Most balance sheets present individual items in distinction to current and non-current (except for banks and similar institutions).
This seems so basic and obvious that most of us do not really think about classifying individual assets and liabilities as current and non-current.
We do it automatically.
But not always correctly.
For example, one of the biggest mistakes I have seen in this area is presenting the long-term loans.
Many companies present them automatically as non-current liabilities – while they are not!
Why?
Just go on reading!
What do the rules say?
The standard IAS 1 Presentation of Financial Statements specifies when to present certain asset or liability as current.
Many people believe that “12 months” is the magic formula or the rule of thumb that precisely determines what is current or non-current.
Not always true.
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More specifically, an asset is presented as current when:
- It is expected to be realized (sold, consumed) in its normal operating cycle.
Here, the standard does not specify what the normal operating cycle is, as it varies from business to business. Sometimes it’s not so clear – in these cases, it is assumed to be 12 months. - An asset is held for trading.
It does not matter that the company will probably not sell an asset within 12 months; as soon as its purpose is trading, then it’s current. - It is expected to be realized within 12 months after the reporting period, or
- It is a cash or cash equivalent (not restricted in any way).
The same applies for liabilities, too, but the standard IAS 1 adds that when there is no unconditional right to defer settlement of the liability for at least 12 months after the reporting period, then it is current.
Everything else is non-current.
Typical examples of current items are inventories, trade receivables, prepayments, cash, bank accounts, etc.
Typical examples of non-current items are long-term loans or provisions, property, plant and equipment, intangibles, investments in subsidiaries, etc.
These are just examples, but there are a few items that are not that outright and need to be assessed carefully.
Property, plant and equipment
In most cases, property, plant and equipment (PPE) is classified as non-current, because the companies use these assets for a period longer than 12 months, or longer than just one operating cycle.
This also applies for most intangible assets and investment properties.
However, there is a few exceptions or situations, when you should present your PPE as current:
Non-current assets classified as held for sale under IFRS 5
When some non-current assets meets the criteria of IFRS 5 to be classified as held for sale, it shall no longer be presented within non-current assets.
Instead, all assets held for sale or of a disposal group shall be presented separately from other assets in the statement of financial position. The same applies for liabilities, too.
So you would include one separate line item within your current assets, labeled something like “Assets classified as held for sale”.
Non-current assets routinely sold after rental
Some companies hold non-current assets for rentals and then they routinely sell them after some time.
For example, car-rental company routinely rents out its cars to various clients for a short period of time and then these cars are sold after 1 or 2 years. Here, I’m not talking about any finance lease – I mean short-term, or even long-term operating lease.
These assets shall be presented as non-current during their rental period, but when a company stops renting them out and wants to sell them, they shall be transferred to inventories.
Inventories
Inventories are a typical current asset, as inventory production usually determines the length of company’s operating cycle.
It does not matter whether the asset produced has the economic life shorter than 12 months or not – if you produce machinery or cars, from your point of view it’s still a piece of inventory (unless you’d like to use some items for your own business, for example for test drives, advertising purposes or so).
I’d like to point out that also inventories whose production period is longer than 12 months and are expected to be realized (sold) beyond 12 months after the end of the reporting period, are classified as current assets.
For example, cheese, wine or whiskey that need to mature for a few years, are still classified as current assets.
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Deferred tax assets and liabilities
No discussion here.
Deferred tax assets and liabilities are always classified as non-current.
Loans with covenants
This is the trickiest one in my opinion. Here, the companies make big mistakes in presenting their loans.
The standard IAS 1 specifically says that when an entity breaches some provisions of a long-term loan arrangement before the period end and the effect is that the loan become repayable on demand, the loan must be presented as current.
The standard is very strict here – it applies also in the case when the lender (bank) agreed not to demand the payment as the consequence of breach after the end of the reporting period, but before the financial statements are authorized for issue.
Let me illustrate it on a short example:
Question:
ABC took a loan from StrictBank repayable in 5 years. The loan agreement requires ABC to maintain debt service cover ratio at minimum level of 1,2 throughout the life of the loan, otherwise the loan may become repayable on demand.
ABC found out that the debt service cover ratio was 1.05 at the end of November 20X1 and reported the breach to StrickBank. How should ABC present the loan in its financial statements for the year ended 31 December 20X1?
Solution:
The answer depends on the reaction of the StrictBank.
If StrictBank agrees NOT to demand immediate repayment of the loan due to the breach of the covenant at or before the period end (31 December 20X1) and this agreement is valid:
- For more than 12 months after the end of the reporting period => the loan is classified as non-current.
- For less than 12 months after the end of the reporting period => the loan is classified as current.
If StrictBank agrees NOT to demand immediate repayment of the loan due to the breach of the covenant after the period end (31 December 20X1), but before the financial statements are authorized for issue, the loan is classified as current, because ABC does not have an unconditional right to defer the loan settlement for at least 12 months after that date.
The impact of presenting the loan as current instead of non-current can be tremendous, as all liquidity rations worsen immediately.
Therefore, if your company took some loans from the banks, I would strongly encourage you to revise and check keeping the covenants well before the end of the reporting period, so that you have enough time to ask your bank for agreement with non-repayment on demand.
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