The Classification of Debt (Topic 740) Is Changing

In September 2019, FASB released a revised exposure draft related to a proposed accounting standard update for simplifying the classification of debt in a classified balance sheet. The new deadline for further comment is October 28, 2019. The FASB originally issued a proposed update back in 2017. It received extensive comments and resulted in the need for additional research before finalizing a standard.

The latest proposed updates would replace the current, overly complex, fact-specific guidance contained in Topic 470, Debt with an overarching, cohesive debt classification principle. The primary change from the original proposal includes specific preclusion of the consideration of unused long-term financing arrangements in classifying current debt on the balance sheet (even if the unused financing could be used to refinance current debt on a long-term basis). However, the latest proposal does explicitly permit the consideration of grace periods in evaluating noncompliance with debt covenants. No other significant changes to the original proposal were made.

A debt arrangement provides a borrower with a contractual obligation to pay consideration on demand or on fixed or determinable dates. This includes lease liabilities, convertible debt instruments and liability-classified mandatorily redeemable financial instruments.

Debt may only be classified as noncurrent if either of the following criteria is met as of the balance sheet date:

1. The liability is contractually due to be settled more than a year (or operating cycle, if longer) after the balance sheet date.
2. The entity has the contractual right to defer settlement of the liability for a period greater than a year (or operating cycle, if longer) after the balance sheet date.

The update would apply to all entities that enter into a debt arrangement and present a classified balance sheet, while a classified balance sheet is still not a requirement.