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Accounting Standards

Changes to GAAP for private companies in Canada

Since the mid 90s there has been debate within accounting circles on whether there should be two versions of GAAP – one for public companies and one for private companies. Big GAAP and little GAAP. The logic is that there are sections of GAAP that do not apply to non publicly accountable entities, and time and money is wasted complying for little benefit.

In 2002 differential reporting became available for private companies which allowed management, with the unanimous consent of shareholders, to choose how they accounted for certain financial statement items from among options. For example, subsidiaries and joint ventures can be accounted for using the equity or cost method, in addition to full consolidation.

IFRS presented the next challenge. Canada will adopt IFRS for public companies for years beginning on or after January 1, 2011. But what about private companies? The AcSB decided to tailor existing Canadian GAAP to the needs of private companies.

The following removed sections, for example, didn’t apply to private companies:

  • Earnings per share, as the measure is primarily used by public companies
  • Interim and segment reporting, for the same reason
  • Most EICs, which are mostly very detailed rules for special, specific situations

Differential reporting options were maintained for the most part, including:

  • Income taxes, which can be accounted for under the future income taxes or taxes payable method
  • Subsidiaries, joint ventures and investments, which can be accounted for under the equity or cost method

Note disclosure is being simplified. For example, property, plant and equipment, which previously required more detail in the notes, will no longer require it. The reasoning was that most third party users of private company financial statements look to key ratios calculated from the financial statement numbers to judge a company’s financial health rather than details on line items.

Financial instruments have been significantly simplified. All will be measured at historical cost, with two exceptions measured at fair market value:

  • Equity investments for which market price is readily available
  • Derivatives not qualifying for hedge accounting

IFRS adoption will be optional for private companies, and will make sense for those that plan to go public in the near future and possibly for those that compete against public companies to aid investors looking to compare their figures. Of course there are already private companies in Canada that are subsidiaries of European entities and have been reporting under IFRS for years now. (I work for one.)

All these changes should lower compliance costs for private companies, which should include lower audit fees. An article on private company GAAP in the current CA Magazine mentions lower costs three separate times. These will be realized primarily thanks to easier to audit information (cost vs. fair value) and lower disclosure requirements.

I hope all the accounting firms are getting ready to lower their prices now that the audit costs will be reduced.

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Accounting Standards

Simplified accounting rules for small business

The CICA announced late last year a draft version of a new accounting framework for small, owner-managed businesses. The framework is being developed because these types of companies don’t have complex reporting needs like public companies, non-profit organizations, or private companies with significant third party investors or creditors.

I haven’t begun working on public company clients yet, although I have a couple equivalent-to-public companies currently. I have made it known in the office that I want to work on public companies in the future, so hopefully I will be scheduled on one or two soon.

Canada is moving towards international accounting standards (IFRS) for publicly accountable enterprises. The decision has been made and the process of reconciling Canadian GAAP to IFRS is in motion. Word around the office is that IFRS is very similar to Canadian GAAP in terms of the financial statements, but much more developed (read: verbose) when it comes to note disclosure.

But back to small business, or Owner Managed Enterprises (OMEs) as the framework calls them. The framework’s Foreword offers a glimpse into the thinking behind the endeavor:

Such a system could share some of the basic requirements of GAAP financial reporting … but expressed in a basic fashion.

You aren’t going to hear me complain if we can make accounting standards more understandable and accessible. In fact, I would consider it a prime concern if we want to create a more robust, entrepreneurial economy, here and around the world in the future. Such a milieu would help developing countries pull themselves up and improve their lot the only surefire way: through the expansion of trade.

A non-GAAP solution opens up a wide range of possibilities. A tax basis of accounting, a modified cash basis of accounting, a less complex version of GAAP – all are possible.

This is really interesting. I can’t say as I think these bases would provide better information, but they would be easier in many ways. The tax basis would obviously make filing a snap, and minimizing taxes is a key concern for small business owners. As for modified cash basis, there’s not enough information here to comment. Modified how?

Concerns were about the loss of a well-known frame of reference for financial statements [due to the transition to IFRS].

IFRS is great for the global economy. You want to tap into the global markets, you gotta play by the global rules (regardless of how dubious the model for the setting of those rules happens to be at this point in time). The conclusion of the CICA stems from the above quote – keep the accounting standards we know, just cut out the complicated stuff that small businesses don’t need. In their words (again):

The existing financial reporting framework in the Handbook represents … the collective intellectual capital of the accounting profession in Canada.

That is the best reason I can think of for reusing the standards for Owner-Managed Enterprises.

The CICA sought comment from interested parties on the framework by January 31, 2008. They recently posted an update on those consultations.

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Accounting Standards

Changeover to IFRS confirmed for 2011

The Accounting Standards Board of Canada has confirmed recently the changeover date to IFRS for publicly accountable for-profit organizations, set for periods beginning on or after January 1, 2011.

The announcement is available in PDF format.

It sounds like we’re going to have to know and be able to apply two sets of principles, as private companies and non-profits won’t be required to switch that early, if at all.

A proposal being looked at right now is having a Framework for Owner-Managed Enterprises, which is based on a pared-down version of current Canadian GAAP. Either know both or limit your possible clients.

At least we won’t have to learn two sets from scratch, but hopefully down the line there’s a more elegant solution to the problem.

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Accounting Standards

A little help for the transition to IFRS

A while ago I received an email informing me of a newsletter available for Canadian accounting professionals detailing the transition from Canadian GAAP to international standards, IFRS.

The newsletter is provided by The Finance Group, headed up by Gordon Heard, CA, and all three issues to date are available for download (in PDF format).

The site is a solid resource for IFRS materials produced by the AcSB, Canada’s Accounting Standards Board, and the CICA as well.

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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?