Almost every loan agreement will be carrying some of the terms and conditions that are required to be fulfilled by a borrower to keep that loan continue as per the agreed terms OR an immediate re-payment might be initiated which can end the relationship related to the debt.
Often these terms are e.g. agreed debt /equity ratio, capital expenditures, default in payments etc. However, there is nothing to be done in terms of accounting treatment under current system that is being followed before adopting Ind AS as per the roadmap suggested by MCA.
Now, After the applicability of Ind AS/ IFRS, the situation will be different and whenever such breach of covenants happens, the classification of such liabilities might change which will eventually affect the ratios and balance sheet strength for sure.
Let's have a quick look at the relevant references for such requirements-
Ind-AS 1 - Presentation of Financial Statements
Para-74 -Where there is a breach of a material provision of a long-term loan arrangement on or before the end of the reporting period with the effect that the liability becomes payable on demand on the reporting date, the entity does not classify the liability as current, if the lender agreed, after the reporting period and before the approval of the financial statements for issue, not to demand payment as a consequence of the breach,
Para-75- However, an entity classifies the liability as non-current if the lender agreed by the end of the reporting period to provide a period of grace ending at least twelve months after the reporting period, within which the entity can rectify the breach and during which the lender cannot demand immediate repayment.
Now,
After reading the clauses as above, it is clear that in case any material covenant will be breached by a borrower relating to its long-term loan, then the loan will be treated as immediate payable and accordingly it will be re-classed from non-current to current liability subject to the cases where lender itself agree not to demand the loan in next 12 months.
There are certain areas which are worth to be noted from the definition as mentioned above in order to understand the implications of the clause in terms of the treatment in financial statements.
i. Standard is highlighting the word "material provisions" which is to be defined by an Entity according to its loan agreements and to be understood in order to distinguish from what is not material and what should not be considered. Many cases were immaterial or non-significant clauses will not trigger for repayment and hence normally will not be considered for immediate repayments and that is the reason the "material provisions" has been used in definition,
ii. Each and every time any such LONG TERM loan is being agreed/ signed by an Entity will required to be documented its processes to capture all such material covenants which needs to be fulfilled/ complied in order to ensure the compliance of such clause and hence should be kept in a way so that it can be audited (externally or internally) properly,
iii. The implication of such definition would be significant because it will change long term liability into CURRENT LIABILITY and will affect ratios of the balance sheet,
iv. The definition talks about the requirement where such classification will not change in case a lender agrees not to demand the loan repayment within next 12 months. But the process should be completed before the approval of financial statements,
v. One needs to be careful about the clause as mentioned above and should not see a chance to avoid such re-class from non-current to current merely by taking a consent from the lender because this should actually have happened and the consent possibly be in writing and to be reviewed/ agreed with external auditors accordingly. There might be significant consequences in case such consent will not be fulfilled in next 12 months it might be considered for restatements of financial statements in coming years,
vi. The period from the end of financial reporting date till it's approved by board will be used to get consent from the lender in order to avoid such reclassifications,
vii. From an auditor perspective, it will be crucial to verify all such material covenants and document in the audit-work papers in order to satisfy "true & fair" view of the balance sheet because falling into such verification might distort the whole picture of the balance sheet and its ratios,
viii. Anything which might be used to satisfy the creditors / lenders to provide their consent should be reviewed carefully as there might be some transactions that would have done which might require post balance sheet event accounting,
ix. As this clause has been brought into very specifically in the standards, hence just to get a management representation letter about the compliances of all loan covenants will not work and hence external auditors might require to deal with this more proactively and documented it's all resolutions properly,
Readers will appreciate about the main objective of the standard and an approach which one can follow while keeping in mind the basis of the origin of such requirements. There could possibly be some specific situations or circumstances where the interpretation of any standard will be different as we should always keep in mind that IND-AS is principle-based standards and lot more areas need management judgment in line with the standards relevant interpretation and best practices.
One has to look into all related facts and patterns before concluding this type of assessment based on this concept. Readers are requested not to take this article as any kind of advice (it is not exhaustive in nature) and should evaluate all relevant factors of each individual cases separately.
The author can also be reached at anuj@gyanifrs.com
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