Standards
The Future of Canadian Accounting Standards
Convergence with IFRS has begun.
FROM: SEP-OCT 2005 ISSUE | BY STEPHEN SPECTOR
More than 40 years ago, Marshall McLuhan coined the term "global village," envisioning a world where electronic media would replace printed matter as the leading form of communication. McLuhan's vision wasn't fully realized until the early 21 stcentury , but thanks to the law of unintended consequences, this new reality has had an unexpected impact — on accounting standards.
In 1973, as increasing globalization of the world's capital markets fuelled the need for a "common language" for commerce, the International Accounting Standards Committee (IASC) was created. Charged with harmonizing the world's accounting standards, the IASC met with modest success until the mid-90s, when the European Community adopted international standards over U.S. standards as the basis for listed company GAAP.
The endorsement in 1999 by the International Organization of Securities Commissions added further legitimacy to IASC standards as the basis for international GAAP. In 2001, the IASC re-imaged itself after the Financial Accounting Standards Board (FASB) into an independent standard setting body, and became the International Accounting Standards Board (IASB). Then, in 2002, the European parliament decreed that all listed companies would have to comply with IASB GAAP effective January 1, 2005.
Meanwhile, Canada was taking a different path. Following the recommendations of the 1998 Task Force on Standard Setting, which recognized that most capital flows in North America were north-south, the Canadian Accounting Standards Board (AcSB) chose to harmonize Canadian GAAP with U.S. GAAP, though it acknowledged that at some indeterminate point in the future, there would have to be a move towards international GAAP. And there we might have remained, but for the spectacular U.S. financial failures of 2002.
The demise of Enron, WorldCom, Global Crossings, Adelphia, and others drew attention to the rule-oriented basis of U.S. GAAP. The reaction to these failures was a directive to the FASB to move away from rules-based regulating, and implement a principles-based system. There was also a general expectation that U.S. standard setters would abandon their insular mindset and recognize the overarching role of global standards.
In November 2002, the FASB and the IASB signed what became known as the Norwalk Agreement. The two bodies agreed on a five-year plan to eliminate differences between international GAAP and U.S. GAAP. The effect of this agreement was to initiate a convergence between U.S. GAAP and IASB GAAP. While not adopting each other's standards, there was an understanding that substantive differences were no longer appropriate.
So where did this leave Canada? Canada had been harmonizing with U.S. standards, but now, U.S. standards were harmonizing with international standards. In a sense, we had a converging spiral where the centre point was a set of GAAP accepted everywhere. Consequently, the AcSB bowed to the inevitable, and determined that the time had come to move away from its 1998 position.
On March 31, 2005, the AcSB issued a discussion paper entitled "Accounting Standards in Canada: Future Directions — Draft Strategic Plan." The paper, breathtaking in its scope, outlined the direction the AcSB would take from 2006 to 2011, assuming the plan was adopted. In one fell swoop, the AcSB would abandon its strategy of harmonizing with U.S. GAAP and, in deference to the nature of Canadian business, segment GAAP into public and non-public company GAAP. Briefly, the document proposes that:
- Separate strategies will be put in place for the major categories of reporting entities (public companies, private businesses and not-for-profit organizations), with the notion of "one size fits all" finally being abandoned. The AcSB acknowledged that each user category merits a strategy that addresses the particular needs of entities in that category.
- The AcSB will consider public company reporting as part of the move toward global convergence of accounting standards. In a decision that acknowledges what CGA-Canada has been recommending since 1999, the AcSB concluded that the best way to achieve the objective of a single set of globally accepted, high-quality accounting standards was to converge Canadian GAAP with International Financial Reporting Standards (IFRS) over a transitional period, expected to be five years. At the end of that period, Canadian GAAP for public companies will cease to exist as a separate, distinct basis of financial reporting.
- What about non-public entities? The AcSB is planning a comprehensive examination of the needs of the users of these businesses' financial statements to determine the most appropriate financial reporting model to meet those needs. Given the nature of the Canadian economy, the discussion paper makes the point that GAAP requirements are intended to apply only to entities that have significant external users of financial information and require the application of a common basis of financial reporting.
- The AcSB will take steps to limit the scope of its standards to non-public entities, thereby exempting a number of smaller private businesses that do not need GAAP financial statements. Current differential reporting alternatives will be maintained, and additional alternatives may be developed as needed.
- Not-for-profit organizations (NFP) will continue to apply those elements of GAAP for profit-oriented enterprises that are applicable also to their circumstances. A consultation process will be undertaken to determine whether NFP should base their accounting on public company GAAP, or whether some might base their accounting on the standards for Canadian private businesses or be exempted from the scope of accounting standards altogether.
So what does this all mean? While some aspects of the answer are easy, the real answer is that we don't know. The potential simplification of the reporting regime for non-public companies is to be applauded; New Zealand already has such a system in place, with small entities with no public accountability not required to follow GAAP.
Furthermore, the decision to converge with IFRS is not as surprising as it might seem. Canadian and international standards are already similar, given that they both derive from a principles-based perspective. And, the convergence of U.S. GAAP and international GAAP means the AcSB policy of harmonizing with U.S. standards was not for naught. The inward spiral mentioned earlier now has three bodies moving to the centre point: U.S. standards are converging with IFRS, and Canadian standards will also converge with IFRS — but Canadian standards already resemble U.S. GAAP, so as U.S. GAAP move to IFRS, Canadian GAAP also move closer to U.S. GAAP.
Why should this last point matter? Recall that a key reason the AcSB initially chose to harmonize with U.S. standards was the north-south capital flows in North America. If the standards used in both jurisdictions converge, then it doesn't matter which set is used. The goal of the IASC from 1973 will have been met and a single lingua franca for financial statements will exist.
Will it happen? Check back in five years and we'll see.
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Stephen Spector, MA, FCGA, owns Spector and Associates and teaches Financial and Managerial Accounting at Simon Fraser University. He also serves on CGA-BC’s board of governors. E-mail shspector@shaw.ca.