements in better understanding/ evaluating short-term liquidity position of the entity. Also, there may be debt covenants and other key performance indicators (KPIs) linked to the current ratio. Hence, there is no doubt that current vs. non-current classification of assets and liabilities is one of the key focus areas for the preparers as well as users of the financial statements.

To clarify the existing requirements for classification of liabilities as current vs. non-current and to address certain issues arising in the practical application, the International Accounting Standards Board (IASB) issued two amendments to IAS 1 Presentation of Financial Statements, in January 2020 and October 2022. The amendments have been made only to the requirements for classification of liabilities as current or non-current and there are no changes to the criteria for requirements for classification of assets. Some of the changes in criteria are likely to have a major impact on classification of liabilities as current or non-current.

Given below is the comparison of pre-amendment and post-amendment criteria:

The amendments have also added various clarifications and related requirement to supplement/ elaborate change in the criteria. Also, new disclosure requirements have been added in the amended IAS 1.

Overview of key amendments

The changes have been made to the criteria for classification of liabilities and there are no changes to the criteria applicable for current vs. non-current classification of assets.

• Right to defer settlement: It has been clarified that the liability arising from a loan agreement is classified as non-current if the entity has a right to defer its settlement for 12 months after the reporting date. It does not matter that the right to defer settlement is conditional on the entity complying with debt covenants after the reporting date.
• Expected deferrals: The classification of financial liabilities as current vs. non-current depends on when they are due for settlement and whether the entity has a right to defer its settlement for 12 months after the reporting date. For this purpose, the expectation or likelihood whether the entity will exercise its right to defer settlement is not relevant.
• Settlement by way of own equity instruments: Settlement by way of an entity's own equity instruments is considered settlement for the purpose of classification of liabilities as current or non-current, with one exception, if, and only if, the conversion option itself is classified as an equity instrument, would be disregarded.
• Disclosures: Additional disclosures have been prescribed for entities that classify liabilities arising from loan arrangements as non-current when the right to defer settlement of liabilities is subject to the entity complying with future covenants within 12 months.

Right to defer settlement

The pre-amended IAS 1 required that to classify a liability as non-current, an entity should have an unconditional right to defer its settlement for at least 12 months after the reporting date. It may be noted in practice, many bank loan and other financial liability agreements require borrower to comply with debt covenants either on an ongoing basis (e.g., there should be no change in control and there should be no material adverse event during the loan tenure) or more frequently than an annual basis(e.g., the borrower should ensure specified debt-equity ratio and current ratio on quarterly or half-yearly basis). Whilst the borrower may expect to comply with these requirements; however, they are not within borrower's control. Hence, there was an issue whether such loans/ financial liabilities meet IAS 1 criteria for classification as non-current liability. It appears that different entities have interpreted and applies this requirement in different manners, resulting in a diversity of practice, which makes it difficult for users to understand and compare financial statements.

Post amendment, the standard no longer refers to an 'unconditional right'; rather, it simply refers to the right to defer settlement. Hence, it seems clear that even a conditional right to defer settlement will result in non-current classification of loan aggrement/borrowings. Further, a new paragraph has also been added which now clarifies that the 'right' to defer settlement of a liability for at least 12 months must have substance and needs to exist at the end of the reporting period in order to classify a liability as non-current.It has also been clarified that the right to defer settlement may be subject to the entity complying with the covenants specified in the loan agreement; only the covenants requiring compliance on or before the reporting date are relevant to decide the classification, even if compliance with those covenants is assessed after that date. However, covenants which need to be complied with only after the reporting date (i.e., future covenants) do not affect a liability's classification at the reporting date. Instead, the amendments require entities to disclose information about such covenants and related liabilities in the notes.

Only the covenants specified in loan agreement and requiring compliance on or before the reporting date affect classification of the liability. Any future covenant is ignored for classification purposes.

Expected deferrals/ expectations to settle early

The amendment clarifies that for a liability to be non-current, an entity must have a right to defer its settlement for at least 12 months after the reporting date and it does not matter whether the entity will exercise such right. The reference to the entity's expectations in paragraph has been deleted and a new paragraph has been added to bring this aspect more explicitly. The new paragraph states that classification of a liability is unaffected by the likelihood that the entity will exercise its right to defer settlement of the liability for at least 12 months after the reporting period. If a liability meets the criteria stated above for classification as non-current, it is classified as non-current even if management intends or expects the entity to settle the liability within 12 months after the reporting period, or even if the entity settles the liability between the end of the reporting period and the date the financial statements are authorized for issue. However, in either of those circumstances, the entity may need to disclose information about the timing of settlement to enable users of its financial statements to understand the impact of the liability on the entity's financial position.

How we see it

The IASB has clarified that classification of loans and similar financial liabilities is unaffected by the management expectations/ intention to settle within 12 months after the reporting date. By implication, it appears that the criterion 'the entity expects to settle the liability in its normal operating cycle' for current classification of liability is relevant only for liabilities, such as trade payables and some accruals for employee and other operating costs, which are part of the working capital used in the entity's normal operating cycle. The said criterion is not applicable for the classification of loans and other similar financial liabilities.

Impact of breaches to debt covenants

IAS 1 position

Under the IFRS Accounting Standards, there are no material changes to the requirements concerning breaches of debt covenants. On the lines of pre-amended IAS 1, the amended IAS 1 clarifies that when an entity breaches a covenant of a long-term loan arrangement on or before the end of the reporting period with the effect that the liability becomes payable on demand, it classifies the liability as current, even if the lender agreed, after the reporting period and before the authorization of the financial statements for issue, not to demand payment as a consequence of the breach. An entity classifies the liability as current because, at the end of the reporting period, it does not have the right to defer its settlement for at least 12 months after that date.

However, an entity classifies the liability as non-current if the lender agreed by the end of the reporting period to provide a period of grace ending at least 12 months after the reporting period, within which the entity can rectify the breach and during which the lender cannot demand immediate repayment.

Position under Ind AS 1 Presentation of Financial Statements

As compared to IAS 1, the current Ind AS 1 contains the following two carve outs on this matter:

1. Under Ind AS 1, only a breach of material provision/ covenant of long-term loan will trigger current classification of the liability. If there is a breach of minor provision/ covenant, the entity can continue classifying the loan as non-current. In practice, differentiation between breach of material and minor covenants may require exercise of the judgment and such assessment/ determination may change from one entity to another and for the same entity over different periods.
2. In accordance with Ind AS 1, if there is a breach of a material covenant of a long-term loan arrangement on or before the end of the reporting period with the effect that the liability becomes payable on demand on the reporting date and the lender has agreed, after the reporting period and before the approval of the financial statements for issue, not to demand payment as a consequence of the breach, then the entity need not to classify the liability as current. In other words, under Ind AS, the waiver granted by the lender after the reporting date and before the approval of the financial statements for issue is treated as an adjusting event.

In the Exposure Draft of the proposed amendments to Ind AS 1 issued by the Accounting Standards Board (ASB) of the ICAI, it was proposed to remove both the above carve outs and align Ind AS with the requirements of IAS 1. It may, however, be noted that the final amendments in Ind AS 1 are yet to be notified. Hence, the final position that will prevail once Ind AS changes are notified is not known.

How we see it

The current version of Ind AS 1 contains two important carve outs which allow entities to classify liability as non-current in a scenario where they breach only non-material debt covenant in a loan agreement and/ or in scenario if they are able to get lender waiver after the reporting date. The ASB of the ICAI had proposed to remove both these carve-outs and align requirements with IAS 1. The final outcome will be known when amendments to Ind AS 1 are notified.

Practical examples

To explain requirements of the above amendments to IAS 1, given below are certain examples. In each of the scenarios, the entity has 31 March year-end, and it is evaluating current vs. non-current classification of liability in IFRS financial statements for the year ended 31 March 2025. Unless stated otherwise, the entity has taken INR1,000 crore loan from the bank, which is repayable on 31 March 2029.

In the above scenarios, the application of amended IAS 1 on current vs. non-current classification is quite clear. As stated earlier, the pre-revised IAS 1 was not clear on future covenants and, therefore, it is possible that entities may have taken different views. It is imperative that these entities review positions taken in past carefully to align with the requirements of the amended IAS 1.

Example: Expected early settlement of loan

As at 31 March 2025, an entity has a loan repayable in five years from the reporting date. The entity is planning to pre-pay this loan in the next three months. The financial statements of the entity for the year ended 31 March 2025 will be authorized for issue on 31 May 2025.

In this case, the entity has a right to defer settlement for 12 months after the reporting date. The intention to prepay loan does not impact classification. Hence, the liability is classified as non-current.

Will it make a difference if the entity has prepaid the loan before the financial statements were authorized for issue?

The standard is clear that the classification is based on the right of the entity at the reporting date. Hence, the loan will still be classified as non-current. However, the entity will be required to disclose subsequent repayment as a non adjusting event.

Will the position change if the entity has notified the bank of its intentions but has not entered into an irrevocable commitment to repay the loan within 12 months?

As stated above, the classification to be made is based on the right of the entity at the reporting date. Hence, the loan will still be classified as non-current. However, the entity should make appropriate disclosures regarding its intention to prepay the loan.

As compared to the above, if the entity has entered into a binding agreement with the bank for early settlement before reporting date and the said agreement is irrevocable, the entity no longer has the right to defer settlement for at least 12 months at the reporting date. In such a case, the loan is classified as current.

Settlement of a liability by issue of equity instruments

Prior to the amendments, the standard required that the 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 a result, a convertible instrument where the holder has the option to require convert to equity before maturity or at any time was classified as non-current if the maturity for cash settlement is greater than 12 months.

The amendments have removed the above clause, allowing entities to ignore early equity settlement at the option of the issue to decide the current vs. non-current classification. Rather, the amended standard requires that settlement through issuance of equity shares is also considered as settlement to decide of classification of liabilities as current or non-current. However, there is only one exception if the embedded equity conversion option itself is classified as an equity instrument based on principles laid down in IAS 32 Financial Instruments: Presentation.

How we see it

Many entities have issued convertible instruments which are either non-redeemable or redeemable at the end of a fixed period. However, the holder can opt to convert such instruments into a variable number of equity shares at any time. Earlier, such instruments were classified as non-current liability. Post-amendment, these instruments will be classified as a current liability.

Example

An entity has issued optionally convertible redeemable preference shares (OCRPS). The OCRPS are redeemable after 10 years either generally or if there is no qualified initial public offer (IPO) by the end of 10th year. However, the holder can require the entity to convert OCRPS into equity shares at any time after the issuance date. Consider the following scenarios for the conversion formula:

• Scenario 1: The OCRPS are convertible into variable number of shares decided based on fair value of equity shares at the conversion date.
• Scenario 2: The OCRPS are convertible into a fixed number of shares decided upfront. However, the issuer has down-round protection, which can trigger a change in the number of shares to be issued on conversion if the entity issues new shares at lower than fair value.
• Scenario 3: The OCRPS are convertible into fixed number of shares decided upfront and there is no down round protection or other clause which may change the number of shares to be issued on conversion.

How should the above instruments be classified in the balance sheet for year one to nine?

Response

Prior to the amendments, the 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. Hence, one may argue that in all three scenarios, the holder option to require early conversion was ignored to decided current vs. non-classification. As a result, in the pre-amended standard, one may have classified OCRPS liability as non-current in the balance sheet for years one to nine.

Post amendment, the equity conversion option is ignored only if it is classified as equity under IAS 32. Hence, the below position will apply in the balance sheet for years one to nine:

• Scenario 1: Since the OCRPS are convertible into a variable number of shares decided based on fair value of equity shares at the conversion date, the equity conversion option is liability under IAS 32. Since the issuer can require settlement in variable number of shares at any time, the entire instrument is classified as current liability.
• Scenario 2: Though the OCRPS are convertible into fixed number of shares decided upfront, the number of equity shares to be issued in conversion could change due to the application of down-round protection clause. Considering that the host instrument itself is financial liability, even such conversion option does not meet fixed-for-fixed criterion to classify conversion option as equity under IAS 32. Rather, it is an embedded derivative. Under IFRS 9 Financial Instruments, the issuer entity may either measure the instrument as at fair value through profit or loss (FVTPL) or it can separate embedded derivative to be measured as at FVTPL and the host liability at amortized cost. Irrespective of the accounting followed, the conversion option is not treated as equity under IAS 32. This requires the issuer to classify the entire instrument (either measured as at fair value or liability at amortized cost plus embedded derivative components at fair value) to be classified as a current liability.
• Scenario 3: Since the OCRPS are convertible into fixed number of shares decided upfront and there is no down-round protection or other clause which may change number of shares to be issued on conversion, the conversion option is classified as equity under IAS 32. However, the issuer will classify the host instrument as financial liability. In this case, since embedded conversion option is ignored for deciding current vs. non-current classification. As a result, OCRPS liability is classified as non-current in the balance sheet for years one to nine.

It is obvious that the liability is classified as current in year 10 balance sheet in all the scenarios and both under pre-amended and post-amendment standards.

Disclosures

The amendments require an entity to provide detailed disclosure when a liability arising from a loan agreement is classified as non-current and the entity's right to defer settlement is contingent on compliance with future covenants within 12 months. The disclosures required include:

1. Information about the nature of the covenants, including:
   1. The nature of covenants
   2. When the entity is required to comply with them
   3. The carrying amount of related liabilities
2. If facts and circumstances indicate that an entity may have difficulty in complying with such covenants, those facts and circumstances must be disclosed. For this purpose, disclosures required may include facts such as below:
   1. The entity has acted during or after the reporting period to avoid or mitigate a potential breach
   2. The entity would not have complied with the covenants if they were to be assessed for compliance based on the entity's circumstances at the end of the reporting period

We believe the above disclosures are new for most entities. In the past, these entities were not making similar disclosures as there was no specific requirement and also, some of these entities considered information related to specific covenants to be confidential. Now, considering specific requirement, entities will need to make these disclosures. Consider an entity having a number of loan arrangement and each loan having many covenants. It may need to disclose a long list of covenants. We believe that the first disclosure is required in all cases where (a) loan liability is classified as non-current, and (b) it has one or more covenants requiring compliance in the next 12 months. This is irrespective of the fact that it may not foresee any particular difficulty in compliance.

With regard to the second disclosure, one may argue that the entities need to assess not only compliance up to the reporting date but also future scenario and identify if any difficulties are expected based on information available at the reporting date. If so, the same needs to be disclosed appropriately in the financial statements. In many cases, the disclosure of potential difficulties may imply that the lenders, the creditors and other stakeholders immediately become more cautious, which may pre-pone the potential issues and reduce the chances of mitigating those successfully. To avoid such scenarios, the entities may also want to disclose how they plan to mitigate potential issues. It is important that any such plan disclosure is verifiable and does not result in disclosure of prospective financial information.

Sample disclosure

Secured bank loan

This loan has been drawn down under a six-year multi option facility (MOF). The loan is repayable within 12 months after the reporting date but has been classified as long term because the Group expects, and has the discretion, to exercise its rights under the MOF to refinance this funding. Such immediate replacement funding is available until 31 July 2029. The total amount repayable on maturity is INR3,500 million. The facility is secured by a first charge over certain of the Group's land and buildings, with a carrying value of INR5,000 million (31 March 2024: INR5,000 million).

The secured bank loan is subject to the following covenants:

• Interest cover ratio greater than five. The interest cover ratio in the secured bank loan is calculated as profit before tax divided by interests on debts and borrowings. The interest cover ratio was 11.1 as of 31 March 2025 (31 March 2024: 9.2).
• Gearing ratio below 45%. Gearing ratio is the entity's total debt (i.e., Interest-bearing loans and borrowings other than convertible preference shares) divided by its shareholder's equity. The gearing ratio was 26% as of 31 March 2025 (31 March 2024: 38%).

Both covenants are tested half-yearly as of 30 September and 31 March each year. The Group has no indication that it will have difficulty complying with these covenants.

Position under Ind AS

In the month of December 2022, the ASB of the ICAI has issued an Exposure Draft of proposed amendments to Ind AS 1 on the similar lines. In the Exposure Draft, the ASB has also proposed to remove two Carve-outs, which are explained above and provide some relief on current vs. non-current classification matter, in Ind AS 1 vis-à-vis the corresponding IAS 1. Based on the information available on the ICAI website, it appears that the Council of the ICAI has finalized these changes and submitted to the National Financial Reporting Authority (NFRA) for recommendation to the Ministry of Corporate Affairs (MCA). It also appears that the NFRA has cleared potential amendments to the Ind AS 1 and the final draft is pending with the MCA for notification. From the information available on the Website, whilst it is clear that the NFRA has recommended final amendments to the MCA notification, it is not clear what exactly those changes are. Particularly, it is also not clear that whether the two carve outs have been retained or removed. We believe that these aspects will be clear once final amendments to Ind AS 1 are notified.

It may be noted that the amendments under IAS 1 are applicable for annual periods beginning 1 January 2024. In the past, endeavor of the ICAI, the NFRA and the MCA has been to implement changes under Ind AS from similar dates and have minimal differences vis-à-vis the corresponding IFRS Accounting Standards. Considering the above, it is expected that the MCA may notify amendments on similar lines in a near future and these amendments may be applicable for financial year beginning on or after April 2024. Considering this, it is imperative that the entities evaluate the impact of potential changes and be prepared for implementing once they are notified