by John Hughes
Although this is an IFRS blog, it’s hard not to keep at least half an eye on the new(ish) Canadian Accounting Standards for Private Enterprises, which become effective at the same time. As I’m sure readers are aware, the CICA based these standards primarily on preexisting Canadian GAAP rather than on IFRS, although private enterprises can certainly choose to adopt IFRS instead. The list of frequently asked questions on the CICA website summarizes some situations where this might be appealing:
When should a private enterprise consider adopting International Financial Reporting Standards (IFRSs)?
A private enterprise should consider adopting IFRSs when:
a. it is possible that the company will become publicly accountable in the near future;
b. its parent company reports under IFRSs;
c. it wishes to be comparable with publicly accountable enterprises; or
d. financial statement users wish to have comparable reporting as publicly accountable enterprises.
This list is not exhaustive.
I think it’s fair to say the private enterprise standards will be (as designed) significantly easier to apply than IFRS in many instances. They allow exemptions for many of the areas that can be most challenging – for example a private enterprise can choose to account for its subsidiaries using the cost or equity method, rather than through consolidation – and they also cut back significantly on disclosure requirements. For a private entity with only a few well-in-the-loop stakeholders, wanting to obtain audit assurance on financial information conforming to an authoritative external benchmark, there’d surely be no reason in most cases to take on the extra costs of complying with IFRS.
My main complaint is that the standards are less helpful than they should be for a private enterprise that might want to adopt IFRS in the future, but has no good reason to commit to it yet. For example, take the area of impairment, often one of the most material considerations for financial statements. Canadian GAAP assesses initially whether an asset’s carrying amount is recoverable based on the sum of the undiscounted cash flows expected to result from it. IFRS of course has a model based purely on discounted cash flows, meaning (all other things being equal and in conjunction with various other differences) it frequently results in recognizing impairment losses earlier and/or in a greater amount than the Canadian GAAP method.
The Canadian GAAP approach seems to me a mere relic from an age when present value concepts were more patchily accepted than they are now, and easily inferior to the IFRS approach. But even if you disagree with that, there’s no disputing that the IFRS approach is different, nor that it’s here to stay, and any private company moving to IFRS in the future will have to grapple with it sooner or later. It seems to me a real limitation then that the private enterprise standards impose the old Canadian GAAP approach rather than (at a minimum) allowing a choice between the two.
After all, what would it matter if a private company followed the IFRS impairment model? Maybe their methods wouldn’t be comparable to other private companies following the Canadian GAAP approach. But if it resulted in identifying and dealing with recoverability issues more effectively, then what’s the harm? Surely comparability from one entity to the next isn’t the major issue in the private company arena – practically speaking it can’t be, given as noted that the standards allow a choice on something as fundamental and potentially pervasive as whether or not to consolidate your subsidiaries. The primary focus should be instead, I think, on whether the financial statements provide an appropriately informative and accessible communication to stakeholders, taking into account cost and other practical considerations. And sometimes, I’d argue, that would mean allowing a private enterprise to move incrementally toward IFRS, rather than saving up all the work for later. I’m not saying you’d allow a free-for-all menu, with complete freedom to select from IFRS for some areas and private company standards for others: I just think I would have chosen a different place on the spectrum of possibilities.
Of course, in many respects, companies can choose to look to IFRS to inform how they apply the private enterprise standards. For example, in the area of property, plant and equipment, following the more tightly defined “componentization” concept in IFRS certainly wouldn’t be inconsistent with the looser requirements of the private enterprise standards. Impairment might fall into that category to an extent. For example, if you know an asset’s carrying amount is less than its recoverable amount on a discounted cash flow basis, you might rationalize it’s pragmatically reasonable to book an impairment loss even if the undiscounted cash flow trigger wasn’t breached (although it appears this would technically contradict the standard as written). But certain aspects of the IFRS model, such as subsequently reversing an impairment loss if the recoverable amount increases, couldn’t possibly be accommodated within the private enterprise standards.
I don’t mean these comments to sound like an argument for some private entities to adopt IFRS sooner than they otherwise would. Doing that might only be like giving up your unglamorous but perfectly adequate compact car to buy a fully-loaded, high-running-cost minivan, just because you vaguely think you might need one in five years. If there was something available in between, you’d jump at it. But there isn’t.
The opinions expressed are solely those of the author.