By: Abdur Sharjeel, CA & Kenneth Ng, CA
As public accountants who work closely with a number of Exempt Market Dealers (EMDs) and Exempt Market Issuers, we are often questioned by our clients (and their advisors) about their regulatory audit requirements, as well as the applicable financial reporting framework for the preparation of their financial statements. Keeping in mind the current reporting requirements as applicable to Exempt Market Issuers, our response to these inquiries is this: it depends on a variety of factors.
Applicable Financial Reporting Framework for Private Enterprises:
In Canada, there are two options for accounting standards available for private enterprises: the International Financial Reporting Standards (IFRS) and the Accounting Standards for Private Enterprises (ASPE). Private enterprises which are not subject to regulation by the securities commission have the option to adopt either one of the two available standards.
IFRS is a set of accounting standards developed by the International Accounting Standards Board with the goal of enhancing the transparency and comparability of financial statements of companies operating in different geographical locations. These standards are complex and rigorous. IFRS often requires significant estimates to be made by management as well as copious disclosure in the notes to the financial statements. Due to their complexity and the significant amount of disclosure required in the preparation, and audit of financial statements, makes using IFRS both costly and time consuming.
· ASPE was developed by the Canadian Accounting Standards Board specifically for private enterprises operating in Canada. The standards take into account that more often than not the stakeholders in Private Enterprises have more ready access to information than a stakeholder in a public company. As such, the disclosure requirements were greatly reduced. In addition, the complexities of operations of Private Enterprises are often limited compared with the public companies and hence the complexity of the standards themselves has been reduced in comparison to IFRS. Our experience is that financial statements prepared under ASPE are easier for the average reader to understand. The reduced complexity and reduced disclosure requirements of ASPE statements often result in a quicker turn around both by internal accounting staff and the external audit staff which often results in reduced cost.
Financial Reporting Framework Choice for Exempt Market Issuers:
Financial statements prepared for inclusion in an Offering Memorandum (OM) are required by National Instrument 45-106F2 to be prepared using IFRS as an accounting framework. After the OM is filed and securities are issued, there is no further requirement by the securities regulators for ongoing disclosures. Therefore, the most appropriate financial reporting framework depends on management’s intention to prepare a subsequent OM.
If management is not intending to prepare subsequent OMs, the company has the option of adopting Accounting Standards for Private Enterprises (ASPE). However, if management intends to update the OM in order raise additional capital, the company would be required to present those statements in accordance with IFRS. Keeping in mind that IFRS financial statements need to include comparative numbers for at least one period, the cost of switching back to IFRS at a later date may be daunting.
In addition, management should carefully consider the following additional factors which would also indicate that staying with IFRS may be more beneficial than adopting a new framework:
· Is there a plan to raise equity in the future for continued growth or expansion, through an Initial Public Offering?
· Is there an intention to expand operations internationally?
· Will the company issue complex equity or debt instruments or have creative compensation plans for management?
· Is there a plan to access investors outside of Canada?
· Is there an opportunity to divest of the company’s shares to a publically listed entity as a liquidity event for the shareholders of the Exempt Market Issuer?
Opting for financial reporting framework:
The decision to choose the relevant financial reporting framework requires careful consideration. Exempt Market Issuers should consider a variety of factors prior to making a decision to determine which accounting standard is the most appropriate for their particular circumstances. The following table summarizes of a number of the advantages and disadvantages of each of the two standards that can be utilized by management when making a determination of the appropriate standard.
· Global financial reporting framework.
· Financial statements, if prepared under IFRS on an ongoing basis, will be readily available should management desire to raise additional capital.
· Long-term financial reporting benefits (IFRS is here to stay).
· Increases reliability of financial reporting and shows management’s intention to hold themselves to public company standards.
· Principle based set of standards and fewer bright lines which may result in divergent practices.
· Extensive disclosure requirements which may result in changes to management information systems as well as additional time and effort on the part of management to ensure reporting is comprehensive.
· Expensive and timely to prepare
· Simpler to prepare financial statements, that are easier to understand by the users.
· Canadian investors and users are familiar.
· Various policy choices available to help simplify reporting, e.g. taxes payable method allowed (not allowed under IFRS)
· Fewer disclosure requirements.
· Not acceptable by public equity and debt investors.
· May not be a long term solution as the Canadian Accounting Standards Board has begun discussing changes to ASPE to minimize the differences with IFRS.
Audit Requirements for Exempt Market Issuers:
Under the Alberta Business Corporations Act, companies are exempt from an audit if:
(a) it is not an offering enterprise; and
(b) all of the shareholders consent in writing to the waiver of audit in respect to that year.
Exempt Market Issuers are required to have audited financial statements included in their OM. As such, the financial statements for the year(s) for which an OM is prepared, as well as the comparative period, are required to be audited. For subsequent years, if management is not intending to include the financial statements in a future OM, the shareholders under section 163 of the Business Corporations Act, can waive the requirement for an audit with unanimous consent. There is no legal requirements for the Limited Partnerships or trusts to be audited and the audit in these cases is dealt by the requirements of the instrument based on which these entities are created.
Ongoing disclosure and audit requirements:
There have been significant discussions with respect to making ongoing disclosure mandatory for Exempt Market Issuers. Our belief is that requiring ongoing financial disclosure, with some level of assurance attached thereto, would be beneficial for the industry. Having ongoing disclosure requirements help keep the lines of communication open between Company’s and their investors. Having an ongoing dialogue in regards to the financial performance of the Company ultimately ensures that investors have a more complete understanding of the performance of their investment. Our experience is that investors who have not been kept informed of the challenges their investment may be facing are significantly more volatile than those who are provided with factual information from which they can draw an understanding of the business.
Any contemplated regulation should clearly delineate which financial reporting framework should be applied by Exempt Market Issuers no longer required to provide an offering memorandum as well as what level of assurance should be provided on the financial statements on an ongoing basis.
Given the fact that generally, the operations of an Exempt Market Issuer are more straightforward and significantly less complex than many reporting issuers, imposing the same reporting requirements to both seems onerous.
In summary, our view the best solution would be as follows:
· To allow Exempt Market Issuers to prepare the financial statements to be included in their OM under ASPE;
· To continue to prepare and disseminate financial statements on an annual basis using ASPE; and
· To require that financial statements included in an OM to be audited, but to reduce the level of assurance on ongoing reporting to the level of a review.