Newsletter Content
• Latest News
• Bill 198 and IFRS
• IFRS – IAS 37 – Provisions, Contingent Liabilities and Contingent Assets
• Ontario HST
Latest News
IFRS – this is not really news per se, but rather a reminder that during 2010, Publicly Accountable Entities (PAE’s) are expected and required to provide additional updates regarding the transition from Canadian GAAP to IFRS, including selection of accounting choices and quantification of the impact of IFRS to financial statements, as part of their 2010 interim filings. During 2010, companies will need to gather IFRS information which will enable them to report under both Canadian GAAP and IFRS, because of the comparative information that will be required for 2011…read more.
Bill 198 and IFRS
National Instrument 52-109 also known as “Canadian Sarbanes-Oxley” and “Bill 198” will be impacted by the transition to IFRS in a number of ways. Here is my perspective:
• The Canadian Securities Administrators (CSA) has indicated that the CEO and CFO certificates will be updated to reflect the revised IFRS financial terminology. Aside from the terminology changes, there are no substantial changes being proposed, however it will be important to ensure that the appropriate forms are being used in the future…read more
• Key Controls pertaining to the internal controls over financial reporting and disclosures, in my opinion, will not really be changing with the implementation of IFRS. By this I mean – whatever approval, review, reconciliation processes are in place to ensure that an organization’s accounting balances are correct, will continue. However what will likely change significantly are the business and systems processes being used to calculate the IFRS compliant financial results, and this has implications throughout the organization. Where and when to start? During the transition to IFRS, an organization will understand the changes to financial reporting and disclosures. This in turn should drive the update to Business Process Narratives, IT General Controls, and Entity Level Controls. The best time to update these processes and / or key controls is during the IFRS transition, so that all controls are updated and properly aligned with the new accounting standards. There are some excellent software packages available to track both IFRS transition and Bill 198 controls, but at the end of the day, nothing is more effective than having experienced accounting professionals review this work. Please contact me to discuss a more thorough review of IFRS and Bill 198.
IFRS vs Canadian GAAP – IAS 37 – Provisions, Contingent Liabilities and Contingent Assets
The following topic generates a great deal of attention on the Edelkoort Smethurst Schein CPA’s LLP web-site, so I thought it would be helpful to provide further information to readers in this e-Newsletter.
IAS 37 is very comprehensive, and for the purpose of this article, only a high level summary is possible. As always, it is important to read and understand the details of each IFRS standard.
IFRS has one standard for provisions – IAS 37 – Provisions, Contingent Liabilities and Contingent Assets, and is a “principles-based” standard. Under Canadian GAAP there is less guidance, and although one related source is CICA 3290 – Contingencies, accountants typically fall back on the fundamental definition of a liability.
The difference between IFRS and Canadian GAAP will depend on the type of provision being considered. Differences may arise in both recognition and measurement of provisions.
Recognition of a provision is based on the probability that you are going to make a payment, or deliver some other asset to fulfill the obligation. Under Canadian GAAP, a provision is based on the “likely” probability that a payment will be required. In comparison, provisions under IFRS are based on a “more likely than not” probability. “Likely” is often taken to be a different and less stringent threshold and therefore it is anticipated that there will be additional provisions under IFRS as compared to Canadian GAAP.
Another important IFRS distinction for provisions is the notion of “constructive obligations” – which are not necessarily legal, but rather where valid expectations have been created to settle an obligation. As an example, a company causes damage to be done to the environment and it needs to be cleaned up. The company commits to the restoration, and this is communicated to external stakeholders. This in turn has created a valid expectation to incur clean up costs among third parties – therefore this is a “constructive obligation”.
Under IFRS, the degree of uncertainty of an obligation (either legal or constructive) determines the manner in which the obligation is categorized and reported for financial reporting purposes.
Obligations with a high degree of certainty would be recognized and reported as payables and accruals. This would include legal obligations such as trade payables, and constructive obligations such as unpaid holiday bonuses which were promised but not yet paid.
Obligations with a lower degree of certainty, but likely, would be recognized and reported as provisions. This would include legal obligations such as a contested lawsuit that will probably require payment, and constructive obligations such as announced warranties beyond contractual rights.
Obligations with a low degree of certainty, and unlikely, would be disclosed as a “contingent liability” in the footnotes of the financial statements, and would not be recognized. Note the significant difference in the definition and reporting regarding contingent liabilities between IFRS and Canadian GAAP.
Terminology and measurement may be different between Canadian GAAP and IFRS, so these standards must be reviewed carefully.
In addition to the classification of obligations by degree of uncertainty, there is also a criterion for recognition that requires a reliable estimate of the amount of the obligation. IAS 37.26 states that the circumstances in which it will not be possible to reach a reliable estimate will be extremely rare. However, if those circumstances exist, regardless of the obligation’s classification, the liability would be treated as a contingent liability and would not be recognized, but disclosed in the financial statements.
IAS 37 also provides practical rules governing the measurement of obligations, particularly under uncertainty. A partial list of these rules includes the following:
• A provision should be recognized at the best estimate or expected value of its outcome. This estimate is the amount that an entity would rationally pay to settle the obligation.
• Where there is a range of amounts, the entity would choose the most likely outcome, or expected value. This would be in contrast to the Canadian GAAP rule where the minimum amount is accrued unless a particular amount in the range appears to be the best estimate.
• Where the effect of the time value of money is material, a provision should be recognized at its present value. The discount rate should be pre-tax, should reflect the risks specific to the liability, and should be adjusted over time.
• Changes in provisions should be recognized at the best estimate as at each statement of financial position date, and the provision can be reversed if it falls below the recognition criteria.
So what does this mean to your organization for the switch to IFRS? At a bare minimum:
• Assess whether any additional provisions exist under IFRS that didn’t exist with Canadian-GAAP:
o Due to the “more likely than not” probability threshold difference.
o Assess whether there are Constructive obligations, in addition to legal obligations.
• Assess whether the $ amount of all provisions under Canadian GAAP is different and adjust any difference.
Please note that the International Accounting Standards Board (IASB) is in the process of reviewing IAS 37 in order to improve the guidance on identifying liabilities, reduce differences between IAS 37 and U.S. GAAP, make the recognition requirements for liabilities in the scope of IAS 37 consistent with those for other liabilities, and clarify the requirements for measuring liabilities. The IASB plans to complete the standard during 2010, so it will be important to monitor the changes. …read more.
Ontario HST – Implementation
Effective July 1, 2010, Ontario’s Retail Sales Tax (RST) will be replaced with the Ontario Harmonized Sales Tax (HST), also known as the Ontario Value Added Tax (OVAT). The HST will have a combined tax rate of 13 per cent — combining the existing five per cent federal Goods and Services Tax (GST) and an eight per cent Ontario component. The HST will be administered by the Canada Revenue Agency. I thought it would be helpful to provide guidance for the implementation of HST within an organization during the next few months.
To begin the preparation process, an organization should consider all facets affected by sales taxes (for example, accounts receivable, accounts payable, payroll, purchasing, forecasting and budgeting to name a few). Although this can be a very time consuming task, the benefit of spending time preparing for implementation is a reduction in costly errors, surprises for overlooked issues, and future audit exposures. Below are a number of issues businesses need to consider for the HST implementation.
HST Sales and Collection
• Perform an internal product and service sales tax analysis. Many goods, services and other items such as intangible personal property and real property non-taxable under the old Ontario sales tax legislation will now become taxable as a result of harmonization. However, unless a supply is specifically excluded from HST (e.g., books, children’s clothing), or under a specific Ontario post-harmonization (e.g., in Ontario certain insurance premiums), the sales tax status will be aligned with current GST rules, which will simplify tax administration for organizations.
• Revise software and/or tax tables used to generate invoices and price adjustments (debit and credit notes) to accommodate additional tax rates/codes.
• Revise automated system-generated entries (e.g., monthly inter-company charges, monthly rent charges or management fees to reflect the new sales tax codes/rates). Note – do not delete or deactivate old tax rate codes since it may be necessary to use them after implementation during the transitional period.
• Consider the impact of HST on real property contracts (during the transitional period and after implementation).
• Determine if prepayments have been made before the implementation date.
• Consider special codes for point-of-sale rebates for the provincial component of HST if applicable.
• Follow transitional rules for volume rebates, promotional allowances, price adjustments, goods returned or exchanges after the July 1, 2010 implementation date and guidance for goods in transit on July 1, 2010.
• Internet web sites – modify tax tables.
• Review ongoing or long-term contracts to ensure the correct sales rate is applied (e.g., service agreements, licences, memberships and leases) especially those straddling the harmonization date.
• Retailers – update point-of-sale terminal or cash-register software.
Remember – All GST registrants will automatically become registered to collect OVAT (and BC HST).
Recovery of HST Paid on Purchases (Input Tax Credits and Rebates)
• A business defined as a “large business” (over $10M taxable sales) or a financial institution cannot claim input tax credits for the provincial component on specified restricted expenses. Restrictions will last up to five years with a three-year phase out. Restricted expenses include some elements of energy, telecommunications, road vehicles and food, beverages and entertainment.
• Develop updated or new tax tables/codes for accounts payable systems that automatically record input tax credits or rebates based on embedded taxes. Prepare to code payables for restricted versus non-restricted expenses. Once again, do not delete/deactivate old tax rates as they may be required in some situations. If your system can only accommodate one or a limited number of tax rates, develop a manual system to record sales taxes correctly during the transitional period.
• During the transitional period, implement procedures to ensure only the HST paid is recovered. Develop a system to track the federal and provincial components of HST if you are part of the “MUSH” sector (municipalities, universities, schools and hospitals) or a qualifying non-profit organization.
• Review and update periodic system-generated payments to apply the new taxes.
• Adjustment the remittance percentages if you are a small businesses or public service body using the simplified remittance methods.
• Revise employee travel expense reimbursement and allowance software or pre-printed forms for not only the new rates but also the restricted expenses and possibly the use of factors. Watch for special transitional rules for expense reports straddling the implementation date.
• Selected listed financial institutions must make adjustments included in the Special Attribution Method calculation if applicable.
Other HST Implementation Considerations
• Staff training – make sure personnel are sufficiently trained to process HST transactions.
• Revise cash flow projections and update budgets and forecasts – there could be significant savings.
• Purchase orders with pre-printed sales tax information or system generated purchase orders should be modified to accommodate the new taxes, e.g. the goods for resale exemption will no longer apply in Ontario.
• Update pre-printed price lists or Internet web-sites containing sales tax information.
• Develop a system to track coupons and rebates by province of redemption or purchase and bad debt adjustments, tracking the tax from the original transaction.
• Develop a process to update taxable benefit remittance rates for the 2010 and 2011 taxation years.
• Subject to the change-in-use provisions, additional calculations may be required for the embedded tax content.
Plan to do a test run of sample data for all modified systems as a result of the numerous changes and revisions. This will reduce the potential for errors and surprises when the systems are activated on July 1, 2010.
• For publicly traded companies, ensure that Bill 198 (NI 52-109) key controls testing during 2010 takes into consideration HST implementation, by reviewing the approval process for system changes, and testing a sample of sales and purchase transactions to ensure the controls are designed and operating effectively. Modify documented procedures for how internal tasks are performed whether automatically or manually.
I hope this helps. Thank you for taking the time to read this. Please don’t hesitate to contact Edelkoort Smethurst Schein CPA’s LLP If you have any questions or require assistance. Best wishes to you.
The views and opinions expressed in the Edelkoort Smethurst Schein CPA’s LLP E-Newsletter are those of Edelkoort Smethurst Schein CPA’s LLP, and include excerpts from other authors and web-sites as identified in the Newsletter. Readers should discuss details with their accounting and tax professionals. Edelkoort Smethurst Schein CPA’s LLP disclaims any responsibility whatsoever in regards to interpretation and use of any of this information.