Current And Noncurrent Classification Of Debt

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P 13–3 Current–noncurrent classification of debt • LO13–1, LO13–4 The balance sheet at December 31, 2013, for Nevada Harvester Corporation includes the liabilities listed below: a. 11% bonds with a face amount of $40 million were issued for $40 million on October 31, 2004. The bonds mature on October 31, 2024. Bondholders have the option of calling (demanding payment on) the bonds on October 31, 2014, at a redemption price of $40 million. Market conditions are such that the call is not expected to be exercised. b. Management intended to refinance $6 million of its 10% notes that mature in May 2014. In early March, prior to the actual issuance of the 2013 financial statements, Nevada Harvester negotiated a line of credit with a commercial bank for up to $5 million any time during 2014. Any borrowings will mature two years from the date of borrowing. c. Noncallable 12% bonds with a face amount of $20 million were issued for $20 million on September 30, 1988. The bonds mature on September 30, 2014. Sufficient cash is expected to be available to retire the bonds at maturity. d. A $12 million 9% bank loan is payable on October 31, 2019. The bank has the right to demand payment after any fiscal year-end in which Nevada Harvester's ratio of current assets to current liabilities falls below a contractual minimum of 1.7 to 1 and remains so for six months. That ratio was 1.45 on December 31, 2013, due primarily to an intentional temporary decline in inventory levels. Normal inventory levels will be reestablished during the first quarter of 2014.

Required: 1. Determine the amount that can be excluded from classification as a current liability (that is, reported as a noncurrent liability) for each. Explain the reasoning behind your classifications. 2. Prepare the liability section of a classified balance sheet and any necessary footnote disclosure for Nevada Harvester at December 31, 2013. Accounts payable and accruals are $22 million.

Paper For Above instruction

The classification of liabilities on a company's balance sheet as current or noncurrent is crucial for accurately reflecting its financial position and liquidity. Determining whether a liability should be classified as current depends on the timing of expected payments and the company's intent and ability to maintain long-term arrangements. Below, each liability outlined in the case of Nevada Harvester Corporation will be analyzed regarding its proper classification as of December 31, 2013.

1. Analysis of Each Liability

a. 11% Bonds Issued in 2004

The bonds have a maturity date of October 31, 2024, and the bonds are callable by bondholders after October 31, 2014, though market conditions make exercise unlikely. The key factor is the maturity date. Since the bonds mature in 2024, which is beyond one year from the balance sheet date (December 31, 2013), and there is no intention or obligation to refinance or call them early, they should be classified as noncurrent liabilities. The callable feature is not exercised and does not affect the classification because the bonds are not expected to be called before maturity.

b. Refinance of $6 Million of Notes Maturing in 2014

Nevada Harvester management intended to refinance part of its maturing debt through a line of credit negotiated early in March 2014. The company plans to refinance the $6 million of notes maturing in May 2014 with the line of credit, which will be borrowed and repaid within two years. According to accounting standards, debt that is intended and has the formal arrangement or financing plan in place before the balance sheet date to refinance a maturing debt qualifies as noncurrent, provided the refinancing occurs after the balance sheet date and before issuance of financial statements (FASB ASC 470-10-45). Since these criteria are met, and arrangements are in place, this portion of the debt can be classified as noncurrent, even though the maturity is in May 2014.

c. Noncallable 12% Bonds Maturing in 2014

This bond has a maturity date of September 30, 2014, and the company expects to have sufficient cash to retire it at that time. Because the maturity date is within one year of the balance sheet date, and there is no indication that these bonds will be refinanced or extended beyond maturity, these should be classified as current liabilities.

d. $12 Million Bank Loan with Conditional Demand Clause

The bank loan is payable in October 2019, but the bank can demand repayment if the current ratio falls below 1.7 to 1 for six consecutive months. As of December 31, 2013, the ratio was below this minimum, but the decline was due to temporary inventory adjustment, and normal levels are scheduled to be reestablished in the first quarter of 2014. According to accounting standards (FASB), a debt classified as noncurrent depends on the company's ability and intent to refinance on a long-term basis. Since Nevada Harvester intends and is able to reestablish the ratio above the threshold shortly after the balance sheet date, and the company has demonstrated commitment to refinancing, this liability should be classified as noncurrent. The company has not yet received a formal refinancing agreement, but management's plans indicate that the condition will not be triggered after the balance sheet date.

2. Liability Section of the Classified Balance Sheet

The liabilities section, as of December 31, 2013, should reflect the classifications based on the above analysis. The current liabilities include accounts payable, accrued expenses, and the portion of the bank loan expected to be payable within one year. The noncurrent liabilities include long-term bonds and the refinancing-receivable portion of the bank loan.

Liabilities

• Current liabilities:
  • Accounts payable and accrued liabilities: $22 million
  • Current portion of the 12% bonds (due September 30, 2014): $20 million
  • Bank loan (expected to be repaid or refinanced within a year): $12 million
• Noncurrent liabilities:
  • 11% bonds (due October 31, 2024): $40 million
  • Refinanced portion of the bank loan (expected to extend beyond one year): $0 (since the intention and plan are to refinance it on a long-term basis)

Footnote disclosures should include details of the refinancing plans, the callable features of bonds, and the contractual obligations, ensuring compliance with accounting standards (FASB ASC 470-10, ASC 405, and ASC 850).

Conclusion

Accurate classification of liabilities ensures transparency and compliance with accounting standards. Nevada Harvester should classify long-term bonds and the anticipated refinancing of maturing debt as noncurrent liabilities, while current obligations such as the bonds maturing soon and short-term borrowings are reported as current liabilities. Proper disclosures regarding the refinancing plans and conditional obligations bolster the clarity of the company's financial statements.

References

• Financial Accounting Standards Board (FASB). (2014). ASC 470-10: Debt—General. Accounting Standards Codification.
• Financial Accounting Standards Board (FASB). (2014). ASC 405: Liabilities—a Liquidity Perspective. Accounting Standards Codification.
• Financial Accounting Standards Board (FASB). (2014). ASC 850: Related Party Disclosures. Accounting Standards Codification.
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