Debt classification matters to health care companies
Published January 15, 2020
In September 2019, the Financial Accounting Standards Board (FASB) issued a proposal to simplify the classification of debt. Many health care organizations are concerned that the proposal, if approved, would distort their financial metrics and trigger debt covenants. In early 2020, the health care sector will get another stab at stating their case to the FASB.
First exposure draft
Initial deliberations for the debt classification project began in 2014. The topic came on the FASB’s radar after a substantial number of public companies had to restate their financial statements following the inspection process of the Public Company Accounting Oversight Board (PCAOB). Outreach to private companies revealed there were unnecessary costs to comply with the rules, and the FASB felt it could provide revisions to help reduce those costs.
Accountants have complained that the current rules under Accounting Standards Codification Topic 470, Debt, for determining whether debt should be classified as current or noncurrent in a classified balance sheet are overly complex. Much of the complexity stems from various narrow-scope, fact-specific debt transactions.
The FASB issued a proposal in January 2017 that received mixed feedback. As a result, it redeliberated several issues, most notably unused long-term financing arrangements and grace periods.
Back to the drawing board
The FASB issued a second exposure draft in 2019. Proposed Accounting Standards Update (ASU) No. 2019-780, Simplifying the Classification of Debt in a Classified Balance Sheet (Current Versus Noncurrent), provides an overarching cohesive principle for classifying debt. It’s mostly unchanged from the 2017 proposal but includes some important clarifications.
Specifically, under the proposed changes, a company would classify a debt as noncurrent if either of the following criteria is met as of the balance sheet date:
- The liability is contractually due to be settled more than one year (or operating cycle, if longer) after the balance sheet date, or
- The company has a contractual right to defer settlement of the liability for at least one year (or operating cycle, if longer) after the balance sheet date.
Debt should be classified based on existing facts and circumstances at the balance sheet date, with one exception: Covenant violations that occur as of the balance sheet date but subsequently are waived before financial statement issuance wouldn’t cause the debt to be classified as current, provided certain conditions are met.
The FASB has said the changes would reduce the cost and complexity for financial statement preparers and auditors when determining whether debt should be classified as current or noncurrent in the balance sheet. The changes are also designed to provide more consistent and transparent information to investors.
Health care industry concerns
Eight health care organizations from various states objected to the 2019 exposure draft. These organizations include:
- Banner Health in Arizona,
- Beacon Health System of Indiana,
- The Healthcare Financial Management Association,
- Munson Healthcare in Michigan,
- Partners HealthCare System in Massachusetts,
- Sharp HealthCare in California,
- University of Chicago Medical Center, and
- West Virginia University Health System.
Their comment letters to the FASB said that the proposed changes related to the treatment of unused backup credit facilities would have a significant negative effect on the presentation of remarketing arrangements. They also said that the proposal would require short-term classification for variable rate debt obligations (VRDOs), which would subsequently impact their financial metrics and debt covenants.
VRDOs were developed as a viable alternative for long-term financing arrangements. The option to finance via VRDO backed by a letter of credit or standby bond purchase agreement has been seen as interchangeable with other long-term financing options such as direct purchase, floating rate notes or fixed rate bonds. Health care organizations have expressed concerns that the proposed changes would preclude them from being able to consider contractually linked long-term financing arrangements — such as letters or lines of credit — when determining the classification of debt.
The saga continues
In early 2020, FASB Chairman Russell Golden plans to meet with health care organizations to walk them through the proposed changes and to fully understand their concerns. He also will seek feedback from others who are in favor of the proposed rules. No vote has been scheduled on the proposal yet. Instead, the FASB plans to continue its deliberations on this topic after weighing comment letters and new insights obtained from both sides.