Classification of Debt by a Company having Material Uncertainty on its Ability to continue as a Going Concern
Facts of the case:
1. Company delisted due to non-compliance of SEBI Laws & rules
2. Due to shutting down of business & divisions in recent past, significant liquidity issues are being faced by company, & it has defaulted in various debts being due for repayment as scheduled
3. Contesting various court cases with respect to above debts in DRT & NCLT with respective counterparts of such debts although as on reporting date liabilities not being admitted by NCLT.
4. These debts are either disclosed as contingent liability and / or are already being shown as current liability due to breach/default in their covenants
5. One of the debts (not included above, specifically Cumulative redeemable preference share capital) due for repayment as on 12.11.2019 in 5 equal annual instalments as scheduled.
Issue/Query:
Query regarding its classification as on reporting date i.e. 31.03.2019, considering above facts stating significant going concern issue:
1. As on reporting date, with respect to Ind AS & Company law in general, whether such liability being prospective but fixed in nature, as such be classified wholly as current (considering above facts) or whether keeping aside facts & following the general terms & conditions of such debt (i.e. scheduled repayment) & classification rules as given by Ind AS (no breach or not yet due as on reporting date), the liability to be separated out as current & non-current & reported as such ?
2. Considering above facts & circumstances surrounding the company’s general & specific environment, whether auditor’s judgement with respect to indicators for testing of Going Concern (indicating significant doubt over its Going concern) suffice for classification of above debt as current in whole as on reporting date (ignoring scheduled repayments & classification criteria as set out)? Taking precautionary view w.r.t going concern being affected can an auditor require auditee to classify such debt mandatorily as current in whole in consequence of true & fair view?
Response:
1. The liability for cumulative redeemable preference shares shall be classified as current and non-current. Assuming that the reporting date is 31 March 2019, in the absence of details, the amount due for repayment on 12 November 2019 will be classified as current and rest of the amortised cost shall be classified as non-current. The classification of an instrument is not changed depending upon the classification of other instruments unless the instruments are designated in an effective hedging relationship.
2. Presentation of classified balance sheet is for an entity that is a going concern. If the company is not a going concern, the company shall disclose the basis on which the financial statements are prepared which could be other than Ind AS. Presenting all liabilities as current in the financial statements of a company that is a going concern though there exist only material uncertainties that cast significant doubt on its ability to continue as a going concern result in financial statements that are not in accordance with Ind AS and thus not presenting true and fair view.
Basis for Response:
1. The concern of the querist seems to be that if the auditor is of the opinion that the company is not a going concern, whether all liabilities shall be classified as current even though few liabilities are due after twelve months of the end of the reporting period. However, it is not clear from the facts submitted, whether the company is a going concern or not a going concern. There could be material uncertainties which raise a doubt on the going concern ability of a company. However, that does not make the company not a going concern.
2. Paragraph 25 of Ind AS 1, Presentation of Financial Statements, provides guidance as under:
“When preparing financial statements, management shall make an assessment of an entity’s ability to continue as a going concern. An entity shall prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties. When an entity does not prepare financial statements on a going concern basis, it shall disclose that fact, together with the basis on which it prepared the financial statements and the reason why entity is not regarded as a going concern.”
3. Therefore, a company may be regarded as not a going concern only in the following three scenarios:
a. It intends to liquidate
b. It intends to cease trading; or
c. It has no alternative but do so.
4. The querist has submitted in the facts that businesses are being shut down. However, it is not clear as to whether all businesses are being shut down or only few are being shut down. The application of paragraph 25 of Ind AS 1 is for the company as a whole and not for a particular division or divisions. For particular division or divisions, the guidance is provided in Ind AS 105, Non-Current Assets Held for Sale and Discontinued Operations.
5. Financial statements of a company that is a going concern though there exist material uncertainties that cast significant doubt on its ability to continue as a going concern shall be prepared in accordance with Ind AS. If the auditor of such a company requires the company to classify all debt as current regardless of the conditions for classification as current or non-current, the resulting financial statements shall not be in accordance with Ind AS.
6. Paragraph 15 of Ind AS 1 states as under:
“Financial statements shall present a true and fair view of the financial position, financial performance and cash flows of the entity. Presentation of true and fair view requires the faithful representation of the effects or transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities income and expenses set out in the Framework. The application of Ind ASs, with additional disclosure when necessary, is presumed to result in financial statements that present a true and fair view.”
7. Therefore, if the auditor requires the company to classify all debt as current just because there exist material uncertainties that cast a doubt on the going concern ability of the company, irrespective of whether the company is a going concern as at the end of the reporting period, the financial statements shall not be considered to present a true and fair view.
8. Paragraph 69 of Ind AS 1 states as under:
“An entity shall classify a liability as current when:
(a) it expects to settle the liability in its normal operating cycle;
(b) it hold the liability primarily for purposes of trading;
(c) the liability is due to be settled within twelve months after the reporting period; or
(d) it does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period (see paragraph 73). Terms of a liability that could, at the option of the counterparty, result in it settlement by the issue of equity instruments do not affect its classification.
An entity shall classify all other liabilities as non-current.”
9. Therefore, if the financial statements of the company are being prepared on a going concern basis though there exist material uncertainties that may cast significant doubt on the ability of the company to continue as a going concern, the company shall classify its liabilities into current and non-current in accordance with paragraph 69 of Ind AS 1 except for those liabilities for which Ind ASs prohibit such classification. Examples of such liabilities for which Ind AS prohibits classification into current and non-current are deferred tax liabilities and regulatory deferral account credit balances.