Definition
Under ASC 470-10, when an entity violates a debt covenant at the balance sheet date and the debt is callable, the debt is classified as current unless the creditor has waived or lost the right to demand repayment for more than one year (or the operating cycle) from the balance sheet date. Alternatively, if a grace period exists and it is probable the violation will be cured within it, the debt can stay noncurrent. Covenants tested at future dates require evaluation of whether violation is probable, with disclosure. Subjective acceleration clauses add judgment.
Why it matters in an audit or review
Reclassification can change working capital and ratios and trigger going concern doubt. Auditors recompute covenant ratios from the audited numbers, obtain waivers, and review post-year-end correspondence with the lender.
Example
(Illustrative) A $3.0 million term loan with a minimum debt service coverage ratio of 1.25 shows a ratio of 1.10 at year-end. With no waiver, the full $3.0 million is current, rather than $0.4 million current and $2.6 million noncurrent.
Common mistakes
- Accepting a waiver that covers only the next quarter.
- Testing covenants on unaudited numbers only.
Sources
- FASB ASC 470-10-45, Debt, callable debt and covenant violations, grace periods
- FASB ASC 470-10-50, Debt, disclosure of covenant compliance
- FASB ASC 205-40, Going Concern (effect on going concern evaluation)
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error