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By Nancy Estey
Illustration: Mike Constable
 NEW STANDARDS DESCRIBE WHAT CONSTITUTES GAAP AND CLARIFY "FAIR PRESENTATION IN ACCORDANCE WITH GAAP"
With the considerable body of accounting material available domestically and internationally, when confronted with accounting and disclosure issues, Canadian financial statement preparers sometimes face difficult questions: Where do I begin? What do I look at? Can I stop now? Now preparers can look to more comprehensive codification of what constitutes generally accepted accounting principles in new Handbook Section 1100, Generally Accepted Accounting Principles. They can also look to General Standards of Financial Statement Presentation, Section 1400 to clarify the meaning of "fair presentation in accordance with GAAP." These new sections apply to fiscal years beginning October 1, 2003, with earlier adoption encouraged.
GAAP and the Handbook
GAAP encompasses broad principles and conventions of general application as well as rules and procedures that determine accepted accounting practices at a particular time. Pronouncements issued by the Accounting Standards Board (AcSB) and by the Emerging Issues Committee (EIC) are extremely important and take primacy, but they represent only part of GAAP. The CICA Handbook – Accounting does not address every situation that may arise. However, this does not imply that entities may do whatever they please. For practical reasons, they must look to other sources for guidance: the AcSB and EIC cannot deal with every topic or with each topic comprehensively. It also allows GAAP to evolve and adapt to changes in economic or social conditions.
Development of the sections
The AcSB added the GAAP project to its technical agenda, in part, in response to a recommendation of the EIC to clarify the status of accounting guidelines and EIC abstracts using the US GAAP hierarchy as a model. In practice, questions arose from time to time as to the status and authoritativeness of guidelines and abstracts within GAAP. Also, provincial institutes/ordre practice advisers and inspectors reported that some practitioners ignored guidelines and abstracts or questioned the need to apply them to private entities.
The GAAP project also addresses concerns expressed by securities commission staff about the possibility of GAAP developing based on the consensus of informal groups of entities and their advisers who might confer and agree on an approach to an issue. Some interpreted the former wording of Financial Statement Concepts, paragraph 1000.60(a) to mean that the fact that a significant number of entities account for something in a certain way as "industry practice" makes it "generally accepted," without taking into consideration other sources of GAAP. In addition, securities commission staff expressed concern that isolated precedents are sometimes cited as justification for practices that contravene the spirit, if not the letter, of Handbook concepts and standards. Section 1100 significantly downplays industry practice as a possible source to consult. Entities pres ently adopting particular industry practices in their selection of accounting policies may no longer conform to GAAP.
The new standards result from a process of extensive research, consultation and debate. In July 2001, the AcSB issued an exposure draft. However, respondents raised a number of matters causing the AcSB to modify its proposals and conclude that they should be re-exposed for further comment. In September 2002, the AcSB issued a re-exposure draft along with an accompanying background information and basis for conclusions document to explain its rationale. To allow interested parties to better understand views on particular issues, AcSB held a roundtable discussion with re-exposure draft respondents in February. Since participants welcomed this opportunity for discussion, AcSB will hold additional roundtable discussions on other projects as part of its communication initiatives.
Overall, respondents supported the re-exposure draft proposals welcoming the improved clarity and simplicity as well as supporting the need to define a GAAP hierarchy in Canada. However, some re-exposure draft respondents had issues in certain areas resulting in further clarification to the proposals including expanded transitional provisions for rate-regulated operations pending completion of a separate project.
Key points
In a speech at the 10th CFO Rising Conference in March, former SEC chairman Arthur Levitt provided a rough list of guiding principles. Two of these principles help explain the essence of the new standards: "Select accounting principles from those that best reflect — from the view of the investor — the actual economics of the underlying business transaction" and "recognize that GAAP is not a standard to be met, but a foundation on which to build. In this new environment, the market is clearly going to reward companies that establish a reputation for both transparency and honesty."
Section 1100 provides two principles to select accounting policies and disclosures: to apply all relevant primary sources of GAAP and, when no relevant primary source of GAAP is available, to adopt accounting policies and disclosures that are consistent with the primary sources of GAAP and developed through the exercise of professional judgment and the application of the concepts described in Financial Statement Concepts, Section 1000 (see paragraph 1100.04). The AcSB developed Section 1100 utilizing a principles-based approach emphasizing these important cornerstones — especially the role of professional judgment in the selection of accounting policies and disclosures. The AcSB also stressed that management be knowledgeable about the primary sources of GAAP and be aware of changes to the primary sources.
Some respondents were troubled by a proposal that when an entity finds one other source of GAAP, it need look no further. The proposals also required an entity that identifies more than one other source to evaluate those sources in making its selection.This conflicting guidance may have lead to inconsistencies between entities in similar circumstances. In revising the proposals, the AcSB adopted a more rigorous approach to selecting the "other source of GAAP" than previously proposed, to avoid possibly perpetuating instances of fringe practice as opposed to reducing or eliminating them. It is now necessary for an entity to refer to other sources when the primary sources of GAAP do not deal with the accounting and reporting in financial statements of transactions or events encountered by the entity or when additional guidance is needed to apply a primary source to specific circumstances. In addition, an entity consults sources other than primary ones to assist in selecting accounting policies and disclosures only when these sources comply with the requirements in paragraph 1100.04, and it evaluates these sources based on all four criteria in paragraph 1100.07, (i.e., the specificity of the source, the authority of the issuer or author, the continued relevance of the source and the development process for the source).
Some respondents questioned the extent to which an entity would consult US or other international literature. Section 1100 says it is not necessary to comply with other literature in order to comply with Canadian GAAP. However, when a primary source of GAAP has been harmonized with, for example, a US or international pronouncement, more detailed and fact-specific guidance in the corresponding US or international pronouncement generally satisfies the requirements of paragraph 1100.04 and may, therefore, be convenient to refer to that source.
As some financial statement users requested clarification of the meaning of "fair presentation in accordance with GAAP," the AcSB also issued new Section 1400, General Standards of Financial statement Presentation. "Fair presentation" is difficult to define unless expressed in terms of compliance with standards. Accordingly, the AcSB clarified that fair presentation is not a separate consideration from whether financial statements are in accordance with GAAP. However, it does contemplate a disclosure stand back provision. An entity now needs to stepback and consider whether its financial statements represent faithfully the substance of transactions and other events in accordance with the elements of financial statements, and the recognition and measurement criteria set out in Financial Statement Concepts, Section 1000, as well as considering the clarity and understandability of the information provided. In a speech at the American Accounting Association 2002 conference, Robert K. Herdman, then SEC chief accountant, expressed support for the view that mere compliance with the rules of GAAP is insufficient — additional disclosures might be necessary.
The AcSB took the opportunity to delete Financial Statement Concepts paragraph 1000.61 and General Standards of Financial Statement Presentation paragraph 1500.06 to remove the ability for an entity to depart from a Handbook recommendation when following that recommendation would result in misleading financial statements. The AcSB believes that GAAP is sufficiently well developed that it should not result in misleading financial statements. Furthermore, if application of a Handbook recommendation could result in misleading financial statements, the proper course of action is to amend the re-commendation, rather than to require a departure from it.
The AcSB also sought to clarify that italicized and nonitalicized paragraphs have equal authority as preparers sometimes paid less attention to non-italicized paragraphs. The AcSB also used this opportunity to include the status and authoritativeness of new forms of guidance such as basis documents. It also saw the need for a new form of authoritative guidance and created board notices to clarify certain aspects of a Handbook section or accounting guideline when it becomes apparent that the text does not adequately convey the AcSB's original intent.
Some respondents believed the proposals should provide a specific scope exemption and/or grant a temporary extension within the transitional provisions for rate-regulated operations because the AcSB is presently considering other aspects of accounting for rate-regulated operations. The AcSB expanded the transitional provisions to address this issue. These entities are required to comply with all disclosure requirements of GAAP and to disclose the nature of the differences between their accounting policies affected by rate regulation and those required by the primary sources of GAAP.
Action plan
With the issuance of Generally Accepted Accounting Principles, Section 1100, and General Standards of Financial Statement Presentation, Section 1400, and related amendments, entities confronted with accounting and disclosure issues can now look to these new sections to address questions — Where do I begin? (with the primary sources of GAAP); What do I look at? (the primary sources of GAAP and other sources); Can I stop now? (Yes, provided you comply with the requirements in paragraph 1100.04 and all criteria in paragraph 1100.07). Entities should review their selection of accounting policies and disclosures to ensure continued compliance with GAPP. As Section 1100 significantly downplays industry practice, entities should review their adoption of particular industry practices. Also, an entity needs to step back to determine the adequacy, clarity and understandability of its disclosures.
Nancy A. Estey, CA, is a principal with the Accounting Standards Board staff, responsible for the AcSB's project on generally accepted accounting principles
Technical Editor: Robert T. Rutherford, FCA, vice-president, Standards, CICA | 
