United States

Fundamentals of Debt Classification

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The current economic environment is forcing many borrowers to take a fresh look at the factors that led them to classify their debt as either current or noncurrent when preparing a classified balance sheet. Seemingly straightforward debt agreements sometimes contain terms that can cause surprising classification issues. Furthermore, with the increased frequency of covenant violations in the current economic environment, both the terms and the form of any covenant waivers require careful analysis by borrowers to determine whether and how such waivers should affect the classification and disclosure of the related debt. A few of the more common issues and factors to consider when determining the appropriate classification of debt include the following: 

  • If a debt covenant has been violated at the balance-sheet date and a waiver has been obtained from the lender for this violation, how is the underlying debt classified? 
  • How does a subjective acceleration clause affect the classification of the underlying debt? 
  • When the lender requires the borrower to have a lock-box arrangement in connection with a revolving credit agreement, how does that arrangement affect the classification of any borrowings under the revolver? 
  • How does a due-on-demand clause affect the classification of the underlying debt? 
  • How does expected long-term refinancing affect the classification of what would otherwise be considered a short-term obligation? 

Proper classification of debt as current or noncurrent is important for a variety of reasons. For example, debt covenants often involve measures that are affected by the current or noncurrent classification of debt (e.g., working capital). As such, properly classifying debt as current or noncurrent could affect a borrower’s assessment of whether it has violated its debt covenants. 

We have prepared a white paper, Fundamentals of debt classification,  which summarizes the relevant guidance in the Codification and provides numerous examples of how to apply the relevant guidance.

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