CLASSIFYING LONG-TERM DEBT AS CURRENT LIABILITIES: THE IMPORTANCE OF LOAN CONTRACT CLAUSES
There is some questioning in practice as to whether or not a long-term debt should be classified as a current liability when an entity applies the accounting standards for private enterprises (ASPE) in Part II of the French GAAP. CPA Canada Handbook – Accounting. Classification as current liabilities is particularly common for long-term debts that are due on demand (despite the fact that they are repayable over several years), as well as for long-term debts that can be renegotiated within the next financial year.
Note that the provisions of paragraph .13 of chapter 1510, Current assets and liabilitiesIn addition to the above, ASPE clearly states that the classification of a debt as a current or non-current liability is based on the facts established at the balance sheet date, and not on expectations of future refinancing or renegotiation. In other words, if the creditor is entitled to demand repayment of a debt, either at the balance sheet date or within one year of the balance sheet date, the debt must be recognized as a current liability on the entity’s balance sheet, even if it is clear that the creditor does not intend to demand repayment in the short term, or will renew the loan within the next financial year.
Long-term debt is therefore frequently classified as a current liability in the following situations:
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Long-term debt is due on demand: the credit facilities of financial institutions (especially chartered banks) very often include a contractual provision giving the financial institution the right to demand repayment of long-term loans on demand1. In other words, the bank reserves the right to demand repayment of its loans at any time, even if the scheduled repayments are spread over several years. Although this is a frequent practice on the part of financial institutions, it is often overlooked by practitioners, as bank confirmations do not necessarily indicate this information.
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Long-term debt is renewable within one year of the balance sheet date: when renewing a long-term loan (for example, a mortgage amortized over 20 years, renewable after 5 years), the financial institution generally has the right, at the end of the 5-year term, to terminate the credit facility and demand repayment of the loan, even though it is virtually certain that it will proceed with renewal.
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Long-term debt is in breach of the loan agreement at the balance sheet date: sometimes a covenant in a long-term loan is breached at the balance sheet date, giving the creditor the right to demand repayment of the long-term loan on demand.
In the three situations described above, long-term debt must be classified in its entirety as a current liability on the balancesheet2.
However, in either of these situations, the entity will not have reclassify a long-term debt as a current liability if, between the balance sheet date and the date of finalization of the financial statements, the creditor has waived in writing its right to demand repayment of the debt for a period exceeding one year, or if the debt has been refinanced on a long-term basis3.
Practitioners therefore need to be careful when determining where to classify long-term debts on an entity’s balance sheet, as many of them have characteristics that dictate that they should be classified in their entirety in the current portion of the balance sheet.
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1 Rather than containing provisions to this effect in the loan contract itself, some long-term repayable loans are sometimes accompanied by a promissory bill, payable on demand, appended to or separate from the contract.
2 The appendix to Section 1510, Current Assets and Current Liabilities, of ASPE provides an interesting example of how to present a debt repayable on demand.
3 Paragraphs .13 and .14 of Section 1510, Current Assets and Current Liabilities, of the ASPE contain specific provisions to this effect.
1 Rather than containing provisions to this effect in the loan contract itself, some long-term repayable loans are sometimes accompanied by a promissory bill, payable on demand, appended to or separate from the contract.
2 The appendix to Section 1510, Current Assets and Current Liabilities, of ASPE provides an interesting example of how to present a debt repayable on demand.
3 Paragraphs .13 and .14 of Section 1510, Current Assets and Current Liabilities, of the ASPE contain specific provisions to this effect.
This article appeared in: Bulletin CPA |
Classification of long-term debt as current liabilities: the importance of loan agreement clauses
| November 12, 2013
Classification of long-term debt as current liabilities: the importance of loan agreement clauses
| November 12, 2013
