Long-term liabilities

Long-term debt violation at the balance sheet date

Note: In the following exercise, you are required to review the Basis for Conclusions (BCs) for the standard(s) that provide the accounting guidance for this topic. As the BCs are generally not included in the codification and thus are not authoritative, it will most likely be necessary for you to research them through review of the pre-codified standards. Appropriate references have been provided to allow you to do so. Pre-codified standards are accessible on the FASB website at www.fasb.org, or in the event that your school participates in the American Accounting Association's Academic Accounting Access program, they may be found there as well.

Scene 1:

At December 31, 2014, the Gray Mountain Company (GMC), a rain-making eco-friendly company, has a five-year note payable to a large bank. The underlying note agreement contains certain restrictive covenants (minimum capital requirements, total debt to equity ratio, working capital ratio, and minimum cash balance requirements) which could accelerate the immediate payment of the debt if GMC did not meet these covenants each quarter-end (March 31, June 30, September 30, and December 31). GMC was not in compliance with two of the ratios at December 31, 2014, but received a waiver from the bank for these two debt covenant violations on January 31, 2015, which was retroactive to December 31, 2014 and through January 1, 2016.

Please read the following:

ASC 470-10-45-12A through 21 and SFAS No. 6, Classification of Short Term Debt Obligations Expected to be Refinanced, paragraphs 1 through 6 and Appendix A Basis for Conclusion, paragraphs 18 through 31.

IAS 1, Presentation of Financial Statements, paragraphs 69, 71, 74, and 75 and the BCs in IAS 1, paragraphs BC 39 through BC 48.

Determine how the debt would be classified in GMCs balance sheet at December 31, 2014, under both US GAAP and IFRS.

Discuss and articulate the rationale and thought that the FASB and IASB went through in reaching their decisions in the accounting for debt balance sheet classification if a debt covenant violation was cured neared the balance sheet date.