This article has been updated and was originally published on April 25, 2020.
Most entities are required to prepare a classified balance sheet in which assets and liabilities are presented as current or noncurrent. Current liabilities include those other liabilities that are expected to be paid (i.e., liquidated) within a relatively short period of time, usually 12 months (or, if longer, the entity’s operating cycle). However, seemingly straightforward debt agreements sometimes contain terms that can cause surprising classification issues. Furthermore, when dealing with debt covenant violations, 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.
Our white paper, Fundamentals of debt classification, summarizes the relevant guidance in the Codification and provides numerous examples of how to apply the relevant guidance.
