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It was a while in the works: the AcSB is putting out the new standards for private entities. Most of them are derived from the current Handbook

By Jeff Buckstein
Illustration: Dan Page

The profession has been waiting for this for a long time and finally, things are changing. The conventional wisdom in accounting standards used to be one size fits all; people believed that a single, wide-ranging umbrella could cover the needs of businesses of all stripes. Not any more. The Accounting Standards Board (AcSB) adopted differential accounting standards for non-publicly accountable enterprises (non-PAEs). The AcSB has issued an exposure draft proposing new Canadian generally accepted accounting principles (GAAP) specifically for private enterprises. The AcSB is canvassing the opinions of not-for-profit organizations to see if these guidelines would also be suitable for them.

“We worked with an advisory committee that included both preparers and users of private company financial statements to identify what’s really needed and important for the users, and what’s difficult for the preparers,” says Peter Martin, director of accounting standards at the Canadian Institute of Chartered Accountants. “This process helped identify which of the current requirements were really important. That’s why the board has worked so hard to come up with a sensible approach to financial reporting that accommodates a scale running from the very small to enormous global organizations.”

This change in direction reflects a recognition that the financial statements of public and private companies are meant to accomplish different things. A public company’s primary focus is on providing investors with sufficient information to make decisions about whether to buy, sell or hold securities.

“For a private company, you can’t say that’s irrelevant, but it’s much less frequent, because its securities aren’t publicly traded. They’re usually closely held — often passed down generation to generation,” says Toronto-based Paul Cherry, newly appointed chair of the International Accounting Standards Board’s Standards Advisory Council and former chair of the AcSB.

“So the AcSB has gone to the end users to ask, Who gets your financial statements? Why do they get them? What do they do with them? And we worked from there to determine where we can provide a simpler approach without compromising quality.”

Upon review, the vast majority of current accounting standards in the Handbook were considered acceptable for private business. Because they have existed for a while, and people are used to them, they will be incorporated into the new standards for private enterprises.

“The nice thing is that it’s all derived from the current Handbook. The bulk of the material [more than 80%] is what they’ve already seen,” says Ron Salole, CICA vice-president of standards. “So I don’t think as big a retooling effort is needed as with IFRS,” he says.

But a small amount of existing Handbook material got a major overhaul as far as future applicability to non-PAEs was concerned. “We’ve been able to chop out whole standards; in a couple of places a few bits and pieces within individual standards were chopped out as well,” says Martin. “There was no point carrying forward standards on topics that are irrelevant to private enterprises.”

That led to some important differences. For example, says Martin, “we have a standard telling people how to calculate earnings per share (Section 3500). That standard is not applicable to nonpublic companies; it’s only public companies that really provide that information, and it’s only relevant to those sorts of companies. So there’s no need to carry forward that standard and it was just simply dropped.”

The standard on interim financial statements (Section 1751) also received close scrutiny. Because interim reporting is typically only applicable to public companies, and private companies generally only report annually using GAAP, this standard was left out of the new requirements for private enterprises. Similarly, the standard for segment disclosures (Section 1701) is mainly a public-company reporting requirement so it won’t be required for use by private companies under the new GAAP.

Income taxes (Section 3465) also warranted close examination. Income taxes have been contentious for many years, featuring an ongoing debate between future income tax accounting versus taxes payable accounting, says Bob Young, Toronto-based partner in the national assurance and professional practice of KPMG and member of the AcSB’s advisory committee to assist with implementing private company standards.

One of the AcSB’s decisions is to allow private enterprises to use the taxes payable method as an alternative to the future income taxes method under which they are required to account for future taxes payable.

Also, because financial professionals in private companies may be more comfortable than those in public companies in using professional judgment, there wasn’t the need for a lot of detailed rules for how to apply standards and basic principles, says Martin. “So we’ve been able to cut back quite a bit there.”

For instance, one area that was reduced substantially involved the Emerging Issues Committee abstracts that have accumulated over the past 20 years. “With the exception of a few bits and pieces of extracts that happen to be more principled than detailed guidance, which we will carry forward, the vast bulk of abstracts are considered too detailed and unnecessary, so we were able to prune those away,” Martin says.

Ditto for financial statement note disclosure. The first step in determining what was relevant to private company financial statement users was to take a hard look — for the first time — at all the costly universal disclosure requirements.

“We’ve accumulated quite a large set of disclosure requirements over the years,” says Martin, “but a number of the specific requirements are not pertinent or needed in the private-enterprise sector. So we’ve gone through all the requirements and essentially tried to take a clean sheet of paper approach [to] figure out what disclosures are useful and necessary.”

In general, the overall reduction applicable to many private firms should be in the 40% to 50% range, he adds. For example, a line item on the balance sheet that reads “property, plant and equipment, net of accumulated depreciation” currently requires a breakdown of that number under full GAAP. But under the new standards, a private company wouldn’t be required to give that level of detail — because most readers wouldn’t typically be looking for that kind of analysis (or if they did need it, they might already have it from another source).

A lot of what publicly accountable enterprises need to present in terms of financial disclosure focuses on what market analysts want. And market analysts demand as much information as possible, says Armand Capisciolto, national accounting standards partner with BDO Dunwoody in Sault Ste. Marie, Ont.

In contrast, the users of a typical private company’s statements are not analysts. “They’re local bankers and leasing companies,” Capisciolto says. “They don’t want to read financial statements that are 100 pages long. Some of the information currently being provided in financial statements of publicly accountable enterprises isn’t that relevant to the users of private companies, so I think they will very much appreciate this change,” he says. Reducing those types of disclosures is an important simplification that can also reduce the extra costs it would otherwise take to prepare and possibly audit them, he adds.

It was not a problem deciding whether and/or how to apply the vast majority of Canadian standards to non-PAEs. However, there were approximately 10 issues involving differences between PAEs and private enterprises that caused some difficulty, and most of those were resolved by a decision to keep existing differential reporting options intact by “hard-wiring those into the standards,” says Salole.

Consequently a lot of the things that private companies are doing right now by virtue of differential reporting they will continue, using the proposed new GAAP for private enterprises.

But that still left the AcSB grappling with two really tough issues involving how to account for financial instruments, as well as consolidations, notes Salole.

Financial instruments are covered under Handbook Section 3855. Consolidations are reflected in subsidiaries (Section 1590); investments (Section 3051; 3050 in the XFI version); and interests in joint ventures (Section 3055). The AcSB agreed that financial instruments of private enterprises could be accounted for at historical cost, with two exceptions: equity investments that have a readily available fair market value (FMV) through a publicly quoted market price; as well as the holdings of any free-standing derivates that are not used for specified hedging purposes, both of which would have to be expressed at FMV.

“We have made quite a side turn, if you will, relative to the financial instruments standards developed to date that you’ll find in today’s Handbook,” says Martin. “People have been pressing us to get away from some of the complexities of those standards and to get away from fair value measurements.”

Removing many financial instruments from the fair value model and stating them at historical cost will make things easier, says Young, who notes that historic cost information is more readily available and thus easier for a public accountant to either review or audit than fair value information.

How did we get from there to here? The movement to obtain unique standards that would apply to non-publicly accountable enterprises (non-PAEs) began during the mid-1990s, when the Accounting Standards Board (AcSB) established a study group to examine the merits of continuing along the traditional path of a one-size-fits-all standards approach, or permitting exceptions to that rule for smaller, private enterprises.           The conventional wisdom then was that the same standards should apply to all types of profit-oriented enterprises, regardless of their size or public/private status, says Ron Salole, vice- president of standards at the Canadian Institute of Chartered Accountants in Toronto. But thinking began to change about 10 to 15 years ago in the face of what became known as the big GAAP/small GAAP dichotomy. A research report commissioned by the AcSB entitled Financial Reporting by Small Business Enterprises, published in 1999, reinforced that new thinking by concluding that standards were becoming too complex for smaller, privately held companies and that a one-size-fits-all approach might not be the best way to go after all. It recommended that Canadian GAAP allow for differential reporting options. In 2000, the AcSB created a Differential Reporting Advisory Committee to provide input into the standard-setting process from the perspective of a private enterprise and to consider further the notion of differential reporting and how to make that work. As a result of these processes, “the AcSB became convinced — and this was a significant mind change — that we would have differential reporting if certain conditions were met,” says Salole. Those conditions, covered in Section 1300 of the Handbook, which were adopted as part of Canadian GAAP effective January 1, 2002, included the need for qualifying enterprises to be privately held, without broad-based owners or shareholders. Also, enterprise owners had to unanimously consent to the use of differential reporting. Differential reporting options, when originally introduced, affected the following six Handbook sections (there have been adjustments since): Section 1590: Subsidiaries — use of the equity method or the cost method; Section 3050: Long-term investments — use of the cost method; Section 3055: Interests in joint ventures — use of the equity method or the cost method; Section 3240: Share capital — limitation of the disclosure to issued classes of shares; Section 3465: Income taxes — use of the taxes payable method with new disclosures; and Section 3860: Financial instruments — disclosure and presentation. In 2006, the AcSB undertook further research to talk to external users and find out what they needed from financial statements, says Salole. The result was the issuance of an invitation to comment supported by a detailed discussion paper that proposed three options for private firms going forward. The first option involved modifying GAAP for non-PAEs by deleting certain requirements or embedding different treatments in IFRS, similar to the differential reporting model. The second option was to pick up an initiative known as IFRS for small and medium-sized enterprises, proposed as a simplified, self-contained set of accounting standards appropriate for smaller, non-listed companies. The third choice was an independently developed set of standards, a made-in-Canada option whereby the AcSB would develop a unique set of standards for non-PAEs, either by drawing on existing standards as a source, or starting fresh. The rationale behind private enterprises not having to adopt the same standards as PAEs is that the latter tend to look toward global markets to raise capital; whereas private enterprises, by definition, don’t have broadly based stakeholder groups. They’re all here in Canada, so having access to global markets is not as significant, says Salole. As the made-in-Canada option was fleshed out, it carried the day. “We were able to take our Handbook and quickly draft a slimmed-down version that would apply just to private enterprises. We were able to demonstrate what the third option might look like, and there was overwhelming support for that,” says Salole. After a great deal of discussion, the board came to the conclusion in February 2008 that of the three options the one that seemed to be the best fit at this particular time would be the made-in-Canada standards, but with modifications from existing GAAP, Salole adds. Canadian standard setters view that as a step in the right direction, because private enterprises will be able to stick not only with Canadian GAAP, but also an adapted form of GAAP that is better suited to their needs, Salole notes. Moreover, there will be some two million private-enterprise corporations in Canada that avoid “the enormous change management that is going to occur in adopting full IFRS.”

Under the new GAAP, private companies will also be able to handle consolidations differently than PAEs, which must consolidate subsidiaries they invest in.

“If you have an investment in a subsidiary, today you would either consolidate the subsidiary the way a public company would have to or you’d have the choice of accounting for your investment on either an equity or cost basis,” Martin says. After deliberating, the decision was made to carry that differential reporting choice forward. “It’s essentially a free choice between the three different methods,” he adds.

Canadian standard setters have said that any private-sector company in Canada, including non-PAEs, can adopt international financial reporting standards (IFRS) if they so choose. There might be certain situations where a private firm elects to adopt full IFRS instead of the new Canadian GAAP, says Capisciolto, who projects three potential scenarios under which this might occur. One is when a company is planning to become a PAE in the future. “When you go public, you have to deal with three years of statements prepared as if you were a publicly accountable enterprise,” he notes.

Another case may be if the private firm is a subsidiary of a European company that has already adopted full IFRS. “If they were to adopt private company GAAP, they would basically be dealing with multiple reporting environments and have to report to their parent company all the differences.” So it might be more cost effective there to just deal with one set of standards and go with IFRS, says Capisciolto. Another circumstance favouring use of IFRS may arise if a private company is very large and in competition with other major PAEs that already report using IFRS or are converting to it. For comparative purposes, the company might also elect to do so if it believes it is adhering to best practices in the industry, he says.

From a logistical standpoint, it is expected that the proposed new GAAP should make life easier for both preparers and users of financial statements. “In talking to our clients, everybody’s very happy that the AcSB is doing this. Accounting standards are getting very complex, and I think it was time to take a step back and look at what is really relevant and understandable to the users of private companies,” says Capisciolto.

Paul Martens, vice-president of finance at The Crossing Co., a firm based in Nisku, Alta., that provides fleets of horizontal directional drilling rigs for oil and gas projects in Canada and the US, agrees that the new Canadian GAAP for private firms will satisfy most of his firm’s operations needs. In the expanding, healthy economy that existed until recently, The Crossing Co. was involved in merger and acquisition activity and putting out financial statements for consideration by bankers and other interested parties that generally only want basic information about the company’s financial health, which can be also obtained from other sources. However, says Martens, with crossborder deals in particular, the possibility always exists his firm will be asked to provide more information than under the new Canadian GAAP, which the company is prepared to do should the need arise.

Kirby Smith, vice-president of finance for Tartan Canada Corp., an Edmonton-based company providing plant maintenance and construction services to the energy, utility and processing industries, agrees that the new Canadian GAAP for financial reporting will serve his company and its stakeholders in a more precise way. Tartan’s major external stakeholder, the bank, is not looking primarily at full disclosures and notes, but more at covenant calculations and key parts of its financial statements, such as senior funded debt over earnings before interest, taxes, depreciation, and amortization, working capital ratio and fixed charge coverage ratio, Smith says.

Jeff Morton, CFO of Piston Ring Service, a wholesale distributor of aftermarket auto parts in Winnipeg, sees the proposed new GAAP as positive in the sense that private businesses tend to have a smaller user group of year-end statements consisting primarily of lenders. When such statements become too complex, “I think readers tend to either stop reading or get a little nervous and pull back,” he says. “They tend to think, ‘I don’t understand it, so I’ll view it negatively.’ So simplicity and clarity are good. I realize that’s tough to achieve in this increasingly complex world we operate our businesses in. But a simplified approach is, I think, more meaningful to the limited number of users who use these sorts of statements.” Moreover, from an administrative standpoint, the simpler and easier they are to prepare, the faster the turnaround, Morton adds.

Tony Chin, CFO of North West Geomatics, a Calgary-based private firm that does digital aerial photography and laser topographical profiling, also views the adoption of the new GAAP for non-PAEs as a favourable move. The administrative and financial costs associated with transitioning to the new IFRS as an alternative to a modified GAAP would have been too onerous, says Chin. North West, whose financial statements are audited despite its private status, currently uses differential reporting options. For instance, it doesn’t have to do future income tax calculations. That doesn’t really serve any useful purpose for most of the company’s stakeholders, which are its private shareholders and the lending financiers, says Chin.

The AcSB has completed its technical deliberations regarding the package of standards for private enterprises, and issued an exposure draft for comment in April 2009. A 90-day comment period will follow with the new GAAP for non-PAEs expected to be finalized and in the Handbook by the end of this year.

“I think that will be an exposure draft people take notice of because there are a lot more private companies than there are public companies in Canada,” Capisciolto says. “This is a pretty important set of standards they’re developing.”

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Jeff Buckstein is an Ottawa-based writer

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