Warped Company has the following liabilities at December 31, 2015. For each liability, indicate the amount...

Warped Company has the following liabilities at December 31, 2015. For each liability, indicate the amount that should be reported as a current and non-current on the December 31, 2015 Balance Sheet:

$18 million of 10% notes are due on March 31, 2017. A debt covenant requires Warped Company to maintain current assets at least equal to 150% of its current liabilities. On December 31, 2015, Warped is in violation of this covenant. Warped Company obtained a waiver from a bank until June 2016, having convinced the bank that the company's normal 2 to 1 ratio of current assets to current liabilities will be reestablished during the first half of 2016.

$30 million of 8% notes were issued for $30 million on May 31, 2011. The notes mature on May 31, 2021, but investors have the option of calling (demanding payment on) the notes on June 30, 2016. However, given current market conditions it is not expected that the call option will be exercised.

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Expert Solution

Non- Current Liabilities: Financial liabilities that provide financing on a long-term basis (i.e. are not part of the working capital used in the entity’s normal operating cycle) and are not due for settlement within twelve months after the reporting period are non-current liabilities.

Current Liabilities: An entity classifies its financial liabilities as current when they are due to be settled within twelve months after the reporting period, even if:

the original term was for a period longer than twelve months, and
an agreement to refinance, or to reschedule payments, on a long-term basis is completed after the reporting period and before the financial statements are approved for issue.

Answer (a)

Facts: Given that, $18 million of 10% notes are due on March 31, 2017. A debt covenant requires Warped Company to maintain current assets at least equal to 150% of its current liabilities. On December 31, 2015, Warped is in violation of this covenant. Warped Company obtained a waiver from a bank until June 2016, having convinced the bank that the company's normal 2 to 1 ratio of current assets to current liabilities will be reestablished during the first half of 2016.

Provision: As per Accounting Standards, when an entity breaches a provision of a long-term loan arrangement on or before the end of the reporting period with the effect that the liability becomes payable on demand, the entity does not classify the liability as current, even if the lender agreed, after the reporting period and before the approval of the financial statements for issue, not to demand payment as a consequence of the breach. However, an entity classifies the liability as non-current if the lender agreed by the end of the reporting period to provide a period of grace ending at least twelve months after the reporting period, within which the entity can rectify the breach and during which the lender cannot demand immediate repayment.

Analysis & Conclusion: In the given case, the Warped company breached the covenant on 31st December 2015, but however it has obtained a waiver from the bank until June 2016 (but not exceeding 12 months), hence the same shall be treated as Current Liability as the grace period is within 12 months after the reporting period.

Answer (b)

Facts: Given that, $30 million of 8% notes were issued for $30 million on May 31, 2011. The notes mature on May 31, 2021, but investors have the option of calling (demanding payment on) the notes on June 30, 2016. However, given current market conditions it is not expected that the call option will be exercised.

Provision: As per Accounting Standards, if an entity expects, and has the discretion, to refinance or roll over an obligation for at least twelve months after the reporting period under an existing loan facility, it classifies the obligation as non-current, even if it would otherwise be due within a shorter period. However, when refinancing or rolling over the obligation is not at the discretion of the entity (for example, there is no arrangement for refinancing), the entity does not consider the potential to refinance the obligation and classifies the obligation as current.

Analysis & Conclusion: In the given case, the maturity of notes is on May 31, 2021 and the entity expects that the call option will not be exercised by the investors on June 30, 2016. As the entity expects and has a discretion to roll over an obligation for exceeding twelve months after the reporting period (i.e, on 31^st December 2015), the aforesaid amount $30 million of 8% notes shall be classified as Non- Current Liability.

ekkarill92 answered 11 months ago

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