Effective for fiscal periods beginning on or after January 1, 2011, the financial reporting framework for Canadian companies will change from the current Canadian Generally Accepted Accounting Principles to either International Financial Reporting Standards (“IFRS”) or new Canadian Accounting Standards for Private Enterprises (“Private GAAP”). Publicly accountable enterprises are required to adopt IFRS, while private enterprises have an option to select either IFRS or the Private GAAP.
As majority of the Canadian subsidiaries of Japanese companies are not considered publicly accountable enterprises, a choice must be made as to which financial reporting framework is to be adopted for fiscal periods beginning no later than January 1, 2011. The choice is neither easy nor straight forward, as the selection of the financial reporting framework will need to be considered in conjunction with the anticipated transition date of the Japanese parent to IFRS as a result of the regulatory changes in Japan. Currently, mandatory transition to IFRS for Japanese public companies is contemplated to occur for fiscal periods beginning on or after January 1, 2015.
Both Private GAAP and IFRS are now considered “Canadian GAAP”. As a result, Canadian subsidiaries of Japanese companies who have contractual requirements to prepare Canadian GAAP financial statements can rest assured that either reporting framework will be acceptable. However, the recently issued stand-alone standard IFRS for Small and Medium-Sized Entities will not be considered Canadian GAAP and is therefore not an reporting option of Canadian subsidiaries of Japanese companies.
When a subsidiary adopts IFRS before its parent company, the parent company will be subject to certain mandatory requirements with respect to the measurement of the underlying assets and liabilities of such subsidiary in its first IFRS statements. These requirements can be onerous to the parent company and can potentially limit the parent’s ability to make certain elections. In order to avoid this problem, the decision to adopt IFRS and if adopted, the IFRS policies chosen and elective exemptions taken should be carefully discussed with the parent company to avoid creating a problem for the parent company down the road.
As well, there is the possibility that on its adoption of IFRS, the parent may for a variety of reasons choose different IFRS accounting policies than those selected by the subsidiary. Given the requirements of IFRS, it may be difficult for the subsidiary to change its accounting policies in future years to align them with those of the parent. If the subsidiary is unable to do so, it may need to maintain two sets of books – one for its own IFRS reporting purposes and another supporting its reporting to the parent company. The process of determine which IFRS accounting policies the parent may select may be somewhat easier if the Japanese parent is early adopting IFRS, but may prove onerous if the Japanese parent is only at a very preliminary stage of analyzing IFRS.
It is anticipated that there will be significant changes to IFRS between now and 2015, as standards setters continue to converge certain aspects of US GAAP with IFRS. It is expected that significant changes to standards involving pension benefits, leases, revenue recognition and financial statement presentation will be effective in 2012 or 2013. Canadian subsidiaries adopting IFRS in 2011 will face not only the challenges associated with adopting existing IFRS, but then face the further burden of implement these proposed amendments. For example, proposed changes to the accounting standards for leases would result in all leases being recorded on balance sheet (together with the related obligation for lease payments) and the discontinuance of operating lease accounting. At a minimum, Canadian subsidiaries may want to postpone their adoption of IFRS until 2013, when a number of current revisions to the IFRS standards are finalized
As IFRS is a principle-based financial reporting framework, there are onerous disclosure requirements for the financial statements. It is anticipated that in many cases, a set of financial statements will be two to three times the volume as they currently are under Canadian GAAP. The impact of such disclosure requirements to local management and accounting group needs to be carefully considered and should not be underestimated.
Unlike IFRS, the new Private GAAP standards are based on existing Canadian GAAP and for many entities, little effort or adjustments will be required in adopting this reporting framework. In addition, Private GAAP provides companies the option to choose certain simplified policies in the areas of financial instruments, hedging and pension benefits and it significantly reduces the volume of disclosures required in the financial statements. Private GAAP, as they apply to most Canadian subsidiaries of the Japanese companies, will generally remain the same, with additional accounting policy option in certain areas to simplify policies, if so desired.
Private GAAP may change in five years. However, by that time, the Japanese parent would have adopted IFRS, making transition to IFRS at that time much easier as the parent would have compiled group accounting policies based on IFRS.
CRA has announced its position that IFRS is an acceptable GAAP for computation of taxable income for companies that are adopting IFRS, as long as IFRS becomes a consistent basis for income tax filings going forward. CRA’s position is that if companies do not adopt IFRS, these companies can continue to use the current GAAP that is been used for income tax filing purposes, or any reporting framework as long as it does not contradict the tax act or case law.
In situations where a parent company in Japan has made a decision to early adopt IFRS, it may be logical that its Canadian subsidiary selects IFRS as its financial reporting framework. However, if that is not the case, it may be prudent for the subsidiary to delay its adoption of IFRS. Canadian subsidiaries should be mindful not only of the cost of adopting IFRS in 2011, but also the cost of ongoing compliance with IFRS as the standards evolve.
Adopting the Private GAAP financial reporting framework is the far simpler option. When its parent adopts IFRS in the future, group reporting packages will then be based on IFRS. At that time, Canadian subsidiaries may want to consider full adoption of IFRS as its financial reporting framework to streamline its financial reporting processes.
We believe it is very important that the parent company be significantly involved in determining the timing of any conversions to IFRS by its subsidiaries.