Current/noncurrent classification of liabilities: IAS 1 amendments

Under legacy IAS 1¹, a company classified a liability as current unless, among other things, it had an unconditional right to defer settlement of the liability for at least 12 months from the reporting date. This requirement resulted in diversity in practice, making it difficult for users to understand and compare financial statements.

The IAS 1 amendments remove the requirement that the right to defer settlement be unconditional; instead, now the right has to have substance and must exist at the reporting date.

A company classifies a liability as noncurrent if it has a right to defer settlement for at least 12 months after the reporting date. The right may be subject to the company complying with conditions (covenants) specified in a loan arrangement. Only covenants that the company must comply with on or before the reporting date are relevant to the classification analysis, even if compliance with the covenants is assessed only after that date. Covenants that the company must comply with after the reporting date (i.e. future covenants) do not affect a liability’s classification at that date. 

Under the IAS 1 amendments, the classification of liabilities is unaffected by management’s intentions or expectations about whether the company will exercise its right to defer settlement or will choose to settle early. The requirement for a company to have discretion to roll over the obligation has also been removed. In our view, under the amendments, a roll-over facility and a term loan with similar terms have the same classification outcome as further illustrated below. 

Example : term loan vs roll-over facility

New disclosure requirements

Under the IAS 1 amendments, when noncurrent liabilities from loan arrangements are subject to future covenants, a company now needs to disclose information in the notes to help users of financial statements understand the risk that those liabilities could become repayable within 12 months after the reporting date.

The following new disclosures about covenants are required:

• Information about the covenants – e.g. nature of the covenants and when the entity is required to comply with them. 
• The carrying amount of related liabilities.
• Facts and circumstances, if any, that indicate the company may have difficulty complying with the covenants within the next 12 months of the reporting date – e.g. actions taken by the company during or after the reporting period to avoid or mitigate a potential breach, or the fact that the covenants would have been breached if assessed for compliance based on the company’s circumstances at the reporting date (i.e. based on a hypothetical test at the reporting date).

A liability can be settled not only by the transfer of cash or other financial instruments, but also through the transfer of goods or services or equity instruments. When a liability includes a counterparty conversion option that involves a transfer of the company’s own equity instruments (i.e. convertible debt), the conversion option is recognized as either equity or a liability separately from the host liability under IAS 32²_.

The IAS 1 amendments clarify that when assessing if the host liability should be classified as current or noncurrent, the company can ignore conversion options that are recognized as equity. This means that:

• When the conversion option is recognized as equity, the host liability is classified as current or noncurrent based on its contractual maturity, without considering the possible transfer of the company’s own equity to early settle the debt. This applies to situations where a fixed amount of debt is convertible into a fixed number of shares (i.e. the IAS 32 ‘fixed-for-fixed’ criteria is met).
• When the conversion option is a derivative liability, the host liability is classified as current if the holder may convert to equity within 12 months of the reporting date. Such instruments include bonds with holder conversion options that are separated as an embedded derivative from the host liability, and instruments that mandate settlement in a variable number of equity instruments.

This may represent a significant change for some companies, because under legacy IAS 1 practice was mixed.   

Example : foreign currency convertible bond 

• A foreign currency convertible bond will mature on December 31, 2027.
• The holder has the option to convert the bond into a fixed number of the company's ordinary shares at any time before maturity.
• Because the bond is in foreign currency, its carrying amount in functional currency is not fixed. Therefore, the conversion option fails the 'fixed-for-fixed' criteria and cannot be recognized as equity. Instead, it is an embedded derivative recognized separately from the host liability. 

At the reporting date (December 31, 2024), the host liability is classified as current, for the following reasons.

• The transfer of the company's own equity instruments is a form of settlement. 
• Because the holder has an option to convert the host liability into the company's own equity instruments at any time before maturity, the company does not have the right to defer settlement for at least 12 months from the reporting date.

The derivative liability is also classified as current.

The IAS 1 amendments introduce new requirements into the current versus noncurrent classification of liabilities, which could change practices and the overall layout of the balance sheet with potential ripping effect on related ratios. Companies need to revisit their loan arrangements now to reconfirm the appropriate classification and prepare to provide new disclosures about certain covenants.

Further, some of the existing differences with US GAAP remain post-amendments – e.g. how subsequent events, such as covenant breaches and waivers, are factored in the analysis. But new differences have also appeared. For more on this topic read KPMG article, Current/non-current debt classification: IFRS® Accounting Standards vs US GAAP . 

^[1] IAS 1, Presentation of Financial Statements 

^[2] IAS 32, Financial Instruments: Presentation