The proposal, unanimously approved by FASB on Oct. 19 would replace existing rules-based guidance with an overriding classification principle. The principle would be based on legal terms of the debt agreement and the company's contractual rights as of the balance sheet date.
An exception would be included for waivers of debt covenant violations received after the reporting date but before the issuance date of the company's financial statement, the board said. Violating a covenant—meaning terms of a loan—means the lender can demand repayment in full or impose other penalties unless the company is given a waiver.
The new rule addresses complaints FASB has received from companies that the current approach for classifying debt is costly and complex. Classifying whether a company's debt is due in the near term, "current," or long term, "noncurrent," is significant because the amount can sometimes be in the billions of dollars for large corporations. In turn, this can affect how banks analysts, investors, lenders and other interested parties evaluate a company's financial health, and its ability to meet its obligations.
In addition to cost savings, the potential changes would improve, or maintain usefulness, of the information reported to financial statement users, according to board discussions.
The proposal will include other matters including how prominent information about waivers of debt covenant violations should be in the financial statement. FASB said by a 5-2 majority that debt that is classified as noncurrent as a result of a waiver should be presented as a separate line item.
The proposal is expected to be issued by the end of December of early January, and the public comment is likely to conclude by the beginning of May.