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Plan to Simplify Classification of Debt in U.S. GAAP Moves Forward

U.S. GAAP requires companies to assess the details of their liabilities to distinguish between long- and short-term debt. The FASB wants to get rid of the rules and develop an overall principle aligned with IFRS.

Companies familiar with the rules-based guidance for classifying debt on their balance sheets may soon instead follow a principle that works for all debt arrangements.

Meeting on January 28, 2015, the FASB moved forward with a plan to simplify the presentation of debt by taking cues from IFRS for distinguishing between short- and long-term liabilities. The difference is important to companies that want to clearly distinguish between the debts that must be paid in the near term and the debts for which they have more time to pay.

If finalized, a company’s debt would be labeled as noncurrent if it’s due to be settled more than a year after the reporting period, or if the business has the right to defer settlement for at least a year, a majority of the FASB voted. The principle follows IAS 1, Presentation of Financial Statements.

The planned amendment to Topic 470, Debt, would make clear that debt arrangements give a lender the right to receive money and require a borrower to make payments. The guidance also would list examples of debt arrangements and make clear that the list wasn’t comprehensive.

The FASB will draft guidance on what it means to have the right to defer settlement, the board’s staff accountants said.

The board also will propose that companies consider their legal rights in their debt contracts and make a determination based solely on those rights. The business won’t consider whether it expects its lender to exercise its rights, such as calling for the debt to be settled earlier than expected.

The FASB added the project to its agenda in August as part of its simplification initiative, which targets narrow, complex parts of U.S. GAAP and attempts to make relatively quick amendments.

The FASB focused on the presentation of debt on the balance sheet because the existing standard requires companies and auditors to consider specific rules that depend on the type of debt arrangement, such as a loan covenant, revolving credit and lock box arrangements, increasing-rate debt, and callable debt. The current standard doesn’t include all scenarios, however.

The board wants the amended standard to include an overarching principle that will classify debt on the basis of a contract’s terms and the company’s compliance with the loan or bond covenants.

“The introduction of a single principle, in place of rules-based guidance, is expected to reduce cost and complexity for preparers and auditors while improving the usefulness of the information reported to financial statement users,” according to a FASB memo prepared for the meeting.

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