At the reporting date, a company has an outstanding bank loan repayable in 18 months. The loan agreement contains a covenant that entitles the lender to demand immediate repayment if breached, and the company was in breach of that covenant at the reporting date. No waiver had been obtained from the lender on or before the reporting date. Under IAS 1, how should the loan be classified in the statement of financial position?
- As non-current, because the loan's original contractual maturity is 18 months from the reporting date
- As non-current, provided management believes it is probable the lender will not demand repayment
- As current, because the company did not have an unconditional right to defer settlement for at least twelve months from the reporting date
- Split between current and non-current based on the likelihood-weighted probability of the lender calling the loan
Why C? And why not the others?
Correct answer: C. As current, because the company did not have an unconditional right to defer settlement for at least twelve months from the reporting date
IAS 1 requires a liability to be classified as non-current only if the entity has the right, at the end of the reporting period, to defer settlement for at least twelve months after that date; all other liabilities are classified as current. A covenant breach at the reporting date, with no waiver in place on or before that date, means the right to defer settlement did not exist at the reporting date — the lender is entitled to demand immediate repayment — so the loan must be classified as current regardless of what happens afterward. The option relying on the original 18-month contractual maturity ignores that the covenant breach overrides the original repayment schedule by giving the lender an immediate demand right at the reporting date itself. The option relying on management's belief that the lender probably will not call the loan is wrong because IAS 1's test is the existence of an unconditional contractual right at the reporting date, not management's expectations about counterparty behaviour. The option proposing a probability-weighted split invents a mechanism IAS 1 does not use for this scenario; classification of the loan is a binary current/non-current determination based on the contractual right that existed at the reporting date, not a proportional allocation.
Source: IAS 1 Presentation of Financial Statements, paragraphs 69, 72A–76 (classification of liabilities as current or non-current; effect of covenant breaches)