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Search Under Hong Kong Interpretation 5 Presentation of Financial Statements – Classification by the Borrower of a Term Loan that Contains a Repayment on Demand Clause (references have been updated to reflect the requirements in HKFRS 18)

Hong Kong Interpretation 5 Presentation of Financial Statements – Classification by the Borrower of a Term Loan that Contains a Repayment on Demand Clause (references have been updated to reflect the requirements in HKFRS 18)

The Questions and Answers (Q&As) below were developed by the Financial Reporting Standards Committee (FRSC) of the Hong Kong Institute of Certified Public Accountants (the HKICPA) and are for general guidance only. The HKICPA, FRSC and their staff do not accept any responsibility or liability in respect of the Q&As and any consequences that may arise from any person acting or refraining from action as a result of any materials in the Q&As. Members of the HKICPA and other users of these Q&As should also read the original text of Hong Kong Interpretation 5 Presentation of Financial Statements – Classification by the Borrower of a Term Loan that Contains a Repayment on Demand Clause, as found in the HKICPA Members’ Handbook for further reference and seek professional advice where necessary when applying the guidance contained in these Q&As.

The HKICPA's Standard Setting Department welcomes your comments and feedback on this paper, which should be sent to commentletters@hkicpa.org.hk.

These Q&As were originally published in November 2010 on issuance of HK Interpretation 5 and subsequently updated in November 2020 and September 2024 as a consequence of revisions to HK Interpretation 5 in October 2020 and July 2024 respectively.

Summary of HK Interpretation 5 Presentation of Financial Statements – Classification by the Borrower of a Term Loan that Contains a Repayment on Demand Clause

HK Interpretation 5 Presentation of Financial Statements – Classification by the Borrower of a Term Loan that Contains a Repayment on Demand Clause (HK Int 5) was issued in November 2010.
HK Int 5 was revised in October 2020 as a consequence of the Amendments to HKAS 1 Classification of Liabilities as Current or Non-current issued in August 2020 (2020 Amendments). The 2020 Amendments provide further guidance on how to classify debt and other liabilities as current or non-current.
In December 2022, the Institute issued Amendments to HKAS 1 Non-current Liabilities with Covenants (2022 Amendments) to deal with the classification of long-term loan arrangements with covenants and defer the effective date of the 2020 Amendments to align with the effective date of the 2022 Amendments. HK Int 5 was updated to incorporate the references to these amendments, but its conclusions are not impacted by these amendments.
In July 2024, the Institute issued HKFRS 18 Presentation and Disclosure in Financial Statements and carried over the requirements relating to the classification of liabilities as current or non-current in HKAS 1 to HKFRS 18. Following the issue of HKFRS 18, the references in HK Int 5 have been updated to reflect the requirements in HKFRS 18. HKFRS 18 is effective for annual periods beginning on or after 1 January 2027. Earlier application is permitted.
"Term loans" are loans which are repayable on a specific date or in instalments over a period of time, usually in excess of one year. Loan facility agreements for such loans will set out the basic terms, such as the scheduled repayment date(s), interest rates and additional charges for early repayment, and may also include specific clauses which define default events which would give the lender the right to accelerate the repayment terms if those events occur.
In addition to defining events of default and the consequences of their occurrence, some term loan agreements include an overriding repayment on demand clause, which gives the lender the right to demand repayment at any time at their sole discretion and irrespective of whether a default event has occurred.
The purpose of HK Int 5 is to set out the conclusions of the FRSC on the question of whether a term loan which is subject to a repayment on demand clause should be classified by the borrower as current or non-current in accordance with the criteria for classification of liabilities as set out in paragraphs 101-102 of HKFRS 18.
The Conclusion reached by the FRSC on this issue is that the classification of a term loan as a current or non-current liability in accordance with paragraph 101(d) of HKFRS 18 shall be determined by reference to the existence of the borrower’s right at the end of the reporting period to defer settlement of the liability for at least twelve months after the reporting period. On this basis, loans subject to loan agreements which include a clause which gives the lender the unconditional right to call the loan at any time shall be classified by the borrower as current in its statement of financial position (balance sheet). In this regard, the probability of the lender choosing to exercise its rights to demand repayment within the next twelve months after the reporting period is not relevant.

Commonly asked questions regarding the application of HK Interpretation 5

Q1.	Why did the HKICPA issue HK Int 5 in 2010?

Answer:

During the course of 2010, the FRSC was asked to consider the practice of some entities in Hong Kong of classifying term loans with repayment on demand clauses as non-current liabilities in their financial statements, based on the schedule of repayments in the loan agreements. Comment letters during the consultation period for the Exposure Draft of HK Int 5 indicated that this was understood to be a widely accepted practice amongst Hong Kong preparers, which was felt to be consistent with the substance over form principle.

At that time, the FRSC noted that paragraph 69 of HKAS 1¹sets out strict criteria, which, if met, should result in a liability being classified by the borrower as current in a set of financial statements prepared in accordance with HKFRS Accounting Standards.

Given the diversity of views received and noting that the issue has widespread implications for financial reporting in Hong Kong, on balance the FRSC decided that the issuance of HK Int 5 would be the most effective way of ensuring a common understanding of the requirements of HKAS 1¹, and would therefore contribute to ensuring continuing consistency of application and full convergence with IFRS Accounting Standards.

In response to members' concerns, the FRSC wrote a letter to all commentators who expressed concerns over the conclusions in HK Int 5 explaining the reasons and the importance of issuing HK Int 5. A copy of the letter is available at
https://www.hkicpa.org.hk/-/media/HKICPA-Website/HKICPA/section6_standards/technical_resources/pdf-file/smp-sme/2010/dec/hk-int5.pdf

[1]

¹When the HKICPA issued HKFRS 18 in July 2024, it carried over the requirement in paragraph 69 of HKAS 1 to HKFRS 18.

Q2.	Can you provide some examples of: (a) "Repayment on demand" clauses which, in accordance with HK Int 5, would result in classification of a term loan as a current liability; and (b) Subjective “events of default” clauses which would not result in such a classification?

Answer:

It should be noted that the terms of a loan agreement are a contract between the borrower and the lender and therefore it is for the lender to decide the terms on which it is prepared to provide the facilities and for the borrower to decide whether those terms are acceptable. Consequently, the examples below are provided for members’ information only. The examples are not the only forms of wording of such clauses which can be found in loan agreements and the HKICPA neither encourages nor discourages the inclusion of such clauses in lending agreements. If any party to a contract is in doubt about the consequences of agreeing to borrow or lend on the terms proposed by the other party, then they should seek professional advice.

(a) Examples of contract clauses which, in accordance with HK Int 5 would result in classification of a term loan as a current liability

"By signing this letter, you [the Obligor] expressly acknowledge that we [the Lender] may suspend, withdraw or make demand for repayment of the whole or any part of the Facilities at any time notwithstanding the fact that the following covenants/undertakings are included in this letter and whether or not the Guarantor is in breach of any such covenants/undertakings."

"As a general banking practice and notwithstanding any terms and conditions specified above, the Lender reserves its overriding right to cancel or to modify the Facility, or to demand immediate repayment of all outstanding balances whether due or owing, actual or contingent under the Facility without prior notice."

"Notwithstanding any provisions stated in this letter, the Facilities are repayable on demand by the Bank. The Bank has the overriding right at any time to require immediate payment (of all principal, interest, fees and other amounts outstanding under this letter or any part thereof) and/or to require cash collateralization of all or any sums actually or contingently owing to it under the Facilities."

"Notwithstanding anything contained in this letter, the Facilities are subject to the Bank's overriding right of repayment on demand, to review, amend, and/or cancel any or all of the Facilities at its sole discretion."

(b) Examples of subjective “events of default” clauses

Note: Typically loan agreements contain an extensive list of “events of default” which, if they occur, would entitle the lender to demand immediate repayment. Listed below are examples of those “events of default” that relate to the company’s performance and are commonly referred to as “subjective acceleration clauses” as they allow a certain amount of scope for the lender to exercise its judgment. In accordance with paragraphs B102 to B103 of HKFRS 18, “events of default” clauses would generally only result in classification of a term loan as a current liability if the event occurred on or before the end of the reporting period and the lender did not provide a waiver or grace period of more than 12 months after the reporting period during which time the lender could not demand immediate repayment as a result of this breach.

“A change in the financial condition occurs in relation to the Group which has, or in the reasonable opinion of the Lenders after due and careful consideration is likely to have, a Material Adverse Effect on:

(a) the business, operations, property or condition (financial or otherwise) of any Obligor or of the Group taken as a whole;

(b) the ability of any Obligor to perform its obligations under the Finance Documents;

(c) the validity, legality or enforceability of this Agreement or the rights or remedies of any Finance Party under the Finance Documents; or

(d) the validity, legality or enforceability of any security expressed to be created under any Security Document or the priority and ranking of such Security.”

“Material adverse change: there occurs, in the opinion of the Lender, a material adverse change in the financial condition of any Obligor, or any other event occurs or circumstances arises which, in the opinion of the Lender, is likely materially and adversely to affect the ability of the Obligors (or any of them) to perform all or any of their respective obligations under or otherwise to comply with the terms of any Finance Document to which any of them is party.”

“Significant investment which may impair or threaten the right of the Lender to collect the loan and interest”

“Involvement in important economic dispute or deterioration of financial status which may impair or threaten the right of the Lender”

“Significant part of or the entire assets being occupied by other creditors, being taken over by appointed trustee, receiver or other similar entities, or being pledged or frozen which may impair the Lender’s right to collect the loan”

“Contracting, leasing, capital restructuring, joint operation, merger, acquisition, joint venture, division, decrease of registered capital, change in shareholding, transfer, or other events which may impair the right of the Lender to collect the loan and its interest”

Q3.

The HKICPA's Financial Reporting and Auditing Alert Issue 11 mentions that in some cases, borrowers may be able to obtain "comfort letters" from their lenders indicating that loans will not be called within the next twelve months and therefore the term loans that are subjected to repayment on demand clause would not be classified as current liabilities in the financial statements. Is there any prescribed wording to be followed?

Answer:

There is no standard wording to be followed, as the basis on which a lender is prepared to lend is a matter for the borrower to discuss with the lender on a case by case basis. However, for the letter to be effective it has to be legally enforceable and the wording needs to be clear that the bank provides an undertaking that it will not exercise the "repayment on demand clause" (i.e. the loan will not be called in) in the period covered by the letter, or that it will only have the right to exercise the clause if some specified trigger default event (such as non-payment of interest or installments on their due date) occurs during that future period (see the answer to question 2 for further guidance on “events of default” wording).

It would not be sufficient if the letter only referred to the lender’s current intentions or expectations about the future, as the conclusion of HK Int 5 is that classification is based on the borrower's right at the end of the reporting period; the probability of the lender choosing to exercise its rights is not relevant.

Q4.	Does HK Int 5 apply to companies using (i) HKFRS for Private Entities and (ii) Small and Medium-sized Entity Financial Reporting Standard?

Answer:

Yes. Both HKFRS for Private Entities (paragraph 4.7(d)) and Small and Medium-sized Entity Financial Reporting Standard (paragraph 1.17(d)) contain similar requirements as set out in paragraph 101(d) of HKFRS 18.

Consequently, it is the FRSC’s view that although HK Int 5 is issued as a clarification of an existing HKFRS Accounting Standards, the conclusion set out in HK Int 5 concerning the classification of a term loan which contains a repayment on demand clause should be considered by management when reporting under “HKFRS for Private Entities” or the “Small and Medium-sized Entity Financial Reporting Standard”.

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Hong Kong Interpretation 5 Presentation of Financial Statements – Classification by the Borrower of a Term Loan that Contains a Repayment on Demand Clause (references have been updated to reflect the requirements in HKFRS 18)