Balance Sheet Classification of Callable Debt Obligations

ASPE 1510 Current assets and current liabilities provides guidance for the classifications of assets and liabilities on the balance sheet.  A common issue is the classification of demand loans and callable debt.

Term Demand Loans

Many clients obtain financing (including term financing) in the form of a demand loan, with agreed repayment terms. The loan agreements for such loans usually contain debt covenants and collateral so that the loan is, in economic substance, a term loan with a floating interest rate. The agreements usually also contain a unilateral demand feature.  ASPE 1510.13 provides the following guidance:

Non-current classification of debt is based on facts existing at the balance sheet date rather than on expectations regarding future refinancing or renegotiation. If the creditor has at that date, or will have within one year (or operating cycle, if longer) from that date, the unilateral right to demand immediate repayment of any portion or all of the debt under any provision of the debt agreement, the obligation is classified as a current liability unless:

1. the creditor has waived, in writing, or subsequently lost, the right to demand payment for more than one year (or operating cycle, if longer) from the balance sheet date;
2. the obligation has been refinanced on a long-term basis before the balance sheet is completed; or
3. the debtor has entered into a non-cancellable agreement to refinance the short-term obligation on a long-term basis before the balance sheet is completed and there is no impediment to the completion of the refinancing

In examining the exceptions above one should be very cautious about how they are worded.  For example, the first exception states that the creditor has waived, in writing, their right to demand payment.  This is not the same as a declaration of intention, written or otherwise, that they don’t intend to call the loan.  In other words, the creditor has to lose the right to demand repayment within one year.

Mortgages and Long-Term Debt - Refinancing

Long term debt is typically classified as such with only the portion of the repayments due within the next twelve months being classified as current.  However, there are situations where this is not the case.  If we re-examine ASPE 1510.13 (b) an exception to current classification is that the obligation has been refinanced on a long-term basis before the balance sheet is completed. In practice, many lenders will only enter into a commitment 90 days before the due date of the debt; thus many borrowers with long-term debt falling due late in their fiscal year will be required to reclassify their entire debt as current on each anniversary of the due date.

Covenant Violations

Most forms of long-term financing from major banks and lending companies come with covenants that allow for the debt to be called when the covenants are breeched.  ASPE 1510.14 provides guidance:

Long-term debt with a measurable covenant violation is classified as a current liability unless:

1. the creditor has waived, in writing, or subsequently lost, the right, arising from violation of the covenant at the balance sheet date, to demand repayment for a period of more than one year from the balance sheet date; or
2. the debt agreement contains a grace period during which the debtor may cure the violation and contractual arrangements have been made that ensure the violation will be cured within the grace period;

and a violation of the debt covenant giving the creditor the right to demand repayment at a future compliance date within one year of the balance sheet date is not likely.

Another matter to keep in mind with debt covenants other than the classification of the liability is the disclosure requirements.  These requirements are not included in ASPE 1510 but rather in ASPE 3856 Financial Instruments. ASPE 3856.46 provides the relevant guidance:

For financial liabilities recognized at the balance sheet date, an entity shall disclose:

1. whether any financial liabilities were in default or in breach of any term or covenant during the period that would permit a lender to demand accelerated repayment; and
2. whether the default was remedied, or the terms of the liability were renegotiated, before the financial statements were completed.

So it is important to note that covenant breeches that occurred during the year but were remedied before the end of the year also need to be disclosed.

Related Party Loans

Lastly, it is important to note that all of the above guidance is applicable regardless of who the creditor is.  Therefore, related party loans fall under the same requirements. Most related party loans have no underlying agreements and thus no repayment terms.  In lieu of this one has to assume that the related party can demand repayment at any time thus triggering the current classification requirement.  If long-term classification is desired than one of the exceptions noted above in ASPE 1510.13 needs to be in place.  The most common is the waiver and the same guidance applies, it needs to be a waiver of legal right to collect the balance and not a declaration of intention.