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Private Companies Criticize Plan to Amend Debt Classification Accounting

A proposal the FASB thought would be a quick solution to simplify how companies classify debt as current or noncurrent has received negative feedback from the board’s Private Company Council (PCC). The panel’s members said the possible accounting change will make more debt classified as due right away, which will hurt many private companies.

Members of the FASB’s Private Company Council (PCC) on May 5, 2015, unanimously criticized a FASB plan intended to simplify how companies classify debt on their balance sheets.

The plan, which the FASB started working on in August 2014, is an effort to change the presentation of debt by distinguishing between short- and long-term liabilities. The difference is important to companies that want to clearly distinguish between debt that must be paid right away and the debt for which they have more time to make payments.

Under the FASB’s plan, 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. 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.

Council members, who represent private companies, lenders, and accountants, said the proposed changes will result in more debt being labeled as due right away, which could turn off lenders, clients, vendors, and, in the construction industry, licensing agencies that assess how much debt a company holds when deciding when to grant licenses.

“By changing that presentation on the financial statement, you’re going to impact the ability of a company to get work, their ability to bid on certain road contracts,” said PCC member George Beckwith, vice president and CFO for National Gypsum Co. in Charlotte, North Carolina. “And that is a much more important thing than just journal entries and how things are presented.”

PCC member Lawrence Weinstock, vice president of finance of Mana Products Inc. in New York, said vendors of a private company also would get the wrong impression if the FASB proceeds with the change.

A vendor could say, “‘Look at all this bank debt due right away. I’ve got to cut back on what I can sell them,'” Weinstock said. “Which is coming to the wrong conclusion based on something that’s not based in economic reality.”

U.S. GAAP requires companies and auditors to consider specific rules that depend on the type of debt arrangement, such as a loan covenant, credit card receivables, increasing-rate debt, and callable debt. But it does not cover all scenarios. The FASB wants to amend the 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.

“I really want this project to work because I believe in theoretical purity. I like the concept,” Beckwith said. “I don’t know that this reclassification into current is always going to provide more relevant information.”

“Every PCC member has expressed concerns about this issue,” said PCC Chairman Billy Atkinson.

FASB members did not seem so convinced.

In response to comments that the potential new accounting could cause a company to be denied a contract or a license, FASB member Harold Schroeder said the companies likely would have been in financial trouble, anyway.

“The accounting is not putting them in any kind of trouble; the accounting is reflecting that the companies are laying close to the edge, not monitoring their covenants, not aware of them, or they’re really highly reliant on someone rolling their debt,” he said. “It’s not the accounting that has put themselves in that situation, it’s themselves that has put them in that situation.”

FASB member Daryl Buck said he was troubled with the idea of “perpetuating” current accounting, which could lead to two “identical” companies having different conclusions about debt classification based on when they issue their financial statements.

“To me, that doesn’t feel right,” he said.

The debt classification proposal is part of the FASB’s effort to find narrow problems in existing U.S. GAAP and find quick solutions. The board last discussed the issue in January and is continuing to conduct outreach.

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