Armanino Blog

Controversy Surrounds Balance Sheet Classification

by Ricardo Martinez
November 03, 2016

In recent years, the Financial Accounting Standards Board (FASB) has tried to simplify and reinforce the reporting framework under U.S. Generally Accepted Accounting Principles (GAAP). One simplification project that’s currently on the FASB’s agenda is the classification of debt. On October 19, the FASB unanimously agreed to issue a proposal on this topic, despite concerns from the FASB’s Private Company Council (PCC) and the AICPA’s Private Companies Practice Section Technical Issues Committee (TIC).

Calling for More Judgments, Fewer Rules
For years, the FASB has discussed amending GAAP to include an overarching principle that will classify debt on the basis of a contract’s terms and the company’s compliance with the loan or bond covenants. The existing rules require companies and auditors to consider specific rules that depend on the type of debt arrangement, such as a loan covenant, revolving credit and lock box arrangements, increasing-rate debt and callable debt. But the rules don’t cover all possible scenarios.

Proponents of changing the classification of debt believe that a single principle, in place of rules-based guidance, could help reduce cost and complexity for financial statement preparers and auditors while improving the usefulness of the information reported to financial statement users. In July 2015, FASB members agreed to propose amending Topic 470, Debt, in order to better distinguish between short- and long-term liabilities.

Struggling with Uncertainty
Under GAAP, short-term debt that’s refinanced after the balance sheet date, but prior to the financial statements being issued, is recorded as a noncurrent liability. The FASB agreed to propose changing the classification of debt so that it reflects the circumstances as of the balance sheet date. This means that refinancings that take place after the reporting date would be classified as current liabilities. For debt to be classified as noncurrent, it would need to be settled, or have a contractual right to defer settlement, at least one year following the balance sheet date.

In July, the PCC voted 9-1 to recommend that the FASB keep existing GAAP for debt refinancings. The vote was the latest in a string of grievances the PCC has voiced on the debt classification project, which some members believe will create new problems in financial reporting that conflict with the project’s broader goals.

In September, the PCC reiterated its misgivings about the project, and members doubted that a few minor adjustments to the FASB’s planned amendment would ease their concerns. PCC Chair Candace Wright said she would like the FASB to drop the project entirely, because of uncertainty about the unintended consequences the yet-to-be-proposed amendments might have.

PCC member George Beckwith agreed that the FASB needed to change its course. “I’m not saying lives are going to be lost over this, but close,” he said.

Listening to AICPA Feedback
During a meeting with the FASB, TIC member Jacob Gatlin spelled out the reasons most committee members want the board to stop pursuing the project. And all of them relate to debt refinancings. In a nutshell, the FASB’s proposed changes would make obtaining a loan or refinancing impractical for some companies. “Lenders often require a year-end financial statement before they’ll process the refinance, so there might be a constraint in processing the request in a timely fashion,” said Gatlin.

Most TIC members also believe the project creates new issues around relevance and uncertainty. “If the current project was implemented, and an existing debt was refinanced subsequent to year end but before the issuance of the statements, then the balance sheet information could be perceived as no longer relevant,” Gatlin said.

He added that unrefinanced debt might be considered an uncertainty that existed as of year end, which is made certain by the issuance date of the financial statements. In addition, the TIC believes the changes could hurt some businesses, using the example of general contractor licensing boards that rely on working capital to approve bid limitations for contractors.

Moving Forward
The FASB plans to release a proposal on balance sheet classification of debt by the end of 2016 or early in 2017 with a comment letter deadline of May 5. FASB Chair Russell Golden said that the unusually long comment period is an effort to offer relief to private companies and accountants who may be busy with tax season. The FASB has already gotten an earful about the proposal—and the board members are bracing themselves for the next round of feedback during the comment period.

November 03, 2016

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