Accounting Standards in Canada: Future Directions Discussion Paper

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Accounting Standards in Canada: Future Directions

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Accounting Standards Board

ACCOUNTING STANDARDS IN CANADA: FUTURE DIRECTIONS

DISCUSSION PAPER

Table of contents

PARAGRAPH

Background ....................................................................................................................................... 1 The Board’s mandate and current strategic plan ............................................................................... 5 Introduction .................................................................................................................................. 5 The need for Canadian GAAP and a Canadian standard setter ..................................................... 7 The Board’s conceptual framework .............................................................................................. 17 Scope of the Board’s activities ..................................................................................................... 19 The standard-setting environment ..................................................................................................... 20 Canadian GAAP reporting entities ............................................................................................... 22 The corporate sector ................................................................................................................. 23 The not-for-profit sector .......................................................................................................... 27 Possible implications ................................................................................................................ 30 Effects of recent financial reporting failures ................................................................................. 31 Standard-setting climate ........................................................................................................... 32 “Principle-based” versus “rule-based” standards ..................................................................... 33 Emergence of international standards ........................................................................................... 37 Development of the IASB ........................................................................................................ 38 Trend to global convergence of standards ............................................................................... 39 Canada’s role in the global standard-setting partnership ......................................................... 41 Acceptance of global standards in Canada ............................................................................... 43 US GAAP harmonization ............................................................................................................. 49 Progress on harmonization with US GAAP ............................................................................. 50 The focus on US GAAP ........................................................................................................... 56 Legal requirements for preparing financial statements ................................................................. 60 Changes to public company reporting requirements ................................................................ 61 Pace of change .............................................................................................................................. 66 Standards overload on financial statement preparers ............................................................... 67 Standards overload on public accountants ............................................................................... 69 Burden of non-financial statement and foreign reporting requirements ................................... 71 Other aspects of change ........................................................................................................... 73 Meeting financial reporting needs ................................................................................................ 77 Standard-setting issues ............................................................................................................. 78 Cost/benefit trade-offs ............................................................................................................. 81 Differential reporting ............................................................................................................... 83 Conclusion ......................................................................................................................................... 97

Background

1 The most recent invitation to the public to comment on the strategy and policies of the

Accounting Standards Board (the Board) was included in the Interim Report of the CICA’s

Task Force on Standard Setting, in 1997. Much has happened since the input in response to

that report was received and considered, both in the way that the Board operates and in the

environment in which it carries out its mandate. As discussed below, the Board believes it is

timely to reconsider its strategy and policies in light of the current environment and current

expectations about the future of accounting standard setting.

2 This Discussion Paper provides some background information and further discussion of the

issues raised in the Board’s Invitation to Comment, “Accounting Standards in Canada:

Future Directions.” The purpose of this Discussion Paper is to stimulate consideration of the

issues by interested parties.

3 Both the Board (and its predecessor bodies) and the accounting profession have sought and

received public input periodically on strategic issues, in various forms. Among the

documents issued in this regard, the following are particularly noteworthy:

• Report of the Commission to Study the Public’s Expectations of Audits (June 1988).1

• Invitation to Comment on the Strategy and Five-Year Plan of the Accounting Standards

Committee (February 1989).

• Report of the CICA Task Force to Review the Recommendations of the AICPA Special

Committee on Financial Reporting (June 1995).2

1 Sometimes referred to as “the Macdonald Commission Report” after the Commission’s chairman, W. A.

Macdonald, QC, this report addressed financial reporting issues of a more general nature and some specific accounting issues in addition to audits.

2 Sometimes referred to as “the Calpin Task Force Report” after the Task Force’s chairman, Martin Calpin, FCA, this report reviewed the findings of the 1994 report, “Improving Business Reporting ⎯ A Customer Focus; Meeting the Information Needs of Investors and Creditors,” prepared by the Special Committee on Financial Reporting of the American Institute of Certified Public Accountants, chaired by Edmund Jenkins.

ACCOUNTING STANDARDS IN CANADA: FUTURE DIRECTIONS | 1

• Interim Report (May 1997) and Final Report (May 1998) of the CICA Task Force on

Standard Setting (TFOSS).

Some of the conclusions from these reports remain relevant to current circumstances. Key

Conclusions and Recommendations From Other Reports on Strategic Issues extracts

relevant parts from these reports.

4 Some of those reports, and others, have focused in part on issues related to the structure and

process for standard setting in Canada. The current Board and its operating practices are the

result of an ongoing evolution that has been heavily influenced by the reports cited above, as

well as other factors. It is the responsibility of the Accounting Standards Oversight Council

(AcSOC) to ensure that the structure, process and resources for setting accounting standards

remain appropriate. The AcSOC undertook a comprehensive re-evaluation of those issues in

2002-2003, including written and oral presentations from interested parties, as a result of

Enron and other recent financial reporting developments. The Board concurs with the

AcSOC’s conclusion that the current organization suits the Board’s mandate and that

adequate resource are available. Accordingly, the Board and the AcSOC are seeking further

input on those issues at this time only to the extent that respondents to the Invitation to

Comment propose a substantial change to the Board’s mandate or strategic direction. The

Board will review its structure, processes and resources after formulating its draft strategic

plan.

2 | ACCOUNTING STANDARDS IN CANADA: FUTURE DIRECTIONS

The Board’s mandate and current strategic plan

Introduction

5 A general description of the Board, including its mandate and current plan, is provided on its

website (www.acsbcanada.org).3

6 The Board’s mission and objectives, set out in its Terms of Reference, are as follows:

Mission

1. The mission of the Accounting Standards Board (“AcSB”) shall be to contribute to enhanced decision-making by continuously improving the quality of financial and other information about organizational performance reported by Canadian entities including profit oriented enterprises and not-for-profit organizations. The AcSB shall serve the public interest by developing and establishing standards and guidance governing financial accounting and reporting domestically and by contributing to the development of internationally accepted standards.

Objectives

2. The AcSB shall have the following objectives: a. To develop standards that improve the quality of information reported by Canadian entities with

due consideration for the costs and the benefits to preparers and users and which recognize changing priorities in the environment.

b. To eliminate or minimize GAAP differences within North America and internationally, as appropriate to facilitate access by Canadian entities to US and global markets.

c. To participate in the development of a single set of high quality internationally accepted accounting standards together with other standard setters.

d. To support our standard setting activities by actively assisting implementation and providing timely guidance on emerging issues.

e. To continuously improve the process of standard setting.

3 See, in particular, About AcSB. For a comparison of the Canadian Board with other major accounting

standard setters internationally, see Accounting Standard Setting Structures a Report to Certified General Accountants Association of Canada on Accounting Standard Setting Structures” (January 2003). As recent as this report is, it will shortly become out of date as the circumstances of the standard setters in Australia, Germany, New Zealand and the United Kingdom (as well as some other countries not discussed in the report) are changing as a result of the upcoming adoption of International Financial Reporting Standards in those countries.


http://www.acsbcanada.org/about-acsb/item17921.aspx

http://www.acsbcanada.org/about-acsb/

The need for Canadian GAAP and a Canadian standard setter

7 The Board establishes its strategic plans within the context of its Terms of Reference. As

indicated in the TFOSS Final Report, there are questions about the long-term need for

Canadian GAAP and a Canadian accounting standard setter if the world is evolving towards

a single, global set of accounting standards. While the Board’s Terms of Reference assume

that both Canadian GAAP and the Board should continue to exist, these remain the subject of

some discussion.

8 Some have proposed that, in an era of globalization of economic activity, there is no need for

a separate Canadian GAAP. They maintain that it is a historical artifact that no longer has a

role to play in financial reporting because it hinders the evolution towards a single, global set

of accounting standards. Among those holding that view, some have advocated the adoption

of US GAAP in Canada and others the adoption of International Financial Reporting

Standards (IFRSs).4

9 Proponents of the US GAAP approach point out the close links between the Canadian and

US economies, in particular the capital markets, and the general similarity of Canadian and

US GAAP. Some consider that US GAAP is more developed and, consequently, provides

better financial reporting than Canadian GAAP or IFRSs. Proponents of US GAAP also

point out that a number of Canadian companies have already adopted US GAAP as either a

primary or secondary basis for financial reporting. As a result, there is growing knowledge

of US GAAP in Canada and experience with its application. There is very little application

of IFRSs in Canada and, accordingly, little knowledge of those standards or experience with

them.

10 Proponents of adopting IFRSs emphasize their increasing global acceptance and the ultimate

objective of a single, global set of standards. Some also consider IFRSs closer in character to

current Canadian GAAP, avoiding the relative narrowness of some US standards, their

sometimes prescriptive nature, their tendency to special treatments and scope exceptions for

various items, the extent of application “rules” and their sheer volume in the aggregate.

4 The standards issued by the International Accounting Standards Board.


http://www.cica.ca/index.cfm/ci_id/7773/la_id/1.htm

11 The foregoing discussion does not provide a complete picture of the alternatives to

maintaining a separate Canadian GAAP ⎯ see also the discussion under “The standard-

setting environment” below and in chapters 2 and 3 of the TFOSS Final Report.

12 Any decision either to maintain or to abandon a separate Canadian GAAP does not answer

the further question of whether there is a continuing need for a standard-setting capability. If

there will be a continuing need for a separate Canadian GAAP for some time to come, the

next question is whether the current standard-setting structure is the most appropriate vehicle

for maintaining and improving Canadian GAAP. On the other hand, if Canadian GAAP

were to be abandoned,5 there might still be a need for a domestic standard-setting body. The

TFOSS Final Report identified a clear need for a national standard-setting body to:

• participate in international standards development;

• assess whether an international standard has any unique impact given Canada’s

legislative, regulatory or cultural structure;

• provide input to the international body as it develops new standards, either at the

development or exposure draft stage;

• consider issues that might need addressing urgently within the Canadian scene but that

are not high on the international agenda; and

• consider the impact of new standards on preparers of financial statements for smaller

Canadian business entities.6

The Board is carrying out these activities currently in pursuing the objective set out in

paragraph 2c of its Terms of Reference, as discussed on page 18 under “Emergence of

international standards ⎯ Canada’s role in the global standard-setting partnership.”

13 On the questions of whether Canada needs its own GAAP and its own standard-setting body,

the TFOSS Final Report adopted the position that is reflected in paragraph 2b of the Board’s

Terms of Reference. The Board’s current plan, for the period April 2003-March 2005, is

5 Any such change would need to be managed very carefully. The current adoption of IFRSs by the

European Union, Australia and New Zealand, provides one indication of the scale and difficulties of the transition. The experiences of some of Canada’s larger companies in applying US GAAP provide another indicator of the challenges involved in a “big bang” transition to another financial reporting system.

6 TFOSS Final Report, pages 24-25.


http://www.cica.ca/index.cfm/ci_id/2894/la_id/1.htm

essentially the most recent iteration of the general direction and strategy adopted in response

to the recommendations of the TFOSS Final Report. The current plan states:

Planning and the setting of priorities are governed by the twin objectives of the Accounting Standards

Board (AcSB): (i) harmonizing with US accounting standards, and (ii) converging with a single set of

globally accepted high quality international accounting standards.

14 The Board has construed those twin objectives to mean the following:

• Harmonization with US GAAP is the elimination of significant unjustifiable differences

with US Financial Accounting Standards Board (FASB) standards. It does not involve

copying all elements of US GAAP or even all elements of a particular US standard. It

does involve developing standards that do not conflict with US GAAP but may also

permit other policies in some cases.

• Convergence is the adoption of the highest quality of US and international accounting

standards; that is, working with the FASB, IASB and other national standard-setting

bodies to agree on much-needed improvements to existing standards and the development

of new standards. To the extent that it is clear that a current US standard is not of

sufficiently high quality and is likely to change, the Board pursues the convergence

objective.

15 These objectives and some other matters mentioned in the current plan are discussed below

in some detail. Still other aspects of the current plan are not specifically raised below, but

may nonetheless suggest to readers additional issues on which they wish to comment.

16 One of the issues of greatest interest to the Board is whether to continue with the twin

objectives of harmonization and convergence, either as described above or in some modified

form. If respondents believe the Board should continue to pursue these objectives, the Board

would like to know which one should take precedence when they happen to conflict and

which should receive more of the Board’s attention and resources.


The Board’s conceptual framework

17 The Board develops accounting standards within the conceptual framework set out in

FINANCIAL STATEMENT CONCEPTS, Section 1000 of the CICA Handbook − Accounting. This

framework is consistent with the frameworks adopted by the FASB, the IASB and other

major standard setters. It specifies that general purpose financial statements provided to

external users and conforming to GAAP are designed to meet the common information needs

of those users. The framework identifies and describes the characteristics of useful financial

information and the fundamental elements of financial statements.

18 The conceptual framework is by nature an evolving document. The Board recognizes the

need to amend and expand the current framework. This work will be done in close co-

ordination with other standard setters because convergence of the various frameworks is an

essential step towards the long-term goal of a single set of global standards. The Board does

not seek comments on potential amendment of the current framework at this stage, although

respondents may wish to refer to the framework in their analysis of general policy and

approach, which are the primary subjects of the Invitation to Comment.

Scope of the Board’s activities

19 The Board’s mission, as stated in paragraph 1 of its Terms of Reference, is to improve the

quality of financial and other information about organizational performance. This is a

relatively broad scope. In practice, the Board has confined its work almost exclusively to the

development of GAAP as the basis for preparing annual and interim financial statements.

The standard-setting environment

20 The Board establishes its strategic policies and direction not only in the context of its Terms

of Reference, but also with regard to relevant factors in the general environment, including

the needs of financial statement users, commercial practices, and legal and regulatory

requirements. This section of the Discussion Paper summarizes the key factors in the

standard-setting environment as currently perceived by the Board, with particular regard to


significant changes since the publication of the TFOSS Final Report.7 The following

discussion highlights certain issues arising from those factors, positions the Board might

adopt relative to the issues, and arguments for and against those positions.

21 In commenting on the following discussion, readers are asked to consider particularly

whether:

• the Board has identified all of the key environmental factors that it should take into

account in developing its strategic plan and direction; and

• the discussion provides a reasonably complete and balanced summary of each of the

factors for the purpose of developing the Board’s plan.

Canadian GAAP reporting entities

22 A fundamental aspect of the standard-setting environment is the nature and number of

Canadian reporting entities of all different types that apply GAAP. Although there are

various ways of categorizing entities that prepare financial statements, the Board has

generally applied the following categories when it has considered it necessary to differentiate

entities for the purposes of standard setting:

• Profit-oriented enterprises:

— Public enterprises (as defined in several Sections of the CICA Handbook −

Accounting).

— Specified non-public enterprises with public accountability (these vary from standard

to standard but include such enterprises as co-operative organizations, deposit-taking

institutions, life insurance enterprises, other regulated financial institutions and rate-

regulated enterprises).

— Qualifying enterprises for purposes of differential reporting (as defined in

DIFFERENTIAL REPORTING, Section 1300 of the CICA Handbook − Accounting).

• Not-for-profit organizations.

7 In developing the following discussion, the Board has incorporated information and views obtained from a

large number of sources, both published and unpublished.


Each of the categories listed above is quite broad and includes a wide variety of entities.8

While the Board does not have a complete statistical picture of all of these categories, it does

have some useful demographic information on which to base its strategic decisions.

The corporate sector

23 The Board can identify the following distinct groups of profit-oriented enterprises, each of

which has different financial reporting needs:

• Public companies interlisted on US or other foreign markets ⎯ These are either large,

international companies that happen to be domiciled in Canada or companies that have

concluded they can obtain financing at a lower cost in foreign capital markets.

• Other public companies ⎯ These tend to be relatively smaller companies (or other

forms of enterprise such as income trusts) that have no interest in foreign capital markets

(unless they have plans to enter those markets).

• Non-public enterprises with public accountability ⎯ These are enterprises that do not

meet the definition of “public” but nonetheless are accountable to a large number of

stakeholders such as depositors or policyholders (in the case of financial institutions),

members (in the case of co-operative organizations), or customers (in the case of rate-

regulated operations).9

• Larger private businesses ⎯ These may be quite large, and tend to require substantial

private placement debt or equity financing on a scale similar to public company financing

and with similar complexity.

• Smaller private businesses ⎯ These tend to be less complex businesses with a small

group of owners and simpler financing, typically private equity and bank loan financing.

8 The Board notes also that the CICA Public Sector Accounting Handbook permits or requires certain public

sector entities to apply some or all of the Board’s standards. 9 The terms “public” and “non-publicly accountable” are defined in paragraph 1300.02 of the CICA

Handbook − Accounting.


Public companies

24 In 1995, the Calpin Task Force Report compared the Canadian and US capital markets. The

Report noted that:

Canada’s capital markets, although smaller than those of the United States have many of the same

characteristics: a high degree of competition, large numbers of suppliers and consumers of capital, and a

wide range of debt, equity and derivative securities. … Even though the scale of the two markets differs

greatly, the operation of the markets and economic trends in each country are similar, and there is

significant interaction between the two markets. Accordingly, the demands of users of business reporting

in each market are likely to be similar.

The Report went on to highlight one noteworthy difference in the two capital markets: the

markedly higher degree of concentration of ownership in the Canadian market reflected in

the much higher percentages of Canadian public companies that are owned more than 20

percent or more than 50 percent by a single shareholder.

25 The Board has obtained some recent statistical information about listed Canadian public

companies that provides a picture of this important segment of the economy.10 Canada’s

3,472 listed companies represent less than 0.2 percent of the approximately 2.1 million

companies in Canada. Almost all Canadian public companies are listed on domestic capital

markets which, although only about 2 percent of the global capital market for listed shares,

are well established. Some relevant points from the statistics include the following:

• For the size of its economy, Canada has a relatively large number of public companies.

The 3,472 Canadian companies listed on Canadian stock exchanges compare to

approximately 14,000 US companies with securities listed on US stock exchanges and

available on other markets (a ratio of about 1:4 whereas the overall sizes of the

economies are in a ratio of about 1:12).

• A significant number of companies (358) are listed on both Canadian and US markets,

accounting for about 2 percent of the total capitalization of the US markets. These

interlisted companies represent fewer than 10 percent of all listed Canadian companies

10 Statistical Information About Canadian Public Companies was prepared from information provided by

TSX Group Inc., which operates the Toronto Stock Exchange and the TSX Venture Exchange. The statistical information is as of October 31, 2003.


and approximately 20 percent of all companies listed on the Toronto Stock Exchange.

However, they constitute more than 55 percent of all listed companies having a market

capitalization exceeding $1 billion and account for a significant portion of total Canadian

economic output. Only a few Canadian companies are interlisted on non-US markets,

primarily on the London Stock Exchange.

• The 2,294 companies listed on the TSX Venture Exchange represent 63 percent of all

companies listed on Canadian markets. Although concentrated in western Canada and

the resource industries, TSX Venture Exchange companies include a wide variety of

businesses across the country.

• For the Toronto Stock Exchange and the TSX Venture Exchange in the aggregate, the

vast majority of listed companies have a market capitalization less than $10 million, and

revenues and assets each less than $100 million. The Canadian capital market differs

significantly from other markets globally in the relatively smaller size of listed

companies.

• Although the Canadian market is small on a global scale, it plays a significant role in the

world’s mining industry. Canadian-domiciled mining companies are active around the

world, and the Canadian market is a key source of financing for the industry. The

Canadian market is home to more than 60 percent of the world’s listed mining

companies, representing more than 50 percent of the industry’s market capitalization. A

significant number of these companies are primarily involved in exploration activities.

• Income trusts and similar entities have recently emerged as a significant segment of the

Canadian public company capital market.

• Companies listed in the Canadian market are concentrated in certain industry groups. By

number of companies, mining accounts for 32 percent, oil and gas 12 percent, technology

12 percent and financial services 10 percent. A “diversified industries” group accounts

for 18 percent.

• More than 92 percent by number of companies listed in the Canadian market are

domiciled in Ontario, Quebec, Alberta or British Columbia, and more than 54 percent in

the two western provinces alone.


Private companies

26 The Canadian Federation of Independent Business (CFIB), which represents over 100,000

small and medium-sized non-public Canadian businesses (SMEs), has published reports

based on Statistics Canada data and other survey information that give a picture of the

Canadian SME population.11 The CFIB reports that, of 977,000 businesses with paid

employees in 2002, fewer than 3 percent had more than 50 employees and 75 percent had

fewer than 5 employees. Approximately 55 percent of the Canadian workforce was

employed by SMEs and these businesses accounted for roughly 45 percent of Canada’s total

economic output.

The not-for-profit sector

27 The not-for-profit sector is large and diverse. It encompasses not only local charities, clubs,

and churches, but also hospitals, social services, universities and colleges, museums and

galleries, and foundations. In Canada, the sector includes over 77,000 not-for-profit

organizations with charitable status, which is a subset of the broader sector estimated to

include 175,000 to 200,000 organizations. Estimates in 2001 indicated that the organizations

with charitable status in Canada alone had revenues of $90.5 billion, employed 1.3 million

people, and had a volunteer labour force estimated to be another 0.5 million full-time

equivalent jobs. The Canadian Not-for-Profit Sector provides further information about

the not-for-profit sector.

28 The not-for-profit sector is commonly thought of as comprising many small local

organizations. However, it also includes large national organizations, and organizations that

carry on operations in a commercial manner that may seek investment in the capital markets

through the issuance of debt obligations and may also borrow from banks and other lenders.

Although all not-for-profit organizations have a form of public accountability to the

providers of their funding, the financial information necessary to inform the public about

their activities may differ substantially from one category to the other.

11 CFIB Research papers “Small Business — Big Picture” and “Small Business — Big Economics,” which

are posted on the CFIB website (www.cfib.ca).


http://www.cfib.ca

29 The Board has recently initiated a program to review the application of current and proposed

standards to not-for-profit organizations and to evaluate possible changes that may be

required to meet the financial reporting needs of the sector. The Board recognizes that the

needs of not-for-profit organizations may not always be addressed in projects focused on

improving financial reporting by profit-oriented enterprises.

Possible implications

30 Various conclusions may be drawn from the information summarized above, particularly

when considered in light of some of the factors discussed in subsequent sections of this

paper. For example:

• Some may conclude that the Board should focus more attention on the financial reporting

needs of private companies and not-for-profit organizations, because they are collectively

significant and far more numerous than public companies.

• Some may conclude that, although relatively few in number, interlisted public companies

should be the focus of the Board’s attention, because they are relatively significant in the

capital markets and the Canadian economy.

These are indicative of the decisions the Board expects to have to make in formulating its

strategic plan, and why information such as that summarized above is helpful to the Board

in assessing where to focus its resources and whose interests may need to be given

precedence when various competing interests cannot be reconciled.

Effects of recent financial reporting failures

31 Since late 2002, global capital markets have been affected significantly by failures in

corporate governance and the financial reporting system, and the steps taken to address those

failures. As has been acknowledged by a number of commentators, the problems revealed by

the scandals at Enron, Worldcom and other large companies pointed out some shortcomings

in accounting standards but were centred mainly on other aspects of the financial reporting

system. In consultation with the AcSOC and the other major accounting standards setters,

the Board examined the circumstances and modified its work program as needed to address

the specific accounting weaknesses identified. The Board has largely completed the steps it


believes are necessary to deal with those weaknesses, but will take into account any new

information brought to light in responses to the Invitation to Comment.

Standard-setting climate

32 The issues raised by the failures in governance and reporting have changed considerably the

climate in which accounting standards are set. The public scrutiny of the financial reporting

system for public companies has created a heightened awareness of the importance of sound

financial reporting. That, in turn, has given accounting standards and the process by which

they are developed a higher profile. The Board believes that this change provides it with

opportunities to improve Canadian GAAP that might not otherwise have been available.

“Principle-based” versus “rule-based” standards

33 The attention paid to the problems in the United States has resulted in a reassessment of the

distinction often drawn between so-called “principle-based” and “rule-based” standards. The

Board shares the views of others that, while the distinction may be useful for certain

analytical purposes, most current standards in Canada, the United States and elsewhere fall

somewhere within a spectrum between the extremes of “principle only” and “rule only”

standards. In July 2003, the US Securities and Exchange Commission (SEC) published a

staff study prepared for the US Congress on this matter.12 That study’s principal

recommendation is as follows:

Principles-only standards may present enforcement difficulties because they provide little guidance or

structure for exercising professional judgment by preparers and auditors. Rules-based standards often

provide a vehicle for circumventing the intention of the standard. As a result of our study, the staff

recommends that those involved in the standard-setting process more consistently develop standards on a

principles-based or objectives-oriented basis. Such standards should have the following characteristics:

• Be based on an improved and consistently applied conceptual framework;

• Clearly state the accounting objective of the standard;

12 “Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States

Financial Reporting System of a Principles-Based Accounting System” is available on the SEC website at www.sec.gov/news/studies/principlesbasedstand.htm.


http://www.sec.gov/news/studies/principlesbasedstand.htm

http://www.sec.gov/news/studies/principlesbasedstand.htm

• Provide sufficient detail and structure so that the standard can be operationalized and applied on a

consistent basis; 1

• Minimize exceptions from the standard;

• Avoid use of percentage tests (“bright-lines”) that allow financial engineers to achieve technical

compliance with the standard while evading the intent of the standard.

34 Ironically, other US developments, such as the requirements of the Sarbanes-Oxley Act, the

vigorous enforcement actions of the SEC and the litigation following from the financial

reporting failures, have tended to fuel the demand for the safe harbour provided by specific

rules. The SEC study has affected the FASB’s approach to standard setting but, as the FASB

and the SEC study point out, real change and the success of principle-based or objective-

oriented standards require a change in behaviour by all parties involved in the preparation

and use of financial statements.

35 Some recent research13 indicates that Canadian GAAP, which is more principle oriented,

results in higher quality earnings than US GAAP, which is more rule oriented. However, the

overall quality of reported financial information is the product not only of standards but also

of other components of the complete reporting regime. The other components include

regulation, enforcement, audit standards and practices, legal environments and corporate

governance. The research found no difference in the overall earnings quality of Canadian

and US companies, which the researcher ascribed to more effective non-GAAP elements of

the US financial reporting regime.

36 The recommendation in the SEC study reflects the current thinking of the Board. It also

highlights the ongoing issue of how much detail to provide in standards. Some financial

statement preparers and auditors want explicit guidance on a wide variety of relatively

specific issues arising from the implementation of standards. They may be concerned about

_________________________ 1 In doing so, however, standard setters must avoid the temptation to provide too much detail (that is, avoid trying to answer virtually

every possible question within the standard itself) such that the detail obscures or overrides the objective underlying the standard.

13 Unpublished working paper, “Earnings and Accrual Quality in Canada and the U.S.” (October 2003) by

Erin Webster of the Queen’s University School of Business, presented to the October 20-21, 2003 meeting of the AcSOC.


diversity in practice that detracts from the comparability of financial information and, thus,

from its utility. They may also be concerned about the possibility that they may have

adopted an interpretation that others may subsequently conclude is unacceptable. Some other

financial statement preparers and auditors want less detail to permit them greater latitude for

applying their professional judgment. They may disagree with some of the interpretations

included in implementation guidance even though they agree with the underlying principle.

The Board has tended to provide more extensive guidance in recently issued standards with a

view to achieving greater consistency in practice, but recognizes that the longer standards

contribute to concerns about “standards overload” (a matter discussed further below).

Emergence of international standards

37 When the Board adopted its current overall strategy, the International Accounting Standards

Committee (IASC) had been in existence for some time and had issued a number of

standards. However, the IASC’s standards were not widely applied and were viewed by

some to lack sufficient quality to be considered seriously. In recommending the twin

objectives of US harmonization and global convergence in 1998, the TFOSS Final Report

showed considerable foresight in anticipating both the emergence of a global standard setter

and the nature of the changes to the IASC that would be necessary to permit that to happen.

Many questioned the recommendation in the report that Canada should make global

convergence a primary objective of the Board, and some still do.

Development of the IASB

38 Since its establishment in April 2001 as the IASC’s successor, the International Accounting

Standards Board (IASB)14 has made considerable progress in establishing itself as one of the

world’s two pre-eminent accounting standard setters (the other being the FASB). The IASB

has adopted as its aim the development of a single set of globally accepted, high-quality

accounting standards. It is pursuing this aim in collaboration with national standard setters.

It has created an infrastructure and processes to help support its ambitious work program. It

has improved 15 of the standards it inherited from the IASC while also addressing new topics

14 For further information about the IASB, refer to its website at www.iasb.org.


http://www.iasb.org

of significance internationally. Perhaps most significantly, the European Union, Australia,

New Zealand and a number of other countries have recently decided to adopt the IASB’s

standards for all public companies and, in some cases, all private companies as well.

Trend to global convergence of standards

39 The IASB works in close co-operation with the major national standard setters, including the

Board and the FASB, to try to achieve the convergence of standards. This process will take

some time, but initial progress has been encouraging. The trend to converged standards will

reduce the extent to which the Board may have to make a choice between adopting a FASB

standard or an IASB standard. It increases the likelihood that new Canadian standards will

be of high quality, as more resources can be directed to their development. Those resources

need not include the Board’s in all cases since the Board can benefit from the work of others,

particularly at the staff level. On the other hand, the need to consult internationally and to

work out any differences of view does require some effort.

40 The trend to global convergence may have benefited from the recent turmoil in US capital

markets. In assessing the state of their own financial reporting system, Americans took note

of developments in other countries and recognized that they could benefit from those

developments. In particular, many Americans have given greater weight in their thinking to

the emergence of global capital markets and the need for global solutions to issues such as

financial reporting. At the same time, some who previously felt that US GAAP was

unquestionably superior to all other bases of accounting, or was universally acceptable, may

have modified their views. IASB standards have gained wider acceptance as a credible

alternative to US GAAP. As a result, Americans may be more open to change that will result

in global convergence on the best possible standards, with less regard for whether those

standards happen to be the current US standards. Tangible evidence of this development can

be seen in the “Norwalk Agreement” between the FASB and the IASB to work co-

operatively, several recent FASB exposure drafts proposing changes to US GAAP to

converge on a higher quality IASB standard, the alignment of FASB and IASB agendas, and

the joint conduct of several projects.


Canada’s role in the global standard-setting partnership

41 The Board has entered into a formal undertaking to work with the IASB and seven other

national standard setters in a partnership arrangement15 that involves the following:

• The participating standard setters align their agendas so that the same issues are being

worked on at the same time by all of the major standard setters, with the objective of

agreeing on common standards. The national standard setters consider the views of the

IASB on common issues and, in turn, the IASB considers the views of all of the national

standard setters.

• The IASB appoints designated members to act as formal liaisons with the national

standard setters (a Canadian IASB member is an ex officio non-voting member of the

Board). The participating standard setters also consult through periodic meetings.

• The national standard setters are prepared to lead or participate actively in certain issues

on the international agenda and devote resources to those activities. They also stand

ready to assist the IASB by publicizing IASB views on issues of common interest and

obtaining input for the IASB.

42 The Board’s agreement to participate in the international partnership has involved

undertaking some projects on behalf of the partnership, such as the research projects on

measurement objectives and disclosure, and contributing information and insights on projects

undertaken by others. It also results in the Board co-ordinating its agenda with its partners’

on projects of common interest that are critical to convergence, which means that the Board

no longer has complete control of its own work program. The convergence agenda of the

partnership standard setters includes, for example, projects on business combinations,

reporting financial performance/comprehensive income, revenue recognition and insurance

contracts. The Board’s current work program is not restricted to convergence topics,

however, and does include projects on issues of domestic interest, such as rate-regulated

operations and not-for-profit organizations.

15 The other national standard setters in the partnership are those of Australia, France, Germany, Japan, New

Zealand, the United Kingdom and the United States.


Acceptance of global standards in Canada

43 The trend to global convergence of accounting standards will be viewed more favourably or

with more interest by some Canadians than by others.16 Users of financial statements of

public companies tend to want better information. They may view the global convergence

trend favourably because it will increase the comparability of financial information reported

by public companies in different countries. Convergence should result in the best possible

standards as interested parties throughout the world bring their abilities and experience to

bear. It also opens up the possibility of better quality information overall as converged

standards bring practices in some countries up to global best practice.

44 Canadian entities would likely not want Canadian GAAP to be seen as second class and their

views ignored in the development of global standards. The TFOSS Final Report concluded

that, to be taken seriously and play a role internationally, Canada needs to maintain a credible

body of Canadian GAAP.17 However, Canadian financial statement preparers may be wary

of having to provide more information or different information in response to changing

requirements. Companies not involved in international capital markets may feel it

unnecessary to meet the requirements of global standards when the resulting financial

information goes beyond the perceived needs of the users of their financial statements.

45 While Canadians generally support the idea of global convergence, the Board is not aware

that very many are interested in the practical application of that idea or have much

knowledge of the IASB’s International Financial Reporting Standards.18 In the Board’s

16 For example, the Certified General Accountants Association of Canada made a presentation to the

January 12, 2001 meeting of the AcSOC proposing the adoption of IASB standards in Canada, based on the Association’s published paper, “The Case for International Accounting Standards in Canada ⎯ A Detailed Report” by Alan J. Richardson and Ian R. Hutchison (1999).

17 This conclusion is being tested currently by the situation unfolding in Australia, New Zealand and the United Kingdom. Each country has developed a credible body of GAAP through the efforts of a well established domestic standard setter. These regimes are being superseded by the decisions of the competent authorities that all public companies in those countries must adopt International Financial Reporting Standards in 2005 (2007 in the case of New Zealand). The effects remain to be seen, but the national standard-setting bodies in those jurisdictions may find themselves playing a diminished role internationally.

18 The principal exceptions are likely to be Canadian subsidiaries of European parent companies.


experience, most Canadians appear to view global convergence as an adjunct to adopting or

harmonizing with US GAAP.

46 Increased acceptance of IASB standards in Canada will likely depend on their quality, as

well as the extent of their convergence with FASB standards. Some point out that the

IASB’s standards have yet to be applied by many major global companies. It remains to be

seen whether they will stand up well when tested in practice.

47 The quality of IASB standards is affected by the way in which they are developed. Concerns

have been expressed about the effects on IASB standards of its recent focus on public

company reporting in Europe and its responses to industry lobbying and political

interference. The IASC Foundation is currently in the early stages of a fundamental review

of its constitution that will consider all facets of the organization, including the IASB’s

processes for developing standards and promoting global convergence.

48 The Board invites comment on the extent to which it should participate in the international

standard-setting partnership and adopt globally converged standards in Canada.

US GAAP harmonization

49 While the movement towards global convergence of standards has been picking up

momentum, the Board has been concentrating on the harmonization of Canadian standards

with US GAAP. It has been following the harmonization policy summarized earlier under

“The Board’s mandate and current strategic plan” since the mid-1990s, well before the

TFOSS Final Report was issued.

Progress on harmonization with US GAAP

50 The Board has eliminated many specific GAAP differences in recent years, such as those

related to income taxes, employee future benefits, business combinations, goodwill and

intangible assets, transfers of receivables, foreign currency translation gains and losses,

earnings per share, stock-based compensation, impairment of long-lived assets, disposal of

long-lived assets and discontinued operations, asset retirement obligations and variable

interest entities. Progress has been made in reducing differences on other topics such as


financial instruments and hedging, and work continues on several more topics. Some of the

changes have not only satisfied the US harmonization objective, but also the global

convergence objective. Some Handbook projects have addressed long-standing differences,

while others were considered necessary to deal with changes to US GAAP that created a

difference.

51 The effects of this effort have been mixed in practice. The Board has periodically surveyed

samples of Canadian/US GAAP reconciliations reported in the financial statements of

Canadian SEC registrants to assess the state of practice.19 On one hand, as expected, some

long-standing differences have disappeared. Others will soon disappear as recently issued

standards take effect. However, the number and overall effect of reported differences has not

decreased correspondingly, for reasons such as the following:

• Some differences are clearly immaterial but are reported because the cumulative effect of

several such differences is material to reported net income.

• Some companies have chosen to adopt non-US GAAP accounting policies for Canadian

GAAP purposes when they could have adopted a different Canadian GAAP policy that

would have avoided a GAAP difference.

• A Canadian standard harmonized with US GAAP may be introduced later than the

corresponding US standard and may have different transitional provisions. The effects of

such temporary differences may persist for an extended period.

52 While the Board has been attempting to eliminate significant unjustifiable differences from

US GAAP, its current policy does not involve the adoption of those elements of US GAAP

that are considered of insufficiently high quality. Accordingly, some GAAP differences

would persist pending development of a higher quality US standard. For example, the Board

decided in 1997 not to adopt the US business combinations standard that permitted the

pooling method; it waited for the FASB to add a project to its agenda and then tracked the

development of the current standard that allows only the purchase method.

19 Reported Canadian/US GAAP Differences: Survey of Canadian annual reports for years ending in 2002

summarizes the most recent survey.


53 The Board’s harmonization policy takes account of the need to address Canadian

circumstances that differ from those in the United States, potentially justifying a different

treatment than that mandated by a US standard. In practice, the Board is not often able to

identify such differences in circumstances, although the guidance for applying a harmonized

standard is occasionally tailored to Canadian business conditions.

54 The Board’s harmonization program has raised some significant implementation issues. As

noted above, in the current, highly charged atmosphere of public company reporting, some

companies and their auditors and advisers have adopted the approach of their US

counterparts by urging the Board to provide specific rules and detailed application guidance

for each new standard. Compliance with specific rules is viewed as providing a “safe

harbour” against legal and regulatory actions, while detailed guidance may reduce the effort

required in applying a standard. The Board recognizes that, in carrying out its recent

program of US GAAP harmonization, it has imported some of the more rule-oriented US

requirements into Canadian GAAP. However, that approach runs counter to the Board’s

desire to develop standards that set out general principles and provide scope for exercising

professional judgment. There is evidence indicating that this latter approach, which has

traditionally been followed in Canada, can result in better quality financial reporting. It

remains to be seen whether US standard setting will evolve towards a more objectives-

oriented approach in the future, and whether financial statement preparers and auditors will

be willing and able to work within such an environment.

55 A related issue in practice is the status of detailed US rules associated with harmonized

standards. In some cases, the Board has decided not to incorporate detailed US application

guidance into a standard. It may have wished to provide more scope for judgment, or it may

have concluded that the US guidance is arbitrary or even inconsistent with some element of

Canadian GAAP. Nevertheless, contrary to the Board’s view and despite what is said in

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES, Section 1100 of the CICA Handbook −

Accounting, some insist that it is necessary to apply the more detailed US rules associated

with a harmonized standard in order to comply with Canadian GAAP. Following the risk

mitigation approach described above, others simply prefer to apply the US rules. These

tendencies negate efforts to promote principle based accounting.


The focus on US GAAP

56 Although some Canadians have recently become more aware of global convergence and a

few consider it a more important objective than harmonization with US GAAP, Canadian

financial statement preparers and auditors are generally much more interested in US GAAP

than in IASB standards, to the extent that they are interested in such issues at all. They are

more concerned with immediate, practical issues than with the longer term possibility of

global convergence. Those practical issues sometimes include obtaining easier access to US

capital markets, which, among many other things, involves reporting financial information

according to SEC requirements. The result is that some Canadians are interested in

amending Canadian GAAP to at least permit, if not require, all aspects of US GAAP as

interpreted and enforced by the SEC. Some are sceptical that global convergence is possible

at all or, at least, achievable within a reasonable period.

57 Until global convergence is substantially achieved and acknowledged by the SEC, financial

statements of SEC registrants prepared in accordance with IASB standards will have to be

reconciled to US GAAP in the same way as Canadian GAAP financial statements. There is

no saving of effort and confusion for Canadian SEC registrants from adopting IASB

standards or having Canadian GAAP converging with them unless the result is also

harmonization with US GAAP. Canadian SEC registrants generally want the fewest possible

differences that will force them to identify, calculate and report a Canadian/US GAAP

difference.

58 Canadian companies that are not SEC registrants take a different view of US GAAP. Some

find it burdensome because of its tendency to include detailed requirements that limit the

scope for applying professional judgment. They prefer broad principles within which a

company may determine how best to present its financial position and results of operations in

a way that meets the needs of its shareholders and lenders. A particular concern is the

manner in which the SEC interprets US GAAP for application by public companies, which

adds considerably to the practical burden of adopting US GAAP. Some disagree with

directions taken by the FASB towards greater use of fair value measurements and a balance

sheet orientation. The pace of change in US GAAP is also a problem for some (see the

discussion under “Pace of change” below).


59 The Board invites comment on its current US GAAP harmonization policy of developing

standards that remove any impediment to those companies that wish to apply a US GAAP

accounting policy, while providing greater latitude when warranted. Respondents may wish

to comment not only on the general direction of this policy but also on the way in which the

Board has been applying it. For example, have Canadian standards provided a sufficiently

wider latitude for a choice of accounting policy than corresponding US standards in enough

circumstances ⎯ are they too often a copy of US standards, or not often enough?

Legal requirements for preparing financial statements

60 A variety of Canadian legal and regulatory provisions require entities to prepare and issue

financial statements to other parties (stakeholders). These requirements are found in federal

and provincial acts of incorporation, securities acts and other acts governing financial

institutions, co-operatives, not-for-profit organizations and other types of entities. In some

cases, the requirements are included in regulations made under the acts. Generally, the legal

requirements specify that financial statements must be prepared in accordance with generally

accepted accounting principles, including the accounting standards in the CICA Handbook

(or other words to that effect).

Changes to public company reporting requirements

61 Recent changes to reporting requirements, some of which are still at the proposal stage, will

give some Canadian companies the option of adopting US GAAP in place of Canadian

GAAP. The Canadian Securities Administrators (CSA) have recently issued their National

Instrument 52-107, “Acceptable Accounting Principles, Auditing Standards and Reporting

Currency.” It provides Canadian public companies that have issued securities registered

under US securities laws with the choice of satisfying Canadian securities legislation by

filing and issuing US GAAP financial statements. Companies taking advantage of this

option thereby avoid having to reconcile Canadian GAAP financial statements to US GAAP

in order to satisfy US requirements. This change in Canadian securities requirements

confirms a practice applied on an ad hoc basis in recent years by which a few dozen


companies had applied for, and been granted, an exemption from the Canadian GAAP

requirement.

62 Corporations Canada, the federal department responsible for administering the Canada

Business Corporations Act, has recently proposed making changes to sections 70 and 71 of

the regulations under that act to harmonize with the CSA National Instrument. However, for

some Canadian SEC registrants, it is not possible to abandon Canadian GAAP entirely

because of other legal requirements, such as those in the Bank Act, Insurance Companies Act

and various provincial statutes, to prepare Canadian GAAP financial statements.

63 In recent years, the Board has spent a considerable amount of time attempting to find

reasonable ways of accommodating Canadian SEC registrants by minimizing the number and

extent of their reportable Canadian/US GAAP differences. This policy direction has caused

the Board to address topics it might otherwise not have dealt with until later, if at all. The

Board’s policy has generally been to avoid an outright conflict between Canadian and US

GAAP, but not necessarily to require the US GAAP treatment. In some cases the result has

been to adopt the US standard virtually unchanged, such as the standard on asset retirement

obligations. In other cases the result has been a standard broader than the US equivalent,

such as the standard on hedging. The Board has sometimes had to modify a position it would

otherwise have preferred to adopt. For example, some standards include relatively complex

transitional provisions designed to allow retroactive application of a US GAAP transitional

provision that is itself complex in some cases. The result may have helped Canadian SEC

registrants while doing little for the users of financial statements or for other Canadian

financial statement preparers. It may even have been detrimental to these other groups.

64 In the circumstances outlined above, the Board has begun to consider whether it should give

less weight to accommodating Canadian SEC registrants and more weight to satisfying the

needs of others. As the move to global convergence continues, the significance of

Canadian/US GAAP conflicts should decrease and eventually disappear, with the result that

Canadian domiciled international companies will be more readily able to comply with both

sets of GAAP, and IASB standards as well, when they wish to do so. On the other hand,

some have expressed the view that Canadian GAAP will soon become irrelevant for public


companies. They see no reason why the option to adopt US GAAP shouldn’t be extended to

public companies that are not SEC registrants. They also believe many companies will soon

exercise that option, making Canadian GAAP irrelevant for public company reporting. In

addressing this issue, the Board has to weigh the trade-off between satisfying the needs of the

users of financial statements of two groups of public companies ⎯ Canadian SEC registrants

and other companies ⎯ to the extent that those needs differ.

65 The Board invites comment on the effects in practice of the recent changes to public

company reporting requirements and the significance of these changes for the Board’s policy

and direction. For example, should the Board assume, for purposes of planning, that all

eligible Canadian-domiciled international companies will adopt US GAAP, or will a number

choose to continue to report on a Canadian GAAP basis? In either case, should Canadian

GAAP place more or less emphasis on meeting the needs of the users of these companies’

financial statements?

Pace of change

66 The pace of change in accounting standards has increased in recent years. The Board and the

Emerging Issues Committee collectively are issuing new and amended standards at a

somewhat faster rate now than in the past. The length and complexity of individual standards

and the effort required to apply them have also increased.20 The overall effect of this trend is

commonly described as “standards overload”.

20 Meaningful statistics to support these statements are difficult to generate. The number of new Handbook

Sections and Guidelines (including replacements for older standards and conforming amendments to them) tends to fluctuate from year to year but, on a trailing five-year average basis, has increased noticeably since 2001. The number of new pronouncements alone is not particularly relevant without factoring in their average length, which has also tended to increase. Less readily measurable is the complexity of the standards, but most would agree that this, too, has increased. The effects in practice vary considerably depending on how widely or frequently a particular standard is applied and how much effort is required to adopt it initially and to continue applying it subsequently.


Standards overload on financial statement preparers

67 Standards overload has a significant effect on financial statement preparers. The preparers

most affected are those individuals within an entity with direct responsibility for financial

reporting. They must stay current with all accounting developments to be able to assess the

relevance of new pronouncements, and then undertake the work of implementing those that

are applicable to them. An entity’s financial management needs to explain accounting

changes and their effects on the entity to senior management, the audit committee, the board

of directors and external stakeholders. Prior to the recent financial reporting failures, these

tasks were sometimes viewed as routine matters of secondary importance. Resources for

accounting policy development and application within entities were constrained. The

financial statements and other related financial disclosures required for public companies are

now viewed as being more important and, accordingly, will demand more attention from

entities’ managements and boards of directors.

68 The work involved in applying recent accounting standards is tending to become more

extensive. The standards are increasingly addressing issues of accounting recognition and

measurement, which are often more difficult and time-consuming to deal with than issues of

presentation and disclosure. Recognition and measurement issues may demand a higher

level of expertise. They often call for changes to established accounting systems involving

changes to data gathering and processing routines outside the accounting department. These

changes take time to implement properly. Although the Board tries to provide a reasonable

time between the issue date and effective date of new standards, financial statement preparers

are pressed to meet the deadlines.

Standards overload on public accountants

69 Auditors are also affected by standards overload. They may be required to stay current on

most or all accounting developments in order to be able to serve all of their clients to the

required standards of practice. The standards of practice (including assurance standards,

independence standards and other requirements applicable to public practitioners) are also

changing, adding to an auditor’s burden. In a number of cases, clients look to their auditor

for advice and assistance in coping with new accounting standards because the clients lack


the expertise or sufficient staff internally. Although recent changes to auditor independence

rules will curtail public practitioners’ ability to accept such outsourcing work from audit

clients, they may be asked to provide the same type of service to non-audit clients. However,

the audit firms collectively have limited resources to be able to service their clientele. They

sometimes find themselves unable to provide advice in sufficient depth on a timely basis to

all of their clients when a new standard has wide application and requires a significant

change to past accounting practices.

70 The problems facing public practitioners are particularly acute for smaller firms. Their

smaller size gives them less flexibility in dealing with change. They are less able to develop

effective internal specialization that enables a division of responsibility. Compounding the

problem, smaller firms tend to deal primarily with smaller clients that are less well equipped

to deal with change internally and more likely to seek help from their external accountant.

The firms are faced with the dilemma of whether to accept audit appointments from their

clients, having regard to the new independence rules, or to accept only those forms of

engagement that permit them to provide advice and assistance on accounting and related

matters. Also, clients often resist paying for accounting services that they do not consider

good value for the fees charged. Subsequent sections of this Discussion Paper explore

aspects of this issue that fall within the Board’s mandate, but the Board has the ability to

address only a part of the problem that practitioners are facing.

Burden of non-financial statement and foreign reporting requirements

71 Another dimension of the accounting standards overload issue is that those it affects are often

responsible for addressing new requirements imposed by other bodies. Public companies are

subject to the requirements of the securities regulators and market authorities, a number of

which involve financial disclosures that require the attention of financial statement preparers.

In light of the recent governance and financial reporting failures and other developments, the

Canadian securities regulators have been more active in recent years in developing new

regulations, rules and policies, as well as enhancing their surveillance and compliance

activities. Other regulators, such as the prudential regulators of financial institutions and rate

regulators in certain industries, periodically implement new requirements, as do the various

taxation authorities. Public accounting firms not only have to remain current on such


developments to be able to assist their clients but, as mentioned above, they also have to

remain current on changing professional standards that govern their practices.

72 A number of Canada’s largest companies also face the added burden of foreign requirements.

Canada’s larger public companies generally have foreign operations, and their securities are

offered and traded in foreign capital markets. As a result, these companies become subject to

a wide variety of foreign legal and regulatory requirements affecting financial reporting and

other finance-related matters. Financial statement preparers, their advisors and auditors may

be required to be knowledgeable in several different sets of accounting and reporting

requirements, all of which are changing periodically. US accounting and securities

requirements are particularly extensive and challenging, and are also changing at least as

rapidly as their Canadian counterparts. While the movement towards the global convergence

of accounting standards helps to reduce the burden of dealing with change, the need to deal

with more than one set of accounting requirements remains an additional source of standards

overload for affected companies.

Other aspects of change

73 In general, the pace of change in other areas has increased at least as rapidly as in accounting

standards. Some commentators have questioned the ability of the financial reporting

system21 to continue absorbing change at the pace set in recent years while avoiding poor

implementation of new requirements. The Board has heard from a number of different

participants in the financial reporting system about the difficulties they are experiencing. In

developing its strategic plan, the Board will need to balance the needs of financial statement

users for better information against the ability of the system to meet those needs.

74 The ability of people in the financial reporting system to absorb new accounting standards

depends to some extent on their familiarity with both the fundamentals of financial

accounting generally and the specific requirements of individual new standards. The Board

has taken steps in recent years to communicate better with all of those most directly affected

21 The term “financial reporting system” is used here in a broad sense to encompass the preparers, users and

auditors of financial statements, and also standard setters, regulators, public policy makers and all others with a role in the development, dissemination and use of financial information.


by its activities. The Board has taken advantage of newer forms of communication available

through the Internet to provide timely, reasonably detailed summaries of its decisions and

other information about its activities, as well as making its exposure drafts widely available.

The Board has also adopted a practice of publishing Background Information and Basis for

Conclusions documents explaining both proposed and final standards, as well as web-based

presentations about the standards. The Board maintains ongoing contacts with key groups

affected by its work, and its representatives participate in conferences and courses. The

Board believes its current communications program results in effective two-way

communication, but is open to suggestions about how it could improve in this regard.

75 While the Board communicates along the lines described above, it has not engaged in

educational efforts designed to train financial statement preparers, auditors and users in the

new standards it publishes. Adequate training is critical to the proper application of

standards. To a limited extent, the more extensive application guidance provided in recently

issued standards is designed to assist accountants who may be unfamiliar with concepts like

fair value, expected value or option pricing that are being incorporated into standards. While

education is beyond the Board’s mandate and resources, it recognizes that hoped-for

improvements in practice may not be fully achieved if those who have to apply standards are

not adequately prepared for the task.

76 The Board invites comment on the effects of the pace of change on its strategic policies and

direction, particularly standards overload, and recommendations for coping with change.

Meeting financial reporting needs

77 The primary users of profit-oriented enterprises’ financial statements are typically most

interested in information that will help them forecast the future cash flows of an enterprise.

The primary users of not-for-profit organizations’ financial statements want a clear

accounting for resources they have provided and how they have been used, or may be used in

the future, to achieve the organizations’ objectives. Other users often have similar

information needs. In attempting to meet the financial reporting needs of various financial

statement users better, the Board encounters issues such as those summarized below.


Standard-setting issues

78 In recent years, accounting standards have gone beyond simply codifying best practices and

moved away from some traditional forms of accounting. Many financial statement preparers

and users are accustomed to a modified form of historical cost-based accounting that focuses

on monetary exchanges and the matching of costs and revenues. Non-monetary transactions

that result in liabilities, such as employee future benefits, stock-based compensation and asset

retirement obligations, are now recognized whereas they may not have been in the past. The

deferral of various revenues, costs, gains and losses, although currently still acceptable under

Canadian GAAP in some circumstances, is being increasingly circumscribed because such

items do not represent assets or liabilities as defined in the conceptual framework (for

example, the foreign currency translation gains and losses deferred prior to 2002).

79 Another significant change involves requirements to measure assets and liabilities at fair

value in an increasing number of circumstances, such as impaired long-lived assets and

goodwill and, in the foreseeable future, many financial assets and liabilities. The trend is to

require fair value measurements when they are more relevant to financial statement users and

sufficiently reliable for accounting purposes. However, there continue to be disagreements

about the relevance of fair value in some situations, particularly when it is asserted that an

asset is intended to be held to its maturity or the end of its useful life. In addition, there are

concerns about the reliability of fair value determinations.

80 Any consideration of these issues, and others, raises questions about how best to

communicate certain types of financial information. For example:

• Some maintain that good disclosure is sufficient to inform financial statement users and

that, accordingly, it is unnecessary to change existing recognition and measurement

practices for various types of transactions or financial statement elements. Others

consider it necessary for the balance sheet, income statement and cash flow statement to

provide a more faithful representation of financial position and operating results through

various changes to recognition, measurement and presentation practices. Thus, for

example, views vary about the need to limit cost deferrals or abandon the matching

concept.


• Some believe it necessary to mandate a single treatment for any given accounting issue,

whereas others consider it reasonable to permit some diversity in practice through

alternative approaches to providing information. Some take the quite different view that

standards should be voluntary benchmarks, since market forces will push financial

statement preparers towards good practices. Thus, for example, some believe that fair

value information should be used for measuring financial statement elements, others that

such information should be, or may be, provided through supplementary note disclosure,

and still others that there is no need to require any disclosure of fair values in financial

statements since entities will provide it voluntarily.

• Views vary as to whether certain types of information belong in financial statements at all

or, instead, should be provided through a separate management discussion and analysis of

financial matters or other supplementary disclosures.

Cost/benefit trade-offs

81 The nature and applicability of accounting standards are determined not only with reference

to the usefulness of the information to be provided, but also with the cost/benefit trade-offs

involved. Better information that meets the needs of financial statement users benefits them

directly, but also benefits the reporting entity by making it more transparent to stakeholders.

Greater transparency generally reduces risk and uncertainty, which in turn reduces the risk

premium that providers of capital would otherwise demand. This benefit is often difficult to

quantify, but some empirical research indicates its existence.22 Better information often

requires financial statement preparers to incur more costs, typically for accounting staff and

outside consultants to develop the information or to modify accounting systems to produce

the necessary data, and also for auditors to verify the information. Financial statement users

also may need to incur costs to modify their analytical tools to be able to use the information.

The costs are sometimes more readily quantifiable, tend to fall mostly on preparers, and are

22 See, for example, “The World Price of Earnings Opacity” by Utpal Bhattacharya, Hazem Daouk and

Michael Welker in The Accounting Review, July 2003 (vol. 78, no. 3, pp. 641-678), and “Disclosure Level and the Cost of Equity Capital” by Christine A. Botosan in The Accounting Review, July 1997 (vol. 72, no. 3, pp. 323-349). Other papers on this topic are forthcoming. The accounting literature also includes papers providing theoretical bases for this phenomenon.


indirectly linked with the less tangible benefits.23 The Board makes an effort to assess the

cost/benefit trade-off for each standard it develops, but it usually does so in the absence of

any specific data.

82 The Board will find it helpful if respondents to the Invitation to Comment can provide clear

evidence of both costs and benefits related to individual standards recently adopted or to the

Board’s general direction and policy over the past few years. The Board also welcomes

recommendations about how such cost/benefit evaluations can be done more effectively.

Differential reporting

83 Some commentators have pointed out to the Board that one implication of standards overload

is that some entities have ceased having their financial statements audited or reviewed, with

the result that the users receive no assurance about the reliability of the information they

receive. Some entities have ceased preparing GAAP financial statements. This phenomenon

results partly from the pace of change, but also from the greater complexity of standards and

the resulting difficulty in applying them at each reporting date and auditing or reviewing the

result. Affected entities, typically smaller private companies, do not see a benefit to them

commensurate with the costs involved.

84 A requirement for GAAP financial statements and audits is a matter for public policy makers

and those who have the ability to contract for the provision of financial information (for

example, providers of capital who may insist on being given audited GAAP financial

statements as a condition for lending or investing). Not all countries require that all reporting

entities apply their national version of GAAP. For example, in the United States, there is

generally no legal requirement for non-public companies to apply US GAAP, and many

adopt one of the several other commonly used bases of accounting (for example, tax basis,

cash basis or modified cash basis). The basis adopted is often determined by agreement with

a bank or other capital provider.

23 The recent financial reporting failures in the United States and Europe have provided some insight into the

value of reliable financial statement information. Many billions of dollars of market value disappeared as a result of those failures, in some cases at the first suggestions that there might be a problem with a company’s financial statements.


85 While the Board would not modify GAAP deliberately in such a way that the needs of

financial statement users are not satisfied, it also recognizes that not all users have the same

needs and not all needs can be fully satisfied by any one set of reporting requirements. The

Board has an established practice of addressing this issue within GAAP by such steps as

exempting some entities from the scope of some standards, providing differential reporting

alternatives in some standards, and developing different standards for different categories of

entities such as not-for-profit organizations. However, the Board also starts from a

presumption that identical transactions and events should not be accounted for differently

according to the nature of the reporting enterprise, on the grounds that comparability is an

important characteristic of useful information (as set out in the conceptual framework).

86 In 2002, the Board introduced a differential reporting approach into GAAP that focuses on

the circumstances of non-publicly accountable business enterprises (see DIFFERENTIAL

REPORTING, Section 1300 of the CICA Handbook − Accounting).24 That approach relies on a

systematic analysis of the benefits and costs of various accounting requirements to the

preparers and users of financial statements of qualifying enterprises, which include most

smaller businesses. Differential reporting is based on the Board’s conclusion that the

cost/benefit trade-off between the various characteristics of useful financial information can

differ from one circumstance to another.

87 In determining which alternative treatments to permit, the Board applies a cost/benefit

analysis to individual standards on the basis of recommendations from the Differential

Reporting Advisory Committee. The analysis of costs and benefits, and thus the committee’s

recommendations, are essentially judgmental and applied to a large and diverse population.

The result is that some qualifying enterprises are not interested in some of the available

alternative treatments and others believe that there should be more.

88 A differential reporting system also needs to include a basis for determining which

enterprises qualify to apply the alternative treatments provided. The system established by

Section 1300 limits qualifying enterprises to those that obtain the consent of all of their

24 Differential Reporting for Profit-Oriented Enterprises provides further information about the differential

reporting approach under Section 1300.


owners and have accountability to only a few other parties (typically banks or similar lenders

that can insist on the type of financial information they want as a condition for lending).

Companies accountable more widely to public shareholders, depositors, policyholders, trust

beneficiaries and others do not qualify on the grounds that those parties generally do not have

the ability to determine what information they will receive.

89 The approach currently in place is not the only one that may be taken to differential reporting

issues. In developing Section 1300, the Board considered differential reporting systems for

smaller non-public companies in the United Kingdom and New Zealand. The Board is also

monitoring work recently started by the IASB and the FASB to consider the financial

reporting needs of such companies.

90 The Board has heard proposals that it broaden the application of the differential reporting

system to smaller public companies. Some of those companies are concerned about the costs

and difficulty of applying GAAP and believe that their shareholders do not need the

information required by some standards. Such a change raises important issues about the

nature of information that should be provided to current and prospective shareholders of

public companies, which are primarily matters of public policy to be decided by lawmakers

and regulators. It would also require that the Board abandon on practical grounds one of the

basic principles underlying the current differential reporting system, namely, the requirement

that an enterprise’s owners unanimously consent to the differential reporting options to be

adopted.

91 One of the factors that may affect the Board’s views on differential reporting for smaller

public companies is the extent to which the securities regulators’ disclosure requirements

provide for different treatments for different categories of public companies. For example,

the Canadian Securities Administrators’ National Instrument 51-102, “Continuous Disclosure

Obligations,” defines a “venture issuer” and imposes different requirements on such entities

for filing deadlines and management disclosure and analysis disclosures.25

25 Differential Reporting Under Securities Legislation provides details of these differential requirements.


92 An important issue in any consideration of differential reporting is whether alternatives or

scope exceptions should be available for disclosure, presentation (statement display),

recognition and measurement issues, or be confined to only some of those issues. Financial

statement preparers have raised concerns from time to time about “disclosure overload.”26

The principal concern is that the key information about an entity can be obscured by a

plethora of specific, required disclosures on less significant matters. Solutions that have been

proposed for disclosure overload include providing scope exceptions for some disclosure

requirements within a differential reporting system.27 This approach has been applied in

GAAP for some time and appears to be widely accepted in principle.

93 GAAP currently provides differential reporting on recognition and measurement issues, as

well as disclosure, in the form of separate Handbook Sections for not-for-profit organizations

on topics such as capital assets, and alternative treatments linked to Section 1300 for

qualifying enterprises. Differential recognition and measurement treatments raise the

following concerns:

• Similar items may be recognized in the financial statements of some entities and not

those of others, or they may be measured on very different bases, leading to a significant

loss of comparability between entities. This concern is more pronounced in the case of

the current approach under Section 1300 that permits enterprises to choose which of the

available allowed alternative treatments to adopt. An “all or nothing” approach to

differential reporting would reduce the lack of comparability among qualifying

enterprises.

26 In the public company context, the disclosure overload issue extends beyond concerns about requirements

applicable to financial statements to encompass various regulatory requirements to provide other financial and non-financial information. The concerns are often about the cumulative effect of all of the requirements and not necessarily about any individual requirement in particular.

27 The Board has also tried to address disclosure overload concerns by taking care in identifying the specific requirements to be included in standards, with a view to keeping disclosure requirements to the necessary minimum for all entities. Recently, it has begun to consider expressing disclosure requirements in more general terms so that each reporting entity can apply more judgment in determining what specific disclosures are material in its circumstances. Both of those approaches, and other disclosure issues, are the subject of a Board research project to develop a disclosure framework intended to apply in all standard-setting projects.


• Some alternative treatments may fail to provide a faithful representation of the economic

substance of assets and liabilities and related transactions and events, result in insufficient

or excessive conservatism, or fail to provide information relevant to decision making.

94 Proponents of the Board’s current approach to differential reporting believe that the

cost/benefit analysis should determine whether certain treatments are not sufficiently useful

to warrant their application in all circumstances. Others are not convinced that the

cost/benefit analysis should determine accounting treatments. They worry that GAAP may

be weakened or financial statement readers confused by different treatments for similar

items.

95 If, on the basis of input received, the Board decides to take a different approach to

differential reporting than it has been following to date, the structure and processes that

support differential reporting would need to be reviewed and probably modified in some

respects. Such a review would be a consequence of, rather than a part of, the Board’s

strategic planning and, accordingly, it would be undertaken separately.

96 The Board is interested in readers’ views about differential reporting and the rationale

underlying their views. Key issues include:

• whether GAAP should continue to have different requirements on certain issues for

different types of reporting entity, and to what extent;

• what the different categories of reporting entity should be for a differential reporting

system;

• what types of alternative accounting treatments should be made available (disclosure

alternatives only, or also recognition and measurement alternatives); and

• whether all of the applicable alternative treatments should be applied by an enterprise that

adopts differential reporting or, as is currently the case, a qualifying enterprise may

choose which alternatives it wishes to apply.


Conclusion

97 This Discussion Paper raises various matters that the Board believes it should take into

account in formulating its strategic direction and policies. The Board expects that members

of the public will be able to provide more information and elaborate on these and other

matters in a way that will be useful to the Board.

98 Comments are invited on any matters that readers believe may prove helpful in the

formulation of a sound plan for the Board’s future activities, whether mentioned above or

not.


Documents

Accounting Standards in Canada: Future Directions Discussion Paper