Private Enterprise GAAP FAQ
Helen Mallovy Hicks
Sal Bianco, a partner in the Audit and Assurance group of PwC, talks about the frequently asked questions around new set of standards that apply to private enterprises (Private Enterprise Generally Accepted Accounting Principles, or GAAP).
Voiceover: Welcome to Strategy Talks, the business podcast series from PricewaterhouseCoopers Canada. Hosted by Dean Mullett, a corporate finance partner specializing in Capital Markets and M&A, and Helen Mallovy Hicks, a partner the Dispute Analysis and Valuations group, this interview series, featuring new topics and guests every episode, is designed to give you valuable insight into some of today's hottest issues affecting your business.
Helen: Today we are here to talk about an important choice that private enterprises need to make related to their accounting standards. The accounting standard board recently released new accounting standards, private enterprise GAAP. Private enterprises will have to decide whether to adopt the new standards, PE GAAP, or whether they choose to adapt international financial reporting standards commonly referred to as IFRS. In having discussions with our clients, it’s become clear that there has been a lot confusion in the marketplace. Our guest today, Sal Bianco is a partner in our private company services group and he’s working with many private companies to help them decide which set of standards to adopt. Sal is here to talk about the choice that private enterprises need to make and answer some of the frequently asked questions we are hearing from clients. Welcome Sal.
Helen: So Sal, let’s start first by talking about what the definition of a private enterprise is.
Sal: A private enterprise is defined as a profit oriented enterprise that’s neither publicly accountable, and means a company who is not public listed on a stock exchange vis-à-vis vis-a-debt or equity and it doesn’t have a fiduciary duty for a broad group of individuals, something like the pension plan. Or it’s a not-for-profit and it’s not government, and that’s pretty much the broad definition of a private enterprise. Private enterprise have a few choices, and if they’re Canadian, GAAP financial statements is what is required from them. And then they’ll have two options: one, to be IFRS, or two, to be private enterprise GAAP. This is what they need to decide on.
Helen: When do they need to make this decision?
Sal: They need to make this decision by January 1st, 2011. But there is a transition phase, and a transition phase will obviously be one year before, because they need comparative figures in order to show the public what this transition is between either IFRS or private enterprise GAAP that they’re taking. So really, private companies need to look at it right now, vs. a year from now.
Dean: So a year from now they couldn’t just go back and restate the financial statements previously under the new standards?
Sal: They could, but there may be certain decisions that they could take under section 1500 of the handbooks that are time sensitive. For example, fair value option, where they can fair value assets and fair value financial instruments, if you wait a year how are you going to be able to do an opening balance sheet in 2010 if you waited a year? What’s the fair value a year behind? You can’t go backwards; it will be difficult to fair value.
Helen: So even with private enterprise GAAP they’re going to need to do fair value?
Sal: Yes, they have that option, and companies like real estate companies may choose that option. There is an option on adoption of private enterprise GAAP that you can fair value your fixed assets or property planting equipment and exception that’s allowed under the standard.
Dean: So when is exactly is the deadline? And then, I’m just trying to think of the decision process that companies will have to go through. Then the world we’re in today, given the economic environment, it is improving but still challenging. It’s probably not high on their priority list but they should be thinking about it based on what you said.
Sal: Absolutely. So really right now is what they should be looking at. What’s the decision? And they have to look at business, the owner/manager has to decide if they have things like, ‘Do I want to exit this business?’, ‘Do I want to take this public?’, maybe they’ll go a different route. Such as IFRS be compliant with the public markets, or they may be in a global industry where they’re being compared to other global companies who are maybe using IFRS and therefore then they have the choice they need to make. Or maybe they’re not; maybe they’re a small business in Canada and really don’t have a lot of outside usage of financial statements, and believe that private enterprise GAAPs is the way to go, and therefore that’s the decision that they need to make. There’s a lot of things to look at, and one of the sources that we have at PwC is a decision tree on our website that helps you go through that and be beneficial to a lot of companies to take a look at that.
Helen: So Sal, so what does this mean on the banking side? What does this mean for banking covenants? And this change, can they adopt this PE GAAP if they are providing their financial statements to bankers?
Sal: Yes, they can. It’s not like you’re precluded because you have some debt with the bank. You’re allowed to adopt as long as you fit the definition of a private enterprise. You’re allowed to adopt this PE GAAP. Therefore bankers will have to meet with their clients to deal with covenants, because covenants could change as a result of the GAAP you adopt, and that’s either with IFRS or with private enterprise GAAP.
Helen: Are companies looking at this now? Are they aware of that issue?
Sal: I think depending on how sophisticated companies are, companies will, depending where they are. I think a lot of knowledge is being passed on from professional advisors saying you should be aware that this could cause your covenant changes and therefore you should be having a discussion with clients.
Helen: And presumably, no matter which route they go, the PE GAAP or the IFRS route, it’s going to impact their covenant calculations.
Dean: If we look at the Canadian economy and what percentage private companies make up of the overall economy, I think it’s a pretty large number, and you perhaps know better than I do: just put it in perspective.
Sal: I think ballpark, it’s about 75 percent, and it’s probably private companies in Canada. If you look at that and you say that at least 75 percent of our economy is run by private companies, you ask what choice they’re going to make and depending on the size of them what choice they’re going to pick.
Dean: That seems like such a massive undertaking. Particularly Helen’s point about bank covenants and bank agreements, and given where we’ve been in the last year and the pressure that companies have felt trying to stay within banking agreements, it seems that being proactive might be a better path for some companies to take. Because last thing you want to do is up end a credit agreement in a tight credit environment.
Sal: I agree. It’s absolutely right.
Helen: And what are you seeing Sal? Are companies being proactive? Are they making decisions and what kind of decisions are they making?
Sal: Well, some companies who are a little bit more on the ball tend to be more proactive in the space. Probably the majority are sitting and waiting to understand it better, to understand what the decisions are. The standard just came out in December in full, so I know people have hardly had time to say, "What’s the effect? What’s the impact? What change from the old Canadian GAAP? Does this new Canadian GAAP now fit what I need to do going forward?" So people need to sit and think about and absorb what’s going, on and as professionals of advisors as well, we should be going out to all our clients and discussing this and make sure they understand what’s going on.
Dean: So this just came out in full in December and the implementation is January 2011?
Dean: Is that pretty quick?
Sal: It coincides with the change in the public companies, which is January 1, 2011 as well, because the CSA has said that all public companies must adopt IFRS. So it all ties together, hand in hand with the CICA’s focus on making sure that we have a streamed approached for both private and public companies.
Helen: So for private companies, what are the sorts of key changes that PE GAAP would bring in? Compared to what they would be reporting currently under GAAP.
Sal: Obviously selection of accounting policies is very critical. There are various choices, for example we talked about fair value as one option, and therefore having those policies decide based on those handbooks will be one thing that they need to focus on and be critical. And you can’t make a broad statement and pick that policy, you have to spend some time and analyze. The earlier you do it, the better it is, and you can understand what’s going on. The next probably big thing is the combinations. So all of the sudden you’re in 2010 and you’re an active private company who buys other companies and goes through that process. Well the business combination standard is a complicated standard to begin with in the old GAAP.
The new GAAP, it’s also going to be more complicated and more information will be required. And as a result of doing comparative figures and you start going through that process you may want to look through that new standard and you want to make sure you are complying and gather the information and by the time you get to do your comparative figures OR adopt that specific standard early, which is probably the only standard allowed under P.E. GAAP because it exists in the old handbook and the new handbook to be adopted early. So that’s one thing to look at, so it’s that type of decision making. We talked about the fair value of property, plant and equipment and there is that option available, so if you sit back and relax and don’t worry about it for a whole entire year – going back to doing a fair value property in December 31, 2010 versus January 1st, 2010 it’s a one year lag. How do you know the fair value is appropriate from Jan 1 to Dec 31? So, those are probably the key things and then the last one is whether to consolidate or not. There’s this wonderful new section in the PE GAAP that says that you don’t have to consolidate your subsidiaries, problem is that you have to apply by consistently.
So some companies went through these exemptions in the old handbook, but they would pick and choose which companies they would consolidate. But in the new standard, it’s basically all or none. So you have to consolidate all your subsidiaries or you don’t. Now, what happens if you happen to be a company that’s been around 50 years and has done a whole bunch of acquisitions in those 50 years and have all these subsidiaries, what kind of information do you have to say ‘I think I will cost account for those.’ How do you know what the true cost of what that business was?
So this will obviously be a lot of work if you want to go that route and may change your mind to say ‘You know what, I better consolidate that.’ I think that the last one is, and this is not as common in private companies, its stocked base compensation. Obviously there are a lot of private companies out there who have some type of stock based compensation. The methodology is going to change, and how you account for that, and there is some grandfathering, meaning that anything that is issued from 2009 will be grandfathered. What about 2010? Or your opening balance sheet? You have to do an opening balance sheet and those are the things you have to concerned about and think about.
Dean: I think we alluded to this; it seems like a pretty large undertaking. A lot of private companies, I think, have limited resources financially: the people on their staff etc., because you’re really going through and looking at all of major elements of how you’re putting your financial statements together. So are a lot of companies going to be really struggling? And be able to pull this off by Jan 2011?
Sal: It’s exactly that point. Are you current resources internally capable of doing one or the other? So if you happened to be a person who wants to go IFRS and your company IFRS and you want to be prepared, that’s a huge undertaking. If you are resource constrained then that’s going to be a problem for you, and you’re going to have to figure out if it’s worth for you to put in the cost to convert and maintain. It’s not only the conversion but maintaining. That’s going to be something to be considered to go private enterprise GAAP or IFRS. Private enterprises GAAP there are a few things that have changed, but still Canadian GAAP. The fundamentals are still the same and therefore might be easier on your staff to stay the status quo and convert to private enterprise GAAP and maybe convert to IFRS later if you plan to do some type of transaction to go into a different marketplace.
Helen: There’s still significant time and cost I would think, even converting to private enterprise GAAP.
Sal: Absolutely. Companies will have to spend the time and if they do it earlier rather than later you won’t feel the pinch or the crunch and all of the sudden from experience we’ve all gone through the stocks 404’s and all that kind of stuff. The more time you have to analyze and figure out where you’re going, the less cost you’re going to end up spending. Because in the end if you resource constraint, all of the sudden you may be bringing in advisors that are a very high cost and therefore balloon your budgets.
Helen: Sal, maybe you can tell us before we wrap, what are the five anticipated transition issues? What should companies be thinking about in transitioning to P.E. GAAP?
Sal: Probably the biggest points would be – One, policy choices: what policy choices are they going to make? Which direction are they going to take? Private GAAP or IFRS? Sitting down with their bankers, to really figure out their agreements and making sure that whichever route they go are there bankers going to be happy? What’s the modelling of their covenants and anything else like that. Spending the time to really analyze their needs, not wants but needs, which is key, and making sure that you pick the appropriate GAAP to fit that. Also, making sure that when you’re going to the transition guidance in section 1500 that you then look at what are time-sensitive issues that we have today, vs. things that we can stagger over the year in 2010 and possibly 2011 to get there.
Dean: All right Sal, well thank you very much for joining us today. I think you’ve given our listeners a lot to think about and I think maybe they’re one take away message is don’t sit on your hands and wait until January 2011 because it might be staring you in the face sooner than you realize. So thank you for joining us.
Sal: Thank you.
Dean: For those looking for more information on this topic, please visit pwc.com/ca/private.
Voiceover: This concludes this episode of Strategy Talks. Thank you for listening. We hope you’ll join us again, soon for another episode. To download or subscribe to this podcast series, or to find more information on this topic, please visit pwc.com/ca/strategytalks.
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