As the maturity date of a liability approaches, the working capital available for other uses is reduced. On the other hand, if the maturity date is in the distant future, the firm can commit its resources to long-run strategies. Thus, information about the remaining time to a liability’s maturity may be helpful for assessing both solvency and earning power.
GAAP call for classifying liabilities as either current or noncurrent according to their due dates. It indicates that a liability is to be treated as current if it falls due in the next 12 months or the operating cycle, whichever is longer. All other liabilities are noncurrent, with the exception of two items discussed below.
When a single liability has payments falling due over several years, those payments due within one year (or a longer operating cycle) are classified as current. When one of these payments is reclassified from noncurrent to current, no journal entry need be made, although the action must be disclosed on the SCFP as a use of working capital.
Two exceptions to the classification scheme are encompassed in GAAP. First, excludes liabilities from being classified as current if they are to be satisfied with noncurrent assets (for example, cash held in a sinking fund). The second exception relates to liabilities that are to be refinanced. In these cases, the liabilities do not need to be classified as current even if they are due within the next year or the operating cycle.
In this context, the term refinanced means replaced with other debt (either by extending the due date of the existing loan or borrowing cash to repay it) or with equity (either by conversion or by issuing shares to obtain the cash to pay off the debt). The major consequence of these actions is the avoidance of a reduction of working capital.
There may be two conditions under which this exception can be applied: the company has either (1) accomplished the refinancing after the end of the fiscal year but before the statement issuance date or (2) has a meaningful agreement that assures that the refinancing can be accomplished within the next fiscal year. The statement further identified characteristics that the agreement must have:
1. It is either not cancelable or not expected to be canceled.
2. It must cover the 12 months or operating cycle following the balance sheet date.
3. The party agreeing to provide the financing must be capable of honoring the contract.
The purpose of the two exceptions to the classification of current liabilities (for payments with noncurrent assets and refinancing) is to avoid misleading statement readers concerning the firm’s short-run solvency. Because the firm’s real working capital is not impaired by the payment of these liabilities, the statements should present a more appropriate picture.
The following example illustrates a disclosure from the published financial statements for Philip Morris Incorporated showing short-term obligations as noncurrent because they are to be refinanced.
The Company has entered into a $300,000,000 revolving credit and term loan agreement, maturing in 2021, and a $250,000,000 Eurodollar revolving credit agreement maturing in 2022, both of which can be used to refinance short-term notes payable. Management intends to exercise its rights under these agreements in the event that it becomes advisable. Accordingly, at December 31, 2018, $550,000,000 of short-term notes payable have been classified as long-term debt.