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By Denise Lugo
Potential accounting rule changes to debt classification could result in more debt being determined as current, possibly boosting costs and creating operational issues for the construction industry, according to private company discussions.
FASB earlier this year proposed simpler, less costly rules for determining whether to classify debt as short or long term on the balance sheet. Implementing the proposal without consideration of the construction industry could bring influence operations and prove costly to contractors, according to July 11 discussions of FASB and the Private Company Council, one of its advisory bodies.
“I had clients whose working capital might drop 50 percent if this went through and that would kick them out of that state entirely in some instances,” FASB member Harold Monk said.
Operationally and from a cost standpoint, it would impact the construction industry because of nuances in that sector, according to the discussions. Contractors on a regular basis renegotiate debt after the balance sheet date but before the financial statement issuance date, in order to increase their legal bid limits.
There are regulations, and in some instances state laws, that place limits on contractor’s bidding process. These limits are based on working capital on a company’s financial statements, the discussions indicated.
Other problems could follow. “We’d have a training issue because those regulators that have to overcome this would have to be trained and then they would have to change their systems,” said Monk, “and in some instances it may require rewriting regulation and in some smaller number of instances it might require statutory change, which takes years.”
The revisions could also greatly reduce the size of jobs that contractors can bid on. Other impacts include an increase in professional fees—incurred for reviewed financial statements after the refinancing has occurred so that the debt could be more appropriately classified as current.
The debt companies carry can total billions of dollars and can weigh on profits. Debt classification therefore enables banks and other lenders to understand whether a company has the ability to meet its current and future obligations.
If finalized, the proposal would replace existing rules-based guidance with an overriding classification principle. The principle would be based on legal terms of the debt agreement and the company’s contractual rights as of the balance sheet date. The proposed debt classification principle might result in more debt being classified as current, which has consequences for existing contracts and debt ratios.
FASB received 29 comment letters in response to the proposal. Most public company respondents were in favor of the changes, board discussions indicated.
PCC members expressed concerns about aspects of the rules, but ultimately a majority agreed that FASB should finalize the guidance for both public and private companies with some minor revisions. “It is a simplification and I welcome the changes—there shouldn’t be any difference in terms of public versus private and in terms of debt because that’s a use of capital,” Yan Zhang, partner at EisnerAmper LLP, said.
“If we’re going to do down a path of creating some sort of difference between public and private in how to account for debt classification or refinance, it would cause a lot of confusion in practice when people look at financial statements,” she said.
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