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// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Debt Classification on a Breach: a Worked Example

One date on one letter, and the balance sheet changes shape.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED · 6 MIN READ

// THE SHORT ANSWER

The question an accountant asks about a loan at year end is whether the borrower had the right, on that date, to avoid repaying it for the next twelve months. A covenant breached on or before balance date usually removes that right, because the lender may now call the loan, so the whole balance moves to current liabilities whatever the final maturity. Agreeing a waiver in February does not bring the right back to December. For a lender, this explains the timing of the December phone call, and why the letter it is asked to sign has consequences beyond the loan.

BASIS  Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// MAKE THE CALL

Issue 07 — Coastline Retail Group. NPAT up 9%. Operating cash flow down 31%. The dividend consent request is on your desk. Your call first, then the senior banker's.

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PART OF Credit Analysis for Beginners

// 01 — WHY THE RIGHT ON THE DAY DECIDES IT

A balance sheet splits liabilities by when they fall due, and the test looks at contractual rights at balance date. It does not look at what the lender intends. A bank with no plan to call a loan can still hold the right to, and the accounts report the right. A loan with four years to run becomes, in presentation, a debt due within a year.

Under IAS 1, which New Zealand issues as NZ IAS 1 and Australia as AASB 101, a liability is current unless the entity has the right at the end of the reporting period to defer settlement for at least twelve months. Under FRS 102, used by most UK mid-market groups, paragraph 4.7 reaches much the same place in slightly stricter words: a creditor is due within one year when the entity lacks an unconditional right at the reporting date to defer settlement for twelve months, looking at the earliest date the lender could require repayment. It has no separate paragraphs on covenants. IFRS 18 replaces IAS 1 for periods beginning on or after 1 January 2027, and New Zealand's standard-setter lists current and non-current classification among the requirements that carry across unchanged. Small companies that prepare special-purpose accounts follow whatever basis those accounts state, so a lender checks.

// 02 — HOW THE RULE WORKS

Breach on or before balance date, no relief by then → current
Lender agrees by balance date to a grace period
ending at least 12 months after it → non-current
Relief agreed after balance date, before signing → current; disclosed
Covenant to be met only after balance date → not affected;
disclosed (IAS 1)

These lines summarise paragraphs 72B, 74, 75 and 76 of AASB 101. The 2022 amendments to IAS 1, effective from 2024, settled one point that catches people out. A covenant that must be met on or before balance date counts even if compliance is only assessed afterwards. A leverage test measured on 31 December figures, certified in February, was breached on 31 December. Conversely, a covenant that first bites after balance date does not affect classification, but IFRS reporters must disclose the risk, including facts suggesting the borrower may struggle to comply.

Waivers vary in substance as well as date, and the accountants read the words. A letter that merely reserves the bank's position restores nothing. Exactly what a waiver must do to keep a loan non-current depends on its terms and those of the agreement.

// 03 — THE EXAMPLE

A manufacturer of crop sprayers, constructed for this page like every figure in it, has a 31 December year-end and a US$24.0m term loan with four years to run, of which US$2.0m is due in the coming year. Net debt is US$23.0m and full-year EBITDA US$5.75m. Its leverage covenant, tested each 31 December at 3.5 times, reads 4.0 times (23.0 ÷ 5.75). The covenant level belongs to the example and is not offered as a market norm.

US$m Relief signed Relief signed after
by 31 December 31 December, or none
Current assets 19.0 19.0
Current liabilities 13.0 13.0
Rest of term loan 22.0
Current liabilities, total 13.0 35.0
Non-current term loan 22.0 0
Working capital: 19.0 − 13.0 = +6.0 19.0 − 35.0 = −16.0
Current ratio: 19.0 ÷ 13.0 = 1.46 19.0 ÷ 35.0 = 0.54

Nothing about the business differs between the two columns. Same stock, same customers, same loan. Three versions of the file show how the date matters. If the bank agrees on 18 December to relief of the kind the standard requires, the loan stays non-current, and an IFRS reporter discloses the next covenant test if it falls within a year. If the bank signs on 20 February, before the accounts are signed, the loan is current at 31 December and the waiver goes in a note as a non-adjusting event. If the bank sends a reservation of rights instead, nothing has been given up, and the loan is current with no relief to report.

A waiver dated December but agreed in February would misstate when the relief was given. A letter should carry the date it was actually agreed.

// 04 — THE EFFECTS THAT SPREAD FROM IT

A breach and a reclassification are separate things. A breach is a contractual event between borrower and lender; reclassification is what the accounts then show to everybody else. Suppliers, credit insurers and other lenders read the balance sheet, and a current ratio of 0.54 prompts questions that a later waiver, disclosed only in a note, may not settle. A cross-default clause in another facility can respond to the breach, and a working-capital covenant, where a document has one, can be tripped by the reclassification alone unless it is carved out.

The reclassification also feeds the auditor's work on going concern, because a business showing its whole loan as payable within a year has to explain how it would meet that if called. Outside FRS 102's small-entity and qualifying-entity exemptions, a UK reporter also discloses breaches not remedied by the reporting date, and whether they were remedied or renegotiated before the accounts were authorised.

DEFINED IN ONE PARAGRAPH → · COVENANT WAIVER → · REPAYABLE ON DEMAND →

// 05 — WHERE IT DECIDES A FILE

The request usually arrives in December because the finance team has seen the management accounts and done the arithmetic. It is framed as a matter of timing. A lender takes it as a credit question first: why is leverage at 4.0 times, what does next year's forecast say, and what does the bank want in exchange for giving up a right? A fee, a tighter reporting pack, a reduced limit or a reset covenant may be the price. The December date is the borrower's pressure, and the bank decides on the merits.

A lender also reads the test date in the document with this in mind. Where a borrower's financial year-end coincides with a test date, every year-end near the line turns into a classification question. Where the test falls later, say a quarter after year end, the accounts may show the loan as non-current but disclose the risk. Borrowers and lenders are both better placed when the conversation starts before the auditors arrive.

FINANCIAL REPORTING, READ BY A LENDER → · LOAN COVENANTS, EXPLAINED → · ONE-MINUTE FILE: THE WAIVER →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

  1. Australian Accounting Standards Board, AASB 101 Presentation of Financial Statements (compiled December 2022), the Australian text of IAS 1 — paragraphs 69, 72A, 72B, 74–76 and 76ZA — States the right-to-defer test, the effect of a breach at or before the reporting date, the twelve-month grace period, and disclosure of later covenants — sections 01 and 02.
  2. Financial Reporting Council, FRS 102, September 2024 edition — paragraphs 4.7 and 11.47 — Classifies a creditor as due within one year absent an unconditional right to defer, and requires disclosure of unremedied breaches — sections 01 and 04.
  3. External Reporting Board (New Zealand), NZ IFRS 18 Presentation and Disclosure in Financial Statements: an overview — Lists current and non-current classification among the requirements with no changes, and gives the 1 January 2027 mandatory date for for-profit entities — section 01.

// QUESTIONS PEOPLE ASK

Does every covenant breach make a loan current?
No. It depends on the date of the breach, whether the breach gave the lender the right to demand repayment, and whether the lender had given relief by balance date. Under IAS 1 a grace period agreed by balance date and ending at least twelve months after it keeps the loan non-current. A breach arising only after balance date does not change the classification either, though it is disclosed if material. A breach that does not give a right to accelerate may have no effect.
Can a waiver after year end keep a loan non-current?
Generally not. Under IAS 1 the loan is current even if the lender agrees not to demand payment after the reporting date and before the accounts are signed, because the right to defer did not exist on the day. The later waiver is disclosed as a non-adjusting event and is still useful evidence for the going-concern assessment. FRS 102 asks whether there was an unconditional right to defer at the reporting date, which leads to a similar answer.
What is the difference between a waiver and a grace period?
A waiver is the lender's agreement to give up a right arising from a particular breach, usually for a stated period and on conditions. A grace period gives the borrower time to fix a breach, during which the lender cannot demand repayment. IAS 1 refers to a period of grace ending at least twelve months after the reporting period. In practice, the letter's wording matters more than its title, and auditors will read it closely.
Why is a loan in breach not shown as long-term if the bank will not call it?
Because the standards report rights, not intentions. If the lender has the right to demand repayment within twelve months, the borrower lacks the right to defer, and a friendly relationship does not change that. A bank's stated intention may help the going-concern assessment, which looks at what is likely to happen. It does not alter classification, which looks at what the contract allowed on the balance date.

// NEXT TO IT

// ON WHOSE DESK

The seats that read this term in an ordinary week. Each page says what the seat is for, who arrives in it, and the shape of the round it runs.

  • Transaction bankerSells and structures the plumbing a business runs on — accounts, payments, collections, liquidity and trade finance.
  • Personal bankerThe bank's face in a branch or on a phone: everyday accounts, cards, personal lending and the first conversation about a home loan.
  • Operations analystRuns the processing every product depends on — payments, onboarding, settlements, servicing — at volume.

THE IN-TRAY · ONE MINUTE

Make the call on one file.

A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

THE FIRST QUESTION · THE BORROWER · EARNINGS

A software company has moved from selling licences up front to annual subscriptions. Revenue fell 15% this year, deferred revenue on the balance sheet rose sharply, and cash collected was flat.

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1 FILES · PICK A CALL ON ANY OF THEM

6 MORE ON THE BORROWER · EARNINGS →WHERE DO YOU READ FROM? THE PLACEMENT →

THE READING ROOMIN ONE PARAGRAPHDebt classification on a covenant breach Why can a covenant breach at year end turn long-term debt into a current liability?