Revolving Debt: Defined and Proposed ASU.

Revolving debt agreements provide companies with access to borrow a fixed amount of money from a lender over a period of time.  The borrower generally can borrow and re-pay the revolving debt agreement as often as the company elects, provided the total borrowings do not exceed the credit line. 

Simply stated, revolving debt is a high limit credit card which the company uses throughout the year. Interest is generally accrued daily. Additionally if unused, the company is generally charged a fee as the bank at all times hold the funds available for the company’s use.

Due to the structure of revolving debt, private companies have historically struggled with classification of the agreements as current liabilities versus non-current liabilities. As the planned repayment of borrowings may be within a year though the agreement is generally made for greater than a year. The Financial Accounting Standards Board (FASB) has proposed an Accounting Standards Update (ASU) which clarifies this for private companies.

Financial Accounting Standards Board Proposed Accounting Standards Update

The FASB recently issued a proposed ASU regarding the classification of debt on classified balance sheets.  This proposed ASU is currently in the comment period, which is when interested parties can submit their opinions on the proposed ASU to the FASB. 

Several Key Takeaways of the proposed ASU include:
  • This proposed ASU bases current vs. non-current classification on the contractual settlement date.  Generally, if the contractual settlement date of the agreement is > 1 year from the balance sheet date, the debt would be classified as non-current.  If the contractual settlement date of the agreement is < 1 year from the balance sheet date, the debt would be classified as current.
  • Short-term debt that is refinanced as long-term debt after the balance sheet date would be classified based on the contractual settlement date as of the balance sheet date.  This is a change from current guidance which allows for non-current classification.
  • Subjective acceleration clauses and material adverse change clauses, which are typical in debt agreements, must be triggered in order to shift debt from non-current to current.  Previously they would be assessed based on the probability of being triggered.

Impacts of this proposed ASU on private companies are:

Private companies may have historically struggled with classification of revolving debt agreements as the planned repayment of borrowings may be within a year.  Companies often borrow and repay on the revolving debt agreement on a daily basis, which appears short-term in nature; however, the proposed ASU clearly clarifies that this arrangement would result in non-current classification if the contractual settlement date is > 1 year from the balance sheet date.

Revolving debt: FASB proposed ASU classification flowchart

Key Ratios Impacted

Private companies may see a change in their ratios from this proposed ASU as well.  The ASU will therefore have an impact on internal reporting or reports provided to investors.  Key ratios impacted include:

  • The Current Ratio (current assets / current liabilities)
  • The Quick Ratio ((current assets – inventory) / current liabilities).

Note that this proposed ASU will only impact companies that present classified balance sheets.  Additionally, debt covenant violations that do not meet certain conditions prior to the financial statements being issued will still require current classification. 

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