Refinancing Short-Term Obligations

Key Concepts:

Terms in this set (21)

On December 31, 20x7, the Bulldog Company reports a current note payable that matures on April 1, 20x8. The note is payable to an equipment dealer. The 20x7 financial statements are issued March 4, 20x8. If any of the following transactions or events occur, then the original note is classified as long term in the 20x7 balance sheet:

1. On February 22, 20x8, Bulldog issues another note payable maturing in 20x9 to replace the existing note.

2. On March 1, 20x8, Bulldog signs a noncancelable refinancing agreement with a lender capable of honoring the agreement. The agreement requires the lender to pay the original note in return for a note from Bulldog due after December 31, 20x8 (at a higher interest rate). The refinancing need not occur before the issuance of the financial statements. Only the agreement must be set in place by that time.

3. In February, Bulldog issues shares of its common stock to the equipment dealer in full payment of the note. (If this occurs before the balance sheet date, then Bulldog has no liability to reclassify.)

However, if the firm extinguishes the original note in February by paying cash, and then replenishes the cash with the issuance of a long-term note, the original note remains a current liability in the 20x7 balance sheet because current assets were used for extinguishment.

Also, if a refinancing agreement is cancelable by either party, then there is no reclassification of the note because then there is no guarantee that current assets will not be used in 20x8 to pay the note.

Finally, if the firm enters into a revolving credit agreement whereby one current liability is continually replaced with another current liability, even though no current assets may actually be used for a significant time period, the agreement does not allow reclassification of the liabilities to noncurrent status. This arrangement falls within the definition of a current liability.