This column has talked a lot about issues relating to assets recently. Whether it’s recognition of intangible assets, impairment or consolidated financial statements, the recognition and measurement of assets has certainly seemed to be in the spotlight.
This month, we will look at two recent developments in accounting for liabilities in the balance sheet and how they interact with existing items within the IFRS Foundation workplan.
Liability or equity?
The International Accounting Standards Board (IASB), which sets IFRS Standards, recently arrived at a tentative agenda decision on the treatment of certain warrants.
Where a warrant gives the holder the right to acquire a fixed number of equity instruments at an exercise price that will be fixed at a future date, it will initially be classed as a financial liability due to the variability element of the exercise price under IAS 32, Financial Instruments: Presentation.
Warrants would be classed as equity only if a fixed amount were to be paid for a fixed number of shares (the ‘fixed-for-fixed’ criterion).
But what if the price is then fixed in the future? In this case, the fixed-for-fixed criterion is met, so the question was raised with the IASB as to whether such warrants should be reclassified as equity.
Surprisingly, the board feels this scenario is too narrow to reach a conclusion on at this point. These warrants are not entirely uncommon, and there is probably scope within IAS 32 to reclassify them as equity now that the fixed-for-fixed criterion is met. The IASB seems to suggest that there is no need to do this, but as it isn’t currently prohibited by the standard, some diversity in application is likely.
The creation of a new line item for non-current liabilities would represent one of the first changes to the balance sheet for a while
While the IASB hasn’t made a definitive decision, the hope is that it will be considered as part of the Financial Instruments with Characteristics of Equity project. As a reminder, this project is already dealing with the areas of classifying whether an item should be a liability or equity. The project has been on the IASB workplan since 2018, and the next step due in the project is to issue an exposure draft.
Current or non-current?
A discussion the IASB recently had revolves not so much around whether an item is a liability or not, but whether it should be classified as current or non-current. The main discussion right now surrounds debt that contains covenants. These could be covenants that require the liability to be settled early or allow the settlement to be deferred for longer than 12 months. Either way, the presence of such covenants leads to some uncertainty over whether an amount should be classified as a non-current or a current liability.
The IASB’s tentative decision is to amend IAS 1 accordingly. The first element of its decision is a reasonably expected amendment, focusing mainly on increasing the disclosures that entities will be required to make. Under the proposed amendments, an entity will have to make disclosures regarding the conditions surrounding a liability. The disclosures will explain the conditions, whether the entity would have complied by the reporting date, and how the entity expects to comply with the conditions on the date they become effective.
The more surprising (and noticeable) proposal is to change how such liabilities are recorded in the statement of financial position. If an entity has a non-current liability with conditions arising in the next 12 months, this will be shown as a new line item. The proposed line item is ‘non-current liabilities subject to conditions in the next 12 months’.
This creation of a new line item would represent one of the first changes to the balance sheet for a while. A lot of current IASB projects centre around disclosures, but decisions such as this highlight that the board continues to weigh up how the presentation of financial statements can be improved.
This proposed change could be applicable from 1 January 2024, with retrospective application suggested to aid comparability. The potential inclusion of a new line item in the balance sheet seems to fit with the other suggested changes to IAS 1 from the ongoing Primary Financial Statements project, which currently propose a new ‘income/expenses from investments’ section in the statement of profit or loss.
It may take a while, but there are likely to be changes in the pipeline. As always, many of these will alter the disclosures that preparers make, but there could also be changes in the presentation of financial statements and the classification of items. This won’t happen in the immediate future, but preparers will need to keep an eye on these developments.
Watch Adam Deller’s series of short videos explaining some of the fundamental concepts of IFRS Standards