Standards overload blues

By Yan Barcelo
Illustration: Gary Taxali

Have accounting rules grown so weed-like that they are now choking the profession? Or is the complaint about over-regulation a misconception?

Ken Maiden is a partner in the 70-employeefirm Smith Nixon LLP, in Toronto. As a CA, he is particularly good at talking about numbers in columns. But recently, he’s been singing about accounting matters — singing the blues, that is. A while ago, at a skit performed at an office party, he sang this song he composed to the tune of Elvis Presley’s Heartbreak Hotel.

The CICA told me
The client can’t be your friend
You can’t go to their parties and the
Golf games must end!

CICA made me so lonely, baby
CICA made me so lonely,
CICA made me so lonely, I could die

The inspiration for this song had been building a long time, and the title could easily be Standards Overload or SO. Of course, the CICA is the wrong target for a satirical song, which could be more appropriately aimed at such rule-setting bodies as the Canadian Public Accountability Board (CPAB) or the Accounting Standards Board (AcSB).Nevertheless, it is a song many accountants might readily sing today, especially those who work for private small and medium-sized enterprises(SME)— these are the accountants most likely to be concerned about the growth of rules and regulations over the past few years.

“This is not a new issue; it’s been around for the past 30 years,” says Woody Hayes, a member of the Accounting Standards Oversight Council, and a partner with Hayes Stewart Little & Co., which employs 45 on Vancouver Island.

But the issue has grown much more acute in our post-Enron world. Clarence Byrd, a professor of accounting at Alberta’s Athabasca University who helped write the Guide to Canadian Financial Reporting,remembers when that book was comprised of roughly 600 pages. Now, the electronic version in equivalent book form would run to more than 1,500 pages. “It used to be fairly manageable, but it has become pretty unmanageable in the last few years,” he says.

Byrd is referring strictly to accounting standards to which the standards overload label can be applied. But Paul Cherry, chair of the AcSB, points out that the issue is not that clearcut: “Lots of other complaints get thrown into the same bag that have nothing to do with standards overload. They have to do with securities regulation, auditing principles, independence requirements, new Basel II standards and so on. People use the term ‘accounting’ very loosely and apply it to everything that relates to numbers.”

Not only is there confusion with what constitutes accounting standards overload, but the issue is fraught with misconceptions, which can add to the frustration and which the AcSB wants to clarify. “I recognize there is significant stress on the financial reporting system in Canada,” says Ron Salole, vice-president of standards at the CICA, “but unless some serious misconceptions are understood and addressed, the stress will continue unabated and solutions found wanting.” The idea that stress is being inflicted by the AcSB is incorrect, says Salole. “In fact, the AcSB agreed that accounting standards for private businesses need to address the special reporting issues of such businesses.”

Another misconception is that standards introduce complexity in financial reporting. Salole finds this simplistic. “Standards cannot remain static. Imagine the outcry if standards did not keep pace by reflecting changes in business practices,” he says. “It isfutile to think that financial reporting can revert back nostalgically to better times or that we all had an inbred ability that precludes any requirement to keep up-to-date.” Salole stresses that failing to analyze separately each issue that causes problems will immortalize the myth of a standards overload and prevent relief from those areas that cause the most stress.

Nevertheless, these requirements all contribute to the feeling some have of being overloaded, whether it is with standards or other regulations. Just ask any small accounting firm that elected not to cough up the fee required to go through the registration process with CPAB. “Any accounting firm that wanted to do the audit of a publicly traded company had to register,” says Peter Martin, director of accounting standards at the CICA. “Some smaller firms said,“we simply can’t put up the time and effort to satisfy the requirements of CPAB. Some who had registered initially even gave up because they felt they couldn’t work in that environment.”

Maiden recalls a recent encounter with one of the supervisory bodies. “I had my file reviewed and was told we had made too much work for putting only a Notice to Reader in a financial statement.” He also has a special place in his heart for inspections from CPAB. “We had been through an audit in 2005, when three people went through our offices and files for six weeks.” At the same time, one provincial inspector came in but didn’t stay as long as the other inspectors.

Strictly speaking, such situations have nothing to do with accounting standards overload, as Cherry points out, but they have everything to do with the standards overload blues. Even if we rigorously stick to the standards issue, the complaint box still fills up rapidly.

Ross McNichol, a sole practitioner in Calgary, thinks much of accounting regulation has become self-defeating. As an example, he cites one of the eight differential reporting areas that deals with taxes payable. Generally accepted accounting principles(GAAP) require a corporation to make provisions for future income taxes and propose relatively complex models to calculate this. With the simplified differential model, which nonpublic companies would readily take advantage of, statements need only show the taxes that are currently payable. “That’s fine,” McNichol says, “but if you only show current taxes, you must attach a note providing all the additional information to explain what additional taxes you might have recoverable or payable in the future. The net result is if you put in that information, then you might as well go through the full calculation and do a straight GAAP statement.”

Jane Halford, CEO of the Institute of Chartered Accountants of Alberta, drives the point farther, digging into more arcane considerations that have turned up in recent years. One issue deals with how callable debt will be classified on statements. Previously, Halford says, if the debt was on schedule with the bank, the accountant simply showed that debt in the long-term section of the balance sheet. Now, if the bank has the ability to call back the debt prior to maturity, the accountant has to show it as callable short-term debt, even if payments are on schedule. “When clients get those statements, they are lost,” she says. “Accounting firms, clients, banks, they all had to be educated about what the change means. It took a few years to make the reasons behind all this clear. Can you imagine the work?”

But even that issue is relatively simple compared with others that the CICA Handbook has recently started to deal with, especially financial instruments and variable interest entities. Halford recognizes there is a very good rationale for the rules concerning these increasingly popular entities. “What worries the smaller firms is that they see that larger firms have specialists who can deal with these new rules. But when you’re a small practitioner, how do you manage that complexity?”

According to Grant Robinson, partner at Robinson & Co. in Guelph, Ont., there is a persistent problem that current differential rules don’t solve: succession issues in family companies. Currently, Robinson says, three out of four companies are in a leadership crisis, and that includes accounting firms, where the average age of the head is 57.

“We’re now required to report preferred shares as debt,” says Robinson, who sees that as a problem, particularly in estate freeze situations. “Such an estate, which an entrepreneur’s children are beneficiary to, ensures that they won’t have to pay one big tax bill that will force the family to sell the company down the line.”

But the obligation to state preferred shares as debt wreaks havoc on the valuation of the company. As an example, Robinson gives a family company that would be worth $3 million, of which $2 million is retained earnings and $1 million is goodwill. Book value would stand at $2 million, but the company could sell at $3 million. “When you do the estate freeze, you have to evaluate the company at fair value, which is $3 million, so you set up preferred shares worth $3 million,” he says.

Now, here’s the kicker. Today’s standards say these preferred shares have to go in the books as a debt of $3 million, which wipes out the retained earnings and shows the company with a deficit of $1 million. “The irony of the situation,” Robinson says, “is for a company that doesn’t perform any estate planning, its statements indicate it is strong, when in fact it is managerially weak. But the company that does the planning is in fact the stronger one, yet the standards make it look as if it were in trouble.”

Cherry notes that this issue has in fact been addressed in the CICA Handbook. Effective January 1, 2002, the AcSB amended the standard that deals with the presentation and disclosure of financial instruments (Section 3861), allowing an enterprise that uses differential reporting (Section 1300) to present as equity preferred shares issued in certain tax planning arrangements, including estate freezes.

Independence is another issue that concerns Robinson. “Take a company where the controller falls sick and calls its accounting firm for help. It can’t help, because it has to stay independent. The firm would do a better disclosing job because it has a relationship [with the company],” he says. “Standards are driving a wedge in one of the most trusted relationships in business at a time when we have a succession crisis.”

So, is there a cost to this overload and do the SMEs’ accountants service feel the pinch? Surprisingly, they don’t seem to. Of the half-dozen companies with fewer than 100 employees talked to, not one felt any stress because of standards overload. One private company official, who insisted on remaining anonymous, gave this fairly typical answer: “[The small firm that audits the company and prepares its statements] takes care of everything and makes sure we comply with whatever the standards are.” Do SMEs perceive any significant increase in charges because of standards overload? There again, the same individual’s response is typical, “Well, fees are always increasing, but I wouldn’t say ‘significantly.’ ”

So, the standards overload debate is very much an inside issue for the accounting profession, a fact Cherry accurately notes: “Those that complain about overload are very much the public accountants in small firms or individual practice. We have not perceived the same from companies.”

In reality, accountants don’t complain about the increase in fees per se; they denounce that they have to perform so much more work that is of little value to clients. “Work we were charging $1,200 or $2,000 for five years ago, we now charge $2,000 or $3,000,” McNichol says. “That’s because there’s so much more work to stay abreast and we spend a lot more time documenting our decisions and actions. Inflation is also a factor.” Murray Mikulak, a partner at Mikulak & Hill LLP in Calgary, and former president of the Alberta institute who spearheaded the charge against standards overload, adds, “We challenged the premise that this information we produced was meaningful, useful and relevant.”

Mikulak insists that reflects the reality of a majority of small firms and sole practitioners. But agreement is not universal. Others prefer to see the glass as half-full. “There are lot of new standards, some not really practical for small companies. I wouldn’t call them overload, but I would say they’re not appropriate,” says Jean Dolbec, a sole practitioner in Laval, Que., who agrees that additional material is coming his way. “I think we’re going toward a greater harmonization in step with international norms, and it’s a normal evolution. That has a single aim: supplying necessary and trustworthy data to readers of financial reports.”

Nevertheless, insists Simon Prévost, director of legislative affairs at the Canadian Federation of Independent Business (CFIB), small companies are the most severely impacted by overload, whether they are aware of it or not. “If you’re a company of five employees and you have to sit down so many more hours with your accountant, that’s 20% of your workforce you’ve just immobilized,” he says. The CFIB has established that the total cost of all regulation (including labour laws, tax requirements and accounting rules) is $5,300 per employee for a small company of less than five employees. For a company of 100-plus, that cost drops to $1,100.

So the impact of standards overload is greater on the smaller players in accounting. “Sole practitioners are a dying breed because they can’t keep up with the flow of regulations,” McNichol says. “So they partner or collaborate. Some merge, others work in looser associations where they can assign specialists to specific areas of regulation.”

There is one overarching drawback to standards overload that a few have lamented. “There results a massive downgrading of assurance engagements, a dumbing down of the practice,” Mikulak says. “An increasing number of practitioners take audits and review engagements and try to downgrade them into notice to readers. This way, they put them under the radar screens of practice reviews, but the primary motivator is that accountants can’t keep up, digest and understand all these changes happening in the rules and standards. It’s a huge concern because we know the trend is spreading and we believe it is tarnishing our profession. Furthermore, we’re shortchanging clients in terms of our value proposition, because in a review engagement, we really do provide added value to the client.”

And then, there’s the mother of changes rising on the horizon: the switch to international accounting standards, scheduled for 2011. As Martin points out, the change will most likely really affect practitioners engaged in serving publicly accountable enterprises, but not everyone is convinced. Some see this as the straw that will break the camel’s back. Many practitioners, now in their 50s, have had more than their share of overload and are thinking of changing the focus of their practice before the 2011 deadline change — at a time the profession is experiencing personnel shortages. “In small offices, I hear that practitioners are deciding whether or not they want to stay performing assurance work at all; whether or not they want to go to preparing tax returns and compilation engagements,” Halford says.

Will this new 2,400-page set of international principles, rules and standards go down easily — or will it cause indigestion? The most candid answer comes from Martin, a strong defender of the push to internationalization, who starts out optimistically: “It will vary very much from one firm to another. Our present handbook and the international one are very close, so it shouldn’t be a problem to learn.” But then, not always. “Some people will find it challenging, but it needn’t be, because all you need [to do] is a Google word search,” he says. “Just finding what is relevant in 2,400 pages could be difficult for some. Applying the relevant requirements may be a separate question, and is therefore much harder. The devil is in the details. If you miss something small, it could still have a big impact on the reporting results of a particular enterprise.” But the real challenge will not be so much learning the new as unlearning the old. “It’s very hard to forget a practice you’ve been working with for 20 years.”

But Martin insists, “To the extent we limit these new standards to public companies, only the percentage of the profession that deals with public companies will be concerned. That’s a group of 4,500 public companies out of a Canadian total of [what could be as much as] two million businesses.”

What will the solution be for the other 1,995,500 companies? Hayes sounds an upbeat note. “The [AcSB] has gotten the message and now recognizes that one size does not fit all,” he says.

Indeed. The AcSB is studying a number of alternatives that could form what Martin calls the “best set of standards for nonpublic companies. It could be the international standards, but we’re not set on that now.” It could also be a “new standard that the International Accounting Standards Board is developing for small and medium-sized enterprises. That is a serious contender we are looking at for Canada.” But then, he recognizes another alternative could be to keep the current model, injecting a few modifications. “We expect to invite comments in 2007 where we will propose two to four different models for public comment.”

Mikulak hopes the model developed by a task force he lead as head of the Alberta institute will be presented. Whichever model wins the day, the result for practitioners will still be more standards, more details, more study, more standards overload blues.

That said, there is a good chance the profession could see the triumph of an alternative set of standards that would specifically address the needs of SMEs, serviced by small firms and sole practitioners. But don’t hold your breath. An alternate model is not a sure thing. Mikulak, who has been fighting since 2003 to see such a model emerge, regards its prospects with a healthy dose of skepticism. “My gut feeling is that the banks will drive this and will hang their hat on the principle of comparability. Comparability and consistency are the two principles they are advocating. They will reject the idea of two GAAPs in Canada. And that will happen even if bankers who understand the full GAAP are primarily in four places in Canada, namely Vancouver, Calgary, Toronto and Montreal. The small banker in a small town wouldn’t recognize full-blown GAAP, including the required note disclosures, if it hit him in the face.”

Maiden’s song does not include a verse dealing with the international standards issue. Maybe that’s because the subject was not very visible on the profession’s radar screen at the time. Perhaps if he writes a followup to his first ballad, his pessimism — and that of Mikulak — may not be warranted.

Yan Barcelo is a Montreal-area journalist