The importance of standard setting - Part 2

Armand Capisciolto:

That for me as a standard-setter is the challenge, is how do I create standards that aren't just relevant today, standards that will remain relevant in a changing economy?

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 will definitely have to manage for the future.

Anne-Marie Henson:

Hello, and welcome to Accounting for the Future. I'm your host, Anne-Marie Henson. Today, in part two of our conversation, we explore some of the practical applications of accounting standards, and how the rapid pace of change is impacting standard-setting. If you missed part one of our conversation, I encourage you to go back and listen to it before tuning into this one today.

With that, I'm pleased to introduce and welcome back our guest and friend of BDO, Armand Capisciolto. As the chair of Canada's Accounting Standards Board, Armand leads the development of accounting standards for use by all Canadian entities outside the public sector. Canada's Accounting Standards Board serves the public interest by establishing standards for financial reporting by all Canadian private sector entities, and by contributing to the development of internationally accepted financial reporting standards. Armand is also a BDO alumni, where he worked for 15 years as the National Accounting Standards partner.

I want to pivot a bit to a bit more practical application with specific situations that we're seeing or hoping to start to see more of in 2025. Capital markets have not been great, we've not seen the IPOs that we've seen, or the go-public transactions that we've seen, in 2020 through 2021, but it looks like the market is starting to pick back up. So in talking specifically, let's say, about public companies for a minute, for companies that are thinking about that now and hoping to be successful in a go-public transaction in 2025, what steps should they be taking to ensure that they're prepared for compliance with relevant standards today, with relevant standards that could be in effect once they go public, what would you say in terms of advice there?

Armand Capisciolto:

Often, when I talk to people about our different standards, because we have this multi-framework approach in Canada, I like to talk about the gap between the gaps, and what I'm talking about there is when we moved to IFRS and ASPE back in 2011 from our pre-change-over accounting standards, if you look at, especially from a recognition and measurement standpoint, the differences were not that significant in 2011. They were relatively minor, the differences, to be honest, compared to what they are today, and that's because since then, we've had a lot of new IFRS standards, IFRS 9, 15, 16, so financial instruments, revenue, and leases. These are really foundational issues, these are big issues that impact every company.

IFRS has moved and our domestic standards have stayed still, so there's now this large gap between part one and part two of our handbook. First and foremost, any company that is applying ASPE and is thinking about going public, and therefore will have to adopt IFRS, has to realize they have a fairly large lift. This is not something you can do at a moment's notice, it takes time. I still remember when I was dealing with companies in 2020 at BDO, and when the capital markets were on fire and it seemed like everybody was going public, there was a lot of work there. Great for accounting firms that all these companies needed assistance to get to IFRS really quickly, but it was hard and it was expensive for them and all of those things, and it continues to be hard. If you're thinking about this, think about it early. I don't think the message has changed from when I was at BDO on that, so that's first and foremost, there is a big gap between the gaps.

The other thing is the gap is going to get bigger. We're very focused at the Accounting Standards Board with our domestic standards on scalability, and why are we focused on scalability is the types of companies that apply our domestic standards are companies that are thinking about going public in the future, but they're also relatively small owner-managed businesses, and they're also some of the largest companies in Canada applying our standards. So to try to meet the needs of all those types of companies and the fact that they have different users, some just rely on banks, some have venture capital or private equity money, there's so many different users, we're saying, "Well, how do we make the standards scalable?"

And basically, the thought is how do we make them scalable, we add optionality. So we have this project called the Detailed Review of ASPE, and that's what we're doing, we're going through the standards and saying, "Are there places where we can add options so that it is scalable, that someone can do something useful for a small business, but also have the option to do something that is useful for a larger business?" And the only way to do that is to have some optionality there.

The other project we're working on that people have been asking for for a while is related to intangible assets and goodwill that arise in a business combination. We actually are working on an exposure draft that will add optionality, that will allow entities, if they choose, to not recognize all the intangible assets separately, subsume them into goodwill, but then require entities to amortize goodwill, which is significantly different than the direction the IASB has gone with their project on goodwill and intangible assets and impairment, so the size difference is going to get bigger. What would I say, we come out with this option in ASPE to not recognize intangibles separately in a business combination? What I would say to an organization that is thinking about going public five years down the line, don't take that option, because the thing if we do add options and add choices, your choices have consequences and you need to think about those. You can't think about, well, this is easier today, you have to think about what the needs of your users are going to be in the future.

Anne-Marie Henson:

Yeah, that's great. On that note, my personal comment to you, I'll put on your accounting standards setter's hat is I love that optionality, there is that option available in US GAAP, which I know isn't part of Canadian GAAP and that landscape, but does provide a great alternative to recognizing those intangibles, determining the fair value of those, access to goodwill, having to test for impairment in a different way. So anyway, I think that's a great option to provide.

Armand Capisciolto:

We've had people asking about it since the FASB did it in the US many years ago and we're finally getting to it, and to me, again, this is where that cost benefit comes in. This is the cost benefit test at work, because what we hear in many private company scenarios is the primary user is a lender, that lender might be a secured lender, so they get financial statements that have all these intangible assets, like customer lists and have goodwill and all that stuff, and what does the lender do? They eliminate that from the balance sheet because they don't care, they have security over the tangible assets, so they don't care about all this intangible stuff.

So if that's the case, and we know the accounting for a business combination and the auditing of a business combination accounting is about as expensive as it gets when it comes to the cost of accounting standards, if the entity is just going to eliminate all that, or the bank's going to eliminate all that when making their lending decision, why the heck are we making people do it? Now, an entity that has private equity investment, they might look at it differently. And I think these are the decisions, when we add optionality, that companies are going to have to consider.

Anne-Marie Henson:

Yeah, I find that really great. I want to talk a little bit more about what's in store for the future, but before that, just a comment to add about how time-consuming and very expensive transition to a different GAAP can be and doing it in advance. I think we saw this as well in that 2020/2021 go-public craze and a lot of transition work. One element I think companies absolutely have to consider today, that maybe wasn't as important 10, 15 years ago with different technology and systems, is the importance of understanding what that change means fundamentally to your organization, outside of just, oh, this is what my financial statements are going to look like. That's the easy part, okay, the numbers changed. But, well, what data do you need to capture to make sure that you're recognizing things the right way and not tracking things on a spreadsheet outside of your system to do these adjustments on a monthly basis? So I think it's just, to add to your point there, advanced thinking, it's not just about, oh, how does this impact the finance function, it's so much larger than that.

Armand Capisciolto:

Exactly, exactly.

Anne-Marie Henson:

Yeah, let's talk a bit about the future and where we're headed. So we've heard a lot about ESG, we've had a lot of podcasts even on accounting for the future about ESG, including with yourself as the host, and we have the ISSB, which was formed a couple of years ago now, and actually established their headquarters in Montreal, which is great, another testament to the importance of Canada and the international standard-setting stage. How would you say today ESG and the ISSB are impacting financial reporting?

Armand Capisciolto:

We spend a lot of time on what we refer to as connectivity, and that's really the connections between sustainability reporting and traditional financial reporting. What we're really talking about there, I think what sustainability reporting is doing is highlighting risks that traditional financial statements have not necessarily covered, and in some cases, shouldn't cover, because sustainability... When I think about sustainability reporting, it's looking quite a ways out into the future. Accounting standards do look out to the future, but not that far.

So when someone starts reporting about sustainability reporting, and not even following the ISSB standards, when someone just puts out, "We're going to be net-zero by 2050," that raises accounting questions. People say, "Well, if you're going to be net-zero by 2050, and you have a transition plan, and that transition plan relates to retiring assets and bringing new assets in and changing your product mix," people start asking the question, "Well, should there be an impairment? Should there be a provision? Should there be something in the financial statements?" And the reality is, in many cases, there doesn't need to be, but that doesn't mean people aren't asking the question.

So the ISSB has... The IASB. If I say it too fast, you can't tell the difference if I'm saying IASB or ISSB. But they actually have a project outstanding right now called Climate and Other Uncertainties in the Financial Statements, and what this is dealing with is this idea that you have these longer-term risks, you have these uncertainties, and what should you be saying about those uncertainties in your financial statements? So there is an example in this exposure draft about a net-zero commitment, and if you've made a net-zero commitment and it doesn't result in an impairment, but someone might think there should be an impairment, it has example of saying, well, you should disclose why it doesn't to build that bridge between the sustainability report or the net-zero statement and the financial statements. So that in itself, we spend a lot of time talking about those types of things.

The other things that are happening is you're just seeing new arrangements, new asset classes. And I'm saying new, they're not new, but they're becoming much more prevalent. I mentioned we did research on carbon credits. Well, carbon credits are becoming much more prevalent because companies want to get to carbon neutrality. They might not be able to get to net-zero on their own, so they're buying carbon credits, so now if they're buying carbon credits, how should those be reflected in the financial statements? How should they be accounted for? The IASB is working on a project related to the accounting for power purchase arrangements. I know, Anne-Marie, in my former days, you and I had many conversations about power purchase arrangements, and power purchase arrangements are becoming prevalent because the companies building wind farms, building solar farms, want a long-term contract to know their energy is going to be sold, they companies want to know that they want to lock in prices for a long period of time, and they want the renewable energy credits related to that. So again, the IASB has a project related to the accounting for power purchase arrangements.

So all of these projects that traditional financial statement accounting standards setter has to take on, because the sustainability report... It's not the sustainability report, because of the move to reduce the effects of carbon in that, they are creating issues that then we, the accounting standards setter, have to address because our current standards may not provide users with the information that they want or need.

Anne-Marie Henson:

Yeah. I want to touch on that a little bit, actually, because it was my last question to you, but you're talking about it now, so I'm going to move it up a little bit and challenge you a bit on what we're seeing in the world with our clients and companies, they're entering into these more unusual arrangements. As we stand today, I think cryptocurrency is a great example, Bitcoin reached almost $100,000 or something, might have a little bit to do with the recent election and the expectation that it's going to be deregulated. So when you look at this, there's an expectation that, okay, there's going to be a lot more activity with regards to cryptocurrency, with regards to blockchain, with carbon streaming arrangements, and oftentimes companies are, and auditors/accountants, are looking to standard-setters to say, "Help us out. What should we do with this?" So could you talk to us a little bit about what's the view of standard-setters, Canadian or international, with regards to dealing with all of these rapid, rapid changes in the world, and how we should apply accounting standards to them?

Armand Capisciolto:

Yeah, and there's different views. So if you look at what the FASB has recently done, so in the US, so they've made some amendments to deal with cryptocurrency accounting, specifically ones like Bitcoin, the ones that have specific prices, they actually have a project on their agenda related to carbon credits. So the US is taking an approach where we have some known issues, we're going to narrowly address these known issues.

Anne-Marie Henson:

For the information of listeners, it's a little bit more customary for US standard-setters to take that route, right? They're very prescriptive.

Armand Capisciolto:

Prescriptive rules, narrow approach, and also only standard-setting for one jurisdiction, which allows them to do some of those things. I think for both cryptocurrency and carbon credits in US GAAP and IFRS, even without the US doing what they're doing, there is an answer that you can come to today. From an IFRS standpoint, when we look at cryptocurrencies, we look at it and say, "Well, they kind of meet the definition of an intangible asset." If you look at what the definition of an intangible asset is, they meet that, and therefore, there is a path to account for them. If they're not an intangible asset, if you're acting as a broker/trader, they're probably inventory, and there's a path to account for them in inventory. And the truth is with carbon credits as well, there's a path to come to an accounting conclusion today.

The question then becomes for standard-setters, is that accounting conclusion fit for purpose? Does it provide users with the information that they need to properly assess what's happening in this company that's entering into these transactions? What our research on carbon credits, as an example, has shown is that although they're increasing in prevalence, although a lot of companies in Canada talk about carbon credits in their management discussion and analysis, in most cases today, they're not material on financial statements.

From a cryptocurrency standpoint, what do we know in Canada? Well, Canada is an interesting jurisdiction, because a lot of companies that operate specifically in the crypto space have decided to list here in Canada, therefore, Canada has probably more than any other jurisdiction entities with material amounts of crypto activities and holdings. Again, there's an answer you can get to. When the IASB looks at cryptocurrencies, and this is a conclusion they've made, is, yeah, you have 60 companies in Canada that have material cryptocurrency activities, but other than Canada, when they look at the capital markets and look at entities applying IFRS, not many of them hold cryptocurrencies. When we think about FTX, as we all know, it failed, it wasn't applying IFRS, I have no idea what they were applying, they were not a public company, domiciled in a tax haven, all those things. So IFRS having accounting standards for cryptocurrency would not have solved anything for the fall of FTX.

At the end of the day, when the IASB is thinking about this, they have to think about what are our priorities? What are the issues that are impacting entities applying IFRS today? And unfortunately, cryptocurrencies isn't prevalent enough for the IASB to take it on. Canadian stakeholders say, "Well, it's prevalent here." It's not prevalent for them from an IFRS standpoint yet. As the IASB considers their Pollutant Pricing Mechanisms project, they have to say... Their test is prevalence and significance. So prevalence, a lot of companies have it, significance, is it material to those companies? So carbon credits, it's prevalent, not necessarily significant yet. So then they have to make a decision, well, do we start our standard-setting before or after it becomes significant?

The other thing the IASB is doing is they have a project, they started a research project, on intangible assets. And this is, again, probably back to that difference between how the IASB standard-sets versus how the FASB standard-sets. The IASB, very focused on principles and saying, "Well, right now, these things both fall within intangibles. We have a project on intangibles. Is there a way to address these in a larger project?" And that might be the approach they take. And so, it's not that they're ignoring it, but they might be taking it in a more holistic approach. Now, the issue with that, dealing with a standard like intangible assets is going to take the IASB a long time to deal with, whereas the FASB, being very narrow with what they're doing, can standard-set quite quickly.

So that's the challenge I think we have to deal with is, as standard-setters, whether it's the FASB, whether it's us in Canada, whether it's the IASB, we only have so many hours in the day, and we have to properly prioritize the projects we're going to work on, and we have to focus on the projects that are going to impact the majority of companies, or the most companies. So crypto, as an example, is not something that means... As much as the price is doing what it's doing, as much as people think it may one day become mainstream, it's not mainstream. Will that change with what's happening in the US? I don't know. We're sitting here recording this on the day that Gary Gensler resigned from the SEC, who's been very against anything crypto and a lot of regulatory burden on crypto, crypto goes crazy today because he resigns. Is the fact that Gary Gensler resigning going to result in way more companies investing in crypto? I have no idea. If it does, then we as standard-setters, our thinking might have to evolve and we might have to change our priorities.

Anne-Marie Henson:

Yeah, that makes a lot of sense. And I think in looking back over the past, say, four or five years, and then looking forward to the next four or five years, it's likely that there are going to continue to be new revenue streams, new product offerings, like completely innovative assets or things in the market that companies are going to continuously think about and go to market with, so I guess it does become a little bit challenging then to say, for each and every new thing that doesn't fit perfectly into the box that we'd like to from a standard-setting perspective, that we need a new standard for.

Armand Capisciolto:

And Anne-Marie, I think this is the challenge, and I think really challenging for auditors, and not dismissing that challenge, I live that challenge, is the reality is standard-setting is slow. We have a due process, it takes time, it's slow by design. So the economy, technology, that change is anything but slow, that is happening at an extremely fast pace. So if you asked me how do we get to standards that are going to deal with those, we have to stick to principles, and then those applying those principles have to use professional judgment.

That might result in some diversity in practice, which I know as an auditor, and I was an auditor, the auditors don't like, the regulators don't like, people don't like it. But the reality is that might be what we have to deal with when you have a standard-setting process that's built around a due process of consultation and outreach that takes time, and economy and technology is just changing and really doesn't care how long standard-setting takes. That for me as a standard-setter is the challenge, is how do I create standards that aren't just relevant today, standards that will remain relevant in a changing economy?

Anne-Marie Henson:

I love the way you said that, actually, and I think it's a great point. For anyone who is uncomfortable with sometimes the lack of prescriptive standards to help us deal with exactly our situation, the upside is that it gives us flexibility. Then you just need to explain your judgment and do research, find out what other companies might be doing or how they're applying it, look at other standards to help, but you have flexibility, as long as you explain how you got to that conclusion. So I think we should probably see it as more of an advantage than a disadvantage, but it is a little uncomfortable sometimes, I guess.

So I have one final question for you, Armand, just the future, where you see yourself and the Accounting Standards Board, what's in store for Canada from a financial reporting perspective in the next few years? You did touch on a few of the projects that the board has on the go, but more broadly, what do you think is in store for us between now and the next few years?

Armand Capisciolto:

I'll talk specifically with some IFRS standards here. So IFRS 18 released, actually just read a wonderful publication from the BDO Global Group, on IFRS in Practice on IFRS 18, it's fabulous. I'm glad to see the work, it continues to be amazing there, the publications they put out. But that's a big one, that's going to change the way the statement of comprehensive income, the income statement looks for pretty much every company, going to bring new disclosures. I think that's a critically important not project, it's done, it's standard that companies should be focusing on sooner rather than later. I know it's a topic that for us at the Accounting Standards Board, we have our IFRS discussion group, we expect IFRS 18 to be a repeat customer at IDG for agenda topics. It will probably be the thing that gets to talked about most between now and its effective date in 2027, and probably even into 2027 and 2028 as we see if diversity emerges on any of those proposals.

The last thing I'll talk about is, talked about sustainability a bit, but just in general, what I would say, and we're seeing this in other projects, the IASB has a project on Business Combinations Disclosure and Goodwill Impairment, and they're proposing some disclosures that are probably things that you would be more likely to see in an MD&A than in financial statements. So that sustainability, what we've been talking about a lot at the Accounting Standards Board and talking about even internationally, is the boundary of financial statements is being blurred. There used to be a very clear distinction, this belongs in financial statements, this belongs in MD&A, this belongs wherever, and it was very clear where things were.

Those lines are being blurred, and those lines being blurred means that companies might have to put stuff that they didn't put in financial statements before, which means then it's subject to the rigor of audit, and they might not be comfortable with that being audited because they haven't had it audited in the past, and you haven't had to audit it in the past so you might not be comfortable auditing it. So I think as the boundary changes, I think we're all going to be a little bit uncomfortable for a while.

Anne-Marie Henson:

Yeah.

Armand Capisciolto:

As these things change, it's just going to create a lot of uncomfortableness. I think that's just the reality is financial reporting is evolving and things are going to change as a result, and change is hard.

Anne-Marie Henson:

Thanks for that closing message. I guess you're right, it's just learning to be comfortable being uncomfortable in these situations. I think this was fantastic by the way. I'd like to maybe have you back for annual updates. I could have talked for two more hours. So really appreciate all of your insights and your time today. I hope our audience appreciated this discussion. And I'd also like to thank you, our listeners, for tuning in today and to all of our episodes. I'm Anne-Marie Henson, and this has been BDO's Accounting for the Future. Please let us know if you found the topic interesting and useful, and remember to subscribe if you liked it, and also subscribe to Armand's LinkedIn publications at the same time. We'll see you next time.