Ind AS Loan Covenant Classification – Non-Current vs Current

1. Question

Sunbeam Technologies Limited (hereinafter referred to as “the company”) had taken a long-term loan from a financial institution. During the year ended 31 March 20X1, the company failed to meet a loan repayment obligation, resulting in a technical breach of the loan covenant. However, before the year-end, the lender waived the breach and imposed a new condition requiring the company to sell a particular division by 31 March 20X1. Additionally, the lender provided a grace period of two months, extending the final compliance deadline to 31 May 20X1.

As of the balance sheet date (31 March 20X1), the company had not been able to find a buyer for the division. However, since the extended compliance date (31 May 20X1) had not yet passed, there was no breach as of the reporting date. The company classified the borrowings as non-current in its financial statements for the year ended 31 March 20X1.

State whether the classification of borrowings as non-current in the financial statements for the year ended 31 March 20X1 appropriate as per the applicable provisions of Indian Accounting Standards (Ind AS)?

2. Relevant Provisions

Ind AS 1, Presentation of Financial Statements

Para 69(d) – An entity shall classify a liability as current when it does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period. Terms of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification.

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.

Ind AS 10, Events after the Reporting Period

Para 3 – The following terms are used in this Standard with the meanings specified:

Events after the reporting period are those events, favourable and unfavourable, that occur between the end of the reporting period and the date when the financial statements are approved by the Board of Directors in case of a company, and, by the corresponding approving authority in case of any other entity for issue. Two types of events can be identified:

(a) those that provide evidence of conditions that existed at the end of the reporting period (adjusting events after the reporting period); and

(b) those that are indicative of conditions that arose after the reporting period (non-adjusting events after the reporting period).

Notwithstanding anything contained above, 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 agreement by lender before the approval of the financial statements for issue, to not demand payment as a consequence of the breach, shall be considered as an adjusting event.

Para 21 – “If non-adjusting events after the reporting period are material, non-disclosure could influence the economic decisions that users make on the basis of the financial statements. Accordingly, an entity shall disclose the following for each material category of non-adjusting event after the reporting period:

(a) the nature of the event; and

(b) an estimate of its financial effect or a statement that such an estimate cannot be made.”

3. Analysis

In general, the classification of liabilities as current or non-current at the end of a reporting period is a critical aspect of financial reporting, as it directly affects users’ understanding of an entity’s liquidity position and its ability to meet obligations. Ind AS 1 requires that an entity classify liabilities based on whether it has an unconditional right to defer settlement for at least twelve months after the reporting period. At the same time, Ind AS 10 governs the treatment of events that occur after the reporting period but before the approval of financial statements.

In this case, although the company initially breached the loan covenant by failing to make a scheduled payment, the lender formally waived this breach prior to the reporting date, thereby preventing the liability from becoming immediately repayable. The waiver came with a revised covenant requiring the Company to sell an operation by 31 March 20X1, with a grace period extending up to 31 May 20X1.

As of the reporting date, there was no breach, and the lender had not demanded repayment. Thus, the company had the right to defer settlement of the borrowing for more than twelve months. The condition for future covenant compliance was still pending and within the grace period, and therefore, the Company’s classification of the loan as non-current aligns with the principles of Ind AS 1.

However, by the time the financial statements are approved for issue, the Company still had not found a buyer, thereby putting it at risk of failing to meet the revised covenant. This development qualifies as a non-adjusting event under Ind AS 10 since the potential breach had not occurred as of 31 March 20X1, and the condition had a future testing date.

Since this event is material and may impact future liquidity and compliance, it requires disclosure under Ind AS 10.

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