Banking covenants – are the terms in your agreement specific?

1 December 2021 / Insight posted in Technical guidance

The London Inter-Bank Offered Rate (LIBOR) will cease to be updated after 31 December 2021. It is being replaced by SONIA, the Reformed Sterling OverNight Index Average. You’re probably now renegotiating your organisation’s finance agreements due to there being no transitional clauses in current contracts.

But, as part of your renegotiations, have you reviewed the definition of the terms used within your loan covenants and considered if these are specific? If they’re not, your organisation could be in breach of the banking covenant and any breaches must be disclosed in your financial statements.

The introduction of FRS 102 has changed accounting for a loan’s directly attributable transaction costs. Costs which would have been recognised within bank charges are now included within interest payable.

A change to timing of recognition of the expense, rather than being recognised evenly across the loan period, changes profit before tax:

 

 

When negotiating with your finance provider on the change to SONIA, please consider the definition of terms included within your loan covenants. If your finance covenant includes an interest cover ratio, should the interest figure included within the calculation be the interest expense as included in the profit and loss account, interest payable per the finance agreement or interest paid per the finance agreement? The inclusion of clear definitions for loan covenant terms can prevent inadvertent breaches from occurring and having to disclose the breach in your financial statements.

If you would like assistance with your loan covenants definitions, please contact us.