Is a Line of Credit a Current Liability?

A line of credit is a flexible loan provided by a financial institution that allows a borrower to draw funds up to a pre-approved limit. Unlike a traditional loan, where a lump sum is received upfront, a line of credit lets a business access capital as needed, repay it, and then borrow again. This revolving access to funds makes it a popular financing tool.

Understanding Current vs Non-Current Liabilities

In accounting, liabilities are classified based on their due date. A current liability is a debt that is expected to be paid within one year or within the business’s operating cycle, whichever is longer. Common examples of current liabilities include accounts payable, which are bills from suppliers, and accrued expenses, like wages owed to employees.

These short-term obligations are contrasted with non-current liabilities, often called long-term liabilities. These are financial obligations that are not due within the one-year or single operating cycle timeframe. A classic example of a non-current liability is a five-year business loan taken out to purchase equipment or a mortgage on a building.

Classifying the Drawn Portion of a Line of Credit

Only the amount actually borrowed from a line of credit, known as the drawn portion, is recorded as a liability on the balance sheet. The total available credit that remains unused is not a debt and therefore does not appear as a liability. The classification of the drawn balance depends entirely on the terms of the credit agreement.

The drawn portion of a line of credit is most often classified as a current liability. This is because lenders usually retain the right to demand repayment at any time or the agreement itself is structured with a term of one year or less. Even if the agreement spans multiple years, if the bank can cancel the arrangement and demand payment with short notice, accounting principles generally require the outstanding balance to be treated as a current obligation.

The classification is also heavily influenced by debt covenants. If a company violates a covenant on its line of credit as of the balance sheet date, the lender may gain the right to demand immediate repayment. In this situation, the debt must be reclassified as a current liability, even if its original term was longer. The only exception is if the lender provides a waiver for the violation that is effective for at least one year past the balance sheet date.

However, a drawn balance can be classified as a non-current liability if the company has both the intent and the ability to refinance the obligation on a long-term basis. The ability to refinance must be demonstrated in one of two ways: either by entering into a long-term financing agreement before the financial statements are issued, or by having a non-cancellable revolving credit agreement with an availability period that extends more than one year past the balance sheet date.

Balance Sheet Presentation and Required Disclosures

The drawn amount of a line of credit that is determined to be a current liability appears on the balance sheet under the “Current Liabilities” section. It is often listed as “Line of Credit” or “Notes Payable” to distinguish it from other short-term debts like accounts payable.

Beyond the balance sheet entry, detailed disclosures in the accompanying footnotes are required. These notes provide essential context that the single line item on the balance sheet cannot. The disclosures must include the total amount of the line of credit available, the outstanding principal balance, and the amount of unused credit. They also detail the interest rate, which may be variable, and the maturity date of the agreement.

Furthermore, the footnotes must describe any significant covenants associated with the line of credit. These are conditions the borrower must meet, such as maintaining certain financial ratios, to avoid default. The disclosure should also specify if any assets, like inventory or accounts receivable, have been pledged as collateral to secure the line of credit.