The Covenant Waiver That Wasn't
Tana Logistics Ltd has a KES 150,000,000 term loan from a commercial bank, repayable in quarterly instalments of KES 7,500,000, with a covenant requiring current ratio of at least 1.25 and debt service cover ratio (DSCR) of at least 1.30. At 31 December 2025 the current ratio is 1.18 and DSCR is 1.12, both breaches. On 20 January 2026, before the financial statements are authorised for issue on 28 February 2026, the bank signs a letter agreeing to waive the breaches for the year ended 31 December 2025 and to reset the covenant tests from 30 June 2026. The letter states the waiver is granted because of the bank's relationship with Tana and does not alter the loan's classification. The CFO wants to present the loan as non-current, arguing the waiver removes the breach. The loan is Tana's largest liability; reclassifying it as current would push the current ratio to 0.86 and trigger a second covenant.
1. Determine the correct classification of the term loan at 31 December 2025 and justify your treatment with reference to the applicable standard.
Read the worked answer
The loan must be classified as current at 31 December 2025.
Under IAS 1 (Presentation of Financial Statements), a liability is classified as current when the entity does not have an unconditional right to defer settlement for at least twelve months after the reporting period. Where a covenant is breached at the reporting date, the liability becomes payable on demand unless the lender has agreed, by the reporting date, to provide a period of grace ending at least twelve months after the reporting period.
Key points:
- The breach existed at 31 December 2025. The waiver was signed on 20 January 2026 - after the reporting date.
- A waiver obtained after the reporting date does not retrospectively create an unconditional right to defer settlement at the reporting date. It is a non-adjusting event under IAS 10 unless it provides evidence of conditions existing at the reporting date; here it evidences the breach, not a cure.
- The waiver letter expressly does not alter classification, so the contractual position at year-end governs.
Therefore the KES 150,000,000 (less amounts due within 12 months) is presented as current. The CFO's argument confuses the economic effect of the waiver with the legal right existing at the reporting date.
2. The CFO warns that reclassifying the loan will breach a second covenant and asks whether the bank's relationship-based waiver can be relied on. Advise the board on the accounting, disclosure and governance response.
Read the worked answer
The board should not rely on the relationship-based waiver to support non-current classification. Accounting classification follows legal rights at the reporting date, not lender goodwill or informal assurances.
Accounting response:
- Classify the loan as current and disclose the breach, the waiver obtained on 20 January 2026 as a non-adjusting event after the reporting date, and the terms of the reset covenants.
- Disclose the second covenant breach or likely breach and its consequences, including any cross-default provisions.
- Assess going concern: if the loan is repayable on demand and the company cannot refinance, there may be material uncertainty. The board must document its assessment and, if needed, include a material uncertainty disclosure.
Governance response:
- The audit committee should obtain the waiver letter and confirm it is enforceable and unconditional for the period it covers.
- The board should seek a formal amendment to the facility agreement, not a side letter, and confirm whether the waiver cures the cross-default.
- The board should disclose the lender relationship issue to the auditor and consider whether reliance on informal support is consistent with directors' duties.
- A refinancing or equity injection plan should be prepared and minuted; if not achievable, the board should consider whether it can continue to adopt the going concern basis.
Relationship-based assurances are not a substitute for enforceable contractual rights.