Choosing the Right GAAP

Armand Capisciolto:

When you're considering what GAAP to follow and preparing financial statements and getting assurance over financial statements is that we shouldn't just be looking at this as a compliance exercise. We should look at financial statements as a communication and deal making tool to help move a company's business plans forward.

Narrator:

Welcome to Accounting for the Future, a BDO Canada podcast for financial leaders to navigate change and achieve business growth. We'll uncover the challenges financial leaders may not have dealt with yesterday, but we'll definitely have to manage for the future.

Armand Capisciolto:

Hello and welcome to Accounting for the Future. I am your host, Armand Capisciolto, BDO Canada's National Accounting Standards partner and leader of Accounting Advisory Services. On today's episode, I'm joined by two BDO partners, Mikaela Taylor and Dave Rasmussen, both of which are firm technical leaders and advise engagement teams and clients on accounting, regulatory and audit matters. I get the pleasure of working closely with both of them and talking about interesting issues daily. Today is not going to be any different for us than any other normal day other than we're recording the discussion for you to listen to. Mikaela and Dave, welcome to Accounting for the Future.

Mikaela Taylor:

Thanks, Armand. Happy to be here.

Dave Rasmussen:

Yeah, thanks.

Armand Capisciolto:

Okay, so we're going to have some, as we normally do ... we have fun talking about accounting issues. This is going to be another one of those fun conversations. But what we're talking about today, usually we get into the weeds, we get into the details, we're talking about specific transactions. Today we're taking it a at a little bit of a higher level. We're going to talk about choosing the right GAAP, and when I say GAAP, I'm assuming most of the people know what I'm talking about, but generally accepted accounting principles. So let's start with GAAP itself. Dave, what is GAAP for business businesses in Canada?

Dave Rasmussen:

Okay, in Canada, we actually have multiple frameworks that fall into the bucket of "Canadian GAAP" as one size does not fit all. In Canada, we have a huge variety of types and sizes of entities. So having some different GAAPs and different options is a great idea. For profit-oriented enterprises, in some cases there's options. There's international financial reporting standards or IFRS, and there's also accounting standards for private enterprises, which is a Canadian GAAP item.

Armand Capisciolto:

Okay. Just for everybody's purposes, international financial reporting standards, we'll probably hear us say IFRS a number of times today and for accounting standards for private enterprises, you'll probably hear us say ASPE a number of times today. So just getting that out there is to help our listeners along. So, Dave, you mentioned options. So, is it a free choice of what GAAP an entity can use?

Dave Rasmussen:

For some it is, but not for all. For instance, publicly accountable enterprises, public companies, financial institutions, they're required to use IFRS, but for other businesses in Canada, they would have a choice of using Canadian ASPE or IFRS.

Armand Capisciolto:

Okay, interesting. So let's focus, given we're talking about choice and choosing the right GAAP, let's keep our focus on the types of entities that actually have a choice. As you said, private enterprises. And Dave, you mentioned ASPE and IFRS. However, I'm also aware of companies in Canada using US GAAP. Mikaela, is that permitted for companies to use US GAAP?

Mikaela Taylor:

So, if they're incorporated under Canadian legislation, then generally Canadian GAAP needs to be followed, which as you said would include IFRS or ASPE. However, with unanimous shareholder approval, an entity could choose to use US GAAP, but depending on the shareholder structure, getting unanimous approval can be really challenging.

Armand Capisciolto:

Yeah, so that's interesting, the unanimous approval. So, if we're talking about an owner managed business and it's a single owner or a family-owned business, relatively easy to get that unanimous consent Mikaela, but have you seen situations where it's a little bit more difficult to get that unanimous consent?

Mikaela Taylor:

I have seen situations like that. If you have a wider shareholder base, if you've issued stock options or shares to people that were involved in the business, that might not be as directly involved anymore, it might be really hard to track them down and get their express approval on that and it has to be 100% in a positive approval. It's not just a 50% vote on a resolution for US GAAPs. So that one can be quite tricky.

Armand Capisciolto:

Okay, very, very interesting. So, let's stay on the topic of shareholder decisions. Is there also an option to not use any GAAP at all?

Mikaela Taylor:

There is Armand. So, with an appropriate shareholder resolution, which just means a positive vote, 50%, you can choose not to follow any GAAP and use more like a cash-based approach or something in between a hybrid model, like an accrual basis.

Armand Capisciolto:

Okay, interesting. So, let's just pause there because so far, we're only a few minutes in and there's been a lot of different choices. I'd like to just pause and recap. So, a private company can choose not to use any GAAP, so that's one choice, but if they are using a GAAP, they can choose to use IFRS or ASPE, but with unanimous shareholder approval, they could use US GAAP and I'm sure there's other GAAPs they could use depending on shareholders from different places. Maybe German GAAP, maybe IFRS or SMEs, but we're only going to focus on US GAAP today.

So that's interesting. But for purposes of our readers, obviously we're accountants. We're more than accountants, we're technical accountants, we're accounting nerds, right. Maybe a little bit of assurance nerd mixed in there and I'm very proud to say that. So, I hope I didn't offend you by bringing yourself into my realm of nerdom. So, we think GAAP's important, but for our listeners out there, if you can choose not to use GAAP, why would any entity ever choose to use GAAP? Why not save themselves of the hassle of GAAP?

Dave Rasmussen:

Yeah, maybe I can weigh in on that one, Armand. I think it's obviously an option there, but in some cases an entity may not have that option as readily. For instance, if the company requires assurance on their financial statements, so they need an auditor review. That requirement usually comes with a corresponding requirement to follow some kind of a formal framework or a GAAP. So, if say an investor or a lender as part of giving the money to the company or investing in the company says, "I want you to have an audit or review," that usually comes hand in hand with having to follow one of the more formal GAAPs that we've talked about, ASPE, IFRS, maybe US GAAP. So generally, when assurance is needed, a formal GAAP also comes into the picture. Again, I said that could be investors and it could be lenders. Even your sort of bank loan could well come with that kind of a requirement.

Armand Capisciolto:

Yeah, I would assume a lot of those, Dave, especially when we talk about bank loans, that would probably even be specified in their covenants of whether they have to follow GAAP or not.

Dave Rasmussen:

Often the bank agreements will have clauses and definitions right in them that define what the accounting principles or GAAP that's required to be followed. So, it usually comes hand in hand with that.

Armand Capisciolto:

Okay, so again, lots of decisions to make, but what I'm hearing is if they need assurance, an auditor review, people like ourselves that provide assurance, you need to measure to provide that assurance. You need a framework to measure against that framework is the GAAP. Again, and we said it could be either ASPE, IFRS or US GAAP are the three we're talking about today.

Mikaela, when you're talking to a client and they're asking you, well what GAAP should I use ... or sorry, not asking you. They're making their decision on what GAAP they should use. What drives their decision?

Mikaela Taylor:

Well, I think what a lot of times companies think about here and now and just getting through this year end, this deadline and what their current compliance needs might be under the current lending agreement or bank covenants. But this can often be really shortsighted. I would rather and always recommend that they think about where they're going, what they need in a couple years from now, where they see their business in two years and three years and five years and how they can best prepare for that.

Armand Capisciolto:

Wow, two, three, even up to five years. Thinking that far in advance, why should an entity think that far in advance?

Mikaela Taylor:

Well, if they're changing from no assurance where they don't have an auditor review and then they will need to have an auditor review. That may mean adopting a different GAAP or adopting a GAAP at all. It's not something that can be done overnight. So, if you don't think about what you are going to need until someone else asks for it, until you have to do it, you can actually delay the transaction you're looking at. If you're thinking about going public, it could actually delay that process and that's a big risk for whatever the growth plans and whatever trajectory they're having. So, we always want to look at even if it might incur some additional costs right now, those actually might be less over the future if you're dealing with certain issues now versus just dealing with what you need for right now, versus what you'll need in two years. It might be actually less expensive to do a little bit more work now than have to go back and redo a bunch of work in the future.

Armand Capisciolto:

Yeah, it's really interesting and it's what are your actual costs versus your opportunity costs? I think it's really interesting the way you put that because I think a lot of people focus on the actual costs and I think, Mikaela, you brought up a couple really interesting points there. One being the actual cost to do in an advance, although it may cost more today, it might actually be less than when you're dealing with it in a rush situation, right. I think we've seen clients in that rush situation and it's a challenge, and everything becomes a little bit more expensive when you're rushing, but probably the bigger one is the opportunity cost, that deal that's not going to happen. That's something that I don't think a lot of people think about. They think about I'm going to eventually have to spend it. If I spend it now, spend it later, who cares? But that opportunity cost is one I don't think people focus on enough.

Dave, let's now think about this and why in entity would choose a specific GAAP? So, if you're thinking about a client and a client asking you, "Should I adopt IFRS versus ASPE or no GAAP at all, what are some examples of scenarios that you would provide to that client of why IFRS?

Dave Rasmussen:

Yeah, it's a good question. So, I can think of a couple off the top of my head. One that's probably more obvious is going public. Public companies in Canada are required to use IFRS as we said before. So, anybody who wants to go public is going to have to prepare IFRS financial statements. In many cases, that would be at least two, maybe even three years of financial statements that are under IFRS. That is not an easy switch to flip on. The transition to IFRS from even from Canadian ASPE or from no framework at all can be quite cumbersome and time consuming. Usually if you're going to go public, it also requires a number of audits. So that involves not just the company doing its part in preparing the IFRS financial statements, but then the auditor has to do their part in auditing it.

So, there's often some back and forth there. It can be quite time-consuming. That can turn from weeks into months. I've seen cases of companies that were ready to go, the market looked hot, the underwriters were advising now's a great time to get into the market and raise some money. So, they started down that venture and, with delays and trying to get everything ready, it took a few weeks, even a couple of months and markets change. We see that happening more and more today, how quickly and fast the markets change. So that can be a real opportunity lost, and in some cases, I've seen where it just doesn't happen, it doesn't go forward. All those plans and costs that were spent even getting halfway there are now lost sunk costs.

Another example I can think of is with private equity investors, we see much more of that happening in the marketplace these days as well. That money is coming not just from local markets in Canada, it's coming from the US, it's coming from international. And so IFRS International Financial Reporting Standards often is seen as a safe GAAP that many can understand, many can compare to. So, it is often a good choice and an acceptable choice for private equity investors as well. So even if the goal is not a full-fledged public company, money from private equity markets can often also lead to the need to adopt IFRS to again seize those opportunities. Again, those opportunities in today's marketplace, they come and go. So being ready for that requires advanced planning. You're certainly able to seize those opportunities much more readily if you've thought ahead and planned the change.

Armand Capisciolto:

The comment on the markets, and at the time of recording this, we are experience extremely volatile markets and especially volatile on the downside right now. That may persist for a while given geopolitical economic factors. It is really interesting because we've seen a number of clients that were well into their process, but the process was taking longer than anticipated and now those deals may be off ... well they're at least off the table temporarily until maybe the market pricing returns. They may never come back. But even if they do come back, I think one of the things that's interesting, especially if going public, is the fact that the statements that you include in your offering documents, whether it's a prospectus or even an information circular, if you're doing it through reverse takeover, they change as time goes by.

Statements get stale dated. So again, not being ready, not doing this in advance can actually increase the cost of doing it at the last minute because every time those statements get stale dated, it gets pushed out and there's another set of statements to convert and costs can start escalating quite quickly related to that. It's interesting. Should clients be thinking about that, the benefit of being ready to move when the market says it's time to move. There's a huge benefit to that. So, Mikaela, US GAAP. Dave talked about IFRS. When should a company think about US GAAP?

Mikaela Taylor:

I would say it's pretty similar in terms of the timelines, in terms of the statements that you're going to need in go public transaction. The rules are fairly aligned, but there's some key differences. So unlike IFRS, which has a standard which makes adoption of US GAAP sort of sets a cutoff point of what you have to look at, there is no similar standard under US GAAPs. So, I always say you have to go back to the beginning of time, which can be a lot more onerous. Mostly where that comes into play is equity instruments and going back to look at what they've had throughout the course of the whole life of the corporation.

So that one, and it's about availability of information and complexity of the instruments themselves that can make that even more challenging. It's not just about going public. As Dave said, we're seeing a lot more private equity looking to Canada for some good investment opportunities and they're not as familiar with IFRS standards and they often prefer to see US GAAP standards because they're more comfortable with it, they know what to expect and then they're more comparable to other investment opportunities that they're looking at as well.

So, it really is something to think about on where your market is, if that is the path that you're taking and think about that if the US GAAP is something that you're seriously considering or need to consider, that gathering the information as you go is really important.

Armand Capisciolto:

Yeah, I really like that you brought up the whole first-time adoption issue or lack of a first-time adoption standard in US GAAP. Yeah, by no means am I saying transitioning to IFRS is easy, but the fact that IFRS has a first-time adoption standard does make it a little bit easier than it is under US GAAP. Michaela, I know you've dealt with a number of clients that have adopted US GAAP related to moving a transaction forward or just switching to US GAAP. And I know it's a challenge. It's a challenge that we find fun as because it's who we are and what we do, but I'm not sure everybody would find that as fun as we find it.

So, if I think about what I just heard the two of you say about IFRS and US GAAP, what I'm hearing is we shouldn't think of financial statements as just something that's about compliance. We should think about GAAP and financial statements as a tool to move strategic plans forward. It's not just an accounting afterthought. I think that's really interesting because I think a couple of things, Mikaela, you said right at the end there, they need to think about the market they're going to be in. I think what you're saying is, and correct me if I'm wrong on this, you're saying kind of think about who you're the users of the financial statements are going to be in a few years' time and make their life easier because that's going to help them provide you with the financing or whatever you need to move your strategic plan forward.

Mikaela Taylor:

Yeah, that makes sense. You want your investors, you want to make their decision as easy as possible, and if they don't understand the standards and have to do more work to be able to make their decision, you're not going to be in the best position for them.

Armand Capisciolto:

Yeah. I've seen it a few times with some clients being acquired by US private equity and I'll get a call, explain this ASPE thing to me, what is APSE? Because the US private equity, they're like, we have no idea what ASPE is. Again, it's not that we can't get them there, not that we can't help them understand the differences, but their decisions are that much more difficult because there's that translation from the language the financial statements are in, ASPE, to the language they understand being US GAAP or IFRS. If we can avoid the need for translation, hopefully the decision gets a little bit easier. Which brings me, Dave, to my next question. We have these standards in Canada, ASPE accounting standards for private enterprise, when are they enough?

Dave Rasmussen:

Yeah, we've talked up IFRS and US GAAP a lot here, but ASPE is a great set of standards for what they were designed to accomplish. They serve the needs of most Canadian private enterprises. They provide some additional accounting policy options and streamlined disclosures. So, they have a little more flexibility in them in terms of choosing some different policies and they have disclosures aren't quite as voluminous as IFRS or US GAAP, which can make sense for a lot of private Canadian enterprises. To be honest, this is what the majority of our clients apply in their annual financial statements. So, if there's no short to medium term plans to go public or to attract substantive private equity investments or sell to a public company, ASPE can meet the needs and of Canadian owners. Canadian lenders and banks are familiar with ASPE. We see that often in bank agreements and that's fully acceptable.

Armand Capisciolto:

Yeah, no, it very much is the vast majority of Canadian companies apply ASPE, of those applying GAAP versus IFRS or US GAAP. So yeah, a hundred percent agree with you Dave. We were by no means saying don't apply ASPE. We're just saying sometimes think beyond ASPE and think a few years down the line. One last question for you, Dave, and it's been brought up a couple of times, this idea of assurance. When we're talking about not following a GAAP and generally you don't follow a GAAP when you don't need assurance. When should companies start thinking about actually following an accounting framework, whether it be ASPE or otherwise, and getting assurance being an auditor, review over those financial statements?

Dave Rasmussen:

Yeah, I think we talked earlier more so about the public company and private equity scenario and they're going to want to see some assurance. Public company financial statements have to be audited. Private equity are going to want at least reviews and most likely audits. But even lenders, banks in Canada, each of them has their own threshold for when they want assurance. And some will accept review engagements up to maybe certain lending thresholds, certain lending amounts, but beyond that may need audits. So, because each bank, each lender has their own thresholds for things, we highly recommend that companies have an open conversation with their lenders, their bankers, whoever they might be looking to raise money with. Just have that open conversation and ask the questions, what's your dollar amount for when I need to move from a review to an audit? What types of facilities are available to me if I had my financial statements audited versus just reviewed or not having them reviewed or audited?

Having those open conversations can really then well before you need the money that can lead to, okay, maybe if I want to get access to that line because I've got expansion plans or I've got acquisition plans, maybe I need to start putting that in place a year or two in advance so then when I do get to that transaction stage, I'm ready to go right away. So having those conversations upfront, internally and with potential financers is the best advice of all.

Armand Capisciolto:

Yeah, open conversations always make decisions easier and the well in advance is a key comment there, whether we're talking about going public, whether we're talking about getting bank financing. You don't want a compliance issue, I'm using air quotes, that no one can see. Compliance should not slow you down. With that, I think you've given us a lot to consider today. The key message I took away from our chat today is that when you're considering what GAAP to follow and preparing financial statements and getting assurance over financial statements is that we shouldn't just be looking at this as a compliance exercise. We should look at financial statements as a communication and deal making tool to help move a company's business plans forward.

To me, that's the key. I really don't think that is top of mind for people because unfortunately they think of financial statements like a tax return as compliance. But I hope our listeners got what I got out of today and realize this is much more than compliance. Mikaela and Dave, thank you very much for your insights on this topic. Myself, our audience appreciates your time and expertise. I'd also like to thank you our listeners for tuning in today. I'm Armand Capisciolto, and this has been BDO's Accounting for the Future. Please let us know if you found this topic interesting and useful and remember to subscribe if you like it. We'll see you next time.