Intermediate Accounting Lecture on liabilities 22-202- 10-03-22

Classification of Liabilities
Under PAS 1 on presentation of financial statement, liabilities are classified into two, namely:

a. Current
b. Noncurrent liabilities

Current liabilities
PAS 1, paragraph 69, provides that an entity shall classify a liability as current when:

a. The entity expects to settle the liability within the entity’s operating cycle.
b. The entity holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within twelve months after the reporting period.
d. The entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.

Trade payables and accruals for employee and other operating costs are part of the working capital used
in the entity’s normal operating cycle.

Such operating items are classified as current liabilities even if they are settled more than twelve
months after the reporting period.

When the entity’s normal operating cycle is not clearly identifiable, its duration is assumed to be twelve
months.

Other current liabilities are not settled as part of the normal operating cycle but are due for settlement
within twelve months after the reporting period or held primarily for the purpose of trading.

Examples of such current liabilities are financial liabilities held for trading, bank overdrafts, dividends
payable, income taxes, other nontrade payables and current portion of noncurrent financial liabilities.

Financial liabilities held for trading are financial liabilities that are incurred with an intention to
repurchase them in the near term.

An example is a quoted debt instrument that the issuer may buy back in the near term depending on
changes in fair value.

Noncurrent liabilities
Noncurrent liabilities is a residual definition. All liabilities not classified as current are classified as
noncurrent liabilities. Noncurrent liabilities include:

a. Noncurrent portion of long-term debt

b. Finance lease liability
c. Deferred tax liability
d. Long-term obligation to entity officers
e. Long-term deferred revenue

Long-term debt falling due within one year

A liability which is due to be settled within twelve months after the reporting period is classified as
current, even if:
 a. The original term was for a period longer than twelve months.
b. An agreement to refinance or to reschedule payment on a long-term basis is completed after
the reporting period and before the financial statements are authorized for issue.

However, if the refinancing on a long-term basis is completed on or before the end of the reporting
period, the refinancing is an adjusting event and therefore the obligation is classified as noncurrent.

Moreover, if the entity has the discretion to refinance or roll over an obligation for at least twelve
months after the reporting period under an existing loan facility, the obligation is classified as
noncurrent even if it would otherwise be due within a shorter period.

The reason for this treatment is that such obligation is condidered to form part of the entity’s long-term
refinancing because the entity has an unconditional right under an existing loan facility to defer
settlement of the liability for at least twelve months after the reporting period.

Note that the refinancing or rolling over must be at the discretion of the entity.

Otherwise, if the refinancing or rolling over is not at the discretion of the entity, the obligation is
classified as current liability.

Covenants
Covenants are often attached to borrowing agreements which represent undertakings by the borrower

These covenants are actually restrictions on the borrower as to undertaking further borrowings, paying
dividends, maintaining specified level of working capital and so forth.

Breach of Covenants
Under these covenants, if certain conditions relating to the borrowers’s financial situation are breached,
the liability becomes payable on demand.

PAS 1, paragraph 74, provides that such a liability is classified as current even if the lender has agreed,
after the reporting period and before the statements are authorized for issue not to demand payment
as a consequence of the breach.

The liability is classified as current because at the end of the reporting period, the entity does not have
an unconditional right to defer its settlement for a least twelve months after that date.

However, the liability is classified as noncurrent if the lender has agreed on or before the end of the
reporting period to provide a grace period ending at least twelve months after that date.

A grace period is a period within which the entity can rectify the breach and during which the lender

Nonadjusting events
With respect to loans classified as current liabilities, the following events occurring between the end of
the reporting period and the date the financial statements are authorized for issue shall qualify for
disclosure as nonadjusting events, meaning the loans remain as current liabilities:

a. Refinancing on a long-term basis

b. Rectification of a breach of a long-term loan agreement
c. The granting by the lender of a grace period to rectify a breach of a long-term loan arrangement
ending at least twelve months after the reporting period.
Presentation of current liabilities
Under Paragraph 54 of PAS 1, as a minimum, the face of the statement of financial position shall include
the following line items for current liabilities:

a. Trade and other payables

b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability

The term trade and other payables is a line item for accounts payable, notes payable, accrued interest
on note payable, dividends payable and accued expenses.

Trade accounts and notes payable are separately presented.