Question

The following information is given for Airflight Airlines:

• As of December 31, 2015, Airflight had $10,000 of notes coming due on January 30, 2016. Also as of December 31,2015, Airflight was negotiating to issue long-term debt so that it could use the proceeds to liquidate these short-termnotes as they mature. On January 4, 2016, the company used $3,000 of excess cash to pay off part of the note. OnJanuary 29, 2016, a refinancing of the entire $10,000 was completed. The $3,000 was replaced and the rest of the notes were extended for another two years.
• Airflight has negotiated a long-term refinancing contract which permits Airflight to borrow an up to 60% of accountsreceivable balances to refinance debt. Accounts receivable are expected to range between $12,000 and $16,000next year.
• Airflight also has negotiated a new long-term refinancing contract which permits Airflight to borrow an amount up to 35%of inventory to refinance debt. Inventory is expected to range between $75,000 and $85,000 next year.

Required:

1. On the December 31, 2015 balance sheet, how much of the $10,000 note should be shown as short-term?
2. Airflight has a currently maturing note payable of $20,000 related to the accounts receivable refinancing contract. Howmuch of the $20,000 note payable can be classified as long-term debt at the end of 2015?
3. Compute the amount of the company's currently maturing note payable of $50,000 related to refinancing inventory thatmust be classified as short-term debt on December 31, 2015.

Answer 1

Short-term debt represents the current portion of long term debt. The fundamental rule for classification of short and long term debt is that as per US GAAP, short-term obligation may be classified as non-current debt if there is an intent and ability to refinance on a long-term basis. Thus, a short-term obligation may be excluded from current liabilities and included in non-current debt if the company intends to refinance it on a long-term basis and the intent is supported by the ability to do so as evidenced either by: the actual refinancing prior to the issuance of the financial statements; or the existence of a noncancelable financing agreement from a lender having the financial resources to accomplish the refinancing. The amount excluded from current liabilities and a full description of the financing agreement shall be fully disclosed in the financial statements or notes thereto.

The following journal entry would be used to record the reclassification:

Short-term liability (Debit) $XXX

To Long-term liability (credit) $XXX

As can be seen from all the three scenarios, the company has clearly shown the ability and the intention to refinance the loans on a long term basis.

1. Current portion: $3,000 as this was paid on January 4 of the next year. The balance of $7,000 would be classified as long term.
2. Noncurrent portion: $12,000 x 60% = $7,200. The balance will be current.
3. Noncurrent portion: $75,000 x 35% = $26,250. The balance will be current.