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12.6 Balance sheet classification — variable rate demand obligations
Publication date: 31 May 2022
us Financial statement presentation guide
A Variable Rate Demand Obligation (VRDO) is a debt instrument, typically a bond, that the lender can put to (i.e., demand repayment from) the borrower. This feature gives the lender the ability to redeem the investment on short notice (usually seven days) by putting the debt to the borrower's remarketing agent. Upon a lender's exercise of a put, the remarketing agent will resell the debt to another lender to obtain the funds to honor the put (i.e., to repay the original lender). If the remarketing agent fails to sell the debt (referred to as a "failed remarketing"), the funds to pay the lender who exercised the put will often be obtained through a liquidity facility issued by a financial institution. Liquidity facilities typically take the form of a standby or direct-pay letter of credit, line of credit, or standby bond purchase agreement.
ASC 470-10-55-7 through ASC 470-10-55-9 addresses these instruments. The guidance indicates that the presence of a "best-efforts" remarketing agreement (typical for VRDO issuances) should not be considered when evaluating whether the VRDO should be classified as current or noncurrent.
A reporting entity should assume that a put will occur, and unless the VRDO borrower has the ability and intent to refinance the debt on a long-term basis, VRDOs should be classified as a current liability.
If a liquidity facility provides the borrower with the ability to refinance, borrowers should evaluate the terms of their liquidity agreements in light of the requirements for refinancing a short-term borrowing on a long-term basis (as addressed in FSP 12.3.4) for attributes that could impact balance sheet classification of the debt, including the following:
- Expiration date of the commitment
To achieve noncurrent classification, a liquidity facility for the VRDOs cannot expire within one year of the balance sheet date. VRDOs supported by liquidity agreements that expire within one year of the balance sheet should be classified as current. - Covenant violations
Violations of covenants in liquidity agreements could cause termination of the agreement or demand for immediate repayment of any draws. Therefore, a violation of any provision in the financing agreement at the balance sheet date, or available information that indicates a violation occurred after the balance sheet date but prior to the issuance of the financial statements, would trigger current classification. A covenant violation occurring prior to or after the balance sheet date requires a waiver to be obtained to achieve noncurrent classification. The form and content of the waiver needs to be in force for at least 12 months and it should not be subject to termination beyond those conditions in the original agreement. - SAC, MAC, or similar clauses
The existence of subjective clauses that provide the lender with the ability to demand repayment based on subjective (rather than objective) criteria will typically preclude classification of the VRDOs as noncurrent. - Repayment terms
The repayment terms of the liquidity facility will impact the determination of amounts due within one year of the balance sheet date (and thus the amount of the VRDOs that must be classified as a current liability). Some liquidity facilities have repayment terms that are installment-based and others require a balloon payment at the facility's expiration date. - Ability to cancel
The lender should not have the ability to cancel the credit facility within one year from the balance sheet date except for violations of the terms of the agreement that can be objectively measured. This may include failure to meet a condition, or a breach or violation of a provision, such as a restrictive covenant, representation, or warranty.
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