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Companies may need to accelerate refinancing timeline due to proposed debt presentation standard

06/18/2018  |  By: Brad Bonde, CPA, Shareholder, Healthcare Services, Courtney Bach, CPA, Shareholder, Audit and Advisory

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In January 2017, the Financial Accounting Standards Board (FASB) issued proposed Accounting Standards Update (ASU), Debt (Topic 470):  Simplifying the Classification of Debt in a Classified Balance Sheet (Current versus Noncurrent). The objective of this proposed standard is to provide guidance that will reduce the cost and complexity of determining the current versus noncurrent classification of debt on the balance sheet. In March 2018, the FASB voted to affirm certain revisions to the exposure draft, and is currently preparing the final ASU for issuance, which is expected to occur in Q3 2018.

The proposed ASU applies to all entities that enter into debt arrangements, defined as, an arrangement that provides a lender with a contractual right to receive consideration and a borrower with a contractual obligation to pay consideration on demand or on fixed or determinable dates. These arrangements would include debt securities, loan agreements and revolving credit arrangements.  In the March 2018 vote, the FASB also voted to include lease liabilities within this proposed presentation guidance.

Main Provisions:

An entity can classify an instrument as noncurrent if either of the following criteria is met as of the balance sheet date:

  1. The liability will be settled more than one year after the balance sheet date.

  2. The entity has the right to defer settlement of the liability for at least one year after the balance sheet date.

The most significant change from current GAAP would prohibit short-term debt that is refinanced on a long-term basis after the balance sheet date to be classified as a noncurrent liability. Current GAAP also requires an entity to consider acceleration clauses or other material adverse change clauses when determining classification of debt as current versus noncurrent. This proposed ASU would remove that assessment and would only impact classification when it is triggered.

IN PRACTICE FOCAL POINT – Entities that have debt maturing within the early months of upcoming reporting periods will likely need to commence refinancing discussions earlier than in the past.  Presentation of debt as current may impact various industries which have regulatory reporting requirements using working capital as a benchmark.  We recommend that entities subject to these requirements discuss these anticipated changes with the appropriate lenders and regulators to coach them on the potential impact, and ensure there will be no unintended negative repercussions because of this change. 

Finally, consistent with current GAAP, the proposed ASU would still allow an entity to classify a debt arrangement as a noncurrent liability when a covenant violation has occurred and the entity receives a waiver of the violation after year end, but before the financial statements are issued, if certain conditions are met, as noted below.

  • One of the criteria in paragraph 470-10-45-22 would have been met absent the covenant violation

  • The period of the waiver is greater than one year (or operating cycle) from the balance sheet date

  • The waiver does not result in a modification that is an extinguishment of debt or a troubled debt restructuring, entity, the guidance for those respective transactions would be applicable

  • It is not probable that any other covenants in the debt arrangement will be violated within 12 months (or operating cycle) from the balance sheet date

However, under the proposed guidance, an entity will now be required to separately present on the balance sheet, the amount of debt classified as noncurrent because of waivers obtained after the balance sheet date (see presentation example below).

Presentation Example:

The proposed ASU would also require an entity to disclose the following information about any events of default:

  1. An explanation of the deficiency

  2. The amount of obligations subject to the default

  3. The terms of the waiver, including the period of waiver, if applicable

  4. A description of the course of action that the entity has taken, or plans to take, to remedy the deficiency

Effective Date:

The proposed ASU will be effective for public entities for fiscal years beginning after December 15, 2019. All other entities would be required to implement for fiscal years beginning after December 15, 2020. Early adoption is permitted. An entity should apply a prospective method transition when the proposed ASU is adopted.

BEST PRACTICE FOCAL POINT – Because of this proposed standard, it is even more imperative for entities to begin planning for events which extend beyond the next 12 months.  This became more prevalent at the end of 2016, due to FASB’s issuance of a new going concern standard ASU No. 2014-15, which required entities to assess going concern for a period ending twelve months after the date the financial statements were issued (or available to be issued). 

A best practice for entities to consider with their lenders is to include a provision within debt agreements to allow for auditor reports which include a going concern emphasis of matter paragraph due to presentation of debt as noncurrent.  This will ensure that entities do not have a covenant violation merely because of presentation of debt as noncurrent. 

A link to the proposed ASU is included below.

http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176168748705&acceptedDisclaimer=true

If you have any questions related to implementation of this proposed ASU, please contact one of LBMC’s accounting and audit experts below:

Brad Bonde, CPA, is a Shareholder with LBMC’s Healthcare Services Assurance team. He primarily specializes in private equity and venture capital-backed healthcare entities. Email Brad at bbonde@lbmc.com or call at 615-309-2434.

Courtney Bach, CPA, is a Shareholder in the LBMC Audit and Advisory practice, and focuses mainly within the healthcare industry. Email Courtney at cbach@lbmc.com or call her at 615-309-2481.

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Companies may need to accelerate refinancing timeline due to proposed debt presentation standard