1. Opinion required regarding waiver for Financial Covenants

Enquiry: 

Background:

An entity ‘A’ has a long term loan from commercial bank for tenure of 5 years. Payments are to be made in semi-annual installments of equal amount. However, as per the loan agreement between the bank and the Company, the Company is required to maintain certain financial ratios, say a current ratio of 0.6 at the end of the year ending 31 December 2011.

Scenario:

Before the year-end 31 Dec 2011, the Company, keeping in view its statement of financial position, requested the Bank to waive off the requirement of meeting the current ratio and defer it until Dec 2012. The Bank, after due verification of the Company’s status and its future projections, waives the requirement and communicates it to the Company on 05 January 2012 (after year end).

Quote from the Bank letter:

“The Bank has waived the Company’s requirement to meet its current ratio of 0.6 effective from 31 December 2011….”

 Quote from IAS 1 para 74:

When an entity breaches a provision 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 authorisation 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 an unconditional right to defer its settlement for at least twelve months after that date.

Another view:

The Bank has not deferred payment as a consequence of the breach (as mentioned above). Rather, the Bank has waived the requirement of meeting the ratio. There was no breach of the loan covenant at the year end, and thus para 74 is not applicable.

he Bank agreeing after the reporting period is simply because of their verification exercise, the proceedings for the same has already begun before the year end.

In view of the above, the Company was not required to meet the ratio at the year end. Waiving the requirement effective from 31 Dec 2011 means that such covenant was not applicable. Hence the loan can be classified as long term with its current maturity under short term.

Is the Company still required to classify its long term liability into short term on account of the above situation?

Opinion: 

The Committee considered your query and from the information provided to us, we understand that the breach of specified “current ratio” limit constitutes an event of default of covenants in your instance. Accordingly, the Committee is of the view that since at the date of balance sheet the bank has not waived the covenant of maintaining “current ratio” at specified limits, the company would need to reclassify the debt from “Non-current” to “Current”.

(August 29, 2013)

2.Accounting Treatment regarding the Presentation of Accrued Network Liabilities to be financed by Long-Term Loans

Enquiry:

Our Company is engaged in the business of providing cellular mobile telephonic services in Pakistan. It is in the stage of expansion, therefore is making heavy investment in network procurement. To comply with the relevant accounting standards we have to capitalize our network under property plant and equipment upon completion of certain milestones by the vendor. The complex and technical nature of our network results in a considerable amount of time lag between the capitalization and final payments to the vendor therefore for capitalization we accrue the differential between total contract amount and total amount paid up to the date of capitalization. The amount thus accrued appears under current liabilities.

We seek the Institute’s advice whether this amount can be disclosed under long-term liability. This we feel can be allowed (ref: para 64 of IAS 1) as this liability will be paid off through long term financing specifically obtained for procurement of network, the facility for which is already in place on the reporting date, though not yet drawn out.

 

Opinion:

The appropriate Committee of the Institute would like to point out that paragraph 64 of IAS 1 does not appear to deal with the query raised by you as that paragraph relates to re-financing or rolling over of an obligation.

The provisions of IAS 1, which deal with your query, are contained in paragraph 60 as reproduced below: –

60. A liability shall be classified as current when it satisfies any of the following criteria:

(a)It is expected to be settled in the entity’s normal operating     cycle;

(b) it is held primarily for the purpose of being traded;

(c) it is due to be settled within twelve months after the balance sheet date; or

(d) the entity does not have an unconditional right to defer  settlement of the liability for at least twelve months after the balance sheet date.

All other liabilities shall be classified as non-current.

As your obligation to pay your vendors appears to fall under the purview of the above-mentioned paragraph, therefore, it cannot be treated as a long-term liability. It is immaterial how this liability is settled which has no relevance to the nature of liability.

(July 2, 2005)