Health Care Companies Weigh In on Debt Classification

The Financial Accounting Standards Board (FASB) issued a proposal in September 2019 to simplify the classification of debt. Some health care organizations have raised concerns about the effects of the proposed changes on their financial metrics and debt covenants. The health care sector will get another stab at stating its case to the FASB in early 2020.

Exposure Draft

In 2014, initial deliberations for the debt classification project began following the inspection process of the Public Company Accounting Oversight Board (PCAOB). A substantial number of public companies had to restate their financial statements as part of this process. The FASB’s outreach to private companies revealed unnecessary compliance costs, which prompted the FASB to propose revisions to help reduce those costs.

Accountants have complained that rules for determining whether debt should be classified as current or noncurrent in a classified balance sheet are overly complex under Accounting Standards Codification Topic 470, Debt. Much of the complexity stems from various narrow-scope, fact-specific debt transactions.

In January 2017, the FASB issued a proposal that received mixed feedback. As a result of this response, the FASB reconsidered several issues, most notably unused long-term financing arrangements and grace periods.

Another Attempt

A second exposure draft was issued in 2019. An overarching cohesive principle for classifying debt is provided under Proposed Accounting Standards Update (ASU) No. 2019-780, Simplifying the Classification of Debt in a Classified Balance Sheet (Current Versus Noncurrent). It’s mostly unchanged from the 2017 proposal but includes some important clarifications.

With 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
• 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 changes, as the FASB has said, 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. Also, the changes are designed to provide more consistent and transparent information to investors.

Concerns from the Health Care Industry

These eight health care organizations objected to the 2019 exposure draft:

1. Banner Health (Arizona)
2. Beacon Health System (Indiana)
3. The Healthcare Financial Management Association
4. Munson Healthcare (Michigan)
5. Partners HealthCare System (Massachusetts)
6. Sharp HealthCare (California)
7. University of Chicago Medical Center
8. West Virginia University Health System

In their comment letters to the FASB, these organizations said proposed changes related to the treatment of unused backup credit facilities would have a significant negative effect on the presentation of remarketing arrangements. Also, they stated 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. The proposed changes, from the perspective of the health care organizations, would preclude them from being able to consider contractually linked long-term financing arrangements — such as letters or lines of credits — when determining the classification of debt.

More to Come

FASB Chairman Russell Golden plans to meet with health care organizations in early 2020 to walk them through the proposed changes and fully understand their concerns. In addition, he will seek feedback from others who are in favor of the proposed rules. No vote has been scheduled on the proposal yet. The FASB instead plans to continue its deliberations on this topic after weighing comment letters and new insights obtained from both sides. For questions on this proposal and classification of debt, contact a Weaver professional today.

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