A publicly traded company, Stellar Corp., is preparing its financial statements for the year ended December 31, Year 1. Stellar Corp. has a note payable with a carrying amount of $500,000. The note is due on March 1, Year 3. However, Stellar Corp. has the intent and ability to refinance the note on a long-term basis. On February 15, Year 2, Stellar Corp. executed a refinancing agreement with a new bank for a 5-year loan, with the proceeds to be used to repay the existing note. The financial statements are authorized for issuance on March 10, Year 2. How should the $500,000 note payable be classified on Stellar Corp.'s December 31, Year 1 balance sheet?
- AAs a current liability, because the refinancing agreement was executed after the balance sheet date.
- BAs a current liability, because it is due within one year of the balance sheet date.
- CAs a noncurrent liability, but only if the refinancing agreement had been executed by December 31, Year 1.
- DAs a noncurrent liability, because Stellar Corp. has both the intent and ability to refinance it on a long-term basis.
Show answer & explanationAnswer & explanation
Correct answer: D. As a noncurrent liability, because Stellar Corp. has both the intent and ability to refinance it on a long-term basis.
A short-term obligation can be classified as noncurrent if the entity intends to refinance it on a long-term basis and demonstrates the ability to do so. The ability is demonstrated by either actually refinancing the short-term obligation by issuing a long-term obligation or equity securities after the balance sheet date but before the financial statements are issued, or by entering into a noncancelable refinancing agreement.
Why the other options are wrong
- A. The execution of a refinancing agreement after the balance sheet date but before issuance of financial statements is a valid way to demonstrate the ability to refinance, allowing for noncurrent classification.
- B. While it's due within one year, intent and ability to refinance can change its classification.
- C. The refinancing agreement does not need to be executed by the balance sheet date. Execution prior to the issuance of the financial statements is sufficient for reclassification.
Current vs. Noncurrent Liability Classification (Refinancing)
Rules for classifying a short-term obligation as noncurrent if the company intends to refinance it and demonstrates the ability to do so on a long-term basis.
- Requires both intent and ability to refinance.
- Ability is demonstrated by actual refinancing or a noncancelable refinancing agreement.
- This must occur between the balance sheet date and the date financial statements are issued.
Memory trick: Refinance: Intent and Ability Before Issuance.