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Amended Standard to Be Issued for Classifying Debt

The FASB agreed to amend U.S. GAAP to make businesses more clearly distinguish between debts that are due right away versus those for which they have time to make payments. The FASB is adopting the accounting change to provide a broad principle for classifying debt based on a contract’s terms and the company’s compliance with the loan or bond covenant.

The FASB on September 13, 2017, agreed to an update to U.S. GAAP that is expected to make more companies’ debts look like they are due in the next year compared to current accounting.

The board approved the update 6-1, with FASB member Harold Monk, a former auditor of private companies, casting the dissenting vote. Monk said he believed the update would disproportionately affect small privately held businesses, particularly construction companies, and could force some to lose business because their new debt ratios would disqualify them for bidding on public works projects.

The FASB is getting rid of the complex, transaction-specific debt classification rules in U.S. GAAP to make the distinctions between short-term debt and long-term debt easier to understand. Topic 470, Debt, requires financial executives and auditors to consider specific rules that depend on the type of debt arrangement, such as a loan covenant, revolving credit, and other specialized types of loans. But the guidance does not cover all scenarios. The FASB wanted to come up with a broad principle to classify debt based on a contract’s terms and the company’s compliance with the loan or bond covenant.

Under the forthcoming update, if a liability is due to be settled more than one year or operating cycle after the balance sheet date, or the business has the right to defer settlement of the liability for at least one year, the debt would not be considered current, or due right away.

FASB member Marc Siegel said he believed the upcoming update not only made sense, but would be a true reflection of companies’ and organizations’ liabilities. He likened the negative reactions to the proposal to how state and local governments reacted when the FASB’s sister organization, the GASB, required them to report liabilities from future pension obligations on their balance sheets.

“This is appropriate; this reflects the economics that goes on at the balance sheet date,” Siegel said. “To the extent it changes people’s opinions, I think that’s appropriate.”

Monk is concerned that the debt classification amendments, when coupled with other FASB’s amendments that require companies to report the liabilities from leasing real estate and equipment on their balance sheets, could be a heavy burden for small companies.

“All of a sudden the smaller companies that do have significant equipment leases are going to be hit with a major change in the presentation on their financial statements,” Monk said.

Monk has consistently raised concerns about the debt classification amendments, and he also dissented when they were issued in draft form in Proposed Accounting Standards Update(ASU) No. 2016-200, Debt (Topic 470): Simplifying the Classification of Debt in a Classified Balance Sheet — Current Versus Noncurrent .

Many businesses, professional groups, and some auditors criticized Proposed ASU No. 2016-200 in their comment letters. But others, including a majority of the FASB’s Private Company Council (PCC) at a meeting in July, said the FASB’s proposal made sense and would simplify U.S. GAAP’s myriad, fact-specific rules about debt classification.

Proponents of the changes also said that by the time the updated guidance became effective, the public would have a better idea about the principles behind the changes. Regulators also potentially could adapt their rules so companies that reported higher short-term debt solely because of the accounting change would not be disqualified from projects.

The FASB agreed that public companies would have to comply with the new guidance for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Private companies and other organizations would not have to follow the revised guidance until their fiscal years that begin after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. All organizations can apply the amendments early.

The lead time between publication and the mandatory effective date will help businesses gear up for the changes, and the extra time for private companies will also help, FASB member Christine Botosan said.

“I think some of those costs are real, and so it’s important for us to try to mitigate those costs,” Botosan said. “At end of day, I feel we’re in a good place.”

The FASB spent a good chunk of the September 13 meeting discussing the terms of an exception to the debt classification principle outlined in the January proposal. The exception allowed businesses and organizations to classify debts as noncurrent liabilities if they violate the terms of their debt covenant but receive a waiver from their lender after the balance sheet date but before the financial statement is issued or available to be issued. In order to take advantage of this break, certain conditions must apply. Many businesses asked the FASB to scale back the conditions, but a majority of the FASB decided to keep the terms intact.

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