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Time for common accounting standards

The move to international financial reporting standards (IFRS) will place Canada on the same reporting playing field as more than 100 other countries, and comes after two years of extensive consultation and public discussions across the country. A comprehensive overview of Canada’s rationale for adopting IFRS was provided in a commentary that appeared in the January 30, 2008 edition of the National Post’s Financial Post section by Paul Cherry, FCA, chairman of the Canadian Accounting Standards Board. The complete article is reprinted below.

“Canada is about to join a growing worldwide migration to common financial reporting standards. In an ever-growing global economy, it is important that we keep in step.

“IFRS will soon become the basis of reporting for public companies in Canada, replacing Canada’s own generally accepted accounting principles (GAAP). The Canadian Accounting Standards Board announced this change January 2006, after two years of extensive consultation and public discussions across the country. The decision has been welcomed, both here and abroad, as serving the best interests of Canadian business and investors alike. The proposed changeover date is 2011. The strategy is supported by a well-developed, comprehensive implementation plan (see www.acsbcanada.org) which has been open for public comment for two years.
“Why change? Because Canada cannot stand in isolation from the growing acceptance of a common financial reporting language. Capital markets have gone global and Canada accounts for less than 4% of the global capital markets. If every country speaks a different accounting language, investors have difficulty comparing companies and investors ultimately bear the costs of translation. A global accounting language is the best solution for both public companies and investors. Many participants in the Canadian capital markets were becoming increasingly uncomfortable with Canadian standards that were neither one thing nor the other – that is, neither IFRS nor US GAAP, but a mix of both.

“Why IFRS? With businesses increasingly making decisions in a global context, the move to IFRS will place Canada on the same reporting playing field as more than 100 countries, including the UK and other European Union countries, as well as Australia, Japan, China, India, Brazil, South Korea and Israel, to name a few, are in the process of converging with IFRS.

“Even the US is signaling an interest in IFRS. Late last year, the US Securities and Exchange Commission (SEC) decided to accept IFRS from foreign private issuers on an equal footing with US GAAP. This means that Canadian companies reporting using IFRS will no longer be required to reconcile their financial statements to US GAAP – a significant cost saving. In addition, there is a formal agreement and work program to converge US GAAP and IFRS and significant progress has already been made. Most recently, the US is considering whether it should adopt IFRS for its domestic issuers. Canada’s implementation plan for changing over to IFRS has been praised south of the border for its high quality.

“Here in Canada, it is recognized that the transition to IFRS poses an enormous challenge, but is manageable if companies start to prepare now. Extensive training and education is already underway and will intensify. Considerable information is already available on the Accounting Standards Board website and is constantly being updated. Board staff meets regularly with stakeholders to ensure that appropriate steps are being taken.

“Long-term benefits outweigh any short-term challenges. IFRS will provide more opportunities for Canadian businesses and investors in Canadian businesses by reducing the cost of capital, increasing access to international capital markets and reducing costs by eliminating the need for reconciliations.

“IFRS has been evaluated by the International Organization of Securities Commissions, including the SEC. The consensus is that the standards are comprehensive, robust and capable of consistent interpretation and application. The balance of informed opinion worldwide, including the US and Canada, is that IFRS strikes the appropriate balance between fundamental principles and more specific implementation guidance.

“IFRS is already being used in most of the world’s major capital markets. Other countries have made the transition to IFRS, often in less time and facing greater challenges than Canada, and public companies, analysts and investors have coped well. The result has generally been greater clarity with no discernible disruption of the capital markets. IFRS will provide a sound basis for high quality, clear and consistent reporting that serves investors’ needs in Canada.

“The Canadian Securities Administrators are expected to publish proposals dealing with related issues such as allowing voluntary adoption of IFRS before 2011 and whether US GAAP can be used instead of Canadian GAAP. They also are expected to publish draft guidance for disclosure in Management’s Discussion and Analysis of the significance of the impending changeover to IFRS.

“Changing the basis of financial reporting for public companies has both costs and benefits. These have been carefully considered. Adopting IFRS will serve Canadians well in the global economy of the 21st century.”

Paul Cherry is chairman of the Canadian Accounting Standards Board. The AcSB confirmed the 2011 IFRS changeover date in February 2008

Reprinted with the permission of The National Post/Financial Post

Canadian performance board seeks comment on EBITDA and free cash flow guidance

CICA’s Canadian Performance Reporting Board (CPRB) is inviting comment until April 30, 2008 on its recently published document, Improved Communication with Non-GAAP Financial Measures – General Principles and and Guidance for Reporting EBITDA and Free Cash Flow.

This guidance responds to the increasing popularity of non-GAAP financial measures among preparers and investors who find such measures provide additional insight in-to an entity’s performance and financial condition. While such measures are widely used in MD&A and other public disclosures, there are few rules governing their construction and disclosure. This leads to varied practices in reporting these measures, even among entities competing in the same industry. Many investors say that more standardization and disclosure would improve the measures’ comparability between entities. This is especially important in today’s reporting environment where analysts’ reports are demanded immediately after publication of an entity’s results.

While investors want more standardization in reporting non-GAAP financial measures, management needs to tell its story. Accordingly, any guidance that advocates standardization also needs to recognize that management often wants to communicate unique entity-specific matters it believes investors should consider.

The guidance sets out general principles that discuss the characteristics of non-GAAP financial measures. These principles are expanded on in the EBITDA and free cash flow guidance that addresses three pieces of information that investors need:

1. Is the measure comparable between entities and consistent from period to period?
For each of EBITDA and free cash flow, the guidance recommends reporting a standardized measure that has a specified GAAP starting point and defined adjustments extracted directly from the financial statements. Accordingly, irrespective of the entity or the industry in which it operates, the standardized EBITDA and free cash flow measures should always contain the same components, and those components will have been constructed from the rigorous GAAP framework that applies to all entities.

2. Why is an entity-specific measure necessary and how does it vary from the standardized measure?
Entities often want to communicate entity-specific information in a non-GAAP financial measure. For example, management may wish to exclude a nonrecurring expense from EBITDA that is retained in the standardized calculation. It may believe that such a cost is not representative of operating costs on an ongoing basis. Accordingly, the guidance recognizes the need for such entity-specific measures and recommends various disclosures that should accompany them. The purpose for each entity-specific adjustment should be explained. As well, to facilitate an understanding of the differences between the standardized and entity-specific measures, the entity-specific measure should be reconciled to the standardized measure. Finally, any entity-specific adjustment should be related to the relevant item in the financial statements, so the reader is able to identify the amount of the item included in the financial statements and the financial statement caption in which that item is presented.

3. What other information is necessary to understand the non-GAAP financial measure?
By their nature, most non-GAAP financial measures use selective information from the financial statements. Accordingly, the guidance advocates additional disclosures to put the measure in context. For example, while standardized free cash flow provides an indication of the entity’s continuing capacity to generate discretionary cash from operations, investors need to understand how the entity’s other financing and investing activities compete with or complement free cash flow. Therefore, the guidance recommends additional disclosures that explain the relationship of the entity’s standardized free cash flow to its other investing and financing activities.

While the guidance focuses on reporting EBITDA and free cash flow, the CPRB believes the general principles, entity-specific guidance and complementary disclosures should be helpful in deciding how to report any non-GAAP financial measure.

The guidance can be downloaded at www.cica.ca/cpr. If you would like to submit comments, please send them to non.gaap@cica.ca.