Question

What is the increasing-rate debt in the exposure draft, Topic 470?

Answer 1

The FASB has issued an Exposure Draft titled, Debt (Topic 470): Simplifying the Classification of Debt in a Classified Balance Sheet (Current versus Noncurrent). The amendments in this proposal would replace the current, fact-specific guidance with an overarching, cohesive principle.

Stakeholders have told the FASB that GAAP guidance on determining whether debt should be classified as current or noncurrent in a classified balance sheet is overly complex. This Exposure Draft has been issued as part of the FASB Simplification Initiative, the objective of which is to identify, evaluate, and improve areas of GAAP for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to users of the financial statements.

The proposed amendments relate to separate classifications of current debt and noncurrent debt within a classified balance sheet. An entity that does not present a classified balance sheet would be unaffected by the proposed amendments.

The main provisions of this Exposure Draft are to introduce a principle for determining whether a debt arrangement, or other instrument within the scope of this proposal, should be classified as a noncurrent liability as of the balance sheet date. That principle is that an entity should classify an instrument 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 one year (or operating cycle, if longer) after the balance sheet date.
2. The entity has a contractual right to defer settlement of the liability for at least one year (or operating cycle, if longer) after the balance sheet date.

An exception to the above principle would be made in the event of a debt covenant violation if the entity receives a waiver of that violation and that waiver meets certain conditions before the financial statements are issued (or available to be issued). If a waiver meeting such conditions is received, and it does not result in a troubled debt restructuring (as defined in the Master Glossary of the Codification) or those that are accounted for as a debt extinguishment in Subtopic 470-50, Debt – Modifications and Extinguishments, the debt would be classified as a noncurrent liability. This classification is similar to current GAAP. The FASB also decided to retain and clarify the probability assessment related to subsequent covenant violations. The proposed amendments also would require an entity to separately present in the balance sheet, liabilities that are classified as noncurrent as a result of this exception.

The amendments in this Exposure Draft could shift classification of certain debt arrangements between noncurrent liabilities and current liabilities as compared with current guidance. For example, the Exposure Draft contains amendments which could affect the classification of short-term debt that is refinanced on a long-term basis after the balance sheet date, subsequent refinancing of short-term debt with the issuance of equity securities, or debt that contains subjective acceleration clauses or material adverse change clauses.

The effective date will be determined by the FASB after considering stakeholders’ feedback. In the first set of interim and annual financial statements following the effective date, an entity would apply the proposed amendments on a prospective basis to debt that exists at that date and after that date. Early adoption of the proposed amendments would be permitted.

Measurement:

Increasing Rate Debt
470-10-35-1 A debt instrument may have a maturity date that can be extended at
the option of the borrower at each maturity date until final maturity. In such cases,
the interest rate on the note increases a specified amount each time the note is
renewed. For guidance on accounting for interest, see Subtopic 835-30.
470-10-35-2 The borrower’s periodic interest cost shall be determined using the
interest method based on the estimated outstanding term of the debt. In estimating
the term of the debt, the borrower shall consider its plans, ability, and intent to
service the debt. Debt issue costs shall be amortized over the same period used
in the interest cost determination. The term-extending provisions of the debt
instrument should be analyzed to determine whether those provisions constitute
an embedded derivative that warrants separate accounting as a derivative under
Subtopic 815-10.
470-10-35-2A If the debt is paid at par before its estimated maturity, any excess
interest accrued shall be an adjustment of interest expense. [Content moved
from paragraph 470-10-45-8]

Classification of Increasing-Rate Debt
470-10-45-7 Paragraph superseded by Accounting Standards Update No. 2019-
XX.Classification of increasing-rate debt as current or noncurrent would reflect the
borrower’s anticipated source of repayment that is, current assets or a new short-
term debt borrowing versus a long-term refinancing agreement that meets the
requirements of this Subtopic and need not be consistent with the time frame used
to determine periodic interest cost.
470-10-45-8 Paragraph superseded by Accounting Standards Update No. 2019-
XX.If the debt is paid at par before its estimated maturity, any excess interest
accrued shall be an adjustment of interest expense. [Content moved to
paragraph 470-10-35-2A]