Deloitte template

1 CAUBO Financial Reporting Seminar – Audit and Accounting Update - 2006 ©2006 Deloitte & Touche LLP and related entities.

Financial Reporting Seminar – Accounting and Audit Update


Agenda:

•Introduction

•What’s new?

– Auditing Standards

– Accounting Standards

– International Financial Reporting Standards (IFRS)

•Wrap –up and Questions


Introduction

14


Our Firm Experience

• Largest professional services firm providing a full range of professional services.

• Over 6,600 highly qualified professionals serve clients from offices in 46 Canadian cities

• Deloitte is a leader in serving Higher Education institutions across North America.

• Our Public Sector Group include research institutions, colleges, multi-campus systems, private and public universities, and a broad range of professional and other schools.

University of Ottawa

University of Calgary

St. Francis Xavier University

Carleton University

University du Québec en Outaouais

University of New Brunswick

St-Paul University

University du Québec à Montréal

Memorial University of Newfondland

University of Guelph

University du Québec à Rimouski

University of Waterloo

McMaster University

University du Québec à Trois Rivières

University of Western Ontario

Queen University

École des Hautes Études Commerciales

University of Windsor

Ryerson University

Université de Sherbrooke

Université Laval

University of Toronto

McGill University

Concordia University


• Christopher Wiegand – Christopher is an audit partner in the Montreal office. He is the engagement partner on the audit of McGill University, and has quality assurance roles on audits of three other universities. He also has extensive experience with not-for-profit organizations.

• Eric Girard – Eric is a senior manager specializing in the public sector. He is the engagement senior manager on the audit of University of Ottawa and has extensive experience with not-for-profit organizations.

• Eric Graham - Eric Graham is the Ottawa leader of our Complex Accounting & Transaction Expertise group. In his role, Eric helps organizations understand complex financial accounting and disclosure issues.

Speakers


What’s New in Auditing Standards


•The assurance practice now lives strictly according to rules

•Compliance with those rules is the major challenge of auditing – and of those who associate with auditors in a multi-disciplinary firm

•Day-to-day behaviour is driven by the objective of compliance – and the consequences of non-compliance

New Standards of Behaviour


New Auditing Standards

•Previously:

– the auditor is permitted to rely upon the assumption of management’s good faith and integrity:

•Now…


Fraud and Error

• Error: an unintentional misstatement in financial statements, including the omission of an amount or a disclosure, such as:

– A mistake in gathering or processing data from which financial statements are prepared;

– An incorrect accounting estimate arising from oversight or misinterpretation of facts; and

– A mistake in application of accounting principles relating to measurement, recognition, classification, presentation, or disclosure.

• Fraud: an intentional act by one or more individuals among management, other employees, those charged with governance or third parties, involving the use of deception to obtain an unjust or illegal advantage.

– Misstatements resulting from fraudulent financial reporting

– Misstatements arising from misappropriation of assets[CICA Handbook]


Fraud and Error – Impact on the Universities• The primary responsibility for the prevention and detection of

fraud rests with both those charged with governance of the entity and with management…

• It is the responsibility of those charged with governance of the entity to ensure, through oversight of management, ….that the entity establishes and maintains internal control to provide reasonable assurance with regard to the reliability of financial reporting…and compliance with laws and regulations…

• In exercising oversight responsibility, the audit committee or equivalent considers the potential for management override of internal controls or other inappropriate influence over the financial reporting process, such as efforts by management to manage earnings in order to influence the perceptions of analysts as to the entity’s performance and profitability.


Changes in Handbook Auditing Standards

• Fraud and Error:– An auditor conducting an audit in accordance with GAAS

obtains reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error…

– An auditor considers the potential for management override of controls and recognizes the fact that audit procedures that are effective for detecting error may not be appropriate in the context of an identified risk of material misstatement due to fraud…

– Members of the engagement team should discuss the susceptibility of the entity’s financial statements to material misstatement due to fraud…

– That discussion occurs with a questioning mind, setting aside any beliefs that the engagement team members may have that management and the audit committee are honest and have integrity…


Changes in Handbook Auditing Standards

•Specific risk areas:

– Management override of internal controls

– Journal entries and other “consolidating adjustments” to the statements

– Complex transactions with no business rational

– Biased accounting estimates

– Material misstatements of revenue


Assurance Developments• A number of new assurance standards were issued or modified

during 2005 in connection with an international audit risk project which has been in progress since 2001.

• The changes in the assurance standards relate to the auditor's understanding of the entity and its internal control and are intended to achieve the following objectives:

Improve risk assessments and better link assessed risks of material misstatement to the auditor's evidence gathering procedures.

Ensure that Canadian standards are harmonized with the equivalent US and international standards.

• The most significant changes include the performance of control testing on the design and implementation of controls each year on all significant business cycles and entity level controls. Additionally, changes have been made to audit planning standards, documentation standards and levels of substantive testing.


Assurance Developments

CICA Handbook Section Withdrawn Added Modified

5130 Materiality and Audit Risk in Conducting an Audit

5140 Knowledge of the Entity’s Business

5200 Internal Control in the Context of an Audit

5205 Understanding Internal Control for Audit Planning Purposes

5210 Assessing Control Risk

AuG-31 Applying Materiality and Audit Risk Concepts in Conducting an Audit

5095 Reasonable Assurance and Audit Risk

5141 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement

5142 Materiality

5143 The Auditor’s Procedures in Response to Assessed Risks

AuG-41 Applying the Concept of Materiality

5145 Documentation

5300 Audit Evidence


Changes to Auditing Standards

•Previous standards required a basic understanding of the control environment sufficient to assess whether or not a control reliance audit approach would be employed.

•New standards require an auditor to evaluate the design of internal controls over financial reporting and to determine if key controls have been implemented.

•These new standards require the auditor to spend time evaluating key internal controls over financial reporting even when no reliance is contemplated.


Changes to Auditing Standards - Auditor Responsibilities

• Auditors are now required to undertake an assessment of the design of key controls for the company including

– entity wide processes;

– business cycle processes; and

– information technology processes

• Requirements are regardless of whether we intend to rely on such controls in conducting our audit, as well as determine if the controls identified exist and are implemented.

• The primary objective of these procedures is to identify any areas of risk that may be inherent in these processes so that we can appropriately plan the nature and extent of our audit tests.


Changes to Auditing Standards – Impact on the Universities

•Management is responsible for preparing the financial statements in accordance with GAAP

•In this regard, Management is also responsible for establishing and documenting internal controls to provide reasonable assurance around the reliability of

– the financial reporting process;

– the effectiveness and efficiency of operations; and

– compliance with applicable laws and regulations.


Changes to Auditing Standards – Impact on the Universities

How to efficiently prepare for those changes:

•Meet with your auditors to determine the level of required documentation

•Start early preparing the missing documentation

•Ask your internal auditors to support you

•Ask your external auditors for guidance


What’s New in Accounting Standards


Non-Monetary Transactions

June 2005

Section 3831


What has changed?

•No culmination of the earnings process test – no more need to evaluate whether productive assets are “similar”

•Definition of non-monetary transaction excludes reference to 10% maximum monetary consideration


Overview

•Record non-monetary transactions at fair value unless:

– Transaction has no commercial substance

– Fair values not reliably measurable

– Transaction is exchange of inventory – Transaction is non-monetary, non-reciprocal transfer to owners

•Gains and losses recognized in net income


Commercial Substance

Transactions have commercial substance if there is a:

• Significant change in the configuration of cash flows

OR

• The entity-specific value of the asset received differs from the entity-specific value of the asset given up and the difference is significant relative to the fair values of the items.


Configuration of Cash Flows

•Consider changes in timing, amount, or risk of cash flows

•Significant change – matter of professional judgement


Entity-Specific Value

•The present value of expected future cash flows from the continuing use of an asset and its ultimate disposal, or from settling a liability.

•Value dependent on specific use to the reporting entity, not on how it could be used by others

•When transaction has commercial substance, measure it at fair value rather than entity-specific value


Reliably Measurable Fair Values

•When comparable market transactions do not exist, fair value is reliably measurable if:

– Variability in range of estimates not significant,

OR–Probabilities can be assigned to each estimate and used in estimating fair value


Scope Exclusions

•Business combinations

•Employee future benefits

•Transactions between related parties

•Stock-based compensation payments

•Contributions received by not-for-profit organizations


Disclosure - Non-Monetary Transactions

•Nature of transaction

•Basis of measurement and amount

•Related gains and losses


Transitional Provisions

•Transactions initiated in periods beginning on or after January 1, 2006

•Early adoption permitted for transactions initiated in periods beginning on or after July 1, 2005

•A transaction is initiated on earlier of:

– Date a binding contract is executed, and

– Date of the exchange

•No retroactive application and no restatements


The New Financial Instruments

Standards for NPOsSection 3855, 3865, 4410


Overview of New Financial Instruments Standards for NPOs

• Financial instrument framework has a broad scope that will affect virtually all entities.

• Increased use of fair value measurement – potential impact is more volatility in the statement of operations. Now is the time to assess the potential impact.

• Framework consists primarily of 3 new Handbook Sections, as follows:

– S.1530, “Comprehensive Income”

– S.3855, “Financial Instruments – Recognition and Measurement”

– S.3865, “Hedges”

• S.1530 will not apply to NPOs; instead S.4400 has been amended

– Revenue, expenses, gains and losses recorded in statement of operations unless GAAP states otherwise.

– Separate disclosure of items recorded directly to the statement of changes in net assets.


Effective date

• Effective for financial statements relating to fiscal years beginning on or after October 1, 2006.– Deferral to fiscal years beginning on or after October 1, 2007 does not apply

to not-for-profit organizations.

• Earlier adoption is permitted, but only as of the beginning of a fiscal year and it requires adoption of all 3 components

• There are decisions that need to be made as a result of this standard and possible documentation. Therefore, assessing the impact prior to the implementation date is recommended.


Transition

With respect to transition to Sections 3855, 3865 and 4400:

• Restatement of prior period financial statements is not permitted

• All financial assets and liabilities at the date of adopting the new standards are classified and measured in accordance with the new standards

• Qualifying hedging relationships at the date of adopting the new standards are accounted for in accordance with the new standards

• Subject to the requirements of Section 4410 “Contributions – Revenue Recognition”, any adjustments to the previous carrying values of financial assets and liabilities at the date of adopting the new standards are included in the appropriate components of net assets at that date


What is a Financial Instrument?

Financial asset

• Cash

• Contractual right– to receive cash or another financial

asset

– to exchange financial instruments under potentially favorable conditions

• Equity instrument in another entity

Financial liability• A contractual obligation to:

– Deliver cash or another financial instrument

– Exchange financial instruments with another party under potentially unfavorable conditions

Under Section 3855:

• A Financial instrument is “any contract that gives rise to a financial asset of one party and a financial liability or equity instrument of another party”

• Some examples: Cash, A/R, portfolio investments, loans payable and receivable, capital leases, A/P, bank indebtedness, derivatives…etc.

• Some examples of assets that are not financial instruments: inventory and prepaids


Sample Statement of Net AssetsCurrent Assets 20X2 20X1

Cash and term deposits 122,000$ 160,000$

Accounts receivable 20,000 10,000

Grants receivable 30,000 25,000

Prepaid expenses 10,000 10,000

182,000 205,000

Investments (market value $260,000) 240,000 100,000

Capital assets (net) 617,000 125,000

1,039,000$ 430,000$

Current liabilities

Accounts payable and accrued liabilities 25,000$ 20,000$

Mortgage payable - current 6,000 -

31,000 20,000

Mortgage payable - long term 441,000 -

Deferred contributions 118,000 105,000 Deferred contributions related to capital assets 67,000 70,000

Deferred building campaign contributions and related investment income 80,000 -

265,000 175,000

Net assets (summarized) 302,000 235,000

1,039,000$ 430,000$


Held for Trading

Financial Asset Classification

•Active and frequent buying and selling – debentures, shares

• Short-term profit generation

• All derivatives

• Record at fair value

• Can irrevocably decide to designate any financial asset or liability as held for trading

• No reclassifications permitted in or out

Financial Assets



• Assets with fixed and determinable payments – i.e. Bonds, and other debt instruments

• Holder must have the ability and intention to hold to maturity

• Record at amortized cost

• Reclassifications out are permitted under certain circumstances

• If “more than insignificant” sales occur:– The company cannot use the “Held

to Maturity” classification for two years

– All “Held to Maturity” assets must be reclassified as “Available for Sale”

Financial Assets

Held For Trading

Held To Maturity



Financial Assets

Held To Maturity

Loans & Notes

Receivable

Held For Trading

• Example: bank loans, A/R

• Excludes debt securities

• Record at amortized cost



Available for Sale

Financial Assets

Held To Maturity

Loans & Notes

Receivable

Held For Trading


Reclassifications Between Categories

Held for Trading

• NO reclassifications permitted in or out

• Difference with US GAAP – in accordance with IAS

Held to Maturity

• Reclassifications out are permitted if they occur:– Within few months of maturity– After 85% of principal is collected– Due to isolated event beyond control of entity

• If “more than insignificant” sales/reclassifications occur:– Company cannot use “Held to Maturity” category for two years– All “Held to Maturity” assets reclassified to “Available for Sale”


Classification of Financial Liabilities

• Amortized cost

• E.g. accounts payable, notes payable, bonds payable…etc

Financial Liabilities

Held for Trading Other than Held for Trading

• Fair value

• Short-term profit making

• Active and frequent buying and selling

• Can irrevocably designate any financial liability as held for trading

• E.g. all derivatives


Reclassification of Financial Liabilities

• NO reclassifications into or out of Held for Trading Liabilities

• Difference with US GAAP – in accordance with IAS

• Reclassifications may occur between Held for Trading financial assets and liabilities


The New Financial Instruments Standards, Assets and Liabilities, Changes in Value

Under Section 3855, (subject to the requirements of Section 4410 “Contributions – Revenue Recognition”):

• Trading assets and liabilitiesAll gains and losses (realized and unrealized) included in current period

net investment income.

• Held-to-maturity assets, loans and receivables and non-trading liabilitiesAmortization of premium or discount in current period net investment

income; and losses on impairment of assets in current period net investment income.

• Available-for-sale assetsAmortization of premium or discount in current period net investment

income; andunrealized fair value gains and losses included directly in current period

changes in net assets, until the financial asset is derecognized/impaired.


Impacts of New Standard

• Balance sheet and equity volatility as most investments will be at fair value

• Significant impact on accounting systems– Fair value calculation

– Keep a classification trail for all financials instruments


Example Financial Statement Implications – Designate Investments as Available-for-sale

Pre 3855 Post 3855Current Assets (excerpt only) 20X2 20X2

Cash and term deposits 122,000$ 122,000$

Accounts receivable 20,000 20,000

Grants receivable 30,000 30,000

Prepaid expenses 10,000 10,000

182,000 182,000 Investments (market value 20X2 - $260,000; 20X1 - $115,000) 240,000 260,000

Capital assets (net) 617,000 617,000

1,039,000$ 1,059,000$ Statement of Changes in Net Assets (excerpt only)

Pre 3855 20X2 Total

Post 3855 20X2 Total

Balance, beginning of year 235,000$ 235,000$

Excess (deficiency) of revenues over expenses 17,000 17,000

Endowment contributions 50,000 50,000

N/A 20,000

Investment in capital assets - -

Internally imposed restriction - -

Balance, end of year 302,000$ 322,000$

Change in fair value of investments classified as available for sale


Financial Derivative Non-Financial DerivativeOR

Value changes with underlying

variable

Requires little or no initial net investment+ Settled at future

date+

Definition of a Derivative

• A derivative is a financial instrument or other contract with three characteristics


Embedded Derivatives

• Examples:

– Lease

– Debt instrument

– Insurance contract

– Equity instrument

– Investment

– etc.

• Clause that affects payoff profile:

– Inflationary increases

– Conversion option

– etc.

Non-derivative

host contract

Embedded derivative

Hybrid Contract


Non-traditional Derivatives and Embedded Derivatives

• Need to review and inventory contracts

• Difficult to identify

• Look for unusual features in debt contracts, lease contracts, service contracts and other relationships


What’s up with IFRS


IFRS

•What is IFRS?

•Why change?

•Why IFRS instead of US GAAP?

•When is this going to happen?

•How does this affect NPOs?


IFRS

•IFRS does not specifically address Not-for-profit organizations– sense that Canadian GAAP will retain NPO accounting– harmonization will therefore relate to sections of Handbook

outside 4400 applicable to NPOs

•Potential areas of difference– no choice of whether to record non-monetary transactions

(e.g. donated services and materials)– challenge in meeting definition of an asset when recording

pledges receivable– donated collections must be recorded and capitalized– consolidation is required if criteria are met (no choice)

•Handbook includes a CICA Comparison between IFRS and Canadian GAAP as at April 1, 2005


IFRS

•What does it mean for me?

– Harmonization is coming

– S.1100 – increases relevance of IFRS as secondary source of GAAP when Cdn GAAP not clear

•Timing & education


A Little Nomenclature….…………

• IFRS – “International Financial Reporting Standards”

• Comprised of:

– IFRS’s (1-7) – International Financial Reporting Standards

– IAS’s (1-41) – International Accounting Standards

– SICs – Standing Interpretation Committee

– IFRICs – International Financial Reporting Interpretations Committee

• In addition, ISA’s (International Standards on Auditing) exist and will affect Canada


Questions?


Any further questions please contact us

• Eric Girard [email protected] (613) 751-5344

• Eric Graham [email protected] (613) 751-5416

• Christopher Wiegand [email protected] (514) 393-7343


Deloitte, Canada's leading professional services firm, provides audit, tax, financial advisory services and consulting through more than 6,100 people in more than 47 offices. Deloitte & Touche LLP, operates in Québec as Samson Bélair/Deloitte & Touche s.e.n.c.r.l. The firm is dedicated to helping its clients and its people excel. Deloitte is the only professional services firm to be named to the Globe and Mail's Report on Business magazine annual ranking of Canada's top employers for two consecutive years: 35 Best Companies to Work for in Canada in 2001 and 50 Best Companies to Work for in Canada in 2002. "Deloitte" refers to Deloitte & Touche LLP and affiliated entities. Deloitte is the Canadian member firm of Deloitte Touche Tohmatsu. Deloitte Touche Tohmatsu is a Swiss Verein (association), and, as such, neither Deloitte Touche Tohmatsu nor any of its member firms has any liability for each other's acts or omissions. Each of the member firms is a separate and independent legal entity operating under the name "Deloitte", "Deloitte & Touche", "Deloitte Touche Tohmatsu" or other related names. The services described herein are provided by the Canadian member firm and not by the Deloitte Touche Tohmatsu Verein.

Documents

Deloitte template