Condoning loan breaches

A 5-year loan has covenants that are breached at year-end making it payable on demand. Management made the bank aware of the breach before year-end and managed to get a letter from them to confirm that the loan will not be called on… only problem is, the letter was only dated and received post year-end.

Both IFRS and IFRS for SMEs requires liabilities to be accounted for as current when the company does not have a right at the end of the reporting period to defer settlement for at least 12 months after year-end (SMEs refers to an ‘unconditional right’).

If a company has breached its loan covenants at year-end then they do not have a right to defer payments for more than 12-months after year-end at that time. It must therefore classify its 5-year loan as a current loan in the statement of financial position.

The fact that the bank condones the breach and confirms that it will not call on the loan for at least 12 months thereafter after year-end and before the financial statements are authorised for issue is not considered an adjusting event.

An adjusting event is an event that occurs after year-end and before the financial statements are authorised for issue that provides evidence of conditions that existed at the end of the reporting period (IFRS and IFRS for SMEs). The bank only condoned the breach after year-end, the company only received that right to defer payment beyond 12 months at that date.

IFRS has made the IASB’s stance on this very clear through the inclusion of paragraph 74 of IAS 1 which says: “When an entity breaches a condition of a long-term loan arrangement on or before the end of the reporting period with effect that the liability becomes payable on demand, it classifies the liability as current, even if the lender agreed, after the reporting period and before the authorisation of the financial statements for issue, not to demand payment as a consequence of the breach.”   While this explicit statement is not included within the IFRS for SME standards, there is supporting material provided for Section 4 which includes two examples explaining that if the bank formally agrees not to demand early repayment of the loan after year-end the company does not have an unconditional right to defer payment at year-end and it must therefore be classified as current.

The question is always the same: Does the company have a(n) (unconditional) right at period end to defer payments for more than 12 months thereafter?

If the answer is a ‘no’, or in doubt, it should probably be classified as current.

Once the confirmation is received from the bank the loan becomes non-current again (depending obviously what terms the bank includes in the condonation) and this should be included as a subsequent event in the financial statements.

Companies do not like this conclusion and often fight it, the standards are, however, very clear on the matter and must be applied. The matter is not up for debate.

Author:

Justine Combrink, Partner

13 April 2023