Question

On December 31, 2020, Millers Grocery Inc. had a 10-year, 7% note payable balance of $100,000. The note payable was originally issued on June 30, 2011. The company will issue its financial statements on March 15, 2021. How will the note payable in each of the following separate scenarios be classified on the balance sheet of Millers Grocery on December 31, 2020? a. The company intends to pay off the note payable when it comes due. b. The company intends to refinance the note payable and will begin discussions with the lender in February 2021. c. The company issues common stock in January 2021. $75,000 of the proceeds of the issuance plus $25,000 in cash are used to pay off the loan. d. The company enters into a refinancing agreement dated January 31, 2021, which allows the issuance of debt up to 50% of the company’s inventory balance, which is expected to be $175,000 during 2021. The interest rate in the refinancing agreement is 6.5% and the debt agreement expires on December 31, 2023. e. The full $100,000 was extinguished on February 1, 2021, when it was paid off with a $100,000, 8%, interest- bearing note payable, due February 1, 2026. f. Assume that the note payable was issued on June 30, 2020. The note payable includes a provision that allows for the lender to call the note at any time. However, the lender has indicated that it does not intend to call the note in 2021. g. Assume that the note payable was issued June 30, 2019, instead of December 31, 2020. Millers Grocery Inc. is in violation of a debt covenant that requires a current ratio of 1.5. Millers obtained a waiver of the debt covenant through September 2021 because it expects to be back at 1.5 by mid-year.

Answer 1

a. Note Payable of $ 100,000 was issued for 10-year period on June 30,2011 which means it falls due to pay on June 30,2021. If company intends to pay when it comes due, it gets reflected under "Current Liabilities" in the balance sheet as of December 31, 2020. Because current liability means any liability falls due within 12 month period from closing date of balance sheet.

b. Company intends to refinance the note payable, for which discussion will commence on Feb 2021 (i.e.) before issuing financial statements on March 15,2021. In such case, once the discussion succeed and if due date of the refinancing option falls after 12 months from closing date of balance sheet, existing note payable of $ 100,000 can be reported under "Non-current liability" by submitting proper documents about refinancing options. {Please note that both conditions are to be met (i.e.) refinance get succeed and due date has to be after 12 month from closing date of balance sheet} If in case refinance not get succeed or if due date of the refinancing option falls within 12 months from the closing date of balance sheet, existing note payable of $ 100,000 has to be reported under "Current liability" only.

c. Though note was paid as on due date (i.e.) within 12 months from the closing date of balance sheet, $ 25,000 only will be classified as "Current Liability" and $ 75,000 gets classified as "Non-Current Liability". Because another condition to classify a liability as "Current" is current liability has to be paid using current asset. If current liability is obliged using creation of another non-current liability, it gets classified as "non-current liability" only. Thus, $ 75,000 gets reported under "non current liability" and $ 25,000 gets reported under "Current liability" in the balance sheet as of December 31, 2020.

d. Refinance allowed up to 50% of inventory balance of $ 175,000 (i.e.) refinance can be made only for $ 87,500 ($175,000*50%). Lets assume refinance option due date is greater than 12 months from balance sheet closing date. Thus balance of $ 87,500 gets reflect under "Non-Current Liability" in the balance sheet dated December 31, 2020. Balance of $ 12,500 gets reported under "Current Liability" in the balance sheet dated December 31, 2020.

e. As said in point c. above, existing current liability paid on Feb 2021, by using new non-current liability. Short term obligation is met with another long term obligation. Thus existing note payable of $ 100,000 has to get reported under "Non current liability" in the balance sheet dated December 31, 2020.

f. Though note payable issued on June 30,2020 has a provision, which allows lender to call the note any time, since the lender has indicated that no intention to call the note in year 2021 (i.e.) not obliged to pay within 12 months time from the closing date of balance sheet, note payable gets reported as "Non-current liability" in the balance sheet dated December 31, 2020.

g. As said in point f. above. since Miller's has obtained waiver of debt covenant through Sep 2021 and expects to be back by mid year, it still can report under "Non current liability".