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.


Hedge funds looking for accountants

According to this recent post on JobsintheMoney’s CareerWire blog, hedge funds are looking for accountants and paying top dollar for them:

The Rothstein Kass report, The Compensation Conundrum, makes clear that even for non-investment professionals, hedge funds pay better than both Wall Street and corporate America.

For instance, senior accountants at surveyed firms earned $71,000 median salary for 2007 and were expected to receive bonuses centering around 50 percent – adding up to total pay of $106,000. Total compensation ranged from $96,000 to $124,000, varying little with firm size.

Those are pretty impressive numbers. This is no doubt going to continue to create pressure on public accounting firms and companies trying to hang on to their professionals.

I don’t personally know anyone who has left public accounting to go to a hedge fund, but with salaries like those above, it won’t be too long before I do. Salary shouldn’t be the only reason one leaves public accounting, and indeed I don’t think it often is. There are certainly some for whom the almighty dollar is the sole reason to leave, but most go somewhere they believe offers a better long-term career opportunity, and possibly work-life balance improvement.

Work-life balance is one area where I don’t think hedge funds have an advantage, even over public accounting, which is notorious for the long hours and demoralizing “busy season”. At a hedge fund you still work for clients, as in public accounting, which is the main reason why things get as hectic as they do. My peers would be wise to keep that in mind when they consider the seemingly greener pastures of hedge funds.


Experts weigh in on interest deductibility issue

The Globe and Mail, a Canadian daily, has a feature on their website today where three tax experts from Couzin Taylor LLP and Ernst & Young LLP answer questions from readers about the interest deductibility “feature” of the Federal government’s budget.

Caribbean beachI’ve blogged about this complicated topic a couple of times now but never really felt I understood the issue as clearly as I could’ve. I think I made that apparent to my readers! The discussion on the Globe really helped me get the gist of this situation better than my rudimentary research before.

Some highlights:

The government has ignored the adverse macroeconomic impact of the proposals. The measure has specifically targeted double-dips that reduce foreign taxes. Reducing foreign taxes increases Canadian wealth and enhances Canadian companies’ ability to compete abroad. There is no benefit to Canada or hard working Canadians from the measure announced today, which increase foreign taxes.

Seems pretty counterproductive to hurt Canadian companies and think this is going to have any kind of positive impact on our country. This will reduce jobs here and abroad in Canadian multinationals and will not increase federal tax revenue here (but it will abroad).

In practice, companies headquartered in countries like the US and UK will have a competitive advantage as they are able to reduce their foreign taxes and thereby reduce their cost of capital, relative to Canadian companies. The budget materials suggest that other countries are considering adopting similar policies, but that remains to be seen. No other country of which we are aware has compromised the international competitiveness of its own multinationals to this extent.

Why are we enhancing the competitive advantage companies already have over our companies? Because those other countries have looked at the same measure in their own tax laws, but have yet to implement them? Sometimes it’s better not to be ahead of the curve.

The proposal as drafted encourages Canadian companies to deduct interest in the highest tax jurisdiction. In this regard, Canada has among the highest marginal tax rates in the industrialized world. In addition, there is often additional complexity and cost associated with obtaining a foreign interest deduction. Most companies will forgo trying to get a foreign interest deduction for these reasons, and will instead just take the Canadian deduction. This will increase foreign tax revenues and reduce Canadian tax revenues.

Wow. I guess a pretty important question is whether there was anyone in the Finance department warning the Minister of these very serious drawbacks to his plan, or whether they were just being ignored. This whole thing is approaching debacle status.


The other upside to income trusts

Bell logoI wrote a post about BCE converting from a corporation to an income trust a couple days ago that set off a veritable firestorm of comments from a few readers. It quickly became the most commented on post here, which is pretty cool.

So with that in mind I jumped at the chance to blog about this article in the Globe and Mail, which talks about the other advantage of income trust conversion:

They function as a kind of a leash on executives bent on sacrificing upfront, predictable profits in their core business in favour of empire-building or diversification. Because trusts pay out the bulk of their cash to unitholders, they are forced, in essence, to ask permission from investors every time they want to raise money for a large acquisition.

BCE has a long history of making big acquisitions that have led to huge losses. The temptation of management to reinvest profits from their core business into diversified ventures has repeatedly destroyed millions (billions?) in shareholder value.

Since the conglomerate enterprise was established during the early 1980s, BCE has got into and out of businesses as diverse as pipelines, packaging, commercial property, a trust company and a television network, frequently generating losses in the hundreds of millions of dollars on its investment miscues.

This is a common problem it seems with large corporations. They diversify to manage risk, ignoring the fact that investors already diversify their portfolios to manage the same risk. The only time it makes sense for a corporation to invest profits into a new venture is when it is so closely related to their core business that they can generate higher returns than an individual (or institutional) investor could by taking their share and investing it in the venture themselves.

This has very rarely been the situation for BCE’s investments, and that’s another reason, and potentially more lucrative than the tax savings, why income trust conversion is a good move for BCE shareholders.


Google the mutual fund company

No, Google isn’t managing investments. They’re still devoted to “organizing the world’s information,” but that doesn’t matter to the SEC. A rule enacted in 1940 could cause increased regulatory headaches for the company.

Companies whose securities make up more than 40 percent of their assets can fall under restrictions that govern the mutual fund industry.

Google apparently is still awash in IPO cash, prompting the question – why did they have it if they weren’t raising funds for something? They’ve got nothing better to do than sit on $9.8-billion, which makes up nearly 70% of their total assets?

It would be “extremely onerous” for a company whose main business involves anything other than managing money to be regulated as a mutual fund, said Kenneth Berman, a former associate director in the SEC’s investment management division. For example, the 1940 law restricts companies’ ability to borrow money as well as issue stock options.

This is kind of telling, now isn’t it? Stock options are bread-and-butter compensation for tech companies, including Google. Case in point, Microsoft and Yahoo had to apply for the exemption from the rule that Google is now applying for.

The SEC will provide an exemption to companies that can show their primary business is other than investing, owning and trading securities. Google’s application said the company’s Internet, advertising and new media operations accounted for 92 percent of net income in 2005.

I don’t think there’s much of a chance that Google isn’t going to be granted the exemption. It sounds like the threshold is pretty low for justifying that the business doesn’t qualify for the regs. And the numbers back it up.

Google has a problem though, and that is what to do with all that cash. Some have already begun speculating what would happen if Google wasn’t exempted from the rules:

Google would be more likely to expand its infrastructure than spring for a large company… Google’s acquisition history shows that the company sticks to smaller companies… They’re going to continue to focus on smaller acquisitions that are predicated on proprietary technology and talented developers and engineers.

Dividends are out of the question strategically, although they are technically an option. Once dividends are paid, the expectation is they will continue to be paid in the future and the market does not look favourably on companies that buck the trend. But then, there was this about a week earlier:

On its India web site, Google has invited applications from people who can “identify and evaluate acquisition opportunities across existing and future market opportunities, drive management team decisions, lead deal execution, and help manage post-acquisition integration and performance evaluation in the South Asia Region.”

So it looks like Google might have some takers for that cash after all. Investing in India is a smart move as well. What do you think Google should do about its abundance of cash?