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CFA Level I · CFA Level I Exam · Topics in Long-Term Liabilities and Equity

Which of the following is the most likely consequence for a borrower that breaches a debt covenant and has not obtained a waiver before the reporting date?

The most likely consequence is that the loan is classified as current. A breach at the reporting date without a waiver means the lender can demand repayment, so the borrower has no right to defer settlement for twelve months. The debt stays a liability and is not derecognized.

  1. AThe loan may be classified as current because the lender can demand repaymentCorrect
  2. BThe loan is reclassified as equity until the breach is cured
  3. CThe loan is derecognized and replaced with a provision

Explanation

If a covenant breach at the reporting date gives the lender the right to demand repayment, and no waiver was received by then, the borrower lacks an unconditional right to defer settlement, so the liability is classified as current. Debt does not become equity, and it is not derecognized.

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