Globalization has generated new challenges in a vast of fields. Accounting practice has not been left behind. Integration of the world financial market is growing by the day. This has necessitated the need for more comparability of businesses across national borders. The International Financial Reporting Standards are developed by the International Accounting Standards Board for application in any nation. Canada wishes to adopt the IFRS by the end of 2011. Many differences emerge in treating some transactions. The most visible five differences are in the treatment of business combinations, asset impairment assessment, foreign operations translations, revenue recognition, and related party transactions. An assessment of these emerging differences shows that the IFRS is more stringent. The improved comparability and more trust in the financial reports are likely to greatly boost the Canadian financial markets.
Different nations have developed different principles for accounting to match home-based dynamics and meet agreed-on criteria developed and applied to home situations. Accounting practices are viewed differently by different accountants and accounting institutions depending on the different points of view. Due to the financial implications of relying on accounting information, it is always important to adopt the best possible interpretations and practices in accounting to seal loopholes and give the best possible disclosures that lead to informed decisions for all the interested parties. Globalization and modernity have presented the need for companies to go international and compare with other companies from other jurisdictions. This prompts the adoption of some universally accepted standards for financial reporting.
With Canada having a large number of companies operating in multiple jurisdictions, the need for greater integration of financial markets has become more urgent. The move to integrate financial markets requires greater comparability of the financial reports of the various international players. The decision by the Canadian Accounting Standards Board to relinquish the use of Generally Accepted Accounting Principles (GAAP) and adopt the International Financial Reporting Standards (IFRS) is set to steer the country towards embracing the systems adopted by counterparts in the European Union as well as other major economies of the world. The deadline for publicly traded companies to fully comply with the international standards is the year 2011. The country always focused on harmonizing with the US GAAPs and not IFRS which are global. This is now changed. The implications are set to be far-reaching. This paper explores the differences between the Canadian GAAPs and the IFRS being introduced as well as the various implications on financial reporting and the effect on the efficiency of the security markets.
There exist numerous similarities between the Canadian GAAP and IFRS just like there are many differences. In general, the two are similar especially in the form as well as the style of the proposed standards. Both are similar in terms of the conceptual framework used as a base to develop the individual standards. They are both principle-based accounting standards but from the outlook, accounting judgments made under the IFRS are more stringent as compared with those made under the Canadian GAAPs. In this regard, the management and accounting staff must be properly prepared and acquainted with the changes brought about by the standards in executing the accounting practice to ensure they meet the higher threshold set by the IFRS. In The discussion of the different ways in which the IFRS affects the accounting and reporting standards, it is crucial to understand that the effects on the businesses largely depend on the nature of the business as well as the prevailing circumstances in which the specific business operates.
The first area of significant divergence in approach between the IFRS and the Canadian GAAP is in business combinations. The general principles are largely similar but the application of some of the principles differs. A business combination refers to the event or transaction where one party (an acquirer) obtains significant control (interest) in an already existing business entity. The date of acquisition as defined by the two accounting standards is the date when the power of control is obtained. The main differences relate to measurement and cost of business combinations, the accounting for step acquisitions, reverse takeover transactions as well as differences in first-time adoption (BDO Dunwoody LLP, Par 2).
Under Canadian GAAP, a business is defined as an integrated set of self-sustaining assets and activities managed and conducted to obtain returns to investors. The three basic components of a business are inputs, processes on the inputs, and the resultant outputs that generate incomes in the form of revenues. On this note, for any transfer to constitute a business combination, it must have well-defined inputs, processes as well as outputs that offer revenues from sales.
The IFRS on the other hand defines a business as an undertaking conducted to offer returns in the form of lower costs, dividends, and any other economic benefits. Notably, a transaction that was treated as an asset acquisition under the Canadian GAAP can very well be dealt with as a business combination while using the IFRS. Again, under the GAAPs business combinations are limited in scope and the interest pooling method can be used. In the IFRS, limitations of scope are nonexistent and the pooling interest method is not used (BDO Dunwoody LLP, Par 3).
Control under the GAAPs is not a significant factor in defining the party which acquires the business. Other factors are deemed significantly important. The first is the party that transfers cash and other assets as well as liabilities. Second is the party issuing interests in the form of equity. Still, the resultant entity’s size after combination and the party which initiated the acquisition are important elements of consideration. On the other hand, the acquirer is simply the party that gains control of a new entity. Control is defined in the International Accounting Standards number 27. Any process seen as a business combination but is not clear as to who between the merging entities is the acquirer as indicated by the IAS 27, can now prompt the use of the GAAPs in identifying the acquiring party (BDO Dunwoody LLP, Par 5).
According to the Canadian GAAPs, the date of business combination is the date when the equity or assets are availed to the acquiring entity or the date mentioned in a written agreement subject to some exceptions that seek to protect the stakes of the engaging entities. Under the IFRS, the date of business combination is strictly the date when control is acquired (Implications Of moving to IFRS for existing Canadian/US GAAP differences, Par 6).
In cases of partial acquisitions, the Canadian GAAPs require the use of the fair value in adjusting the value of assets and liabilities and are restricted to the proportion of the acquired interests. The IFRS requires the recognition of the full fair value of liabilities and assets.
The GAAPs have no exceptions to the measuring principle. Guidance is however offered on concepts like treatment of plant and equipment, income taxes, and inventories. The IFRS has some limits in the application of the measurement principle for certain transactions involving specific assets and liabilities. Some of the areas touched include indemnification of assets, the case of reacquired rights, and contingent liabilities. Others include assets held for purposes of future sale as well as share-based payment.
The Canadian GAAPs the schedule for adjusting the purchase equation after the business combination is in line with the provisions of the IFRS. Differences emerge on the fact that the Canadian GAAPs allow extension beyond the 12 months in unusual circumstances which do not require retrospective application. In the IFRS adjustments are mainly limited to the known facts during acquisition (Implications Of moving to IFRS for existing Canadian/US GAAP differences, Par 8).
There also exist differences in the calculation of non-controlling interest. Canadian GAAPs view it as the proportion of ownership of the net assets carrying amount in the entity acquired which is not part of that acquired. The IFRS measure non-controlling stake using the determined fair value of the noncontrolling interest or the portion of interest assets valued using the fair value principles.
Canadian GAAPs only recognize the fair value of liabilities, equity and assets gained in determining consideration during acquisitions. The IFRS goes an extra step to incorporate any significant contingent considerations in finding the final consideration. Again, the Canadian GAAPs combine the market price of equities before and after the announcement of the business combination to determine the fair value of shares. Under the IFRS, the value of shares and other equities is prescribed purely by the market prices at the date of combination. Also, the consideration for acquisition under GAAPs incorporates the expenses incurred in the process of acquisition. IFRS provides that the costs should be accounted for as expenses as they are incurred (IFRS in Canada, Par 5).
The step acquisitions are more complex and elaborate. However, the fundamental difference between the two standards is in the valuation of previously acquired equity during the successive acquisition of equities.
The Canadian GAAPs provide that during subsequent acquisitions, the previous interest already owned by the party acquiring is not revalued. Adjustments in equity held are only to reflect the fair value of the extra interest acquired. The IFRS requires that the already existing stakes owned by the acquiring party be revalued at the date of the new acquisition. The resultant valuation of the equity interest of the acquirer reflects the revaluation of the existing equity interest as well as the additional interest resulting from the acquisition.
Reverse take-over transactions are also prescribed differently under the two standards. The consideration in the case of a reverse takeover is done according to Section 1581 under the GAAPs. There exist detailed specifications in determining the value of equities in a case where the market prices of the subsidiary do not indicate the fair value or if the fair value cannot be attained using any other suitable method. The IFRS 3 concerned with reversed takeover transactions does not offer guidelines in transactions not reaching the threshold of business combinations. In this regard, there are no set valuation rules in the case of legal subsidiaries without clear indications of the fair values. The overall effect of the changes in the way cases of business combinations are handled is expected to improve accuracy in measurement and close up loopholes. This way there will be less likelihood of overvaluations of transactions. The overall effect is that equities will be valued lowly as compared to the current case where the accountants can exploit loopholes and overvalue (IFRS in Canada, Par 9).
The second important area of divergence of the two standards apart from the business combination is revenue recognition. The overall basic criteria for recognizing revenues for both standards are similar. Just like the Canadian GAAPs revenues are only recognized after a seller has shifted sizeable risks and returns to the purchaser. The IFRS however imposes some detailed regulations. Under the GAAPs persuasive evidence of an arrangement by customary practices should be available. No such formal requirements are needed to prove the existing arrangements though it would not be possible to conduct proper audits without the evidence (BDO Dunwoody LLP, Par 5).
In a situation where the purchase has been done but delivery is yet to be done, the GAAPs propose some criteria in recognizing the revenues which slightly differ from those proposed by the IFRS. In cases where delivery has been made and awaiting customer acceptance, GAAPs insist that such revenues should not be recognized but IFRS concedes that if the process of installing is simple and the inspection is purely for verification of prices then such revenues should be recognized. The effect is that some revenues which could not be recognized under the GAAP are recognized under the IFRS. Therefore the share prices may in such instances be higher than under the current IFRS (IFRS in Canada, Par 5).
Another fundamental point of divergence is in asset impairment. The GAAP has a two-step testing approach for impairment. The IFRS uses a single-step approach. Secondly, the IFRS assesses impairment losses as the difference between the recoverable sum and the impairment loss. The Canadian GAAP views the impairment loss as any excess amounts beyond the fair value. Again, the GAAP tests for impairment are to be done in groups rather than individually (such as long-term assets) as well as at the reporting level. The IFRS propose that testing be done on specific assets. Finally, the GAAP disallows any reversal of losses due to impairment. The IFRS on the other hand proposes such reversals except those relating to goodwill. The effect on share prices resulting from the changes in the treatment of business combinations is positive owing to the leeway available in the single-step approach and the higher valuation resulting from singling out assets.
The fourth point of diversion in the two standards relates to the issue of foreign currency translation. Under the GAAPs the current rate is used to translate foreign operations though it depends on whether the operation is categorized as self-sustaining or intergraded. IFRS on the other hand does not categorize foreign operations. Therefore the resultant differences in exchange rates are separately recognized in the equity category (PriceWaterhouseCoopers, Par 5).
Again any revenues, liability asset, or expense should be recognized using the exchange rate in effect at the date of occurrence according to the Canadian GAAP. The IFRS provides that monthly averages in exchange rates can be used unless in cases where the fluctuation rate is high. Under the GAAPs, monetary items represented in foreign currency in the balance sheet are converted using the rate on the date of the balance sheet just like in IFRS. However, nonmonetary items are converted using the exchange rate prevailing in the date of determination of the fair value using the IFRS while the Canadian GAAPs allow the use of the rates at the balance sheet rate. The slowly increasing rates of exchange in Canada mean that the IFRS will lead to undervaluation hence a decrease in prices of equities in the financial markets. (PriceWaterhouseCoopers, Par 7).
The fifth issue raising significant differences in the two standards concern related party transactions. Differences arise on how to value such transactions and the disclosure needs. The GAAPs allow all commercial transactions to be valued at the point and time of exchange. For transactions that do not meet such specifics, they are measured using the carrying amount. The IFRS requires some restatements from the propositions of the GAAPs. Again the Canadian GAAPs require a business to avail information about the relationship with other parties only in incases where the party engages in transactions with the said party. The IFRS requires the information disclosed even in cases where there are no transactions between the two. The requirement for disclosures introduced by the IFRS will introduce higher levels of transparency and reduce cases of collusions in boosting business performances. The overall effect is a short-term reduction in share prices (IFRS in Canada, Par 2).
As can be seen, the implementation of the IFRS introduces some very significant changes in the way accounting will be done in Canada. Some of the new requirements are more stringent than the GAAPs while others give some extra leeway. However, put on a scale the IFRS are more stringent compared to the Canadian GAAPS. The resultant long-term effect on the Financial Markets in Canada is positive. This is because Canadian firms will be presenting more acceptable financial statements which are comparable over the world. The influx of investor funds will be high and the financial markets will significantly grow.
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