Accounting Standards

IFRS and principles too weak to work?

Al Rosen, in the second of a three part series in the Financial Post about the transition from Canadian GAAP to IFRS:

IFRS is too weak in its current form for investors to accept on par with current Canadian standards. Nonetheless, we are on course to implement IFRS in just three years.

He quotes and agrees with Arthur Levitt, who spoke out against IFRS and principles-based standards, claiming they will increase risk to investors, conceal fraud longer than current standards, and increase, not decrease, the cost of capital.

He believes that rules are necessary and argues that Canadian GAAP is largely rules-based:

In actuality, court cases have shown that Canadian auditors automatically gravitate towards a rules-based mentality. Published materials provide extensive appendices, interpretations, industry tabulations and other comparative guidance that are nothing more than rules.

I can see where he’s coming from, but I don’t agree that we should abandon plans to adopt IFRS and go back to what is essentially accounting isolationism. The standards are new and evolving, just as standards have done in individual countries before them, because that is just their nature.

Principles can work, and in theory are better than rules. Two additional changes should be made to the profession in order to fully realize the benefit, however. Mandatory audit firm rotation and even tighter restrictions on the ancillary services a company’s auditor can provide will help principles work.

Those steps could also increase competition for audits, helping to keep costs associated with switching auditors manageable. Although the effect is uncertain, they could make it easier to find fault in fraud cases, whereas rules may provide management or the auditors to make the case they followed the letter, if not the spirit, of the standards.

In a perfect world we wouldn’t need more rules, but history has shown that in this one we do.

History has also shown that rules don’t always work and often open a new loophole for each it closes. We can either try to find a better way or just make more rules.

The benefits of a strong set of international standards based on principles is a worthy goal and will require eternal vigilance. Perhaps the standards today need improvement in areas. This shouldn’t derail the whole process.

What do you think of Al Rosen’s position? Have rules been unfairly criticized? Could international standards be improved with greater specificity? Or should we just forget the dream entirely?

Accounting Standards

Income trusts get distributable cash standard

Canada’s CAs have announced guidance for a key metric of income trusts, that of distributable cash.

The term ‘distributable cash’ generally refers to the cash that an income trust could potentially distribute to unit holders. Investors use this information when assessing the entity’s ability to fund future distributions and to help value their investments.

But the problem with the measure is that investors had no way of knowing where the cash had come from: general operating activities, or selling off productive assets and related future capacity. There was no way to compare across trusts since they all defined the term differently, or even to compare the same trust year over year. The CICA recommendations seek to remedy this:

The CICA guidance recommends that income trusts report a new measure called “Standardized Distributable Cash” to improve consistency of reporting and comparability between entities. Together with other disclosures recommended in the framework, the new measure gives the industry a common methodology for providing investors with information.

Standardized Distributable Cash is defined as cash from operations, after adjusting for capital expenditures, restrictions on distributions due to debt covenants, and minority interests.

The recommendations are not without criticism, however.

Independent investor advocate Diane Urquhart noted that the new CICA measure of distributable cash is not an addition to generally accepted accounting principles and will appear only as part of management’s discussion and analysis. […] “It’s ugly,” declared Al Rosen of forensic accountants Rosen and Associates. “When you needed this – and in a tougher form – would have been at least five years ago.”

I believe those are the biggest criticisms of it: the “standard” isn’t part of GAAP officially, but merely guidance to help trusts provide investors with higher quality information, and the recommendations are a little late in coming.

Better something than nothing, and better late than never.