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1 Ernst & Young Global Limited Becket House 1 Lambeth Palace Road London SE1 7EU Tel: +44 [0] Fax: +44 [0] ey.com Tel: International Accounting Standards Board 30 Cannon Street London, EC4M 6XH 10 June 2015 Dear IASB members, Invitation to comment Exposure Draft ED/2015/1 Classification of Liabilities (Proposed amendments to IAS 1) Ernst & Young Global Limited, the central coordinating entity of the global EY organisation, welcomes the opportunity to offer its views on the Exposure Draft ED/2015/1 Classification of Liabilities (Proposed amendments to IAS 1) (the ED) issued by the International Accounting Standards Board (the Board) in February We support the Board s efforts to clarify the requirements on classification of liabilities. However, we believe that the ED needs some additional consideration, clarification and guidance in certain areas so that it can be effectively applied in practice. These are explained in the Appendix as responses to the specific questions asked by the ED. Should you wish to discuss the contents of this letter with us, please contact Leo van der Tas on +44 (0) Yours faithfully Ernst & Young Global Limited is a company limited by guarantee registered in England and Wales No

2 2 Appendix Question 1 - Classification based on the entity s rights at the end of the reporting period The IASB proposes clarifying that the classification of liabilities as either current or noncurrent should be based on the entity s rights at the end of the reporting period. To make that clear, the IASB proposes: (a) (b) (c) replacing discretion in paragraph 73 of the Standard with right to align it with the requirements of paragraph 69(d) of the Standard; making it explicit in paragraphs 69(d) and 73 of the Standard that only rights in place at the reporting date should affect this classification of a liability; and deleting unconditional from paragraph 69(d) of the Standard so that an unconditional right is replaced by a right. Do you agree with the proposed amendments? Why or why not? (a) (b) We support the proposed amendment to replace discretion in paragraph 73 of the Standard with right, to align it with the requirements of paragraph 69(d) of the Standard. The intention of the proposed amendments to paragraphs 69(d) and 73R is to make it clear that only rights in place at the reporting period end affect the classification of a liability. However, we do not think the proposed amendments including explicit references to the end of the reporting period in both paragraphs 69(d) and 73R are sufficient to clarify how to apply the requirements in practice. More specifically, it is unclear if and how management expectations about future breaches of covenants are to be reflected in the classification of liabilities at the reporting date. In the proposed paragraph BC16, in which the Board addresses whether events after the reporting period end should affect the classification of liabilities, it is noted that ( ), the Board considered the effect on classification of management s expectations about events after the reporting period that prevent the application of rights to defer settlement (such as management s intention to repay borrowings within twelve months or management s expectation about a future breach of covenants that would render the borrowings repayable on demand). The Board was concerned that basing classification of a liability on management s expectations about future events ( ) would place too much emphasis on management s intentions and expectations. In the proposed paragraph BC17, it is concluded that ( ) the Board does not propose amending the guidance on the effect of events after the reporting period.

3 3 The proposed paragraphs BC16-17 seem to address two different aspects, namely: (1) whether events after the reporting period should impact the classification at period end; and (2) whether management s expectations at period end about future events should impact the classification at period end. On point (1) above, we agree that events after the reporting period should not impact the classification at period end, as concluded by the Board in the proposed paragraph BC17. However, on point (2), the ED is less clear on the Board s conclusion. The proposed paragraph BC4 states that ( ) The Board concluded that, when a right is subject to a condition, it is whether the entity complies with that condition as at the end of the reporting period that determines whether the right should affect classification. This wording seems to suggest that the Board believes that management s expectations at period end about future events should be disregarded when determining the appropriate classification at the end of reporting period. We agree with this approach. However, we believe the Board should clearly outline it within the body of the Standard itself. Furthermore, if management s expectations are not to be reflected in the classification, we believe the Board should clarify the guidance in paragraphs 69(a) and 71 accordingly. Paragraph 69(a) requires an entity to classify a liability as current when ( ) it expects to settle the liability in its normal operating cycle (emphasis added). We believe the words it expects in 69(a) pertain to the type of liability (i.e., the liability is expected to be a part of the working capital), rather than to the period of settlement itself, and paragraph 71 further clarifies this concept. However, we are also aware that paragraph 69(a) could be read to imply that management s expectations should be taken into account in the assessment of settlement period of any liability, and if that period is expected to be less than the entity s normal operating cycle, the liability should be classified as current. The latter interpretation seems to contradict the proposed paragraph BC4 as it relies on management s expectations. Therefore, we believe the Board should clarify that the reference to an entity s expectation in paragraph 69(a) only refers to whether a liability is considered to be a part of the operating cycle or not, and is not suggesting that all liabilities that management expects to be settled within the time frame of the normal operating cycle should be classified as current. (c) It is not clear what the objective of the proposal is and whether this objective is achieved by replacing an unconditional right by a right. The proposed paragraph BC2 seems to suggest that the intention is to amend classification requirements in such a way that an entity that has a conditional right at the end of the reporting period to defer settlement of the liability for at least twelve months after the reporting period (e.g., a right conditional on compliance with covenants in future periods on a quarterly or monthly basis) must classify that liability

4 4 as non-current if it is in compliance with those conditions at reporting period end. Under current practice, an unconditional right is interpreted similarly. Therefore, we do not believe the proposed amendment will impact current practice. This is reasonable, in our view, as a right is generally considered unconditional, unless it is outlined that the right is or may be conditional. As a result, we believe the Board should consider whether the proposal is intended to represent an amendment to the Standard, which could potentially have an effect on current practice, or merely a clarification confirming that current practice continues to be appropriate under the Standard. Furthermore, we are concerned that the proposed amendments do not provide sufficient clarification of what a right at the end of the reporting period to defer settlement of the liability for at least twelve months after the reporting period represents. Consider the following two examples: An entity has a long-term loan arrangement that is due to be settled more than twelve months after the reporting period. Under the arrangement, covenants are to be tested shortly after the end of the reporting period. The financial position at the end of the reporting period is insufficient to meet the covenants. An entity has a long-term loan arrangement that is due to be settled more than twelve months after the reporting period. Under the arrangement, covenants are to be tested half-yearly. The entity breaches a covenant before the period end. The entity obtains a waiver before period end. The waiver does not include a grace period per se, but as the original loan agreement requires half-yearly covenant testing, the entity must fix the breach such that compliance with the waiver is achieved before the next testing occurs in six months. We do not think the proposed amendment articulates the meaning of a right in circumstances such as those illustrated above sufficiently clearly. Based on our understanding, a right to defer settlement for at least twelve months after the end of the reporting period exists in both scenarios. This is regardless of whether management in either of these scenarios expects to be in breach at the next testing date, as per our discussion of the impact of management expectations in Question 1(b). However, in the first scenario above, if the time between the end of the reporting period and the testing date is so short that a breach cannot under any circumstances be fixed, we acknowledge that, effectively, the testing date could be at the end of the reporting period. Thus, it could be the case, in such a scenario, that a right to defer settlement for at least twelve months does not exist at the end of the reporting period, even though there has been no formal breach at that point in time. In the second scenario, the waiver effectively fixes the breach, and the originally agreed half-yearly testing of covenants applies. If it is concluded that a right to defer settlement for at least twelve months does not exist in this scenario, the loan should

5 5 have been classified as current originally, which seems inconsistent with the proposed amendments. In addition, we understand that the proposed amendment and, in particular, the discussion in the proposed paragraph BC2, would allow for non-current classification of liabilities conditional on any type of future events. This would include not only future events in the form of compliance with covenants made by the borrower referring to the entity s performance, but also any other types of covenants referring to the performance of something outside the control of the entity, such as a market index or the like. If this is the case, we recommend the Board to articulate it more clearly in the body of the Standard itself. Other comments We note that, in addition to replacing discretion with right, the Board also proposes to remove the reference to refinance while keeping roll-over in the proposed paragraph 72R(a). The ED provides no further explanation of the basis for this proposed amendment. Proposed paragraphs BC9-11 discuss whether a roll-over implies that the entity s financing is with the same lender before and after the roll-over. The Board concludes that introducing a reference to same lender involves complexities and may be difficult to apply in practice. However, the Board does not clarify whether a right to refinance with a different lender would allow for the use of the reclassification exception in the proposed paragraph 72R(a). It could be assumed that the removal of refinance, while keeping roll-over, confirms that only arrangements with the same lender are within the scope of the exception. Moreover, the proposed Basis for Conclusions could be read as suggesting that arrangements involving refinancing with other than the same lender could also qualify for roll-over classification. Therefore, we recommend the Board to clarify the objective of the proposed amendment. If refinancing by other than the same lender is intended to be within the scope of the exception, we believe the Board should provide guidance on how entities are to address the complexity introduced by consortia of lenders (proposed paragraph BC10) in practice. The following real-life examples illustrate our concern: An entity has a commercial paper facility managed by a bank in which the entity issues short-term commercial papers on a rollover basis. The lenders under the commercial papers are third party investors attracted by the bank. The entity also has a committed credit facility with the same bank in case the bank fails to roll over enough commercial papers. As explained above, one might assume that by taking out refinance, the Board intends to address this issue, i.e., the liabilities arising from the commercial paper facility cannot be classified as non-current, since non-current classification would rely on the credit facility with the bank (i.e., a different lender than the holders of the commercial papers). However, this intention is not clearly reflected in the ED.

6 6 An entity has a long-term loan arrangement that is due to be settled within ten months after the reporting period. However, before the end of the reporting period, the entity enters into an arrangement with another bank to refinance the loan under the same terms. Under the new arrangement, the second bank will transfer funds directly to the first bank to settle the loan. In this case, considering that at the end of the reporting period, the entity does not expect an outflow of resources to settle the liability within twelve months after the reporting period, would the loan be classified as non-current, and if not, why? In addition, paragraph 72R(a) refers to the potential to refinance the obligation. Considering the above, it may be that it should read the potential to roll over the obligation (emphasis added). We would also suggest the following amendment to the wording of the proposed paragraph 72R(a), as we do not think there is any example included in the sentence: When the entity does not have the right to roll over the obligation because, for example, i.e. there is no arrangement in place at the end of the reporting period for rolling over the obligation, the entity ( ). Question 2 Linking settlement with the outflow of resources The IASB proposes making clear the link between the settlement of the liability and the outflow of resources from the entity by adding by the transfer to the counterparty of cash, equity instruments, other assets or services to paragraph 69 of the Standard. Do you agree with that proposal? Why or why not? We agree that forms other than cash may be used to settle liabilities and that, for the purpose of classification, such alternative forms of settlement must be considered. However, the transfer of equity instruments does not represent an outflow of resources of the entity, in our view. This is supported by the discussion in paragraph 4.30 of Exposure Draft ED/2015/03 Conceptual Framework for Financial Reporting: ( ) It follows that an obligation of an entity to transfer its own equity claims to another party is not an obligation to transfer an economic resource. Whether the proposed paragraph BC14 acknowledges this when it is emphasised that settlement for the purpose of classification of a liability ( ) would also refer to the transfer of equity instruments ( ), and, thus, that settlement by way of transfer of equity instruments is an exception to the outflow of resources concept, is unclear. Considering that The Board concluded that it was important to link the settlement of the liability with the outflow of resources of the entity (the proposed paragraph BC12), providing such an exception seems inconsistent. However, as explained below, we believe paragraph 69(d)

7 7 already assumes that settlement by equity instruments must be considered when classifying liabilities. If the Board decides to keep the exception from the outflow of resources concept, we believe the placement of the proposed clarification may raise questions as to its interaction with paragraph 69(d) and the reference therein to settlements by the issue of equity instruments. In particular, paragraph 69(d) provides an exemption (from the condition that an entity must have a right to defer settlement for at least twelve months to achieve non-current classification) by stating that the holder s discretion to demand settlement by the issue of equity instruments does not affect its classification. In our view, this already implies that settlement by the issue of equity instruments affects classification. The proposed new text, coming after paragraph 69(d), reaffirms the same. To clarify the interaction between the two, we suggest that the Board considers if the exemption, i.e., the last sentence in paragraph 69(d), should be moved to after the proposed new text. We would also suggest the following minor editorial amendment to the new sentences added at the end of the proposed paragraph 69: For the purposes of classification as current or non-current Question 3 Transition arrangements The IASB proposes that the proposed amendments should be applied retrospectively. Do you agree with that proposal? Why or why not? We support the IASB s proposal to require retrospective application of the proposed amendments. However, we disagree with the suggested basis for this conclusion. We do not follow the logic outlined in the proposed paragraphs BC19-20 of the ED. Paragraph BC19 states that the Board concluded that the proposals would not result in a change of accounting policy, and that any resulting change in classification would be more in the nature of a change in accounting estimate. It is unclear to us on what basis an amendment considered to be a clarification of existing requirements that leads to reclassifications can be considered to be a change in estimate. In addition, in spite of the Board arguing that any change will be in the nature of a change in estimate, paragraph BC20 concludes that the proposal should be applied retrospectively. We believe that any change in classification of liabilities occurring as a result of the application of the proposed amendments should be treated as a change in accounting policy. Paragraph 19 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors suggests that the default approach to account for a change in accounting policy resulting from the initial application of an IFRS is to apply the change retrospectively. Therefore, we recommend that the Board describes the basis for conclusions on retrospective application accordingly and avoids analogising it with a change in an accounting estimate.