In this article, we are going to discuss the current and non-current classification of financial liabilities in the financial statements. Let’s first understand what is financial liabilities and why is the current and non-current classification important?
MFRS 132 Financial Instrument: Presentation defines a financial liability as any liability that is either:
- A contractual obligation to deliver cash or another financial asset to another entity or to exchange financial asset or financial liability with another entity under conditions that are potentially unfavourable to the entity.
- A contract that will or may be settled in the entity’s own equity instruments and is a derivative or non-derivative with certain conditions.
The classification as current and non-current indicates the entity’s ability to meet its obligations as of the reporting date. It provides creditors or potential creditors and financiers some insights on whether to give provide lending to the company.
The principles for classification of financial liabilities
Paragraph 69 of MFRS 101 Presentation of Financial Statements requires an entity to classify financial liabilities as current when:
- it expects to settle the liability in its normal operating cycle (paragraph 69(a));
- it holds the liability primarily for the purpose of trading (paragraph 69(b));
- the liability is due to be settled within twelve months after the reporting period (paragraph 69(c)); or
- 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 (paragraph 69(d)).
However, the International Accounting Standards Board (“IASB”) issued the amendments to paragraphs 69 to 76 of IAS 1 Presentation of Financial Statements. Following that, the Malaysian Accounting Standards Board (“MASB”) also adopts the same amendments for MFRS 101. The effective date of amendments are 1 January 2023, similar to the effective date of IAS 1 amendments. Take note that MFRS is converged with the International Financial Reporting Standards (“IFRS”).
This effective date is after a deferment by a year following the COVID-19 pandemic. Because of the deferment, companies will have more time to assess the impact of the amendments to their financial statements.
How will the classification of financial liabilities change?
The amendments made to IAS 1 are as follows:
1. Existence of the right to defer settlement of financial liabilities
The amendments to paragraph 69(d) of IAS 1 which emphasise that the right to defer the settlement of liabilities must exist at the end of the reporting date.
2. Right to defer financial liabilities must have substance
IASB has also included a new paragraph 72A. The paragraph states that the right exists at the end of the reporting date must also have substance.
3. Compliance with conditions for a right to exist at the reporting date
The new paragraph 72A further emphasise the need of an entity to comply with the specified conditions at the end of the reporting period if the right to defer settlement is subject to those conditions. This is regardless of whether the lender will only test such compliance to the specified conditions at a later date.
4. Management intention to exercise its right
The amendments also introduce a new paragraph 75A. The paragraph clarifies that the likelihood of the management to exercise its right to defer settlement of the liability for at least twelve months after the reporting period will not affect the classification of current and non-current liabilities.
For example, if a liability meets the criteria to be classified as non-current, such classification does not change, even if the management intends to settle the liability within 12 months after the reporting period. However, the new paragraph 75A further states that disclosure on the timing of settlement may be necessary. This is to inform users of financial statements of such fact.
5. Classification of settlement
In the amendments, the IASB has also included a new paragraph 76A to explain or clarify the word “settlement” to classify a liability as current or non-current. This could either be through the transfer of cash or other economic resources to the counterparty or transfer of the entity’s own equity instruments, with an exception in the newly added paragraph 76B.
How does the amendments affect you?
The amendments to MFRS 101 require you to re-visit or re-consider your existing classification of financial liabilities. Entities must also determine and assess the impact of the amendments on the presentation of financial liabilities in the financial statements.
Some of the considerations to focus on are:
- There is no further guidance and explanation of how an entity would know whether such a right has substance. As such, entities apply their judgments to determine whether the right to defer has a substance. Additionally, if this judgment is significant, entities must consider whether a disclosure in the financial statements is necessary.
- Entities can no longer classify their financial liabilities based on management intention. If previously management had classified its liabilities based on management intention, this can no longer continue under the new amendments. In fact, entities must consider whether a re-statement is necessary for the comparative numbers.
- If your company has a rollover credit facility and it is classified as current, the amendments may or may not change such classification. Rollover facility may come with specific conditions or covenants that an entity may need to meet be able to rollover. Often times, financier will only test these covenants post reporting period. Under the new amendments, these covenants must be tested for compliance and met as at the reporting date. This is regardless whether the financier will only test them later.
- If a change in the classification of financial liabilities is required in the light of the amendments, such change must be applied retrospectively in accordance with MFRS 108 Accounting Policies, Changes in Accounting Estimates and Errors. And because it is a retrospective application, the comparative reclassification is also required.
The full version of the amendments are available at Malaysian Financial Reporting Standards (MFRSs) page on the MASB website.