Entities may have to reclassify their borrowings at 31 December 2024 – Part 5

New rules for classifying liabilities as current or non-current commence for annual periods beginning on or after 1 January 2024. One of the most complex areas of the new rules relates to entities classifying loan arrangements with loan covenants.

The following diagram summarises whether loan covenants will affect the classification of your loan arrangements (IAS 1 Presentation of Financial Statements, paragraph 72B):

To classify a loan as a non-current liability at the reporting date, it must meet any loan covenant test required on or before the end of the reporting period.

If the entity breaches a loan covenant before the reporting date such that the loan becomes repayable on demand, the loan would be classified as either:

• A current liability because the borrower does not have a right to defer settlement, or
• A non-current liability if the entity obtains, before the end of the reporting period, a waiver for the breach, or a period of grace whereby the borrower agrees not to demand repayment for at least twelve months after the end of the reporting period. Please refer to our previous article, which explains the difference between a waiver and a period of grace in more detail.

Flow chart

Our publication includes a flow chart to help you determine the appropriate classification of a loan arrangement with loan covenants.

Example E(I) – Cross-default liabilities

Entity A has two term loans from Bank B – Term Loan I and Term Loan II.

Term Loan II requires Entity A to meet a working capital covenant at the end of the annual reporting period.

If Entity A fails to meet the loan covenant for Term Loan II, Bank B has the right to demand immediate repayment for both Term Loan I and Term Loan II.

Analysis

The assessment for cross-default liabilities would be similar to that of other loan arrangements. The conclusion as to the classification of the loan would apply to all the loans covered by the cross-default terms, unless there are other terms applicable to any one or more particular loans in the group of loan arrangements.

Example E(II) – Multiple covenant breaches and waivers

Entity A has a term loan from Bank B. The loan is repayable after five years. The loan arrangement includes a working capital ratio test at the end of the annual reporting period i.e. 31 December and at every calendar quarter (March, June, September). If Entity A fails to meet the quarterly covenant, Bank B has the right to demand immediate repayment of the loan until the next covenant test.

The following facts are relevant:

• The covenant tests for the 20X1 year were not met for the March, June and September quarters. However, for each breach, Bank B waived its right to demand repayment until the next quarterly covenant test.
• The 31 December 20X1 covenant test was met.
• Entity A does not expect to meet the covenant test for March 20X2.

Analysis of classification as at 31 December 20X1

We use the flow chart above to assess whether the term loan is classified as a current or non-current liability as at 31 December 20X1.

	Answer
Question 1: Does the liability arise from a loan arrangement?	Yes
Question 2: Is the loan scheduled to be repaid within the next 12 months?	No
Question 7: Is the entity required to comply with a covenant on or before the end of the reporting period, with failure to comply resulting in the lender having the right to demand immediate repayment? Note: If the covenant test was waived prior to the point at which the covenant was to be tested, answer ‘NO’.	Yes The covenant test was not waived prior to the covenant being tested.
Question 8: Did the entity comply with the covenant?	Yes
Question 9: Has the lender provided a waiver for the covenant violation by the end of the reporting period?	N/A
Question 10: Has the lender provided a period of grace for the covenant violation by the end of the reporting period?	N/A
Question 11: Is the period of grace ending at least 12 months after the reporting period?	N/A
Classification	Non-current liability

The multiple covenant breaches and waivers received for the March, June and September quarters do not affect the classification of the loan as current or non-current as at 31 December 20X1. The anticipated covenant breach of the future covenant test in March 20X2 is also not relevant to the classification of the loan as at 31 December 20X1 (IAS 1.72B(b)).

Example E(III) – Two-stage covenant test

Entity A has a loan which provides for a covenant test to be performed semi-annually on 30 June and 31 December. The covenant requires Entity A to have an interest coverage ratio of at least 8.

If the covenant is not met:

• Entity A is required to deposit cash in a designated bank account within one month.
• The amount of cash required to be deposited is the amount, which, if added to the net income, would result in the interest coverage ratio being at least 8.
• If the cash is not deposited in the bank account within a month, the bank obtains the right to demand immediate repayment of the loan.

As at 31 December 20X1, Entity A's interest coverage ratio is 6. Therefore, the first covenant is not met. Entity A has sufficient funds to deposit in the designated bank account by 31 January 20X2.

Analysis of classification as at 31 December 20X1

Analysis:

In this case, the covenant is tested in two stages:

• Stage 1 is the test of the interest coverage ratio, which was breached before the end of the reporting period
• Stage 2 is the requirement to deposit cash in a designated bank account. The due date for compliance with this requirement is after the end of the reporting period.

IAS 1 does not provide any specific requirements for such cases.

Disclosure about standards issued that are not yet effective

We remind entities preparing Tier 1 general purpose financial statements of the requirement to disclose and quantify the impact of new and amending standards that will take effect in a later period. Entities with loan arrangements subject to loan covenants will have to assess the implications of the IAS 1 changes on their borrowings and disclose the effect on the comparative and opening balance sheets for reporting periods starting before 1 January 2024.

Year-end	First-time application	Comparative restatement	Opening balance sheet
31 December	31 December 2024	31 December 2023	1 January 2023
31 March	31 March 2025	31 March 2024	1 April 2023
30 June	30 June 2025	30 June 2024	1 July 2023
30 September	30 September 2025	30 September 2024	1 October 2023

More information

For more information on this topic, please look at our new publication or listen to our recent webinar, which provides further explanation and examples.

Need help?

Classifying loan arrangements and other liabilities as current or non-current may be complex, particularly when they involve roll overs and covenant tests. Please contact our IFRS & Corporate Reporting team for help.