PORTER HETU INTERNATIONAL
July 26, 2004
ACCOUNTING STANDARDS IN CANADA:
In Response to the Invitation to Comment
Porter Hetu International (PHI) is an association of independent firms established in 1988. In 34
offices from Halifax to Victoria we provide accounting, assurance, tax and management consulting
services primarily to private (small) businesses and not-for-profit (NFP) organizations. Although
we have 2 offices qualified by the Canadian Public Accountability Board (CPAB) and we provide
assurance services for a small number of listed venture corporations, this is not yet a significant area
with respect to revenue or resource allocation at this stage of our development.
Our primary experience is with the 97% of small businesses with fewer than 50 employees, and
with the 175,000 or so not for profit organizations in Canada.
In this context, financial statements, to be useful for user decision making should be understandable
(not unnecessarily complex), and not misleading (complete and straightforward).
It is in this framework that we set forth these comments.
1. We believe that the Accounting Standards Board should maintain its own
standard setting capability, and its own GAAP. Harmonizing with US GAAP or
increasing convergence with International Financial Reporting Standards (IFRS) are
not matters, in our view, that weigh on the minds of NFP management or contributors,
nor on the minds of small business operators or their bankers and leasing brokers.
As discussed later, it is our view that IFRS and US GAAP are, quite naturally, under
the heavy influence of global enterprises and their investors and creditors who are also,
for the most part, global or large national financial institutions. These players are under
pressure from regulators and institutional investors, especially after Enron but even
before, to provide fair value based position statements. The advent and evolution of
complex financial instruments and the calamity resulting from off balance sheet
“special purpose entities” push forward this trend.
The consequence is that the global financial reporting community seems bent on
emphasizing the position statement over the income statement (the opposite of the over
emphasis on the income statement through the eighties and early nineties) and fair
value over historical cost.
Previously, the position statement resembled a repository of debits and credits on hold,
waiting to be moved to the more dominant income statement. Currently, the income
statement appears increasingly like a spill tank to clear fair value adjustments on the
increasingly dominant position statement.
This seems to us to result in standards which are expensive to implement and add little
value to users of financial statements of the private business and NFP communities we
serve. Moreover, the increasing use of fair value, with its alternative methods and
highly sensitive assumptions in many cases, is clearly open to manipulation by those
willing to do it.
A balanced effort to report both position and income in understandable ways for
the often less sophisticated users we serve is far more useful. The usefulness of
financial statements – to each of the types of reporting entities and their users -
should be their dominant quality.
These brief comments are to indicate why we believe that the Board must
continue its standard setting capabilities, whatever theoretical winds are sweeping
through the international standard setting community in any given decade.
Modified historical cost basis accounting has served the needs of small business for
6000 years. Practical GAAP for smaller users must be maintained in a sovereign
Canada, and not subordinated to outside standard setters with their own often
irrelevant, sometimes conflicting interests, and needs to serve.
2. Our committee does not have a common view on harmonization with US GAAP and
international convergence. Some of us think that the inter-listed Canadian companies
will use US GAAP in any case, and therefore we should probably harmonize for large
public enterprises and then support convergence with IFRS. Others hold the view that
convergence with IFRS should be the main line of march.
We note, with some curiosity, that a number of contributors to this discussion from
larger public companies have taken the time to oppose Differential Reporting. We
wonder why, given that they are unaffected. Because our clients are largely private
businesses and NFPs we have largely left the discussion of standard setting for public
companies out of this submission. We suggest that public company participants might
wish do the same with respect to Differential Reporting.
3. We support the modification of GAAP to provide better information to NFPs
(Section 4400 etc.) and “non-publicly accountable enterprises” (Section 1300). In
our experience, such modified GAAP rules should be maintained and extended.
However, the requirement for unanimous shareholder approval to use differential
reporting (DR) is difficult to understand. The concern for minority or non voting
shareholders must be weighed against these facts. A majority of voting shareholders
can make most major decisions and 2/3 of voting shareholders can decide almost
everything else including issuing shares, assuming heavy debt loads and selling the
enterprise. In this context, the DR requirements are excessive. It is also difficult and
expensive, for purely logistical reasons, to obtain. Similarly, the rule that any
shareholder change requires repeating the whole process is excessive.
We have other comments on these matters but such comments are better reserved for
Exposure Drafts (EDs). Here, our only purpose is to support the direction of
modifying GAAP to meet the needs of users of financials of different types of
The use of DR is not merely a cost benefit issue. In many cases, the use of DR is better
understood, and therefore more useful to our clients, their shareholders, creditors etc.
But the implied burden on public accountants (*to ensure that all are adequately
informed, advised to seek counsel etc.) is frequently not worth the effort and costs more
than the savings offered as a reason for DR.
4. In the Board’s Invitation to Comment a chart of scenarios is presented with comments
on the effects on standards, timing and implications. Larger public enterprises should
comment on the harmonization with US GAAP and convergence with IFRS.
We believe that the cost of maintaining Canadian participation in the
international discussions is worthwhile. Not only does the work of the Board assist
in these global deliberations, but the international process, we are sure, informs the
process of formulating Canadian GAAP. As we outlined in point 3, however, we
believe GAAP has to allow for the needs of users (including management) of smaller
business and NFP entities. We do not see that any of your scenarios quite fits this
5. In our view, many smaller public (venture) companies can ill afford the cost of an
increasing number of GAAP standards (e.g. standards requiring valuation where
market prices are not available).Extension of Differential Reporting to such
companies is a possible solution. Perhaps a criterion such as market value of total
shares and public debt outstanding not to exceed $X million. Such an approach could
NOT be justified for inter-listed companies.
6. In our view the Board should proceed on a “principles based” approach to
standard setting. Such standards should generally be guided by an up to date
conceptual framework. However, we do not hold the view that consistency with
such a framework should stand above usefulness and the cost-benefit calculation.
Standards should set out clearly the objectives intended by the Board. We welcome the
recent trend towards increased implementation assistance for accounting standards. We
encourage the Board (and the Institute) to do more to provide implementation
assistance for different types of entities, including smaller private businesses and NFPs.
7. Like many of our colleagues who serve our markets, we welcome the recognition in the
Board’s discussion paper of “standards overload” (exhaustion) and the problems of
coping with change. We are not convinced that all of the changes are necessary for
private businesses and NFPs. We are very concerned with the increasing cost to public
accountants, and the increasing resistance of our client markets to paying higher fees to
apply standards for which they see no purpose. The result for us is a reduction in
Quite frankly we are working longer and harder, incurring higher staff costs and
making less money at the end of the day. The accounting profession, for all its skill,
cannot continue on such a course. Why should anyone enter such a profession? For the
past 16 years we have striven to maintain high quality work by becoming associates of
a Canada wide entity, establishing common standards, using a division of labour to
make more feasible compliance with GAAP and GAAS. Even so, the effort at our
individual offices is very taxing.
8. The costs of standards are not easy for us to calculate. We spend more time reading
exposure drafts, attending standards update seminars both within Porter Hetu and
outside, more time considering how they affect our working paper templates and how
they apply to individual clients. We spend more time training students because the
standards have changed, often significantly, since they graduated from university. We
spend more time explaining such standards to clients, including what benefit, if any,
there may be for such clients.
We recommend that a part of each request for comments on each ED be an
estimate by respondents of the costs associated with the implementation of the
change(s) for companies and public accountants. In addition, comments should
be sought on the expected benefits to user decision making of the proposed
We further recommend that the Board continue and extend its recent trend
towards reducing the impact of standards changes through management of
implementation times for smaller entities to establish a more survivable pace of
We suggest that such implementation management not only consider time
required to adapt to a particular change, but that the total volume of changes be a
factor and that this too be managed.
9. We support the development of Differential Reporting. In these comments we have
recommended simplified qualification rules with respect to shareholder approval;
consideration of the extension of the rules to single listed public venture firms below a
set level of value of public securities. (see point 3 above)
We further recommend that non market based (more subjective and more
expensive)) fair valuations (including goodwill) be avoided for qualifying
enterprises in future extensions of DR.
10. We welcome the establishment of the Differential Reporting Advisory Committee and
the Not for Profit Advisory Committee.
However, we recommend that the Accounting Standards Board itself increase
representation from public accountants in the small business and not for profit
areas of practice. Their financial reporting needs and their resource limitations
can best be presented by a stronger voice at the big table.
We further recommend that the terms of reference, activities and summaries of
advice from the DR Advisory Committee be made available on the web.
11. We wish to take this opportunity to comment briefly on some of the ways GAAP
changes can have an impact – often negative - on smaller private businesses. Small
companies – especially growth companies – often face cash flow problems. For tax
reporting purposes, CRA looks generally to GAAP where the Income Tax Act (ITA)
does not explicitly modify reporting requirements. Thus, when accounting policy was
changed to recognize retractable preferred shares issued under certain tax arrangements
as debt instruments, CRA began considering the treatment of dividends on such shares
as interest. Differential reporting options for such shares solved the problem.
Similarly, callable debt obligations (CDOs), reported as current liabilities, has created
some problems. In our view, these problems do not arise so much from the correct
view of the Board that such debt should be current, but the bureaucracy in some banks.
Most banks key certain numbers from customer financials into bank-wide software.
Even though the bank itself is often the lender under CDOs, most appear to accept their
presentation as term debt for the purposes of ratio calculation. Such a presentation
produces a better working capital ratio.
Presenting CDOs as strictly current debt is being mechanically applied by some
bankers resulting in current ratios being out of covenant. Some small business lending
managers at the banks have made an issue of this – even though nothing has changed
but the presentation, and the loan payments are up to date.
A third area of concern is the trend towards fair valuation and the recognition of
unrealized gains and losses. Taxation has always been based on realized gains and
losses with certain exceptions (e.g. death of a taxpayer). This tax policy matches tax to
cash flow from sale proceeds. Some at CRA see the trend in GAAP towards
recognizing unrealized gains as an opportunity to press their long held view that tax
should be based on the same principle. The mismatch between tax and cash flow can
be very difficult for small businesses. It would certainly impair their ability to finance
growth and jobs.
In these and other ways, the law of unintended consequences seems to include negative
economic and tax consequences as part of the cost benefit calculation with respect to
changes in GAAP for smaller private businesses and to a lesser extent for NFPs. We
believe these wider costs must be included in such calculations.
We appreciate the opportunity to provide comments on the future direction of the Board’s
Gary Porter, FCGA CA
For the Committee