GAAP/GAAS updates 2009-2010
Section 1000: Internally developed intangible assets
Section 1400: General standards of financial statement presentation
Section 1506: Accounting changes
Section 1530: Comprehensive income
Section 1535: Capital disclosures
Section 1582, 1601 and 1602: Business combinations
Section 1651: Foreign currency translation
Section 3031: Inventories
Section 3051: Investments
Section 3055: Joint ventures
Section 3064: Goodwill and other intangible assets
Section 3070: Consequential changes from the financial instruments sections
Section 3110: Asset retirement obligations
Section 3251: Equity
Section 3475: Disposal of long-lived assets and discontinued operations
Section 3500: Earnings per share
Section 3820: Subsequent events
Section 3831: Non-monetary transactions
Section 3840: Related party transactions
Section 3855: Financial instruments
Sections 3862: Financial instruments
Section 3865: Hedges
Section 3870: Stock-based compensation and other stock-based payments
Section 4400 – 4470: Not-for-profit organizations
Section 5021: Authority of assurance guidance
Section 5030: Quality control procedures for assurance engagements
Section 5090: Audit of financial statements — An introduction
Section 5095: Reasonable assurance and audit risk
Section 5110: Terms of the engagement
Section 5135: The auditor’s responsibility to consider fraud
Section 5141: Understanding the entity
Section 5142: Materiality
Section 5143: The auditor’s procedures in response to assessed risks
Section 5145: Documentation
Section 5295: An audit of internal control over financial reporting that is integrated with an audit of financial
statements
Section 5300: Audit evidence
Section 5301: Analysis
Section 5305: Accounting estimates
Section 5310: Audit evidence considerations when an entity uses a service organization
Section 5370: Management representations
Section 5400: The auditor’s standard report
Section 5970: Auditor’s report on controls at a service organization
Section 6550: Subsequent events
Section 6930: Audit of group statements
Section 7200: Auditor assistance to underwriters and others
Section 8200: The review engagement report
Section 9110: Agreed-upon procedures regarding internal control over financial reporting
Section 9200: Compilation engagements
GSF-QC: Quality control standards
Adopting IFRS
The Clarity Project
1
Adopting International Standards on Auditing (ISAs)
Audit Documentation CAS 230
The Auditor’s Responsibilities Relating to Laws and Regulations in an Audit of Financial Statements CAS 250
Materiality in Planning and Performing an Audit CAS 320 and Evaluation of Misstatements Identified During the
Audit CAS 450
Considering the Relevance and Reliability of Audit Evidence CAS 500
Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures CAS 540
Related Parties CAS 550
Going Concern CAS 570
Written Representations CAS 580
The Auditor’s Consideration of the Internal Audit Function CAS 610
Public sector Release 26
Section 1000: Internally developed intangible assets
(Substantial changes Feb. 2009)
Background

In December 2005, the AcSB issued an exposure draft to modify sections 1000 and
3062.

The proposed changes reinforced the principle-based approach to the recognition of
costs as an asset in accordance with section 1000. The objective was to eliminate the
practice whereby items were recognized as assets even though they did not meet the
definition and recognition criteria in section 1000.

To accomplish these objectives, the AcSB intended to delete paragraphs 1000.26 and
1000.51, to remove any ambiguity about the rationale for the recognition of assets.
The removal of paragraph 1000.51 turned out to be quite controversial — it
essentially removed the matching principle from the conceptual framework!

In addition, guidance was to be added to section 3062 (replaced by section 3064),
regarding the recognition of internally developed intangible assets not addressed by
other Handbook sections. Specifically, section 3062 would define an intangible asset
as “… an asset other than goodwill or a financial asset (as defined in section 3855)
that lacks physical substance”.

It is this second change that is most important — no longer will it be necessary for an
intangible to be acquired in order to be recognized in the financial statements.

The criteria for recognition of an internally generated intangible asset are essentially
the same as those for the deferral of development costs (see paragraph 3450.21).
2

An internally developed intangible asset should be recognized only when all of the
following criteria are met:
o
the intangible asset is clearly defined and its cost can be reliably identified and
measured;
o
the technical feasibility of producing, marketing or using the intangible asset
has been established;
o
the management of the enterprise has both the intention and ability to produce,
market or use the intangible asset;
o
. adequate technical, financial and other resources exist, or are expected to be
available, to complete the development and permit the use or sale of the
intangible asset; and
o
the management of the enterprise can demonstrate that the intangible asset will
generate probable future economic benefits by demonstrating, among other
things, the existence of a market for the output of the intangible asset or the
intangible asset itself or, if it is to be used internally, the usefulness of the
intangible asset.

As a result of these changes, Canadian practice was to have been aligned with
international practice with respect to the accounting treatment of start-up and similar
costs.

However, comments received required that the AcSB issue a re-exposure draft in
early third quarter of 2007.

The re-ED maintained much of the original intent, but it recognized that redundancy
would occur and proposed to alleviate that issue.

The main changes from the 2005 ED related to the incorporation of guidance directly
from current IFRSs and the related withdrawal of section 3450.

Section 1000 changes include removal of material potentially permitting the
recognition of assets that would not otherwise meet the definition of an asset or the
recognition criteria.

As well, guidance from the IASB Framework for the Preparation and Presentation of
Financial Statements has been added to clarify the distinction between assets and
expenses.

Section 3062 was replaced by section 3064.
3
Effective date

The changes to section 1000 and section 3064 are effective for fiscal years beginning
on or after October 1, 2008.
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Section 1400: General standards of financial statement presentation
(Minor changes Feb. 2009)
Background

In October 2003, section 1400 was released in conjunction with section 1100. It
replaced the existing section 1500 of the same name. Sections 1100 and 1400 were
effective for fiscal years beginning on or after October 1, 2003.
Going concern changes — June 2007

As of June 1, 2007, neither Canadian nor US GAAP addressed management’s
responsibility when there is substantial doubt about an entity’s ability to continue as a
going concern.

On the other hand, GAAS in both Canada and the US does deal with going concern
issues, although not in the same manner.

In Canada, the project resembled the Cheshire cat from Lewis Carroll’s novels — now
you see it, now you don’t.

Beginning in March 2004, the AcSB consulted with the AASB’s Going Concern Task
Force to assess the going concern guidance found in IAS 1.

Then, in December 2005, the AcSB decided to discontinue the project, as it believed
amendments were not warranted at that time.

In May 2006, the AcSB reconsidered and issued an exposure draft proposing to adopt
paragraphs 23 and 24 from IAS 1 into Canadian GAAP. Given that IAS 1 guidance is
followed in US practice — specifically through AICPA AU Section 341, The Auditor’s
Consideration of an Entity’s Ability to Continue as a Going Concern — it was not
surprising that the AcSB was convinced to reinstitute the project.
Sections 23 and 24 read as follows:
23. When preparing financial statements, management shall make an assessment of
an entity’s ability to continue as a going concern. Financial statements shall be
prepared on a going concern basis unless management either intends to liquidate the
entity or to cease trading, or has no realistic alternative but to do so. When
management is aware, …, of material uncertainties related to events or conditions
4
that may cast significant doubt upon the entity’s ability to continue as a going
concern, those uncertainties shall be disclosed. When financial statements are not
prepared on a going concern basis, that fact shall be disclosed, together with the basis
on which the financial statements are prepared and the reason why the entity is not
regarded as a going concern.
24. In assessing whether the going concern assumption is appropriate, management
takes into account all available information about the future, which is at least, but is
not limited to, twelve months from the balance sheet date. The degree of
consideration depends on the facts in each case. When an entity has a history of
profitable operations and ready access to financial resources, a conclusion that the
going concern basis of accounting is appropriate may be reached without detailed
analysis. In other cases, management may need to consider a wide range of factors
relating to current and expected profitability, debt repayment schedules and potential
sources of replacement financing before it can satisfy itself that the going concern
basis is appropriate.

Given that IAS 1 guidance is followed in US practice — specifically through AICPA AU
Section 341, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going
Concern — it is not surprising the AcSB reinstituted the project.

The key issues remained the same:
o
What is management’s responsibility to assess the appropriateness of the going
concern assumption;
o
Under what circumstances would the going concern assumption not be
appropriate; and
o
If the going concern assumption is not appropriate, what financial statement
disclosures should be made.
Summary of Changes — June 2007

In June 2007, section 1400 was amended as follows:
o
Management is required to make an assessment of an entity’s ability to continue
as a going concern;
o
The assessment must take into account all available information about the future,
which is at least, but is not limited to, twelve months from the balance sheet
date;
o
Financial statements must be prepared on a going concern basis unless
management intends either to liquidate the entity, to cease trading or cease
operations, or has no realistic alternative but to do so;
5
o
When financial statements are not prepared on a going concern basis, that fact
must be disclosed, together with the basis on which the financial statements are
prepared and the reason why the entity is not regarded as a going concern;
o
disclosure is required of material uncertainties related to events or conditions
that may cast significant doubt upon the entity’s ability to continue as a going
concern.
Application (entities)

The requirements apply to both profit-oriented and not-for-profit organizations.
Effective date

The requirements are effective for interim and annual financial statements relating to
fiscal years beginning on or after January 1, 2008.
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Section 1506: Accounting changes
Background

In September 2003, the AcSB issued an exposure draft of proposed amendments to
section 1506 which would converge the section with equivalent amendments to U.S.
GAAP and with existing international accounting standards.

The AcSB decided to wait and finalize a harmonized standard subsequent to the
expected completion of a similar project to amend U.S. GAAP.

Finally, the AcSB released the updated section in July 2006.
Summary of Changes

Under the revised section, a change in accounting policy could be made only when it
is required by a primary source of GAAP or results in a reliable and more relevant
presentation in the financial statements.

Further, unless the primary source of GAAP contains specific transitional provisions, a
change in accounting policy would have to be applied retroactively.

An exception exists if it is impractical to apply the change retroactively. The notion of
impracticability is defined in the section.

Section 1506 requires that material prior-period errors be corrected retroactively.
6

New disclosures are required in respect of changes in accounting policies, changes in
accounting estimates, and correction of errors.

In other respects, the section remains the same — there are no changes to the
underlying notions of what constitutes an accounting change, what constitutes a
prior-period adjustment, or what is meant by an accounting error.
Effective date

The revisions apply to interim and annual financial statements relating to fiscal years
beginning on or after January 1, 2007.
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Section 1530: Comprehensive income
(Minor changes Feb. 2009)
See under section 3855 for the history of changes to the topic of Financial Instruments.
Background

In April 2005, the AcSB released three new Handbook sections:
o
Section 3855: Financial Instruments — Recognition and Measurement
o
Section 3865: Hedges
o
Section 1530: Comprehensive Income

An integral part of the FASB standards on recognition and measurement of financial
instruments is the ability to present certain gains and losses outside net income, in
other comprehensive income.

Accordingly, it was necessary to create this same ability within Canadian generally
accepted accounting principles.
Application (entities)

Although the requirements apply to both profit-oriented and not-for-profit
organizations, section 1530 itself does not apply to the latter organizations.

Instead, equivalent requirements were added to section 4400, using terminology
appropriate for not-for-profit organizations.

In substance, the requirements are the same.
7
Summary of changes

Section 1530 defines comprehensive income as the change in the value of net
assets that is not due to owner activities, that is, investments or distributions.

Further, section 1530 uses the term other comprehensive income to refer to
revenues, expenses, gains, and losses that are reported outside of net income.

The Statement of Comprehensive Income must have the same prominence as other
financial statements that constitute a complete set of financial statements, in both
annual and interim financial statements.

The Statement of Comprehensive Income comprises:
o
net income for the period;
o
each component of revenue, expense, gain, or loss that is required by primary
sources of GAAP to be recognized in other comprehensive income; and
o
a total.

An enterprise must disclose separately adjustments to reclassify amounts of revenue,
expense, gain, or loss previously recognized in other comprehensive income to the
income statement, as well as the amount of income tax expense or benefit allocated
to each component of other comprehensive income.

Exchange gains and losses arising from the translation of the financial statements of a
self-sustaining foreign operation, previously recognized in a separate component of
shareholders’ equity (as per section 1650), are now recognized in a separate
component of other comprehensive income.

When comparative statements are provided for earlier periods, section 1530 requires
restatements only for the following items:
o
foreign currency translation of self-sustaining foreign operations;
o
appraisal increase credits; and
o
donations from non-owners, unless impractical.
Effective date

As part of the financial instruments “package,” this section was to apply to interim
and annual financial statements relating to years commencing on or after October 1,
2006. CICA Handbook Release 39 of June 2006 deferred implementation to interim
and annual financial statements relating to fiscal years beginning on or after October
1, 2007. Deferral does not apply to non-for-profit organizations.
8
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Section 1535: Financial instruments and capital disclosures
(Substantial changes Feb. 2009)
See Section 3862 for a detailed history of changes to Financial Instruments
Background

Section 1535 requires disclosures about capital, and is harmonized with the
amendment to IAS 1 for capital disclosures.

It applies to all entities, irrespective of whether they have financial instruments.

This section requires:
o
the disclosure of qualitative information regarding an entity’s objectives,
policies and processes for managing capital.
o
an entity must disclose quantitative data about what it regards as capital
o
An entity must disclose whether it has complied with any externally imposed
capital requirements and, if not, the consequences of such non-compliance.

The requirements were effective for fiscal periods beginning on or after October 1,
2007.

Subsequent to implementation, and as with section 3862, the AcSB concluded that
relief for non-publicly accountable enterprises was warranted.

It was acknowledged that most non-publicly accountable enterprises do not have
complex capital structures requiring active management.

There was also some question as to whether the value of the information required by
section 1535 was greater than the costs of preparing it.

In July 2008, the AcSB amended section 1535 to limit a non-publicly accountable
enterprise with externally imposed capital requirements to disclose only the
nature of its capital requirements and how it manages those requirements, along with
information about compliance with those capital requirements.

A non-publicly accountable enterprise without externally imposed capital
requirements would be exempt from the requirements of section 1535.
9
Effective date

This change was effective for fiscal years beginning on or after August 1, 2008, with
earlier adoption permitted.
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Section 1582, 1601 and 1602: Business combinations (section 1582 will
replace 1581)
(Substantial changes Feb. 2009)
Background

In August 2005, the AcSB issued an exposure draft proposing to replace section 1581
with section 1582.

The changes were converged with proposals issued by the IASB and the FASB.

Harmonization would enable cross-border and/or international compliance.
Application

Section 1582 would not apply to the following:
o
the formation of joint ventures
o
combinations involving only enterprises or businesses under common control
o
combinations between not-for-profit organizations or the acquisition of a forprofit business by a not-for-profit organization.
Summary of proposed changes

The proposals will result in a significant change in the way we account for business
combinations.

The proposals require an acquirer to recognize an acquired business at its fair value
as at the acquisition date rather than at its cost.

Moreover, the acquirer would have to measure the fair value of the acquiree, as a
whole, as of the acquisition date.

Furthermore, the acquirer will have to measure and recognize the individual
assets acquired and the liabilities assumed at their fair values at the acquisition date,
with limited exceptions.
10

The proposals would apply even if the acquirer obtains control of a business by
acquiring less than 100% of the equity interests in the acquiree.

The underlying presumption is that the acquirer obtains control of the acquiree at the
acquisition date and therefore becomes responsible and accountable for all of the
acquiree’s assets, liabilities, and activities, regardless of the percentage of
its ownership in the acquiree.

One of the limited exceptions cited earlier relates to goodwill.

In general, goodwill is to be measured and recognized as the excess of the fair value
of the acquiree, as a whole, over the net amount of the recognized identifiable
assets acquired and liabilities assumed.

Without evidence to the contrary, the fair value of the consideration would be used
to determine the fair value of the acquired business.

Equity instruments issued as part of the purchase consideration are measured at fair
value on the acquisition date rather than on the date the terms of the business
combination are agreed to and announced.

Other exceptions relate to the following:
o
long-lived assets (or a disposal group) classified as held for sale
o
future income-tax assets or liabilities
o
assets or liabilities related to the acquiree’s employee-benefit plans

These would be measured in accordance with the specific generally accepted
accounting principles called for by their Handbook sections.

With respect to income taxes:

o
The acquirer will have to exclude any changes in the amount of its future incometax benefits that are recognizable as a result of that business combination.
o
Section 3465 will be amended to require that such changes be recognized either
in income from continuing operations in the period of the combination, or directly
to contributed surplus, depending on the circumstances.
A final exception relates to leases:
o

If the acquiree is a lessee to an operating lease, no asset or related liability would
be recognized — provided the lease is at market terms.
Another major change relates to negative goodwill:
11
o
Section 1581 does not provide for the recognition of negative goodwill.
o
If a business combination is effected as a bargain purchase, section 1581
requires that the excess of fair value over the consideration paid be first offset
against non-monetary assets, and then, if necessary, against monetary assets.
o
Under section 1582, the acquirer will account for that excess by reducing
goodwill until the goodwill related to that business combination is reduced to
zero. Then, recognize any remaining excess in income.

Another aspect of the proposed revisions relates to the required reporting subsequent
to acquisition. These changes are covered in under section 1600.

Although the IASB and the FASB had agreed on the principles underlying accounting for noncontrolling interests, they had not agreed on specific provisions.

The 2005 Business Combinations exposure draft indicated that the AcSB had delayed proposing
changes to section 1600 pending finalization of the international standard, since the eventual
release would likely influence the details of a Canadian standard on non-controlling interests.

In January 2008, the IASB issued a revised IFRS 3, Business Combinations, together with
amended IAS 27, Consolidated and Separate Financial Statements.

The AcSB decided to defer the release of section 1582, which incorporated the provisions of the
revised IFRS 3, so that it could be issued concurrently with section 1602.

In April 2008, the AcSB released its exposure draft for Section 1602 based on the IASB’s
amended IAS 27.

However, the AcSB decided against incorporating all of IAS 27 into Canadian GAAP now
because it did want to change current standards which differ from IFRSs.

Doing so would result in a mixture of new and old requirements which would only have to be
changed again in 2011.
o
a) IAS 27 includes a definition of control that differs from that in section 1590,
and it could result in changing which entities are required to be consolidated.
o
b) SIC-12, Consolidation — Special Purpose Entities, is not the same as AcG-15,
Consolidation of Variable Interest Entities.
o
c) IAS 27 does not include guidance on investment companies that is comparable
to AcG-18, Investment Companies.

In April 2008, the AcSB issued its exposure draft based on the IASB’s amended IAS
27.

However, the AcSB decided to split section 1600 into two new sections.
12

In deciding not to adopt all of IAS 27 now, those requirements of section 1600 that
do not involve non-controlling interests can remain unchanged in a proposed new
section 1601.

By separating the guidance for non-controlling interests from that for other aspects of
consolidation, it will be easier to distinguish the guidance that is new from the
guidance that is unchanged.

Section 1601 will carry forward the requirements for preparing consolidated financial
statements after acquisition and some aspects of consolidation at the date of a
business combination but remove the existing guidance on non-controlling interests.

Most of section 1600’s provisions on preparing consolidated financial statements at
the date of a business combination would be replaced by guidance in section 1582.

A new section 1602 entitled Non-controlling interests (NCIs) will be issued to provide
guidance on accounting for non-controlling interests subsequent to a business
combination.

Lastly, the AcSB intends to delete all illustrative examples from section 1600.

It believes that the examples available in both IFRSs and US GAAP would be
appropriate in applying Canadian GAAP.

Section 1602 is the same as IAS 27 with respect to non-controlling interests other
than the disclosure requirements.

The AcSB decided against including the disclosure requirements of IAS 27 in section
1602 as they are similar in nature and extent to those in existing Handbook sections.

The key principles for the revisions would be:
o
NCIs would be reported as a separate component of equity.
o
Changes in ownership interests in a subsidiary that do not result in a loss of
control would be accounted for as capital transactions.
o
On loss of control, any retained interest would be re-measured to fair value on
the date control is lost with the gain or loss recognized in income.
o
Net income or loss and each component of other comprehensive income would
be attributed to the controlling interests and NCI, based on relative ownership
interests or other contractual arrangements.
o
This would include circumstances when the NCI’s share of losses exceeds its
interest in the equity of the subsidiary.
13
o
The consolidated income statement would show the consolidated net income
and comprehensive income and the amounts attributable to the controlling
interest and to the NCI.
Effective date

The IASB’s standards will be effective for fiscal years beginning on or after July 1,
2009, and the US standards will be effective for fiscal years beginning on or after
December 15, 2008.

The AcSB intends that sections 1582, 1601 and 1602 will be mandatory for fiscal
years beginning on or after January 1, 2011 with earlier adoption permitted.

The three new Sections must be implemented concurrently.

Balances relating to business combinations completed prior to the implementation date are to
presented in accordance with sections 1601 and 1602 but are not to be re-measured until an
entity adopts IFRSs for the first time.
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See Section 1582, 1601 and 1602: Business Combinations for more information.
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Section 1651: Foreign currency translation (replaced 1650)
Summary of Changes

Section 1650 was updated and replaced by section 1651.

Most of the changes were due to the introduction of sections 3855 and 3865.

These changes are related to exceptions that are no longer necessary, crossreferences that have changed, or terminology that has changed.

Other changes were due to the introduction of section 1530:
o
Previously, exchange gains and losses arising from the translation of the financial
statements of self-sustaining operations were to be deferred and included as a
separate component of shareholders’ equity.
o
Now, that component is part of other comprehensive income.
Effective date
As part of the financial instruments “package,” this section was to apply to interim and
annual financial statements relating to years commencing on or after October 1, 2006. CICA
14
Handbook Release 39 of June 2006 deferred implementation to interim and annual financial
statements relating to fiscal years beginning on or after October 1, 2007. Deferral does not
apply to non-for-profit organizations.
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Section 3031: Inventories
(Minor changes Feb. 2009)
Background

In June 2006, the AcSB issued an exposure draft to replace current section 3030.

The revised section 3031 provides more explicit guidance on the measurement and
disclosure requirements for inventories than did section 3030

It is the first section to reflect the AcSB’s strategic goal of adopting IASB standards
for publicly accountable enterprises.

With the exception of additional material addressing not-for-profit entities (which
neither the IASB nor the FASB deal with), section 3031 is fully converged with IAS 2
and FASB 151.

In keeping with the move to IFRS, the paragraph numbering in section 3031 has been
aligned with that of IAS 2, “Inventories.”
o
When a particular paragraph in IAS 2 has not been adopted, it is identified as
"[Not used]”
o
When a paragraph or sub-paragraph not in IAS 2 has been added, the paragraph
or sub-paragraph is numbered so as to maintain this symmetry, e.g, 08A, 09A,
39A, 39B, 39C, etc.
Application (entities)

Section 3031 applies to all inventories of all entities, including not-for-profit
organizations, except the following:
o
work in progress arising under construction contracts, including directly related
service contracts
o
financial instruments
o
contributions not recognized by not-for-profit organizations in accordance with
paragraph 4410.16
15

There is also a scope exemption from the measurement (but not the disclosure)
requirements for agricultural inventories up to and including the point of harvest.

The inventories measurement exemption also applies to the following:
o
producers of agricultural and forest products
o
agricultural produce after harvest
o
minerals and mineral products to the extent that they are measured at net
realizable value in accordance with well-established practices in those industries
o
commodity broker-traders who measure their inventories at fair value less costs
to sell
Summary of changes


Section 3031 requires the following:
o
measurement of inventories at the lower of cost and net realizable value —
rather than the unspecified term “market”
o
allocation of fixed production overhead based on normal capacity levels, with
unallocated overhead expensed as incurred
o
the cost of inventories of items that are not ordinarily interchangeable, and goods
or services produced and segregated for specific projects, is to be assigned by
specific identification of their individual costs
o
consistent use (by type of inventory with similar nature and use) of either FIFO
or weighted average cost formula to measure the cost of other inventories. LIFO
has been proscribed
o
reversal of previous write-downs to net realizable value when there is a
subsequent increase in the value of inventories
o
disclosure of the accounting policies used, carrying amounts, amounts recognized
as an expense, write-downs, and the amount of any reversal of any write-downs
recognized as a reduction in expenses
There are no differential reporting exemptions.
Effective date

Section 3031 is effective for interim and annual financial statements for fiscal years
beginning on or after January 1, 2008, with earlier application encouraged.

Section 3031 requires that an entity apply the recommendations either:
16

to the opening inventory for the period and adjust opening retained earnings by the
difference in the measurement of opening inventory (prior periods are not restated);
or

retrospectively and restate prior periods in accordance with section 1506.
Consequential amendments

Paragraph 1520.03(r) inserted, which added “the amount of inventories recognized as
an expense during the period” to the required income statement disclosures.

Paragraph 1520.04(c) deleted to remove “the amount of cost of goods sold” from the
desirable income statement disclosures.

Paragraphs 1751.18 and 1751.26 amended in Interim financial statements to remove
references to the LIFO method.

Paragraph 3061.04, Property, plant and equipment amended to include guidance on
the accounting for spare parts and servicing equipment

Paragraph 3062.03, Goodwill and other intangible assets amended to exempt from
that standard, intangible assets that are within the scope of section 3031. Note that
section 3062 has now been replaced by section 3064; however, paragraph 3064.03
retains the scope exclusion from section 3062.
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Section 3051: Investments (replaced section 3050)
Summary of changes

Section 3051 represents a mix of old and new recommendations.

The key factor is the nature of the investment — if it is a financial instrument, it falls
under the aegis of section 3855

The changes also reflect the change in terminology resulting from the implementation
of section 3855.

For example, there are no longer “portfolio” investments, “temporary” investments,
or “long-term” investments.

There are just “investments.”

A substantive change relates to what constitutes an other-than-temporary loss in the
value of an investment.
17

Previously, section 3050 afforded unclear guidance as to what was meant by an
other-than-temporary loss.

Now, a significant or prolonged decline in the fair value of an investment below its
carrying value is evidence of an other-than-temporary loss in value of an investment.
Effective date

As part of the financial instruments “package,” this section was to apply to interim
and annual financial statements relating to years commencing on or after October 1,
2006. CICA Handbook Release 39 of June 2006 deferred implementation to interim
and annual financial statements relating to fiscal years beginning on or after October
1, 2007. Deferral does not apply to non-for-profit organizations.
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Section 3055: Joint ventures
Summary of changes

Implementation of amendments to section 3831 required amendments to section
3055, Joint ventures:
o
When the venturers are unrelated, transfers will be measured at fair value since
there is a significant change in cash flow configuration.
o
When the venturers are related, transfers will be deemed related party
transactions.
(Section 3831 applies to all non-monetary transactions initiated in periods beginning
on or after January 1, 2006.)
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Section 3056: Joint Arrangements
(Substantial changes Feb. 2009)
Background

In October 2007, the IASB published ED 9 Joint Arrangements, to replace IAS 31.

ED 9 is part of the process to bring about the convergence of IFRS and US GAAP.

In November 2007, the AcSB issued a corresponding ED to amend section 3055.
18

As part of the adoption of the proposed IFRS in Canada prior to the complete
changeover to IFRSs, the AcSB proposed retaining the guidance for joint venture
transactions in paragraphs 3055.26-.40 by adding it to paragraph 27 of ED 9, since
similar guidance is not contained within ED 9.

Likewise, the AcSB has decided not to make other conforming changes to existing
Canadian GAAP and, therefore, Canadian GAAP and IFRSs will differ in a minor way in
respect of joint arrangements until the complete changeover to IFRSs.

In other respects, the scope of section 3056 does not diverge from that of section
3055 — unanimous agreement is still required between the key parties that have the
power to make the financial and operating policy decisions for the joint arrangement.

The exposure draft carries forward modified versions of the three types of joint
arrangement identified in IAS 31.

For the first two types — Joint Operations and Joint Assets — the description of these
types and the accounting for them is consistent with Jointly Controlled Operations and
Jointly Controlled Assets in IAS 31.

The underlying principle of both EDs is that the parties to a joint arrangement must recognize
their contractual rights and obligations arising from the arrangement.

Accordingly, the EDs focus on the recognition of assets and liabilities by the parties to
the joint arrangement.

Accounting for a right leads to the recognition of an asset, and accounting for an
obligation leads to the recognition of a liability.

Thus, a joint asset would be recognized when the party has exclusive rights to a
share of the asset and the economic benefits generated from that asset.

This approach is similar to the way both section 3065 and IAS 17 deal with leases:
the right to use an asset in a joint arrangement and the right to use an asset in
accordance with a lease contract.

There are two key changes proposed by the exposure draft:

o
The first is the elimination of proportionate consolidation for a jointly controlled
entity.
o
The second change is the introduction of a ‘dual approach’ to the accounting for
joint arrangements.
The elimination of proportionate consolidation will have a fundamental impact on the
income statement and balance sheet.
19

Under the equity method, entities will replace the line-by-line proportionate
consolidation of the income statement and balance sheet with a single net result and
a single net investment balance.

The IASB has justified the withdrawal of proportionate consolidation by arguing that
the method leads to recognition of assets that an entity does not control and liabilities
for which it has no obligations.

The AcSB ED makes no comment regarding this assertion — implicitly agreeing with
the IASB.

The dual approach will also significantly affect the manner in which joint
arrangements are addressed.

The dual approach takes the perspective that a single joint arrangement may contain
more than one type — for example, Joint Assets and a Joint Venture.

The party to such a joint arrangement accounts first for the assets and liabilities of
the Joint Assets arrangement and then uses a residual approach to equity accounting
for the Joint Venture part of the joint arrangement.

The dual approach reflects the IASB’s view that entities must separate transactions
into their components to properly understand their economic substance.
o
For instance, the sale of goods and an associated service contract for those goods
requires that the sale and service components be accounted for separately, even
if they are part of the same contract.

However, a key weakness of the dual approach is the use of equity accounting for the
residual interest.

In fact, the use of equity accounting is a major problem with ED 9: under
proportionate consolidation, investors had a sense of what comprised the assets and
liabilities of the joint venture.

Under the equity method, investors will be presented a single line item representing
the net assets of the joint venture.

Investors will have to do the work to determine how the joint venture’s assets and
liabilities align with the venturer’s assets and liabilities.

How is this a step forward?

The AcSB intends for section 3056 to become effective as part of the complete
adoption of IFRSs.
o
Canadian entities would be permitted, but not required, to adopt the new
standard before then.
20
o
When he IASB publishes the new standard in final form, the AcSB would publish
it as a Handbook section with a deferred mandatory effective date and permit
early adoption.
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Section 3064: Goodwill and other intangible assets
(Material added Feb. 2009)
See also section 1000 for the history of the changes on this topic.
Background

Section 3064 changes include the inclusion of guidance from IAS 38, Intangible
Assets, on the definition of an intangible asset and the recognition of internally
generated intangible assets, and the “transfer” of material related to section 3450
into section 3064.

In particular, section 3064 now adopts IAS 38’s requirement that an intangible asset
meet key three criteria.

Specifically, an intangible asset is an identifiable, non-monetary asset without
physical substance.

An asset meets the identifiability criterion in the definition when it:
o
is separable, i.e., capable of being separated or divided from the entity and sold,
transferred, licensed, rented or exchanged, either individually or together with a
related contract, asset or liability; or
o
arises from contractual or other legal rights, regardless of whether those rights
are transferable or separable from the entity or from other rights and obligation.

For intangible assets acquired separately, or as part of a business combination, there
is a presumption that the criteria are met.

On the other hand, section 3064 (and IAS 38) takes the position that (almost) all
internally-generated intangible assets are to be expensed as incurred.

Section 3064 makes an exception for development expenditures, but imposes strict
conditions (paragraph 3064.40) on the recognition of such assets.

The conditions are the much the same as those that previously were found in
paragraph 3450.21.
21

Effectively, except for development expenditures, section 3064 prohibits the
recognition of internally generated intangibles.

Paragraph 3064.46 specifically states that internally generated brands, mastheads,
publishing titles, customer lists and items similar in substance shall not be recognized
as intangible assets.

Effectively, except for development expenditures, section 3064 prohibits the
recognition of internally generated intangibles.

Paragraph 3064.46 specifically states that internally generated brands, mastheads,
publishing titles, customer lists and items similar in substance shall not be recognized
as intangible assets.

Paragraph 3064.47 notes that expenditures on internally generated items such as
brands, mastheads, etc. cannot be distinguished from the cost of developing the
business as a whole.

However, externally acquired items can be recognized as intangible assets since they
will meet the three recognition criteria cited earlier.

Section 3450: withdrawn, since assets developed as a result of research and
development activities would be included within the scope of Section 3064.
Effective date

The changes to section 1000 and section 3064 are effective for fiscal years beginning
on or after October 1, 2008.
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Section 3070: Consequential changes from the financial instruments
sections (withdrawn April 2005)
Current assets and liabilities

With the introduction of held-for-sale, available-for-sale, and held-for-trading
categories of financial instruments, the notion of “temporary investments” as
contained in section 3010 became meaningless.

Further, the requirement to measure financial instruments using fair value meant that
the manner in which deferred charges were reported could not continue as before.

Consequently, both sections 3010 and 3070 were withdrawn in April 2005 and
amendments were made to eliminate the “temporary” classification in section 1510.
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22
Section 3110: Asset retirement obligations
Background

In December 2002, the AcSB approved this new Handbook section and related
amendments more or less the same as proposed in the April 2002 exposure draft.

The recommendations are harmonized with FASB Statement 143, Accounting for
asset retirement obligations.
Effective date

Section 3110 was effective for fiscal years beginning on or after January 1, 2004, but
earlier application was encouraged.
Summary of changes

The focus of section 3110 is on the recognition and measurement of liabilities for
obligations associated with the retirement of property, plant, and equipment when
those obligations result from the acquisition, construction, development, or normal
operation of the assets.

Any statutory, contractual, or other legal obligation must be recognized, normally
when incurred.

The obligations are measured initially at fair value and the resulting costs capitalized
into the carrying amount of the related asset.

In subsequent periods, the liability is adjusted for the accretion of discount and any
changes in the amount or timing of the underlying future cash flows.

The asset retirement cost is amortized to income on a systematic and rational basis.

Entities are required to disclose certain key information about the liability.
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Section 3251: Equity (replaced 3250)
Background

Section 3251 replaced section 3250, Surplus

It established standards for the presentation of equity and changes in equity during
the reporting period.
23

The requirements of section 3251 are in addition to those in sections 1530, 3240, and
3260.
Summary of changes

According to section 3251:
o
Equity is the residual interest in the assets of the enterprise after deducting all
of its liabilities.
o
Contributed surplus comprises amounts paid in by equity holders.
o
Retained earnings represents the accumulated balance of net undistributed
earnings of the entity, after taking into account refundable taxes and other
amounts that are supposed to be charged or credited to the account.
o
Accumulated other comprehensive income comprises the accumulated
balance of all components of other comprehensive income recognized in section
1530.

Section 3251 requires separate presentation of the various components giving rise to
changes in equity each period.

Likewise, it requires disclosure of the various components that comprise equity.

Compliance with statutory requirements regarding how certain items of equity are to
be designated does not override the basic classifications of the section.

In other respects, section 3251 retains the same requirements as section 3250.
Effective date

As part of the financial instruments “package,” this section was to apply to interim
and annual financial statements relating to years commencing on or after October 1,
2006. CICA Handbook Release 39 of June 2006 deferred implementation to interim
and annual financial statements relating to fiscal years beginning on or after October
1, 2007. Deferral does not apply to non-for-profit organizations.
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Section 3500: Earnings per share

In July 2004, the AcSB issued an exposure draft of amendments proposed for section 3500.

The amendments were in light of changes being made to U.S. GAAP as part of the IASB/FASB
short-term convergence project.
24

The key changes are:
o
amending computational guidance for calculating the number of incremental
shares included in diluted shares when applying the treasury stock method;
o
eliminating the provisions that allow an entity to rebut the presumption that
contracts with the option of settling in either cash or stock will be settled in
stock;
o
requiring that shares that will be issued upon conversion of a mandatorily
convertible instrument be included in the weighted average number of ordinary
shares outstanding used in computing basic earnings per share.

With respect to the first change, paragraph 3500.42 will be revised to specify that when
computing EPS, the number of incremental shares included in current interim and year-to-date
diluted earnings per share is computed using the average market price of common shares for the
current interim and year-to-date periods, respectively.

However, the number of incremental shares included in the year-to-date period is not a
weighted average of the incremental shares included in each interim computation.

For example, an entity with a calendar year-end would compute the number of incremental
shares used for its third quarter diluted EPS using the average market price of common shares
during the quarter ended September 30.

However, the number of incremental shares used to calculate diluted EPS at the end of the third
quarter would be determined using the weighted average market price of common shares for the
year-to-date period ended September 30 — not a weighted average of interim prices.

The second change is addressed by deleting paragraph 3500.46(c).

The third change is addressed by modifying paragraph 3500.55 to delete reference to weighted
average.

Instead, it will be assumed that the contingently issuable shares have been issued and they will
be included in the year-to-date calculations.

It is expected that the revisions will be issued late in 2004, to be effective for interim and annual
periods beginning on or after January 1, 2005.
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Section 3820: Subsequent events

In March 2004, the AcSB issued an exposure draft of proposed amendments to
section 3820.
25

The key change was to define the subsequent event period as being from the date of
the balance sheet to the date the financial statements are authorized for issue.

This change would extend the “subsequent” period from the current “date of
completion.”

Another change was to define the “date of authorization of issue” and to require that
this date — and who authorized the statements for issue — be disclosed in the notes
to the financial statements.

The original exposure draft was intended to apply to all entities.

There were to be no exceptions for not-for profits or exclusions under differential reporting.

The revisions were intended to be effective for fiscal periods beginning on or after January 1,
2005.

As a consequence of feedback from the initial exposure draft, a re-exposure draft was released in
March 2005.

The key change was to differentiate between publicly and non-publicly accountable enterprises
in specifying the requirements for application.

The revisions will harmonize this GAAP with IASB standards.

There will still be a U.S./Canadian GAAP difference since the U.S. GAAP defines the subsequent
period to be the period between the balance sheet date and the date the financial statements
are issued.

An entity will be required to adjust amounts recognized in its financial statements for subsequent
events that
o
occur between the balance sheet date and the date of authorization for issue of
the financial statements;
o
provide evidence of conditions that existed at balance sheet date;
o
are material.

The subsequent events review includes consideration of whether the entity is, or will remain, a
going concern.

Entities that choose to follow U.S. GAAP will comply with section 3820.

An entity will be required to disclose the financial effects on its financial statements for
subsequent events that:
26
o
occur between the balance sheet date and the date of authorization for issue of
the financial statements;
o
relate to conditions that arose after the balance sheet date;
o
would influence the economic decisions of users made on the basis of the
financial statements taken as whole.

Publicly accountable enterprises are “public enterprises, co-operative business enterprises,
regulated financial institutions and regulated financial institution holding companies, enterprises
subject to rate regulation, government business enterprises and government business-type
organizations.”

Non-publicly accountable enterprises include small and/or private enterprises, not-for-profit
organizations, and pension plans.

Assuming the revisions proposed are approved, the “new” section 3820 would apply to financial
statements covering interim and annual periods ending on or after June 30, 2006, with earlier
adoption encouraged.

A publicly accountable enterprise must search for, identify, and report subsequent events that
occur between the balance sheet date and a date no earlier than the date of authorization for
issue.

For non-publicly accountable enterprises, the end-point is the date of completion.

A publicly accountable enterprise will be required to adjust amounts recognized in its financial
statements for subsequent events that
o
provide evidence of conditions that existed at balance sheet date;
o
are material;
o
occur between the balance sheet date and the date of authorization for issue of
the financial statements.

The subsequent events review includes consideration of whether the entity is, or will remain, a
going concern.

Entities that choose to follow U.S. GAAP will automatically comply with section 3820.

A publicly accountable entity will be required to disclose the financial effects on its financial
statements for subsequent events that
o
between the balance sheet date and the date of authorization for issue of the
financial statements;
o
relate to conditions that arose after the balance sheet date; and
27
o
would influence the economic decisions of users made on the basis of the
financial statements taken as whole.
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Section 3831: Non-monetary transactions (replaced section 3830)
Background



Section 3831 replaced section 3830, Non-monetary exchanges.
The revisions harmonize section 3830 with the FASB’s revisions to APB 29, Exchanges
of Productive Assets and the IASB’s revisions to IAS 16, Property, Plant and
Equipment.
Effective date

Section 3831 applies to all non-monetary transactions initiated in periods beginning
on or after January 1, 2006.

The section provides for early adoption as of July 1, 2005.

In no case is retroactive application permitted. There is to be no restatement of
balances resulting from prior transactions.
Summary of changes
28

Key change is that all non-monetary transactions will be measured at fair value unless
o
the transaction lacks commercial substance;
o
the transaction is an exchange of a product or property held for sale in the
ordinary course of business for a product or property to be sold in the same line
of business to facilitate sales to customers other than the parties to the
exchange;
o
neither the fair value of the assets or services received nor the fair value of the
assets or services given up can be reliably measured;
o
the transaction is a non-monetary, non-reciprocal transfer to owners that
represents a spin-off or other form of restructuring or liquidation.

Gone is the need to determine whether an exchange results in the “culmination of the
earnings process.”

Likewise, determining whether the assets exchanged are similar productive assets will
no longer be necessary.

Focus is now on “commercial substance.”

o
Commercial substance is deemed to occur when a transaction causes an
identifiable and measurable change in the economic circumstances of an entity.
o
Because the commercial substance tests require assessment of all cash flows, the
10% cash “boot” has been eliminated.
Two tests determine whether commercial substance is present follow:
o
The first test compares the configuration of the asset-specific or service-specific
cash flows before and after the transaction.
o
The second test compares entity-specific values.

Commercial substance occurs when either the difference in cash flow configuration or
entity-specific value is significant relative to the fair value of the assets exchanged.

Cash flow configuration looks at the risk, timing, and amounts of the cash flows
directly associated with the assets or services exchanged.

A transaction will have commercial significance if there is a significant difference in
any of these elements relative to the fair values of the assets exchanged.

The test is a straight comparison.
29

Entity-specific value is the present value of after-tax cash flows expected from both
the continuing use of an asset and the proceeds at the end of its useful life.

The test is broader than the one related to cash flow configuration.

Moreover, the difference must be significant relative to the fair value of assets
exchanged.

Implementation required consequential amendments to remove references in other
Handbook sections to either the culmination of the earnings process or the exchange
of similar assets, or both.

Implementation also required consequential amendments to section 3055, Joint
ventures:

o
When the venturers are unrelated, transfers will be measured at fair value since
there is a significant change in cash flow configuration.
o
When the venturers are related, transfers are deemed related party transactions.
Implementation also required amendments to section 3840, Related party
transactions:
o
Commercial substance replaces the “culmination of the earnings process” test for
both normal course transactions and transactions not in the normal course of
operations.
o
On the other hand, exchanges of products or property held for sale in the normal
course of business to facilitate sales to customers will be measured at carrying
value.
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Section 3840: Related party transactions

Implementation of section 3831 (effective January 2006) also required amendments
to section 3840, Related party transactions.

Commercial substance replaced the “culmination of the earnings process” test for
both normal course transactions and transactions not in the normal course of
operations.

Exchanges of products or property held for sale in the normal course of business to
facilitate sales to customers are to be measured at carrying value.
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30
Section 3855: Financial instruments – Recognition and Measurement
(Substantial changes Feb. 2009)
See also section 1530, Comprehensive Income, section 3865, Hedges, section 3862, and
section 3863,
Background

In April 2005, the AcSB released three new Handbook sections:

Section 3855: Financial Instruments — Recognition and Measurement

Section 3865: Hedges

Section 1530: Comprehensive Income

Enterprises that reported in accordance with US GAAP were also to comply with
Canadian GAAP.

In addition, the AcSB revised section 3250, Surplus, and re-issued it as section 3251,
Equity.

Finally, a host of related amendments were required for section 3860 as well as
changes to sections such as 1650, 3025, 3050, etc.; (not covered)

The standards were to apply to financial instruments held by all entities, including
not-for-profit organizations.

Paragraph 3855.07 scoped out a veritable “laundry list” of instruments to which the
section would not apply, and it noted circumstances under which the exclusions would
not apply.

The sections were intended to be applicable to interim and annual financial
statements relating to years commencing on or after October 1, 2006 for all entities.

Retroactive application was not permitted.

On March 1, 2006, pending completion of research into the financial reporting needs
of users of non-publicly accountable enterprises, the AcSB decided to defer the
mandatory effective dates of the sections.

Accordingly, for non-publicly accountable enterprises, the sections were to be
applicable to interim and annual financial statements relating to years commencing
on or after October 1, 2007.

On October 1, 2008, the CICA released a statement “updating” interested parties on
the AcSB’s private enterprise strategy.
31

The release referred to a July 3rd update wherein it was reported that “the AcSB had
taken several steps to address the challenge of developing private enterprise financial
reporting standards that are timely and relevant to the market they serve.”

The update contained a bombshell — as part of the solution, the AcSB decided that
private enterprises would not be required to apply current financial instruments
standards.

What was so unexpected was a decision by the AcSB to waive exposure of the
Handbook changes giving effect to this decision.

Sections not applicable included:
o
1530, Comprehensive Income
o
1651, Foreign Currency Translation
o
3051, Investments
o
3251, Equity
o
3855, Financial Instruments – Recognition and Measurement
o
3862, Financial Instruments – Disclosures
o
3863 Financial Instruments – Presentation
o
3865, Hedges

Private enterprises that have already adopted these sections were not required to
revise their reporting.

Private enterprises that have yet to prepare their statements could report on the
basis of the standards in the Handbook prior to the issue of the revisions on financial
instruments.

Sometime in 2009, a new financial instruments standard will be exposed for
comment, with the following details:
o
Existing differential options will be required rather than being optional.
o
There will be fewer measurement categories of financial instruments than in
section 3855 and no measurement choices for individual instruments.
o
Investments in equity securities with readily determinable fair values and
free-standing derivatives outside a hedging relationship will be measured at fair
value.
32
o
All other financial instruments will be measured at cost or amortized cost, with
no option to measure them at fair value.
o
Impairment of financial assets will be recognized and measured in accordance
with the requirements of various standards currently in the XFI version of the
Handbook.
o
A simplified hedge accounting model will be available.
o
Derivative instruments in a qualifying hedging relationship may be accounted
for on an accrual basis or when settled on sale or maturity.
o
A simplified model for dealing with equity derivatives embedded in liabilities,
such as convertible debt, will be explored.
o
Finally, all contracts to buy or sell non-financial items, and derivatives
embedded therein, will be scoped out of the standard.

Up until October 2008, an entity could not reclassify a financial instrument out of
the held-for-trading category while it is held or issued, so care had to be taken with
initial designation.

While the “due diligence” requirement has not be lifted, illiquidity in the credit
markets had a tremendous impact on fair values.

Accordingly, section 3855 was amended to permit transfers out of the held-fortrading category if a financial asset is no longer held for the purpose of selling it in
the near term (even if the asset may have been acquired principally for the purpose
of selling it in the near term) … if the requirements in paragraph 3855.80A are met.

And what does paragraph 3855.80A say?
o
A financial asset to which paragraph 3855.80(c) applies may be reclassified out
of the held-for-trading category only in “rare” circumstances.

Transfers into the category are still proscribed.

Section 3855 was also amended to permit limited transfers out of the available-forsale category.

A financial asset … that would have met the definition of loans and receivables (if it
had not been designated as available for sale) may be reclassified … to the loans and
receivables category if the entity has the intention and ability to hold the asset for the
foreseeable future or until maturity.

In both cases:
33
o
If an entity reclassifies a financial asset … the financial asset should be
reclassified at its fair value on the date of reclassification.
o
The fair value of the financial asset on the date of reclassification becomes its
new cost or amortized cost, as applicable.

If an entity reclassifies a financial asset out of the held-for-trading category , any gain
or loss already recognized in net income is not reversed.

If an entity reclassifies a financial asset out of the available-for-sale category, any
gain or loss already recognized in other comprehensive income in accordance with
paragraph 3855.76(b) should be be amortized to net income over the remaining life
of the asset using the effective interest method.

If an entity reclassifies a financial asset out of the available-for-sale category, any
gain or loss already recognized in other comprehensive income in accordance with
paragraph 3855.76(b) should be be amortized to net income over the remaining life
of the asset using the effective interest method.

If an entity reclassifies a financial asset out of the available-for-sale category, any
difference between the new amortized cost and maturity amount should be
amortized over the remaining life of the financial asset using the effective interest
method, similar to amortization of premium and discount.
Effective date:

These new provisions apply to reclassifications made on or after July 1, 2008.

An entity cannot reclassify a financial asset in accordance with these amendments
before July 1, 2008.

Any reclassifications made on or after November 1, 2008 take effect from the date of
the reclassification.

However, any reclassification before November 1, 2008 can take effect from July 1,
2008 or a subsequent date.

On the other hand, reclassifications are not to be applied retrospectively to reporting
periods ended before July 1, 2008.

Furthermore, an entity should not reclassify financial assets in accordance with these
amendments retrospectively in periods reported on in previously issued financial
statements.

If there is a change in circumstances such that it is no longer appropriate to classify
an investment as held-to-maturity, it should be reclassified as available-for-sale and
re-measured at fair value.
34

The difference between its carrying amount and fair value should be accounted for in
accordance with the treatment for changes in fair value of available-for-sale financial
assets.

When a quoted market price in an active market becomes available for a financial
asset for which such a price previously was not available, the asset should be remeasured at fair value.

The difference between its carrying amount and fair value is also accounted for in
accordance with the treatment for changes in fair value of available-for-sale financial
assets.

Another change relates to recoverability (think asset backed commercial paper).

If a financial asset is reclassified and the entity subsequently increases its estimates
of future cash receipts as a result of increased recoverability of those cash receipts,
the effect of that increase is recognized as an adjustment to the effective interest rate
from the date of the change in estimate rather than as an adjustment to the carrying
amount of the asset at the date of the change in estimate.
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Section 3862  Financial instruments
(Substantial changes Feb. 2009)
Background


In April 2006, the AcSB issued an exposure draft of three new standards: two related
to the disclosure (section 3862) and presentation of financial instruments (section
3863), and one related to disclosures about capital (section 1535).
As with section 3031 and IAS 2, the paragraph numbering in section 3862 has been
aligned with that of IFRS 7:
o
when a particular paragraph or sub-paragraph in IFRS 7 has not been adopted, it
is identified as “[Not used]” (e.g., .13);
o
when it has been necessary to add a paragraph or sub-paragraph not included in
IFRS 7, the paragraph or sub-paragraph is numbered so as to maintain this
correspondence (e.g., 3862.13A).

Similarly, the Appendices correspond to those in IFRS 7.

When a particular Appendix in IFRS 7 has not been adopted, it is listed where it
otherwise would have appeared in the section and its disposition is indicated.

One part of IFRS 7 that has not been adopted relates to hedge disclosures.
35

Rather than adopt IFRS 7’s requirements, paragraph 3862.21A specifies that an
entity that holds or issues derivatives, non-derivative financial assets or nonderivative financial liabilities that are designated and qualify as hedging items is to
follow the disclosure requirements of section 3865.

Section 3862 replaced the disclosure requirements of section 3861, Financial
Instruments — Disclosure and Presentation, and was harmonized with IFRS 7.

Section 3862 placed increased emphasis on disclosures about risks associated with
both recognized and unrecognized financial instruments and how these risks were
managed.
Summary of requirements

Section 3862’s requirements for an entity to disclose the significance of financial instruments for
its financial position and performance have been revised relative to those of section 3861.

However, the disclosures about fair value, although revised, are not substantially different from
those of section 3861.

These requirements are less detailed than those of Section 3861 in certain areas (for
example, terms and conditions) and more so in others (for example, reclassifications,
collateral, allowance for credit losses, compound financial instruments with multiple
embedded derivatives, and defaults and breaches).

Section 3862’s requirements for the disclosure of qualitative and quantitative
information about exposure to risks arising from financial instruments have been
revised from, and are more extensive than, those of Section 3861.

The qualitative disclosures must describe management’s objectives, policies and
processes for managing such risks.

The quantitative disclosures must provide information about the extent to which the
entity is exposed to credit risk, liquidity risk and market risk (i.e., currency risk,
interest rate risk, and other price risk).

Section 3862 requires that the disclosures related to the risks faced by an entity must
either be incorporated directly into the financial statements or incorporated by crossreference from the financial statements to some other statement, such as a
management commentary or risk report.

If cross-referenced, the originating report must be available to users of the financial
statements on the same terms as the financial statements and at the same time.

Effectively, without the information — either directly or incorporated by crossreference — the financial statements are deemed incomplete.
36

Recently, CGA-Canada issued a Practice Alert as part of the Public Practice Manual
subscription service.

The release detailed the disclosure requirements of section 3862, as well as
describing the nature of those disclosures.

Members whose responsibility includes compliance with section 3862 should seek out
this Practice Alert.

Section 3863 carried forward unchanged the presentation requirements of section
3861 (which was based on IAS 32).

Sections 3862 and 3863 both had an effective date of October 1, 2007.

Note that while section 3862 applies to all entities, paragraphs .42A and .42B provide
some relief for non-publically accountable enterprises.

An enterprise that qualifies under section may elect to disclose the information
required by paragraphs 3862.25-.30A only for financial assets and financial liabilities,
both recognized and unrecognized, for which fair value is readily obtainable.

Also, such enterprises may elect to disclose the fair value required by paragraph
3862.37(b1)(i) only for those financial assets for which fair value is readily
obtainable.

Basically, the differential reporting option relieves an entity of having to estimate fair
value if an active market does not exist.

It also reduces the extent of the disclosures since reference to active markets reduces
the extent of disclosures necessary.

In July 2008, section 3862 was amended such that non-publicly accountable
enterprises would not be required to disclose an analysis of their sensitivity to market
risks.

The changes were effective for interim and annual financial statements for fiscal years
beginning on or after August 1, 2008.

In July 2008, section 3862 was also amended such that non-publicly accountable
enterprises could elect the date of adoption of section 3855 as the transition date for
recognizing embedded derivatives.

The changes were also effective for interim and annual financial statements for fiscal
years beginning on or after August 1, 2008.
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Section 3865: Hedges
37
Summary of requirements

Section 1650 used to deal with foreign currency hedges, and AcG-13 used to specify
when hedge accounting may be used, as well as when and how it should be
discontinued.

Section 3865 extends section 1650’s guidance to all financial instruments and
expands AcG-13 by prescribing the actual accounting treatment.

One critical factor to bear in mind is that hedge accounting is optional.

Hedge accounting ensures that the timing of the income recognition on the hedging
item matches that of the hedged item.

Care is required in designating the hedged item and the hedging item.

Derivatives cannot be designated as hedged items, only hedging items.

An anticipated transaction may be hedged but may not be a hedging item.

Hedges can be designated as fair value hedges, cash flow hedges, or hedges of a net
investment in a self-sustaining foreign operation.

Because hedge accounting is optional, a hedging relationship must be designated and
documented before hedge accounting may be applied.

Documentation includes the risk management objective and strategy for the
relationship, as well as the method for assessing the effectiveness of the hedge on an
ongoing basis.

A fair value hedge is a hedge of the exposure to changes in the fair value of all or a
portion of a recognized asset or liability, or previously unrecognized firm commitment
attributable to a specified risk.

All gains and losses from both the hedged item and the hedging item attributable to
the hedged risk are recognized in current period net income.

The carrying amount of any hedged item is adjusted for the gain or loss on the
hedged risk.

Hedge accounting does not apply to investments in equity instruments that cannot be
reliably measured at fair value, but instead are measured at cost in accordance with
section 3855.

A cash flow hedge is a hedge of the exposure to variability in cash flows of a
recognized asset or liability or a forecasted transaction attributable to a specified risk
or variability in cash flows of a firm commitment attributable to foreign currency risk.
38

The portion of the gain or loss on the hedging item determined to be effective is
recognized in other comprehensive income.

The ineffective portion is handled in the same manner as the instrument would be
treated under section 3855.

The accumulated gains or losses in other comprehensive income are recognized in net
income in the same period that the resultant asset, liability, or anticipated transaction
affects net income.

However, section 3865 specifies that non-derivative financial assets or liabilities, or a
group of non-derivative financial assets or liabilities (provided all items in the group
are similar), can only be used to hedge foreign currency risk exposure.

A hedge of a net investment in a self-sustaining foreign operation follows the same
accounting as a cash flow hedge.

Lastly, internal hedging arrangements qualify for hedge accounting only when the
hedge is a cash flow hedge of foreign currency risk in an anticipated transaction.

Since most intra-group transactions are eliminated on consolidation, internal hedging
arrangements qualify for hedge accounting treatment for financial reporting purposes
only.

However, internal hedging arrangements may qualify for hedge accounting in the
separate financial statements of individual entities within a consolidated group,
provided they otherwise meet the criteria of section 3865.

A hedging relationship ends no later than the contractual repayment date of the
hedged item.

When the hedged item has no contractual repayment date, the hedging relationship
ends no later than the earliest date on which payment could be demanded.

Section 3865 specifies how to deal with any gains or losses previously recognized in
other comprehensive income when a hedge of an anticipated transaction
subsequently results in the recognition of a:

financial asset or financial liability; or

non-financial asset or non-financial liability.

The treatment differs depending on which type results.

When an asset designated and accounted for as a hedged item becomes impaired,
the change in carrying amount due to impairment should be recognized after
adjusting the carrying amount of the hedged item in accordance with the provisions
of section 3865.
39

Disclosures must enable users of an entity’s financial statements to understand its
objectives for holding or issuing the hedging items, the entity’s strategies for
achieving those objectives, and the effect of hedge accounting on the financial
statements.
Effective date
As part of the financial instruments “package,” this section was to apply to interim and
annual financial statements relating to years commencing on or after October 1, 2006. CICA
Handbook Release 39 of June 2006 deferred implementation to interim and annual financial
statements relating to fiscal years beginning on or after October 1, 2007. Deferral does not
apply to non-for-profit organizations.
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Section 3870: Stock-based compensation and other stock-based payments
Background

Section 3870 contains standards for the recognition, measurement, presentation, and
disclosure of expenses and liabilities resulting from such transactions entered into by
profit-oriented enterprises in exchange for goods and services.

Section 3870 applies to all types of stock-based awards, the most common of which
are stock, stock options, warrants, and stock appreciation rights (SARs).

It also applies to circumstances where liabilities are incurred based on the price of
stock or other equity instruments.

Before the latest update, section 3870 would have had no effect on income
measurement, for most enterprises with stock-based awards

For enterprises with stock appreciation rights and/or awards settled in cash, there
would have been a significant impact on opening retained earnings for the year of
adoption; in addition, there would have been ongoing income statement impact.

And there it might have stayed, if not for Enron.

The actions of Enron’s senior management gave impetus to a move to recognize the
costs associated with issuing stock options.

The IASB issued an exposure draft in late 2003.

The IASB position was that stock options were not “free.”

There were to be no exceptions from the requirements to recognize an expense when
stock-based compensation was issued.
40

IFRS 2, issued in March 2004, confirmed that approach.

The AcSB also concluded that an enterprise should recognize the “real” cost of issuing
stock-based compensation.
Effective date

In November 2003, the AcSB announced that section 3870 would be amended
effective January 1, 2004.
Summary of changes

All stock-based compensation would result in expense being recognized in the income
statement.

Section 3870 requires that the fair value method be used to account for the cost of
stock-based compensation.

The previously permitted alternative of recognizing no costs, and reporting the proforma impact in the notes, has been prohibited.

Fair value must be measured using an option-pricing model, such as the BlackScholes or binomial tree option-pricing model.

The IASB position is that there are to be no exceptions from the requirements to
recognize an expense when stock-based compensation is issued.

The Canadian exception is that the minimum value method is only acceptable for nonpublic entities.

Compliance with section 3870 would, for the most part, result in conformance with
IFRS 2.

Enterprises other than public enterprises, co-operative enterprises, deposit-taking
institutions, and life insurance enterprises were permitted to defer application of the
revised section 3870 until January 1, 2005.

However, they were required to disclose pro-forma net income and pro-forma EPS if
the provisions of section 3870 would otherwise apply.
Employees

Employees: The recipient of an award is deemed to be an employee if the grantor
exercises, or has the right to exercise, sufficient control over that individual to
establish an employer/employee relationship as determined by law.
41
Public enterprise

Public enterprise: An enterprise whose equity securities trade in a public market, or is
one which has made a filing with a securities commission in preparation for the sale
of any class of equity securities in a public market, or is controlled by an enterprise
defined in (1) or (2).
Vesting

Vesting refers to the “earning of rights to” something. An award of stock-based
compensation becomes vested at the date on which the employee’s right to receive or
retain shares of stock or cash under the award is no longer contingent on the
employee remaining in the service of the enterprise or the achievement of a
performance condition (other than the achievement of a target stock price or
specified amount of intrinsic value).
Fair value of a stock option

The fair value of a stock option is determined using a model that, as of the grant
date, takes the following into account:
o
the exercise price;
o
the expected life of the option;
o
the current price of the underlying stock;
o
the expected volatility of the underlying stock;
o
the expected dividend; and
o
the risk-free interest rate.
Compensation cost

Section 3870 will cause volatility in the reported earnings of enterprises subject to its
requirements.

Compensation cost is now re-measured at each reporting date based on changes in
the underlying stock’s market value over the option’s exercise price.

Compensation cost will be amortized over the service or vesting period.

Furthermore, depending on the nature of the award, the employee’s ability to
demand cash instead of equity, and the company’s past practice, such awards may
have to be reported as liabilities on the balance sheet, rather than equity.
42
Direct awards of stock

Compensation expense should be recorded for direct awards of stock to employees
and non-employees.

For awards earned over a period rather than immediately, the compensation is to be
expensed over the service or vesting period.
Modification of an award

Normally, when an award is modified, it is deemed to have been cancelled and a new
award is issued.

However, if the modification results in an award becoming more valuable, the original
award is deemed to have been exchanged for a new award.

The incremental value must be measured and reported in the financial statements.
Repurchase of instruments

If an enterprise repurchases an equity instrument (option), the amount of cash or
other assets exchanged or the liabilities incurred are to be charged to equity.

If the amount paid exceeds the fair value of the instrument(s) repurchased, the
excess is shown as an expense on the income statement of the period in which the
repurchase takes place.
Business combinations

Section 3870 does not deal with business combinations. They are scoped out by
subparagraph 3870.06(a).

Appendix A of section 1581 requires that stock options granted as part of the
purchase consideration in a business combination be measured at their fair value and
included in the cost of the purchase.
Classification

If an instrument is to be settled in cash or other financial assets, the award is
classified as a liability.

If the award is to be settled with equity, the instrument is shown as equity.
43
New disclosure requirements

An enterprise must describe its accounting policy with respect to stock-based
compensation.

It must describe any employee plans and the general terms of such awards.

It must describe any non-employee plans, provided those plans are significant.

Section 3870 adds new requirements for the disclosure of the following:
o
Most disclosures are the same as those previously stipulated by EIC-98;
o
weighted average grant-date fair values of options and equity instruments
granted during the reporting period;

separate disclosure of weighted average exercise prices and weighted average fair
values of options, where the exercise price is less than, equal to, or greater than the
market price as of the date of the grant; and

a description of the method used, as well as any significant assumptions made, to
estimate the fair values of options, including weighted average information on riskfree interest rates, expected lives, volatilities, and dividends.
Requirements to account for stock-based awards

Stock-based awards granted to employees are accounted for using the fair value
method.

A direct award of stock must be accounted for at fair value. Stock options with a
nominal exercise price are considered direct awards of stock.
o
Awards that are required, or expected, to be settled in cash must be accounted
for as a liability and re-measured on an ongoing basis at each reporting date
based on changes in the fair value of the underlying stock.

Stock appreciation rights to be settled by issuing equity instruments are
measured, at the company’s option:


at fair value, or
in a manner similar to the accounting method applied to awards
that are required, or expected, to be settled in cash.
Compensation cost

When an enterprise accounts for stock-based compensation awarded to employees,
the other “side” of the transaction is the cost recognized.
44

This compensation cost is dependent on a number of factors, one of which is the
service period over which the instruments vest.
Vesting methods

Section 3870 defines two methods of vesting: graded and cliff.

The graded method is used when an award vests in specific quanta over a specific
period, for example, 25% over each of four years.

Each of the quanta is treated as a separate award, with each award having its own
separate service period and vesting date.

The cliff method is also known as the “rateable” method. Here, compensation cost is
recognized using the straight-line method over the service period, which is the period
of the award.

The key point is that the award vests at a specific time, for example, at the end of the
third year. Until that time, none of the award is vested. It is an all-or-nothing option.
Tandem awards

Tandem awards are the most troublesome of all employee stock-based compensation
arrangements.

These awards are stock options in form, but are direct awards in substance.

Their accounting is further complicated by the fact that the method of settlement
affects the choice.

If the method of settling the award is the employee’s choice, it must be accounted for
as a liability.

If the choice rests with the issuer, it is normally accounted for as an equity, unless
the enterprise has a history of settling in cash, in which case the award must be
accounted for as a liability.
Non-employee awards

Non-employees are grantees who are not employed by the granting enterprise. Nonemployee awards also include non-reciprocal transfers.

As with employee awards, section 3870 requires that all stock-based awards granted
to non-employees be accounted for at fair value.
Equity instruments
45

If tradable equity instruments are issued, the fair value of the instruments is used to
measure the transaction.

If non-tradable equity instruments are issued, the fair value of the goods and services
received or the fair value of the instruments issued is used to measure the
transaction, depending on which is more reliable.
Measurement date

The asset or cost is recognized as if cash had been paid.

The measurement date is the earlier of:
o
date performance is complete, or
o
commitment date.
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Section 4400 - 4470: Not-for-profit organizations
(Substantial changes Feb. 2009)
Background

In August 2007, the AcSB issued an omnibus exposure draft of proposed
amendments to, and a new section for, the not-for-profit part of the Handbook.

The amendments represent the first major revisions to the NFP material since the
4400 series of sections was issued in 1996.

Since 1996, there have been revisions to many of the Handbook sections on which
parts of the 4400 series were based; however, not all the amendments have been
carried forward to the corresponding section in the 4400 series.

The proposals in the exposure draft fall into three categories: new requirements,
changes to existing requirements, and conforming and clarifying amendments.

The objective of the proposals is to improve financial reporting by NFPs in the context
of current Canadian GAAP prior to the adoption of IFRSs as GAAP for publicly
accountable profit-oriented enterprises.

The first amendment was to provide additional guidance to clarify the application of
section 1100.

In particular, specific reference to Accounting Guidelines and EIC Abstracts as well as
other primary sources of GAAP in the Introduction to Accounting Recommendations
46
that Apply Only to Not-for-Profit Organizations was added to assist NFPs in applying
section 1100.


Next, amendments to the rReporting of internally restricted net assets and net assets
invested in capital assets were proposed:
o
section 4400 now better describes the different treatment accorded internal and
external restrictions on net assets in general, rather than on net assets invested
in capital assets, specifically.
o
An NFP reporting internally restricted amounts will now be required to disclose
what these amounts represent and how they were determined, including the
extent to which related debt has been taken into account.
Third, amendments related to the reporting gross amounts of revenues and expenses
were made:
o
Paragraph 4400.37 states that “revenues and expenses should be disclosed at
their gross amounts,” but the material that followed tended to undermine that
principle.
o
The proposals amend the existing language to make clear the objective of
paragraph 4400.37.

With respect to the Statement of cash flows, amendments to section 4400 will require
NFPs to apply section 1540.

As a result, NFPs will no longer be permitted to group cash flows from financing and
investing activities.

Changes related to Interim financial statements were also proposed.

Specifically, proposed amendments to section 4400 made section 1751 applicable to
the relatively rare situations where an NFP is required to prepare interim financial
statements in accordance with GAAP.

In order to clarify requirements related to capitalization, amortization and writedown of capital assets, amendments to section 4430 stipulate that an NFP that
chooses to recognize capital assets must subsequently depreciate them and assess
them for impairment.

A change to the reporting of controlled and related entities was proposed.

Amendments to section 4450 would require that all assets controlled directly or
indirectly by an NFP, and all obligations to which those assets are subject, be
recognized in the NFPs statement of financial position

Specifically, section 4450 would require all controlled entities to be consolidated.
47

The changes would eliminate the current consolidation exemption available when an
NFP has a large number of individually immaterial controlled organizations.

A conforming amendment to section 4460 would result in paragraph 4460.02
conforming with paragraph 3840.02 in respect of employee future benefits.

Finally, the disclosure of allocated fundraising and general support costs would be
expanded and reflected in a new Handbook section.

A new section 4470 will require NFPs that are making allocations of general support
and fundraising costs to other functions to disclose:
o
the policies adopted for the allocation of expenses among functions
o
the nature of the expenses being allocated
o
the basis on which such allocations have been made
o
the functions to which they have been allocated.

Furthermore, the allocations that are to be disclosed are those made after individual
expenses have been attributed among the functions to which they relate and all of
the expenses of a function have been accumulated within that function.

Comments were due November 15, 2007.

The AcSB intended to issue the revisions early in 2008, and they were to apply to
interim and annual financial statements relating to fiscal years beginning on or after
January 1, 2009 with the exception of the changes to section 4450.

The AcSB planned to extend the transitional period, for section 4450 only, for NFPs
that controlled a large number of individually immaterial organizations.

This action was intended to permit NFPs to make the necessary changes to their
accounting records in order to be able to consolidate these controlled, but
unconsolidated, organizations.

The revisions to section 4450 were to apply to interim and annual financial
statements relating to fiscal years beginning on or after January 1, 2012.

On May 26, 2008, the AcSB approved, subject to written ballot, a number of
amendments to the standards in the 4400 series of Handbook sections, with one
exception.

The AcSB did not proceed with proposed amendments to section 4450, pending the
outcome of its deliberations on the future basis for setting standards for the not-forprofit sector.
48

All of the other amendments proposed in the August 2007 exposure draft were
approved with no significant changes.
Effective date

The revisions will apply to interim and annual financial statements relating to fiscal
years beginning on or after January 1, 2009.
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Section 5021: Authority of assurance guidance
Effective date

In July 2005, the AASB issued new Handbook section 5021 setting out a Canadian
GAAS hierarchy.
Background

Section 5021 is based on the AICPA Statement on Auditing Standards No. 95,
Generally Accepted Auditing Standards.

Section 5021 provides guidance on the authority of recommendations, explanatory
material, interpretive publications, and other auditing and assurance publications that
a practitioner may refer to when performing an assurance engagement, or when
providing related services.

However, plans to update the Introduction to Assurance and Related Services
Recommendations to clarify the relative authority of italicized and non-italicized
wording were put on hold.

At issue are potential problems resulting from changing the drafting conventions used
in standards on a “go-forward” basis.

Doing so may result in terminology in older standards having different meanings than
in newer standards.

Similarly, changing the terminology in older standards to be consistent with new
drafting conventions may change the meaning of the older standards.

The U.S. and international standards on which Canadian standards are based often
have different structures and/or use different terminology.

Accordingly, the AASB will wait for the IAASBs Clarity Project — which deals with
matters such as drafting conventions used in standards as well as issues surrounding
their length, complexity, and structure — to finish.
49
Summary of requirements

Section 5021 categorizes GAAS into four classifications:
o
recommendations
o
explanatory material
o
interpretive publications
o
other auditing and assurance publications

Recommendations constitute the professional standards issued by the Auditing and
Assurance Standards Board (AASB) with which a practitioner must comply when
performing an assurance engagement.

They are contained in the CICA Handbook – Assurance, together with related
guidance in the form of explanatory material.

Explanatory material in the Handbook, including examples and appendices, provides
explanation and guidance on the recommendations.

This material provides additional information for a practitioner to consider in
exercising professional judgment when performing the engagement.

Interpretive publications are auditing and assurance guidance on the application of
recommendations issued under the authority of the AASB. These publications are not
standards for assurance engagements.

Interpretive publications include Assurance and Related Services Guidelines issued
under the authority of the AASB.

Other auditing and assurance publications include documents that have not been
issued under the authority of the AASB, such as:
o
auditing and assurance publications of the CICA not referred to above
o
auditing and assurance articles in CA Magazine and other professional journals
o
continuing education programs and other materials, textbooks, guide books,
audit programs, and checklists;
o
auditing and assurance publications of other auditing and assurance standard
setters
o
other auditing and assurance publications from organizations.
50

As of June 30, 2007, section 5021 lists the following as being “other auditing and
assurance publications”:
o
Risk Alert




o
Implementing audit risk and quality control standards, May 2007.
Auditor involvement with management's internal control certifications,
January 2007.
Responding to the special needs of regulators or funding bodies, March 2006.
Written consent to use of the audit report, January 2006.
Practice Advice

Annual bulletin, October 2006.

Section 5021 requires that a practitioner identify, understand, and comply with the
recommendations in the Handbook that are applicable to assurance engagements.

Departures are prohibited unless there are clear and compelling reasons.

The reason(s) for any departure, and how the alternative was sufficient to achieve the
objectives of the recommendations, must be documented.

Section 5021 also requires that a practitioner be aware of and consider interpretive
publications applicable to the assurance engagement.

If a practitioner ignores an applicable interpretive publication, the practitioner must
document how compliance with the recommendations addressed by such auditing and
assurance guidance was achieved.
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Section 5030: Quality control procedures for assurance engagements
Background

Unlike GSF-QC, section 5030, Quality control procedures for assurance engagements,
is part of GAAS.

Section 5030 establishes standards and provides guidance on the specific quality
control procedures to be performed by a practitioner and other members of the
assurance team in an assurance engagement.
Effective date
51

The recommendations were effective for assurance engagements concerning financial
statements and financial reports for periods commencing on or after December 1,
2005.

However, as with the general standard, the effective date of section 5030 for a firm
registered with CPAB was January 1, 2005.
Summary of changes

Section 5030 sets out specific responsibilities relating to the performance of each
assurance engagement for which a practitioner is responsible.

Specifically, section 5030 addresses:
o
the quality of the work performed and the promotion of a quality-oriented
culture;
o
determining that the assurance team, collectively, has the competencies,
resources and time necessary to complete the engagement;
o
the compliance of the assurance team with applicable ethical requirements,
including independence requirements, directed to practitioners and other
members of the assurance team when performing assurance engagements; and
o
various aspects of engagement performance such as planning, supervision and
review, consultation, resolving differences of opinion, and ensuring that an
engagement quality control review is performed when required.
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Section 5090: Audit of financial statements
Effective date

New changes are effective for audits relating to periods ending on or after December
15, 2004.
Summary of changes

Section 5090 has been amended to incorporate changes made to its equivalent ISA
200, International standard on auditing.

The 2004 amendments incorporate changes resulting from revisions to section 5135.

As before, there have been no changes to the fundamental responsibilities of any of
the parties — auditors, management, and the board of directors — to detect fraud.
52

The key change is the elimination of references to the assumption of management’s
good faith.

Professional scepticism plays an even bigger role than before.

Previously, when planning and performing the audit, the auditor neither assumed that
management was dishonest nor assumed unquestioned honesty.

Now, the auditor is required to plan and perform an audit with an attitude of
professional scepticism, recognizing that circumstances may exist that cause the
financial statements to be materially misstated.

The admonition that the auditor should not be obsessively sceptical nor overly
suspicious remains.

But there has been a change in perspective — one which may not sit too well with
many auditors and/or clients.

Section 5090 now requires that the auditor be alert for evidence that contradicts or
brings into question the reliability of documents or representations of management or
those charged with governance.

The auditor must approach the audit with an attitude that includes being alert for
indications of dishonesty.

Furthermore, notwithstanding prior experience indicating that management is honest,
the auditor must obtain corroborating evidence for management representations,
including responses to enquiries resulting from the performance of analytical
procedures.

If the auditor has specific reason to doubt management’s honesty and integrity, the
auditor should consider:
o
whether audit evidence may be compromised and if so, to what extent;
o
whether the risk of compromised audit evidence can be mitigated by different or
more extensive audit procedures; or
o
whether the auditor can even complete the audit.
ISA terminology

Because section 5090 has adopted ISA terminology, the term “management” now
excludes directors and members of the audit committee.

Section 5090 also introduced two terms commonly found in ISAs:
o
those charged with governance; and
53
o
those with oversight responsibility for the financial reporting process.

Thus, “management” refers to any person(s) having responsibility for planning,
directing, and controlling the activities of an entity.

While individual members of management might also be members of bodies charged
with governance, the functions relating to these activities are separate and distinct.
“Those charged with governance”

“Those charged with governance” refers to the board of directors or its committees,
including the audit committee or its equivalent body and, in some cases, individuals
whose responsibilities derive directly from the board’s governance responsibilities.
“Those with oversight responsibility for the financial reporting process”

“Those with oversight responsibility for the financial reporting process” refers to the
audit committee or, if there is no audit committee, to the equivalent responsible
body.

In the Handbook, “audit committee” is the term most often used to refer to those
with this oversight responsibility.
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Section 5095: Reasonable assurance and audit risk
Background

In May 2005, the AASB issued a series of new and revised Handbook sections dealing
with the audit risk model.

The new and revised standards:

o
call for an understanding of the entity and its environment, including internal
control;
o
define the concepts of reasonable assurance and audit risk;
o
require the auditor to assess the risks of material misstatement; and
o
specify that the auditor must design audit procedures that are responsive to
assessed risks and for audit evidence.
The standards apply to all audits in Canada, for both small and large entities.
Effective date
54

The new requirements are all to be applied at the same time and are effective with
respect to financial statements and financial reports for periods beginning on or after
January 1, 2006.
Summary of changes

Section 5095, Reasonable assurance and audit risk, is a new section that:
o
defines the concept of reasonable assurance;
o
notes that the auditor cannot obtain absolute assurance that the financial
statements are free from material misstatement because of various factors;
o
defines the concept of audit risk; and
o
permits the auditor to make separate or combined assessments of inherent and
control risk.
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Section 5110: Terms of the engagement

In July 2005, the AASB issued new Handbook section 5110 establishing standards
and providing guidance on agreeing to terms of an engagement relating to an audit of
financial statements.

Likewise, section 8200 was revised to incorporate guidance on agreeing to the terms
of an engagement relating to a review of financial statements.

Section 5110 is based on AICPA Audit Section 310, Appointment of the Independent
Auditor, and IAASB International Standard on Auditing 210, Terms of Audit
Engagements.

Section 8200 revisions are based on AICPA SSAR AR100, Compilation and Review of
Financial Statements, and IAASB ISA 910, Engagements to Review Financial
Statements.

Although there are specific sections in the Handbook that suggest obtaining a letter
relating to the terms of the engagement prior to section 5110, there was nothing that
required a signed engagement letter in order to carry out an audit engagement.

One could say that the AASB is finally doing what CGAs have been doing for years:
requiring a written engagement letter for all engagements.

A review of section 5110 shows that much of the guidance currently found in the
CGA-Canada Public Practice Manual is reflected in the Handbook.
55

The section specifies the expectations and responsibilities of the parties to the
engagement letter, namely the auditor and management.

Section 5110 identifies the responsibilities of both the auditor and management, and
stipulates that they be explicitly covered in the engagement letter.

The section provides an illustrative engagement letter that covers just about
everything but the kitchen sink (or maybe it is there in the fine print).

Section 5110 requires the auditor to:
o
establish an understanding of the terms of the engagement with the entity and to
document this in a written agreement;
o
include in the written agreement:
o
the objective, scope, and limitations of the engagement;
o
the responsibilities of the auditor;
o
the responsibilities of the entity’s management; and
o
other relevant and important matters.

Likewise, section 8200 specifies the expectations and responsibilities of the parties to
the engagement letter, namely the practitioner and management.

Like section 5110, section 8200 identifies the responsibilities of both the practitioner
and management, and stipulates that they be explicitly covered in the engagement
letter.

However, because the level of assurance provided by a review engagement is less
than an audit, the extent of the responsibilities is not nearly as extensive as for an
audit

Notwithstanding, for those areas of the engagement that are similar to an audit, the
responsibilities are similar.

Where they are less, the expectations are less.

Like section 5110, Appendix A to section 8200 is an illustration of an engagement
letter.

It is less substantial than for an audit, but no less thorough.
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Section 5135: The auditor’s responsibility to consider fraud
56
Effective date

This set of changes is effective for audits relating to periods ending on or after
December 15, 2004.
Summary of changes

Section 5135 was revised to narrow its scope to address only misstatements due to
fraud.

Material previously dealing with misstatements due to error was moved to sections
5095, 5142, and 5143.

Additionally, the material dealing with communication matters has been moved to
sections 5750 and 5751.

The revised section 5135 also introduced the concept of significant risk.

There are two requirements for significant risks:

o
The auditor must identify risks that are significant so as to require special audit
consideration.
o
The auditor must understand related control procedures to the extent that
identification has not yet been done.
The key changes are:
o
more emphasis on the respective responsibilities of auditors, management, and
those charged with governance with respect to fraud;
o
significantly more guidance on assessing the risks of misstatement due to fraud,
including requirements to make enquiries of management and others within the
entity, and understanding the role of those charged with governance;
o
discussion of earnings management;
o
significantly more emphasis on management’s ability to override internal controls
and management fraud generally;
o
classification of fraud risk factors into factors relating to incentive to commit
fraud, opportunity to commit fraud, and the ability to rationalize the fraudulent
act;
o
requiring procedures to be performed to address management’s ability to
override internal controls by requiring the testing of journal entries, reviewing
accounting estimates for bias, and understanding the business rationale for
significant transactions outside the normal course of business; and
57
o
requiring procedures to be performed to address the presumed risk of improper
revenue recognition.

Applying section 5135 requires the auditor to be able to distinguish between fraud
and error.

The auditor must be alert to the possibility that a material misstatement due to fraud
could exist, notwithstanding past experience with the entity about the honesty and
integrity of management and those charged with governance.
Error in financial statements

What is considered an error in financial statements?
o
mathematical or clerical mistakes in the underlying records and accounting data;
o
oversight or misinterpretation of facts; or
o
misapplication of accounting policies.
Fraud in financial statements

What is considered a fraud in financial statements?
o
manipulation, falsification, or alteration of records or documents;
o
misappropriation of assets;
o
suppression or omission of the effects of transactions from records or documents;
o
recording of transactions without substance; or
o
misapplication of accounting policies.
Fraudulent financial reporting

An example of fraudulent financial reporting is when a company ships customers’
goods that have not been ordered and then records the revenue as if it had met all
the criteria necessary for revenue recognition.

Another example is when a company’s employees provide customers with a side
agreement granting “right of return” for any reason. The side agreement is not
disclosed to the auditor because the underlying transaction would not meet the
criteria for revenue recognition under GAAP.
Distinguishing between fraud and error
58

The distinguishing factor between fraud and error is whether the underlying action
that results in the misstatement in the financial statements is intentional or
unintentional.

Unlike error, fraud is intentional and usually involves deliberate concealment of the
facts.

A properly conducted audit is less likely to detect fraud than error, and less likely to
detect management fraud than employee fraud.
Obtaining reasonable assurance

With respect to fraud and error, the auditor’s responsibility in planning an audit is
related solely to obtaining reasonable assurance concerning the absence of material
misstatements in the financial statements.
Evaluating misstatements

As part of the assessment of inherent and control risks, the auditor must now
evaluate how the financial statements might be materially misstated as a result of
fraud or error.

As part of the risk assessment, the auditor must consider whether fraud risk factors
are present.
Other specific changes


What are some specific changes in the section?
o
The audit team must regularly meet and discuss the susceptibility of the entity to
material misstatements arising from fraud or error.
o
The audit team must consider which matters should be communicated to those
members not involved in the discussions.
o
The auditor must obtain an understanding of how those charged with governance
exercise oversight of management’s processes for identifying and responding to
the risks of fraud and error in the entity and the internal control that
management has established to mitigate these risks.
o
The auditor must enquire of management, the audit committee (if there is one),
internal audit (if it exists), and other appropriate personnel within the entity,
whether they have knowledge of any actual, suspected, or alleged fraud affecting
the entity, and whether management has discovered any material errors.
The auditor must consider whether the information obtained during the course of the
audit indicates that one or more fraud risk factors are present.
59

The auditor performs this assessment in conjunction with the assessment of whether
the audit indicates risks of material misstatement due to fraud or error.

Fraud risk factors might include:



o
The need to meet expectations of third parties to obtain additional equity
financing.
o
The granting of significant bonuses if unrealistic profit targets are met.
o
An ineffective control environment.
Fraud risk factors that need to be considered in assessing the likelihood that the
financial statements may be materially misstated:
o
Management’s characteristics and influence over the control environment.
o
Industry conditions.
o
Operating characteristics and financial stability.
Fraud risk factors that need to be considered in assessing the likelihood that there are
misstatements resulting from the misappropriation of assets:
o
susceptibility of assets to misappropriation; or
o
lack of controls.
To respond to the risk of management override of internal controls, the auditor
should design and perform audit procedures to:
o
test the appropriateness of journal entries recorded in the general ledger and
other adjustments made in the preparation of financial statements;
o
review accounting estimates for biases that could result in material misstatement
due to fraud;
o
obtain an understanding of the business rationale of significant transactions that
are outside of the normal course of business for the entity or that otherwise
appear to be unusual given the auditor’s understanding of the entity and its
environment.

When a misstatement has been identified, the auditor should consider whether the
misstatement is indicative of fraud or error.

If fraud is suspected, the auditor should consider the implications of the misstatement
in relation to other aspects of the audit, particularly the reliability of management
representations.
60

When the auditor confirms that, or is unable to conclude whether, the financial
statements are materially misstated as a result of fraud or error, section 5135
provides guidance with respect to the implications for the audit and the auditor’s
responsibility to notify appropriate parties.

Notwithstanding, the auditor’s professional duty to maintain the confidentiality of
client information usually precludes reporting fraud and error to a party outside the
client entity.

However, there may be certain circumstances where this prohibition is not a factor.

The auditor should obtain legal advice in any case.

If a misstatement resulting from anything other than a trivial error is identified, the
auditor should communicate the misstatement to the appropriate level of
management on a timely basis and consider the need to report it to the audit
committee, whether or not the error has been corrected.

If the auditor has identified a fraud or obtains information that indicates that a fraud
may exist, that conclusion must be communicated to the appropriate level of
management on a timely basis.

Irrespective of other matters, the auditor should communicate to the audit
committee:
o
questions regarding the honesty and integrity of management;
o
fraud involving management;
o
fraud involving employees who have significant roles in internal control;
o
fraud, whether caused by management or other employees, that results, or may
result, in a non-trivial misstatement of the financial statements; and
o
matters that may cause future financial statements to be materially misstated.

If the auditor encounters exceptional circumstances that call into question the ability
to continue performing the audit, consideration should be given to the possibility of
withdrawing from the engagement.

If the auditor does withdraw from the engagement:
o
discuss the withdrawal with the appropriate level of management and the audit
committee, citing the reasons for the withdrawal;
o
consider whether there is a professional or legal requirement to report to
regulatory authorities the withdrawal and the reasons therefore.
61
Example: Conditions/events that increase risk





Integrity or competence of management
o
One person (or a small group of people) dominates management, and there is no
effective oversight board or committee.
o
There is a continuing failure to operate key controls or to attend to major
weaknesses in the internal control structure that are correctable.
o
There are frequent changes in key accounting and financial personnel as well as
in legal counsel and auditors.
Unusual pressures within an entity
o
Declining profits or rapid expansion have caused an inadequacy in working
capital.
o
The entity has a significant investment in an industry or product line that is noted
for changing quickly.
o
Accounting personnel are pressured to complete the financial reports in an
unusually short time period.
Market pressures
o
The industry is declining, and failures are increasing.
o
The industry is subject to specific or complex legislation.
o
The industry is volatile with numerous corporate takeovers or mergers.
Unusual occurrences and/or transactions
o
Unusual transactions, especially near the balance date, have a significant effect
on profit.
o
Payment for services (for example, to lawyers) appear excessive.
o
There is evidence of falsified documents.
Unsatisfactory records and/or problems in obtaining sufficient appropriate audit
evidence
o
Inadequate accounting records (for example, incomplete files, excessive
adjustments to accounts)
62
o
Inadequate documentation of transactions (for example, lack of proper
authorization, alteration to documents)
o
Excessive number of differences between accounting records and third party
confirmations, conflicting audit evidence, and inexplicable changes in operating
ratios
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Section 5141: Understanding the entity and its environment and assessing
the risks of material misstatement (replaced section 5140)


This new section 5141, requires the auditor to do the following:
o
understand the entity’s business risks to the extent they are relevant to the
financial statements
o
understand each component of the entity’s internal controls as defined in the
Treadway Report
o
obtain an understanding of the design and implementation of controls on all
audits
o
understand an entity’s risk assessment process and its monitoring of controls
o
specifically address significant risks
In addition, section 5141 places more emphasis on the following:
o
using various sources to obtain a broader understanding of the entity and its
environment, including its internal control
o
supporting the assessment of the risks of material misstatement at the financial
statement level and at the assertion level
o
adhering to more rigorous documentation requirements
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Section 5142: Materiality and audit risk in conducting an audit (replaced
section 5130)

The scope of section 5130, which previously dealt with materiality and audit risk, has
been narrowed in section 5142 to address only materiality.

Audit risk is addressed in section 5095.
63

The AASB intends to revise Handbook section 5142 to converge with ISA 320 and a
new ISA dealing with the evaluation of misstatements identified during the audit.

The revisions are closely linked with the planned revisions to Handbook section 5305
dealing with accounting estimates and Handbook section 6930 dealing with the audit
of group financial statements.

As with the accounting estimates project, the actual release date of a Canadian
exposure draft depends on when the IAASB finishes its Clarity Project.

It is expected that the IAASB will expose revisions to ISA 320 and its project on
identified misstatements in quarter 3 of 2006, and the AASB will issue its exposure
draft (based on the IAASB exposure draft) soon after.

The Canadian exposure draft will focus on section 5142 and AuG-41.

The following are key aspects of the revisions:
o
The definition of materiality is clarified — Materiality depends on the size and
nature of an item judged in the surrounding circumstances.
o
However, if the applicable financial reporting framework used to prepare the
financial statements provides a different definition of materiality, the auditor is to
use that definition for the purpose of the audit.
o
There will be guidance on the use of percentages as benchmarks for the initial
determination of materiality when establishing the overall audit strategy.
o
Notwithstanding, the auditor must consider whether misstatements less than the
materiality level determined for the financial statements as a whole could
reasonably be expected to influence economic decisions of users taken on the
basis of the financial statements.
o
Materiality is to reflect the auditor’s judgment of the needs of users in relation to
the information in the financial statements and the possible effect of any
misstatements.
o
However, in an audit of general purpose financial statements, the auditor’s
judgment as to matters that are material to users of the financial statements is
based on consideration of the needs of users as a group.
o
The auditor must communicate to management all known and likely
misstatements identified during the audit, other than those that the auditor
believes are clearly trivial, and request that management correct all known
misstatements.
64

o
Evaluation of uncorrected misstatements — determining materiality levels does
not mean that identified misstatements below the threshold are always
considered to be immaterial.
o
There may be circumstances related to some misstatements that can lead the
auditor to evaluate them as material even if they are of a lower level than that
the auditor had determined to be material when establishing the overall audit
strategy.
o
When evaluating whether the financial statements are free of material
misstatement, the auditor must consider both uncorrected misstatements and
the qualitative aspects of an entity’s accounting practices.
o
The cumulative effect of a lack of neutrality, together with uncorrected
misstatements that have been identified during the audit, may cause the financial
statements as a whole to be materially misstated.
It is anticipated that the AASB will issue an exposure draft by the end of 2006, with
the revisions to section 5142 and AuG-41 being approved in mid-2007.
back to top
Section 5143: The auditor’s procedures in response to assessed risks
Auditor’s procedures in response to assessed risks


This new section 5143 establishes standards and provides guidance on:
o
determining overall responses to assessed risks
o
designing and performing further audit procedures to respond to the assessed
risks of material misstatement at the financial statement and assertion levels
Section 5143 contains requirements for specifically addressing significant risks and
places more emphasis on:
o
directly linking assessed risks to audit procedures that are responsive to those
risks;
o
performing tests of controls when the auditor has determined that evidence
obtained from substantive procedures alone will not reduce risk to an acceptably
low level;
o
assessing whether, in certain circumstances, reliance can be placed on evidence
from prior periods;
o
obtaining evidence about disclosures; and
65
o
like section 5141, adhering to more rigorous documentation requirements.
back to top
Section 5145: Documentation

An exposure draft was issued in July 2005 with comments due August 31, 2005.

Although not part of the material related to the audit-risk model, the revised section
5145 is effective for financial statements and financial reports for periods
commencing on or after January 1, 2006.

This project revised section 5145, Documentation, to harmonize it with the revised
International Standard on Auditing 230, Documentation, and AICPA SAS No. 96, Audit
Documentation.

The revised section contains principles, procedures, and guidance on audit
documentation for the following:
o
audit of financial statements
o
audit of internal control over financial reporting
o
auditor’s review of interim financial statements

In addition, the project also added to General standards of quality control for firms
performing assurance engagements, GSF-QC, to incorporate guidance on policies and
procedures designed to maintain the confidentiality, safe custody, and retention of
engagement documentation.

The main features of the revised section 5145 follow:
o
establishing the overarching requirement for sufficient audit documentation
o
documentation of significant issues and findings in an engagement completion
document
o
guidance on making changes to audit documentation between the audit report
date and the date the auditor’s report is issued
o
documentation of audit evidence that the auditor has identified as being
contradictory or inconsistent with the final conclusions, and how the auditor
addressed the contradiction or inconsistency
o
assembly and completion of the final audit file within 45 days after the date the
auditor’s report is issued, after which nothing can be deleted from the file and
any additions or modifications must be explained and currently dated
66

o
the use of an experienced auditor as a point of reference for assessing the
adequacy of documentation
o
documentation of the identifying characteristics of the specific items tested
during the audit
o
identification of the preparer and reviewer the of audit documentation
The main features of the additions to GSF-QC follow:
o
introduction of a new element to the firm’s system of quality control, namely
engagement documentation
o
a requirement for a firm to establish policies and procedures designed to maintain
the confidentiality, safe custody, integrity, accessibility, and retrievability of
engagement documentation
o
a requirement for a firm to establish policies and procedures requiring the
retention of engagement documentation for a period sufficient to meet the needs
of the firm or as required by law or regulation

The revised standards apply to engagements in both the private and public sectors.

The amount and quality of audit documentation will likely be higher as a result of
these proposals.

For instance, practitioners would now be required to document inconsistent or
contradictory evidence as part of documenting final conclusions.
back to top
Section 5295: An audit of internal control over financial reporting that is
integrated with an audit of financial statements
(Material added Feb. 2009)
Background

In January 2008, the AASB issued section 5295, establishing standards and providing
guidance regarding the auditor’s responsibilities when engaged to perform an audit of
internal control over financial reporting that is integrated with an audit of financial
statements.

Section 5295 provides requirements related to:
o
management’s written assessment about the effectiveness of internal control
over financial reporting;
67
o
integrating the audit of internal control over financial reporting with the audit of
financial statements;
o
the use of suitable criteria;
o
planning and performing the audit, using a risk-based approach;
o
identifying and selecting controls to test, using a top-down approach;
o
testing controls selected;
o
evaluating identified deficiencies;
o
forming an opinion;
o
communicating certain matters; and
o
reporting on internal control over financial reporting.

Section 5295 requires the use of a top-down approach to select controls to test.

A top-down approach begins at the financial statement level and with the auditor’s
understanding of the overall risks to internal control over financial reporting.

The auditor then focuses on entity-level controls and works down to significant
accounts and disclosures and their relevant assertions.

This approach directs the auditor’s attention to accounts, disclosures, and assertions
that present a reasonable possibility of material misstatement to the financial
statements and related disclosures.

The auditor then verifies this understanding of the risks in the entity’s processes and
selects for testing those controls that sufficiently address the assessed risk of
misstatement to each relevant assertion.

Section 5295 is intrinsically linked with CSA MLI 52-109.

The definitions and requirements of the Handbook section are intended to ensure that
an entity required to comply with MLI 52-109 is able to do so.

Anyone affected by MLI 52-109 will need to be aware of section 5295’s requirements.

Section 5295 differs from many other Handbook sections in that virtually all of the
section is italicized.
Effective date

The section is effective for audits of internal control over financial reporting that are integrated
with audits of financial statements for periods beginning on or after January 1, 2008.
68
back to top
Section 5300: Audit evidence

New section 5300 revises and replaces the existing section 5300 to incorporate ISA
500, Audit Evidence, into the Handbook with as few changes as possible to conform
to existing Handbook references and terminology.

There are no substantive changes from the material in the previous version of section
5300.
back to top
Section 5301: Analysis

In August 2005, the AASB issued a revised Handbook section 5301 dealing with
analytical procedures.

The most visible change was to terminology.

Here, and in many other Handbook sections, the term analysis has been replaced
with analytical procedures.

The revised section 5301 incorporates concepts related to the new audit-risk model:

o
There is increased emphasis on the use of analysis and analytical procedures as
risk assessment procedures to obtain an understanding of the entity and its
environment, including its internal controls.
o
There is additional guidance provided when analytical procedures are used as
substantive procedures, showing how their use can be more effective or efficient
than tests of details in reducing the risk of material misstatement at the assertion
level to an acceptably low level.
o
There is additional guidance provided related to the use of analytical procedures
as an overall review of the financial statements at or near the end of the audit.
As with the rest of the material related to the audit risk model, the revised section
5301 is effective for financial statements and financial reports for periods
commencing on or after January 1, 2006.
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Section 5305: Accounting estimates

The AASB intends to revise Handbook section 5305 to converge with ISA 540.
69

The revisions are closely linked with planned revisions to the Handbook section 5142
on materiality.

While there are no plans to deal with fair-value measurements and disclosures in
section 5305, that aspect is lurking in the background.

The actual release date of a Canadian exposure draft depends on when the IAASB
finishes its Clarity Project.

It is expected that the IAASB will expose revisions to ISA 540 in quarter 3 of 2006,
and the AASB will issue its exposure draft (based on the IAASB exposure draft) soon
after.

Section 5305 will now contain requirements for greater rigour and scepticism in the
audit of estimates, excluding those related to fair-value measurements and
disclosures.

These requirements will focus on the auditor’s determination and documentation of
misstatements and indicators of possible management bias relating to individual
accounting estimates.

Key aspects of the revisions include the following:
o
Risk assessment procedures — the auditor will have to obtain an understanding
of the processes, including relevant internal controls, used by management to
make accounting estimates.
o
The auditor will also need to review the outcome of accounting estimates made in
the prior period financial statements.
o
Estimation uncertainty is defined as the susceptibility of a financial statement
item to a lack of precision in its measurement because the outcome of future
events is not known.
o
Therefore, the auditor must use the information gathered from the riskassessment procedures to determine which accounting estimates have high
estimation uncertainty and therefore require special audit consideration.

Misstatements — The difference between management’s judgment and the auditor’s
judgment concerning the reasonableness of accounting estimates will be considered a
“known misstatement involving subjective decisions.”

Therefore, the auditor must determine whether such a misstatement in fact exists.

Where an accounting estimate falls within a reasonable range of outcomes that is
greater than materiality, the auditor must determine whether the applicable financialreporting framework requires disclosure of the estimation uncertainty and, if so, to
evaluate the adequacy of such disclosure.
70

Where the auditor has determined that an accounting estimate gives rise to a
significant risk, the auditor must consider how management has assessed the effect
of estimation uncertainty:

The auditor must evaluate whether the significant assumptions made by management
provide a reasonable basis for the accounting estimate.

The auditor must evaluate whether and how management has considered alternative
assumptions or outcomes, and why they have rejected them.

It is anticipated that the AASB will issue an exposure draft by the end of 2006, with
the revised section 5305 being approved in mid-2007.
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Section 5310: Audit evidence considerations when an entity uses a service
organization
Background

In July 2005, the AASB issued a revised Handbook section 5310, Audit evidence
considerations when an entity uses a service organization.
Effective date

Like section 5970, the revisions in section 5310 are effective for financial statements
and financial reports for periods beginning on or after January 1, 2006.
Summary of changes


Section 5310 has been revised and expanded to set out requirements for the auditor
of an entity’s financial statements who uses a service auditor’s report when:
o
planning the audit;
o
assessing control risk at the entity;
o
using audit evidence obtained from substantive procedures performed by service
auditors; and
o
evaluating audit evidence.
Section 5310 also deals with the communication of internal control weaknesses and
the content of the auditor’s report when a service auditor's report is used.
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Section 5370: Management representations
Effective date

In August 2005, the AASB issued new Handbook section 5370 dealing with
management representations.
Summary of requirements

Section 5370 requires an auditor to obtain written representations from management
as part of the evidence obtained to support the conclusion in a report providing
assurance on financial statements

Section 5370 aligns Canadian standards with U.S. and international standards on
management representations.

Management’s written representations will need to be obtained for both an audit and
a review engagement.

Section 8200 was also been amended to require such representations, although the
level of detail is considerably less.

Section 5370 makes it clear that management representations are a complement to,
but not a substitute for, other audit procedures that the auditor must perform to
obtain sufficient appropriate evidence in order to be able to draw reasonable
conclusions on which to base the audit opinion.

In many ways, the section codifies practice that had been in place.

For example, the section states that if a representation from management is refuted,
the auditor should determine whether reliance on management’s other
representations is appropriate and justified.

This perspective had been part of the audit program for some time now.

Likewise, the requirement to obtain written representation is something that many
auditors already did as a matter of practice.

Section 5370 provides a “laundry” list of the representations required.

The goal is to confirm in writing any verbal statements made by management.

Written representations should address:
o
the financial statements;
o
completeness of information;
72
o
fraud and error; and
o
recognition, measurement and disclosure.

Specific representations are listed in paragraphs 5370.17 and .18.

Written representations must be signed by members of management with overall
responsibility for financial and operating matters whom the auditor believes are
responsible for and knowledgeable, directly or through others in the organization,
about the matters covered by the representations.

Current management with overall responsibility must sign the rep letter even if they
were not “management” during part of the period covered by the auditor’s report.

If current management refuses to sign the rep letter because they were not
management for the whole period, then the auditor is faced with a scope limitation.

A refusal by management to provide written representations required by the auditor
is a limitation imposed by the entity and constitutes a scope limitation, regardless of
whether the auditor is able to obtain the necessary evidence by performing
alternative procedures.

In such circumstances, the auditor should express a qualified opinion or even deny an
opinion.
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Section 5400: The auditor’s standard report
Background

Section 5400 was amended to deal with differential reporting under section 1300.

It clarifies the responsibilities of management and the auditor regarding the ability of
the enterprise to use, and the necessary documentation for, differential reporting.
Summary of changes
Auditor’s duty

Before completing the engagement, the auditor should:
o
be satisfied that the enterprise is a non-publicly accountable enterprise as
defined in paragraph 1300.02;
o
be satisfied that the enterprise meets the disclosure requirements of paragraph
1300.21; and
73
o

obtain evidence that each owner has consented to the application of differential
reporting options in accordance with paragraph 1300.13.
The auditor should obtain written representation from management confirming that:
o
the enterprise is a non-publicly accountable enterprise as defined in paragraph
1300.02;
o
management provided appropriate information to the owners regarding the
differential reporting options; and
o
management has obtained in writing the unanimous consent of the owners to the
application of each differential reporting option to the financial statements, which
are the subject of the audit, and this consent has not been withdrawn.
The Auditor’s Standard Report
I have audited the balance sheet of ......... as at .........., 20..., and the statements of
income, retained earnings and cash flows for the year then ended. These financial
statements have been prepared in accordance with Canadian generally accepted accounting
principles using differential reporting options available to non-publicly accountable
enterprises, as described in Note X to the financial statements.
The auditor’s report

The AASB intends to revise Handbook section 5400 along with a number of other
related sections in two phases.

The first phase will see section 5400 converge with ISA 700.

The second phase will specifically revise sections 5090, 5095, 5110, 5405, and 6550,
along with the examples to audit reports scattered throughout the Handbook.

The IAASB issued revised International Standard on Auditing 700, The Independent
Auditor’s Report on a Complete Set of General Purpose Financial Statements, in
December 2004.

ISA 700 expanded and updated the wording of the auditor’s report in order to
enhance readers’ understanding of the auditor’s role and the auditor’s report.

Key aspects of the revised ISA 700 follow:
o
better explanations of the respective responsibilities of management and the
auditor
o
an updated description of the audit process to reflect the new audit-risk
standards
74
o
clarification of the scope of the auditor’s responsibilities with respect to internal
control

Phase II will deal with a much more complicated issue:

There is a requirement for the auditor to “stand back” and assess whether the
financial statements are fairly presented.

While such a requirement is implicit in that the auditor must not be associated with
false or misleading information, GAAS does not currently explicitly require such a
perspective.

ISA 700 applies to the auditor’s report when the financial statements meet two
criteria: 1) that the financial statements are general purpose financial statements;
and 2) the financial reporting framework used is designed to achieve a fair
presentation.

Unfortunately, ISA 700 does not define the second criterion.

If it is not met, the auditor is required to report under ISA 800,The Auditor's Report
on Special Purpose Audit Engagements, which means that the auditor does not qualify
the opinion but gives a “properly prepared in accordance with the framework” form of
opinion.

The problem is that Canadian GAAS is based only on the first criterion.

The auditor’s opinion on general purpose financial statements is always based on the
“fairly presents” form and on the assumption that the framework is designed for such
a presentation.

If the statements do not conform to the framework, then a qualified opinion must be
issued.
Effective date

It is anticipated that the AASB will issue the Phase I exposure draft by the end of
2006, with the revised section 5400 being approved in mid-2007.

The Phase II exposure draft will likely follow the completion of Phase I, with a final
Handbook release expected quarter 1 in 2008.
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Section 5970: Auditor’s report on controls at a service organization
(replaced section 5900)
Background
75

In 2004, the AASB began a project to update and expand auditing and assurance
standards and guidance for engagements to provide assurance on controls at a
service organization, and for the use of assurance reports as evidence in a financial
statement audit as well as in assurance engagements to report on internal control
over financial reporting.

The project was initiated due to the following:
o
Existing Handbook material was over 15 years old.
o
There had been an increase in outsourcing activity, especially for IT-related
services.
o
There had been an increase in the cross-border flow of outsourced services,
which puts additional pressures on organizations to comply with legislation such
as the Sarbanes-Oxley Act.
o
There had been an increased focus on reporting on internal controls (for
example, various regulatory requirements for internal control reporting).
o
There had been increased focus on measuring and adhering to compliance
requirements in service level agreements between service organizations and their
clients.
Effective date

In July 2005, the AASB issued new Handbook section 5970, Auditor’s Report on
Controls at a Service Organization, to replace section 5900, Opinions on Control
Procedures at a Service Organization.

The section is effective for financial statements and financial reports for periods
beginning on or after January 1, 2006.

Section 5970 conforms terminology with section 5025, SAS 70, and the revised auditrisk framework.

More precisely, it is harmonized with SAS 70 for the specific regulatory issues related
to the Sarbanes-Oxley Act and the Ontario Securities Commission Investor
Confidence Rules and for auditor-to-auditor communications in financial statement
audits.

Section 5970 includes requirements for service auditors related to matters such as
the following:
o
the service auditor’s procedures
o
use of the work of others
76

o
changes in the service organization’s controls
o
complementary user organization’s controls
o
subsequent events
o
consideration of significant deficiencies in the design and/or operation of controls
o
reports on controls placed in operation and tests of the operating effectiveness of
controls
o
communications of matters such as illegal acts, fraud and uncorrected errors
o
distribution of reports and reporting on substantive procedures
Section 5970 provides guidance for service auditors who issue reports on controls at
a service organization when those reports are intended only for the use of user
organizations and their auditors.
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Section 6550: Subsequent events
Background

An exposure draft was released in June 2005, with comments due for August 10.

This project complements the accounting project intended to revised Handbook
section 3820.
Summary of changes

Based on ISA 560, Subsequent events, these revisions focus on procedures designed
to determine whether management has identified subsequent events.

The principal change is to revise paragraph 6550.04 to add several matters to the list
of procedures performed by the auditor when auditing subsequent events.

Specifically, the revisions require auditor to do the following:
o
make enquiries to obtain an understanding of the procedures management has
established to ensure that subsequent events are identified
o
expand the list of specific matters that might require adjustment to and/or
disclosure in the financial statements
77

Note that the auditor is not expected to perform a continuing review of all matters to
which previously applied procedures have provided satisfactory conclusions.

The revised section 6550 is effective for financial statements and financial reports for
periods commencing on or after January 1, 2006.
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Section 6930: Audit of group statements
Background

The AASB intends to revise Handbook section 6930 to converge with ISA 600.

Section 6930 applies where there is reliance by one auditor (the primary auditor) on
the report and work of another auditor (the secondary auditor) when reporting on
financial statements that include financial information from the financial statements
reported on by the secondary auditor.
Summary of proposed changes

Key aspects of the revisions follow:
o
the definition of “related auditor”
o
the group auditor’s procedures in relation to both significant components and to
the work of other (related and unrelated) auditors — including the meaning of
the term “involvement”
o
access to information and the effect that a restriction may have on the group
auditor’s report
o
materiality
o
the structure of the revisions — in particular, whether they reflect a risk-based
approach
o
the use of percentages to determine financial significant components
o
the elimination of the division of responsibility — in particular, whether the
revisions should explicitly require sole responsibility and prohibit reference to
another auditor in the group auditor’s report.
Effective date

Although the AASB issued an exposure draft in March 2006, it is not expected that
the revised section 6930 will be approved before the end of 2006.
78

The AASB intends to wait until the IAASB completes its review of the topic, especially
in light of any changes that might be required because of the Clarity Project.
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Section 7200: Auditor assistance to underwriters and others
Background

Section 7200 was the first stage in a project to revise and expand section 7100, The
auditor’s involvement with prospectuses and other offering documents.

Section 7200 represents a codification of the best practices already in effect in
Canada and the United States.
Summary of changes
Terms

The term “auditor” is used in section 7200 to refer to any public accountant engaged
by, or on behalf of, an issuer of securities to provide assistance to an underwriter or
other party requesting a comfort letter, regardless of whether the public accountant is
the auditor or the issuer.
Communication issues

Section 7200 does not deal with communications issued in connection with the
purchase or sale of a business through securities transactions other than through an
offering document (for example, a report on a purchase investigation).
Due diligence meetings

Paragraphs 7100.55-.62 dealing with letters to underwriters were withdrawn and the
material was incorporated into section 7200.

Recommendations dealing with an auditor’s participation in “due diligence” meetings
with underwriters were added.
Four principles

The recommendations are based on four underlying principles:
o
Only the underwriter can determine what is necessary for a reasonable investigation.
o
A statement made by a professional accountant or auditor, written or oral, will be taken to
add credibility to the subject matter of the statement.
79
o
In order to make a statement that would be appropriately supported, an auditor:
o
needs to possess adequate knowledge of the subject matter;
o
act with due care and an objective state of mind.
o
An auditor should not provide assurance, positive or negative, unless there are
suitable criteria that can be applied in reaching the conclusion expressed.
International offerings

When all or part of a securities offering is made in other countries, the auditor needs
to consider whether procedures need to be extended or otherwise modified in
response to foreign regulatory requirements or the request of the underwriters.

When asked to carry out an audit under foreign standards, a Canadian auditor may
use the standards of the country in which the offering is made, provided that the
auditor meets the general and examination standards set out in section 5100 and
adheres to the applicable rules of professional conduct.

Reporting in accordance with the reporting standards of another country would
require knowledge of, and adherence to, all of the auditing standards of that country.

In a cross-border offering, if the audit has been conducted in accordance with
Canadian GAAS, the auditor may draw attention to that fact in the comfort letter and
point out that there may be differences between Canadian auditing standards and
those of the foreign country or countries in which the offering is made.
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Section 8200: The review engagement report
Background

Before completing the engagement, the public accountant should obtain the same
“satisfaction” that is required for the audit report.

The public accountant should obtain the same written representation from
management that is required for the audit.

In August 2005, the AASB issued new Handbook section 5370 dealing with
management representations.

Section 5370 requires an auditor to obtain written representations from management
as part of the evidence obtained to support the conclusion in a report providing
assurance on financial statements.
80

Management’s written representations will need to be obtained for both an audit and
a review engagement.
Summary of changes

Section 8200 has been amended to require such representations, although the level
of detail is considerably less.

Section 8200 calls for the practitioner to obtain management’s written
representations on matters that are important to support the content of the report.

Paragraph 8200.31 provides an indication of the sort of representations required, but
they are nowhere near as extensive as those of section 5370.

However, section 8200 follows section 5370 when management refuses to provide
written representation.

Section 8200 requires the practitioner to express negative assurance with a
qualification or a denial of assurance in the review engagement report if management
refuses to provide the written representation required.

As with an audit, this constitutes a scope limitation.
The Review Engagement Report
To (person engaging the public accountant)
I have reviewed the balance sheet of Client Limited as at (Date) and the statements of
income, retained earnings and cash flows for the year then ended. My review was made in
accordance with Canadian generally accepted standards for review engagements and,
accordingly, consisted primarily of enquiry, analytical procedures and discussion related to
information supplied to me by the company.
A review does not constitute an audit and, consequently, I do not express an audit opinion
on these financial statements.
Based on my review, nothing has come to my attention that causes me to believe that these
financial statements are not, in all material respects, in accordance with Canadian generally
accepted accounting principles.
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Section 9110: Agreed-upon procedures regarding internal control over
financial reporting
Background
81

Section 404 of the Sarbanes-Oxley Act (SOX) requires the auditor to provide an
opinion on management’s assessment of internal control over financial reporting
(ICFR).

Section 404 of SOX also requires the auditor to provide his own opinion on the
entity’s system of internal control over financial reporting.

In March 2003, the AASB approved a project to develop general standards for
reporting on ICFR and to revise Section 5220 as required.

In December 2003, the AASB began work to develop a generic Canadian standard
that would be harmonized with both the PCAOB standard for public companies and
with the AICPA standard for other entities.

In October 2004, the AASB issued an exposure draft that reflected the US standard
approved by the PCAOB in March 2004 and by the US SEC in June 2004.

In February 2005, the AASB approved, subject to written ballot, a new standard, An
Audit of Internal Control over Financial Reporting Performed in Conjunction with an
Audit of Financial Statements.

In February 2005, the CSA issued for comment its proposed MLI 52-111 to deal with
the fact that MLI 52-109 did not require certification regarding ICFR.

The MLI was supposed to be effective for fiscal periods ending on or after June 30,
2006, subject to certain exemptions, including the market capitalization of issuer.

In July 2005, the CSA announced a one-year delay in the effective date of the
proposed MLI, ostensibly to allow time to study the impact of SOX 404 in the US.

On March 10, 2006, the CSA announced that it would not proceed with MLI 52-111.
Instead, MLI 52-109 would be expanded to require certain disclosures intended for
52-111.

Unlike section 404, an issuer would not be required to obtain from its auditor an audit
opinion concerning management’s assessment of the effectiveness of ICFR, nor would
the auditor be required to provide an opinion on ICFR.

In February 2007, the PCAOB proposed revisions to Auditing Standard No. 2.

In March 2007, the CSA proposed revisions to MLI 52-109 to require the certification
of the operating effectiveness of internal control over financial reporting.

Accordingly, the AASB decided that a Canadian standard regarding the audit of ICFR
should be developed based on the PCAOBs proposed revisions to Auditing Standard
No. 2. The standard would be “generic” in that it may be applied in any case when an
entity is required or opts to have an audit of internal control over financial reporting.
82
As noted, the CSA amended MLI 52-109 to require that management provide specific
certifications related to ICFR.

Worried that practitioners would not be able to function on their own, the AASB
concluded that a standard was needed to assist public accountants in providing
services to their clients in relation to their regulatory certifications. The outcome was
section 9110, Agreed-upon procedures regarding internal control over financial
reporting.
Effective date

Section 9110 is effective for agreed-upon procedures engagements regarding ICFR
entered into on or after May 1, 2007.
Summary of requirements

Section 9110 specifies that that the public accountant is not engaged to provide
assurance or an opinion on internal control, but to report findings from performing
the agreed-upon procedures engagement so that the engaging party may use the
public accountant’s report and other available information to form their own opinion
on internal control over financial reporting.

Section 9110 also specifies that responsibility for the sufficiency and appropriateness
of the agreed-upon procedures remains with the engaging party, although the public
accountant may discuss the procedures to be performed and come to agree on the
procedures.

The key is that it is the engaging party who is responsible for specifying the
procedures to be performed. Moreover, it is the engaging party who is responsible
for determining that the agreed-upon procedures are sufficient and appropriate for
their purposes.

Section 9110 also provides guidance on the form and content of the report that the
public accountant issues in connection with such an engagement.
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Section 9200: Compilation engagements
Background

In 2005, the AASB proposed to converge section 9200 with International Standard on
Related Services 4410, Engagements to Compile Financial Statements (ISRS 4410),
taking into consideration Canadian specific circumstances.
83

In March 2006, the AASB decided to reduce the scope of the project until such time
as the Accounting Standards Board (AcSB) completed its research into reporting
models for non-publicly accountable enterprises.

At the same time, pressure to amend section 9200 came from those who argued that
the enactment of the Independence Standards placed an unreasonable burden on
practitioners who prepared compilation reports.

They noted that section 9200 focused on what the practitioner didn’t do (has not
audited, reviewed or otherwise attempted to verify the accuracy or completeness of
the information …), rather than what was done (book-keeping services), and they
suggested that this was inconsistent with the Independence Standards.

In June 2006, the AASB issued an exposure draft proposing changes to section 9200.

In April 2007, the AASB released Handbook update 28 with revisions to section 9200.
Effective date

The amendments are effective for compilation engagements and Notice to Reader
communications issued on or after July 1, 2007.
Summary of changes

The two most critical changes relate to the scope of the section and the wording of
the Notice to Reader communication attached to compilation engagements.

The change in scope relates to tax-based engagements.

Section 9200 does not apply to financial information presented solely in, or
incorporated by reference in, government-prescribed tax or other forms such as
corporate, trust or personal income tax return forms.

Financial information excluded from section 9200 must be accompanied by a
disclaimer from the public accountant stating “prepared solely for income tax
purposes without audit or review from information provided by the taxpayer.”

The troublesome aspect of this exclusion is that it should only take place “when it
does not purport to convey the financial position and the results of operations of the
enterprise” — a full set of statements for tax purposes does purport …

The other change relates to the Notice to Reader communication itself:
o
Previously, the report [paragraph 9200.23(b)] included the disclaimer that the
public accountant has not audited, reviewed or otherwise attempted to verify the
accuracy or completeness of such information. The highlighted material is now
gone.
84
o
The report [paragraph 9200.25(b)] now states that the public accountant has not
performed an audit or a review engagement on such information.
o
There is no comment regarding the accuracy or completeness of the information.
o
Readers, you’re on your own.
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GSF-QC: Quality control standards
Background

GSF-QC General standards of quality control for firms performing assurance
engagements — GSF-QC — was the first standard to be published in the CICA
Handbook — Assurance that is outside assurance standards.

Notwithstanding, it forms part of generally accepted auditing standards for auditors.

GSF-QC establishes a framework and provides guidance on quality-control policies
and procedures applicable to assurance engagements (collectively, “the system of
quality control”) to be established by a firm that performs assurance engagements.
Effective date

The recommendations were effective December 1, 2005.

However, for a firm registered with CPAB, the effective date was January 1, 2005.
Summary of changes


A firm must establish a system of quality control designed to provide it with
reasonable assurance of the following:
o
the firm and its personnel comply with professional standards and regulatory and
legal requirements
o
that reports issued by the firm or the practitioner are appropriate in the
circumstances
Specifically, a firm must establish policies and procedures designed to provide the
firm with reasonable assurance of the following:
o
It and its personnel maintain independence in all required circumstances, and it is
notified of breaches of independence requirements.
85
o
It identifies and assesses the potential sources of risks associated with a client
relationship or a specific assurance engagement.
o
It has sufficient personnel with the competencies and commitment to ethical
principles necessary to perform its assurance engagements.
o
Any assurance team assigned to an engagement collectively possesses the
competencies necessary to complete the engagement.
o
Appropriate consultation takes place on difficult or contentious matters.
o
Sufficient resources are available to enable consultation to happen.
o
Differences of opinion are dealt with and resolved.
o
It deals appropriately with complaints and allegations that its work fails to comply
with professional standards and regulatory and legal requirements.
o
Appropriate documentation is available to provide evidence of the operation of
each element of its system of quality control.

Lastly, a firm must establish policies and procedures requiring an engagement
quality-control review for all audit engagements to report on the financial statements
of a public enterprise.

A firm must also establish criteria for considering whether such a review should be
performed for other assurance engagements.
Additions to GSF-QC

The main features of the additions to GSF-QC follow:
o
introduction of a new element to the firm’s system of quality control, namely
engagement documentation
o
a requirement for a firm to establish policies and procedures designed to
maintain the confidentiality, safe custody, integrity, accessibility, and
retrievability of engagement documentation
o
a requirement for a firm to establish policies and procedures requiring the
retention of engagement documentation for a period sufficient to meet the needs
of the firm or as required by law or regulation

The proposed standards would apply to engagements in both the private and public
sectors.

The amount and quality of audit documentation will be likely be higher as a result of
these proposals.
86

For instance, practitioners would now be required to document inconsistent or
contradictory evidence as part of documenting final conclusions.

An exposure draft was issued in July 2005 with comments due August 31, 2005.

Barring the need for re-exposure, it is expected that the new and revised material will
be issued by the end of the first quarter of 2006.
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Adopting International Financial Reporting Standards (IFRS)
(Substantial changes Feb. 2009)

In January 2006, the AcSB announced its decision to move financial reporting for
Canadian publicly accountable enterprises to a single set of “globally accepted highquality standards” — namely, IFRSs issued by the IASB.

At that point in time, the term “publicly accountable enterprises” was used in the
same sense as that of section 1300 of the Handbook.

As such, it would encompass both “public” companies and entities having relatively
large or diverse classes of financial statement users.

In November 2006, the AcSB amended the definition to be consistent with the one
used by the IASB in its project relating to IFRS for SME organizations.

An entity has public accountability if:

o
it has issued debt or equity securities in a public market; or
o
it holds assets in a fiduciary capacity for a broad group of outsiders.
Effectively, the definition is such that it applies to all entities other than those
described in the chart below.
87

The onus will fall on management to demonstrate that an entity falls within one of the
scope exclusions in order to be exempt from mandatory adoption of IFRS.

In September 2008, the AcSB further refined the definition:
o
A PAE is a profit-oriented entity that has issued (or is in the process of
issuing) debt or equity securities that are (or will be) outstanding and traded in
a public market, or holds assets in a fiduciary capacity for a broad group of
outsiders.

“A public market” is defined in section 1300, Differential Reporting.

NFPs do not fall within the definition, even if such an organization happens to meet
one or more of the criteria for a profit-oriented enterprise to be considered a PAE. In
February 2008, the AcSB confirmed that publicly accountable enterprises will be
required to report using the Canadian version of IFRS-based standards for fiscal
periods beginning on or after January 1, 2011.

In February 2008, the AcSB confirmed that publicly accountable enterprises will be
required to report using the Canadian version of IFRS-based standards for fiscal
periods beginning on or after January 1, 2011.
88

One must pay special attention to the precise words used by the AcSB — “IFRS-based
standards.”

Compliance with local standards will result in compliance with IFRS.

Why? Doing it this way leaves the CICA Handbook as the source of GAAP, rather than
having firms use IASB publications.

To be fair, most federal, provincial and territorial laws, regulatory rules and other
requirements related to financial reporting specifically refer to “GAAP as reflected in
the CICA Handbook.”

Therefore, IFRSs have to be imported into Canadian GAAP, and be described as
Canadian GAAP, until changes are made by the relevant bodies.

Notwithstanding, the AcSB intends that IFRSs — without modification — replace
Canadian GAAP for profit-oriented Publicly-Accountable Enterprises (PAEs).

The adaptation of IFRS for country-specific needs has not generally worked well in
practice and defeats the objective of global harmonization.

In addition, should Canada modify IFRS for Canadian-specific circumstances, this will
deviate from the official IASB-issued IFRSs.

The official IFRSs are the only IFRSs accepted by the SEC for foreign private issuers.

Furthermore, the Canadian Securities Administrators (CSA) will only accept financial
statements compliant with IFRSs as issued by the IASB.

In addition, the IASB-issued IFRSs are also required under IFRS 1 — First-time
adoption of IFRS.

Annual reports for years ending December 31, 2008 and 2009 will have to disclose an
enterprise’s plan for convergence and any anticipated effects that will arise with the
change to IFRSs, with 2009 reports providing a greater degree of quantification of the
effects of the change.

Annual reports for years ending December 31, 2010 will be the last year of reporting
under current Canadian GAAP.

Annual reports for the year ending December 31, 2011 will be the first year of
reporting under IFRS-based Canadian GAAP.

It is anticipated that the AcSB will maintain separate versions of the Handbook
(pre/post IFRS) as it currently does with its pre/post financial instruments versions.
89
Figure 1. IFRS Conversion Timeline

In May 2008, the CSA issued Staff Notice 52-320, providing guidance to an issuer on
disclosure of expected changes in accounting policies relating to an issuer’s
changeover to International Financial Reporting Standards as the basis for preparing
its financial statements.

The guidance applies to disclosure relating to each financial reporting period in the
three years before the first year for which an issuer prepares its financial statements
in accordance with IFRS.

Essentially, the CSA Staff Notice reinforces the CICA requirements to begin disclosing
information as early as interim statements prepared in 2009.

Amendments to Canadian GAAP up until 2010 will be focused on aligning Canadian
GAAP with IFRS as the need arises.

For example, the revisions to sections 3031, 3862 and 3863 resulted in Canadian
GAAP that is essentially the same as international requirements.

Furthermore, proposed new and/or revised requirements for sections 1582 (Business
Combinations), 1601 (Consolidated Financial Statements),1602 (Non-Controlling
Interests) and 3056 (Joint Arrangements) will result in Canadian GAAP that is
virtually the same as the related IFRS.

Consequently, the “switchover” to IFRS will be more a case of creeping
incrementalism than a clear change in reporting requirements.
90

In April 2008, the AcSB released an exposure draft entitled Adopting IFRSs in
Canada.

The ED itself was only 13 pages — but it came with a 2,400 page appendix — all
IFRSs as of January 1, 2007!

The goal of the ED was not seek comments on individual issues, but rather to identify any areas
where problems could arise.

In its review of comments received, the AcSB noted that respondents presented no compelling
arguments for why one or more of the IFRSs exposed in the omnibus ED should not be applied in
Canada.

It further noted that a large majority of respondents were not concerned about the
possibility of some entities in Canada choosing to adopt IFRSs in advance of the
mandatory changeover date.

Therefore, the AcSB decided to continue with its plans to incorporate the IFRSs
exposed in the omnibus ED into the Handbook in mid-2009.

If the preceding deals with publicly-accountable entities, what about private (i.e.,
non-publicly accountable) entities?

When it announced the “move” to IFRS early in 2006, the AcSB noted that “one size
does not necessarily fit all” and stated that it would pursue separate strategies for
public and private enterprises.
91

The AcSB proposed a comprehensive examination of the needs of the financial
statement users of private enterprises to determine the most appropriate financial
reporting approach.

In May 2007, the AcSB published an Invitation to Comment [ITC] and a Discussion
Paper [DP] to solicit stakeholders’ views as to the best approach.

Possibilities ranged from a set of standards not very different from current standards
to a set of standards substantially different from current standards to something “in
between.”

Tentative conclusions set out in the ITC and DP included the following:

o
The private enterprise standard will be a GAAP standard developed to meet the
needs of significant external users.
o
All private enterprises will be eligible to apply the private enterprise GAAP —
there will be no size tests to restrict who can use it.
o
All private enterprises will be eligible to apply the standards applicable to public
enterprises if they so choose.
o
From about 2011, those [public] standards will be International Financial
Reporting Standards (IFRSs).
o
The same conceptual framework (i.e., financial statement concepts) will apply to
private and public enterprise GAAP.
The DP identified three approaches to developing private enterprise GAAP:
o
a top-down approach based on public enterprise GAAP (i.e., IFRSs) but
providing for differences on certain topics (essentially section 1300’s approach);
o
adoption of the proposed IASB IFRS for Small and Medium-sized Entities [IFRS
SME] standard when finalized, possibly with some modification; or
o
an independently developed set of standards

The AcSB set October 31, 2007 as the deadline for comments.

The AcSB planned to develop the individual standards once they assessed feedback
from constituents.

The timing of development and implementation of private enterprise standards would
vary depending on the approach taken.

The DP also addressed enterprises with no significant external users.
92

These enterprises argued that GAAP is of little benefit to them.

They supported a system which shared some of the basic requirements of the GAAP
financial reporting — for example the definitions of assets, liabilities, revenues and
expenses — but expressed in a basic fashion.

At the time the DP was issued, there was a view that a non-GAAP solution could open
up a wide range of possibilities — a tax basis of accounting, a modified cash basis of
accounting, and/or a less complex version of GAAP were all possible under such an
initiative.

The DP suggested that the defining factor in determining which standards would be
appropriate for non-publicly accountable enterprises was whether the entity had
significant external users.

In June 2008, the AcSB issued its FYI Bulletin outlining decisions taken by the Board
during the previous six months.

The most critical decision taken was that neither full IFRSs nor the proposed IFRS for
SMEs would be used as a starting point for standards applicable to private
enterprises.

Instead, a “made in Canada” version would be created.

There will be no size test — an entity will not be subject to a size test or other
qualifiers such as unanimous consent as a condition of applying the standards for
private enterprises.

Private enterprises will be given a free choice to elect to follow (a) full IFRS, (b) these
standards being developed, or (c) no specific standards at all.

The conceptual framework will be the same for both publicly and non-publicly
accountable enterprises.

The definitions of assets, liabilities, revenue and expenses and the
recognition/derecognition criteria must be the same.

This does not rule out differences from standards applicable to publicly accountable
enterprises — the cost/ benefit constraint will be the basis for differences.

Standards must be developed based on user needs, recognizing that creditors are the
most frequent user of private enterprise financial statements.

The existing CICA Handbook − Accounting will be used as a starting point for drafting
purposes.

The AcSB noted that there had been a strong demand from stakeholders to produce
the standards for private enterprises as soon as possible, and this factor appears to
93
be the basis for the AcSB’s decision to base private enterprise standards on the
existing Handbook.

Despite the decision to craft a made-in-Canada solution to private company reporting
standards, the AcSB position is that these standards must be linked to standards for
publicly accountable enterprises.

This connection facilitates users’ understanding of financial reports and eases the
burden on education and training.

Nevertheless, the AcSB acknowledged that there are a number of areas in the
existing Handbook that are problematic for private enterprises.

These areas will be examined and if appropriate, changes will be made to the
standards, primarily based on cost/benefit considerations.

The AcSB identified the problematic areas as financial instruments, consolidation and
accounting for affiliates, future income taxes, asset retirement obligations, employee
future benefits, leases, current/non-current classification, goodwill and intangible
assets, and stock-based compensation.

A complete reconsideration will be given to the existing disclosure requirements.

The AcSB expects the disclosure requirements in the standards for private enterprises
to be significantly fewer than in the existing Handbook.

Finally, sections, Accounting Guidelines and EIC Abstracts that are relevant only to
publicly accountable enterprises will be excluded.

For example, sections such as 1701, 1751, and 3500 have already been identified as
being excluded from private company reporting standards.

One interesting decision taken by the AcSB is that it may permit not-for-profit
organizations to apply the standards for private enterprises, supplemented with
additional standards addressing unique circumstances of NFPs.

Anyone who could be affected by either (or both) the private company standards or
the NFP standards should regularly check the CICA’s web site to determine if any
updates to the preceding have been made.
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The Clarity Project

In 2005, the IAASB announced its Clarity Project, whereby it intends to improve the
clarity of ISAs through the following measures:
94

o
using the word “shall” to clearly identify the requirements that a professional
accountant is expected to follow in the vast majority of engagements
o
eliminating possible ambiguity about the requirements a professional accountant
needs to meet arising from the use of the present tense in current ISAs, including
elevating some present tense sentences to requirements
o
setting an objective in each ISA
o
making structural improvements to enhance the overall readability and
understandability of the standards
The IAASB plans to begin by revising the following ISAs:
o
ISA 240, The Auditor’s Responsibility to Consider Fraud in an Audit of Financial
Statements
o
ISA 300, Planning an Audit of Financial Statements
o
ISA 315, Understanding the Entity and its Environment and Assessing the Risks
of Material Misstatement
o
ISA 330, The Auditor’s Procedures in Response to Assessed Risks

Redrafted ISAs will contain four principal sections: Introduction, Objectives,
Requirements, and Application Material. Where appropriate, a fifth section —
Definitions — will be added.

The separation of requirements from application material is a significant structural
change from existing ISAs and, given the AASB plan to adopt ISA standards as
Canadian GAAS, this change will have a major impact on the future direction of
Canadian auditing standards.

The AASB began its move in January 2006 when it issued an exposure draft with the
lofty title of Improving the Clarity of Canadian Auditing Standards
— Phase One.

The first goal of the exposure draft was to conform Handbook sections 5135, 5141,
5143 and 5150 to comparable ISAs in terms of format.

Specifically, the AASB would incorporate IAASB content and style revisions into these
Handbook sections:
o
Section 5135, The Auditor’s Responsibility to Consider Fraud;
o
Section 5141, Understanding the Entity and its Environment and Assessing the
Risks of Material Misstatement;
o
Section 5143, The Auditor’s Procedures in Response to Assessed Risks; and
95
o
Section 5150, Planning.

Accordingly, recommendations will now contain five principal sections: Introduction,
Objectives, Definitions, Requirements, and Application Material.

Although the separation of Handbook Requirements from Application Material is a
significant structural change, there is expected to be no significant changes to
content.

A second goal of the ED was to enhance the direction given by Canadian (and IAASB)
standards.

This objective focused on the wording of assurance recommendations rather than
content.

Current Canadian standards use the word “should” as a directive — the auditor should
do this or should do that.

This usage draws from the British heritage of the language, where should is used in a
directive sense.

However, it is possible to construe “should” as meaning, “it’s a good idea, but it’s up
to you to decide if you want to do it”.

To avoid this possibility, the word “shall” replaces “should” in all recommendations.

Another change relates to the tenses used in standards.

The Handbook tends to use the present tense to specify actions expected of an
auditor.

For instance, paragraph 5141.054 reads: “Obtaining an understanding of internal
control involves evaluating the design of a control and determining whether it has
been implemented.”

As of June 30, 2007, information posted to the AASB web site indicates that the final
Handbook revisions to the content of the standards have been drafted, but not yet
released.

Moreover, it is not clear when these changes would be effective — the IAASB
amendments will not be effective earlier than audits of fiscal periods beginning on or
after December 15, 2007.
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Adopting International Standards on Auditing (ISAs)
96

In February 2007, the AASB announced that, following the completion of the IAASB’s
Clarity project, Canada would adopt International Auditing Standards issued by the
International Auditing and Assurance Standards Board.

The resulting standards would be called Canadian Auditing Standards (CASs) and be
numbered identically.

The planned timing for adopting ISAs as CASs is dependent on the IAASB’s progress
with its Clarity Project.

The AASB approach will be to issue an exposure draft of a proposed CAS at or near
the same time as the corresponding IAASB exposure draft of a clarified ISA, and
finalize the CAS as soon as possible after the IAASB issues the final clarified ISA.

The IAASB currently expects that all exposure drafts of proposed clarified ISAs will be
issued by the third quarter of 2007 and that the final clarified ISAs will be approved
by the end of Fall 2008.

The AASB will use the same effective date for its new standards as the IAASB uses for
the clarified ISAs.

It is expected that the earliest effective date for clarified ISAs will be for periods
beginning on or after December 15, 2008. Therefore, the effective date for CASs is to
be for periods beginning on or after December 15, 2008.

The adoption of CASs will impact the structure of the Handbook The structure of the
Handbook – Assurance will be the same as that of the auditing and assurance
segments of the Handbook of International Auditing, Assurance and Ethics
Pronouncements (The IFAC HB).

An example of the impact of this change is that CASs dealing with the audit of
historical financial information, including financial statements, will be separate and
distinct from standards dealing with other assurance and related services.

For each ISA, there will be a corresponding CAS that has the same number and title.

For example, section 5370, Management Representations, will be replaced by CAS
580, Written Representations, when the clarified and revised ISA 580 is adopted as a
Canadian Auditing Standard.

CASs for which there are no equivalent ISAs will be identified by a “-C” following the
number of the CAS.

For example, section 5365, Communications with Actuaries, will be revised to
conform to the new drafting style, but since there is no ISA equivalent, it would be
titled CAS 880-C, Communications with Actuaries.
97

The scope of certain Canadian assurance standards will change to deal separately
with financial statement audits and audits of other subject matter.

For example, section 5050, Using the Work of Internal Audit, covers all types of audit
engagements, not just audits of historical financial information.

To the extent considered appropriate, matters regarding other assurance services
currently addressed in section 5050 would be addressed in a separate CAS.

Guidelines in the current Handbook will be called Practice Statements to adopt IFAC
HB terminology

There are only a few International Auditing Practice Statements (IAPSs) in the IFAC
HB.

This is in contrast to the nearly 30 Assurance Guidelines in the Handbook

Guidelines in the current Handbook will be called Practice Statements to adopt IFAC
HB terminology:

o
Canadian Auditing Practice Statements (CAPSs)
o
Canadian Review Engagement Practice Statements (CREPSs)
o
Canadian Assurance Engagement Practice Statements (CAEPSs)
o
Canadian Related Services Practice Statements (CRSPSs)
o
Canadian Practice Statements on Securities Regulations (CPSSRs)
As of June 30, 2007, the AASB had issued the following EDs as part of the process of
converting to CASs:
o
CAS 200, Overall Objective of the Independent Auditor, and the Conduct of an
Audit in Accordance with Canadian Auditing Standards
o
CAS 230, Audit Documentation
o
CAS 250, The Auditor's Responsibilities Relating to Laws and Regulations in an
Audit of Financial Statements
o
CAS 260, Communications with Those Charged with Governance
o
CAS 320, Materiality in Planning and Performing an Audit
o
CSA 450, Evaluation of Misstatements Identified during the Audit
o
CAS 500, Considering the Relevance and Reliability of Audit Evidence
98

o
CAS 540, Auditing Accounting Estimates, Including Fair Value Accounting
Estimates, and Related Disclosures
o
CAS 550, Related Parties
o
CAS 560, Subsequent Events
o
CAS 570, Going Concern
o
CAS 580, Written Representations
o
CAS 600, The Audit of Group Financial Statements
o
CAS 610, The Auditor’s Consideration of the Internal Audit Function
o
CAS 720, The Auditor’s Responsibility in Relation to Other Information in
Documents Containing Audited Financial Statements
For more details and up to date information, refer to:
http://www.aasb.ca/index.cfm/ci_id/11265/la_id/1.htm
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Audit Documentation CAS 230

The AASB intends to replace section 5145, Documentation, with a new Canadian
Auditing Standard that essentially adopts the revised and clarified ISA 230, Audit
Documentation.

CAS 230 would be consistent with section 5145, with the following two exceptions.

Currently, section 5145 defines the report release date as the date the auditor grants
permission to use the auditor’s report in connection with the issuance of the entity’s
financial statements.

Accordingly, section 5145 requires the auditor to assemble a complete and final audit
file as at a date not more than 45 days:
o
after the report release date, if a report is issued in connection with the
engagement;
o
from the date that the examination was substantially completed, if a report is not
issued in connection with the engagement; or
o
from the date the engagement ceased, if the auditor was unable to complete the
engagement.
99

On the other hand, ISA 230 simply requires assembly of the final audit file on a
“timely basis” after the date of the auditor’s report.

Consequently, CAS 230 will require that the final audit file normally be assembled as
at a date no more than 60 days after the date of the auditor’s report.

CAS 230 will also recognize that there may be exceptional circumstances where the
auditor judges it necessary to depart from a basic principle or an essential procedure
that is relevant in the circumstances of the audit.

It will require the auditor to document how the alternative audit procedures
performed achieved the objective of the audit, and, unless otherwise clear, the
reasons for the departure.

The IAASB comment period ended March 31, 2007.

Assuming there are no serious flaws identified in the comments submitted to the
IAASB, and no specific Canadian issues identified that affect ISA 230, it is expected
that CAS 230 will be effective for periods beginning on or after December 15, 2008.
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The Auditor’s Responsibilities Relating to Laws and Regulations in an Audit
of Financial Statements CAS 250

The AASB intends to replace section 5136, Misstatements — Illegal Acts, with a new
Canadian Auditing Standard that essentially adopts the revised and clarified ISA 250,
The Auditor’s Responsibilities Relating to Laws and Regulations in an Audit of Financial
Statements.

CAS 250 would be consistent with section 5136, but with much more rigour.

Section 5136 deals with the auditor’s approach to dealing with “laws and regulations
that, if violated, could reasonably be expected to result in a material misstatement in
the financial statements.”

CAS 250 identifies two categories of laws and regulations:
o
those generally recognized by the auditor to have a direct effect on the
determination of material amounts and disclosures in the financial statements;
and
o
those that do not have a direct effect on the determination of the amounts and
disclosures in the financial statements, but compliance with which may be
fundamental to an entity’s ability to continue its business or to avoid material
penalties.
100

Among the actions to be taken by the auditor when non-compliance is identified or
suspected:
o
obtain a general understanding of the applicable legal and regulatory framework
and how the entity complies with that framework;
o
obtain sufficient appropriate audit evidence regarding compliance with laws and
regulations generally recognized by the auditor to have an effect on the
determination of material amounts and disclosures in the financial statements;
o
have sufficient understanding of the laws and regulations to consider when
auditing relevant assertions underlying the financial statements, and obtain
sufficient appropriate audit evidence about compliance with those laws;
o
evaluate the implications of any non-compliance in relation to other aspects of
the audit and take appropriate action;
o
discuss the auditor’s findings about the possible instance of non-compliance with
management and where appropriate, those charged with governance;
o
assess the need for the auditor to obtain legal advice regarding a possible
instance of non-compliance;
o
when sufficient information about suspected non-compliance cannot be obtained,
evaluate the effect on the auditor’s report;
o
communicate as soon as practicable to those charged with governance instances
of non-compliance that the auditor believes to be intentional;
o
when there has been non-compliance, determine whether there is a responsibility
to report the matter to a party outside the entity that overrides the auditor’s
professional duty of confidentiality; and
o
document instances of identified or suspected non-compliance and any related
discussions with management, those charged with governance, or parties outside
the entity.

The IAASB comment period ended July 31, 2007.

Assuming there are no serious flaws identified in the comments submitted to the
IAASB, and no specific Canadian issues identified that affect ISA 250, it is expected
that CAS 250 will be effective for periods beginning on or after December 15, 2008.
back to top
Materiality in Planning and Performing an Audit CAS 320 and
Evaluation of Misstatements Identified During the Audit CAS 450
101

The AASB intends to replace Handbook section 5142, Materiality, with two new
Canadian Auditing Standards that essentially adopt the revised and clarified ISA 320,
Materiality in Planning and Performing an Audit, and ISA 450, Evaluation of
Misstatements Identified During the Audit.

The following identifies the differences between section 5136 and the forthcoming
ISAs.

The AASB intends to adopt the revised and clarified ISAs without change.

Key aspects of the changes:
o
The definition of materiality — clarifies that materiality depends on the size and
nature of an item judged in the surrounding circumstances.
o
However, if the applicable financial reporting framework used to prepare the
financial statements provides a different definition of materiality, the auditor is to
use that definition for the purpose of the audit.
o
There will be guidance on the use of percentages as benchmarks for the initial
determination of materiality when establishing the overall audit strategy.
o
Notwithstanding, the auditor must consider whether misstatements less than the
materiality level determined for the financial statements as a whole, could
reasonably be expected to influence economic decisions of users taken on the
basis of the financial statements.
o
Users — materiality is to reflect the auditor’s judgment of the needs of users in
relation to the information in the financial statements and the possible effect of
any misstatements.
o
However, in an audit of general purpose financial statements, the auditor’s
judgment as to matters that are material to users of the financial statements is
based on consideration of the needs of users as a group.
o
Communication to management — the auditor must communicate to
management all known and likely misstatements identified during the audit,
other than those that the auditor believes are clearly trivial, and request that
management correct all known misstatements.
o
Evaluation of uncorrected misstatements — determining materiality levels does
not mean that identified misstatements below the threshold are always
considered to be immaterial.
o
There may be circumstances related to some misstatements which can lead the
auditor to evaluate them as material even if they are of a lower level than that
the auditor had determined to be material when establishing the overall audit
strategy.
102
o
When evaluating whether the financial statements are free of material
misstatement, the auditor must consider both uncorrected misstatements and
the qualitative aspects of an entity’s accounting practices.
o
The cumulative effect of a lack of neutrality, together with uncorrected
misstatements that have been identified during the audit, may cause the financial
statements as a whole to be materially misstated.
o
The IAASB comment period ended February 15, 2007.
o
Assuming there are no serious flaws identified in the comments submitted to the
IAASB, and no specific Canadian issues identified that affect either ISA 320 or
450, it is expected that CASs 320 and 450 will be effective for periods beginning
on or after December 15, 2008.
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Considering the Relevance and Reliability of Audit Evidence CAS 500
The AASB intends to replace section 5300, Audit Evidence, with a new Canadian Auditing
Standard that essentially adopts the revised and clarified ISA 500, Considering the
Relevance and Reliability of Audit Evidence.

CAS 500 will contain requirements that are not specifically presented as
recommendations in section 5300.

Under CAS 500, the auditor must:

o
consider the relevance and reliability of information to be used as audit evidence;
o
evaluate whether information produced by the entity is sufficiently reliable for the
auditor’s purposes; and
o
determine, when there is an inconsistency in audit evidence obtained from
different sources or when the auditor has doubts about the reliability of
information to be used as audit evidence, what modifications or additional audit
procedures are necessary to resolve the matter.
However, there will be one change that is more related to the structure of the
Handbook than content:
o
Section 5300 requires the auditor to use assertions underlying aspects of the
financial statements in the assessment of material misstatements and the design
and performance of further audit procedures.
o
CAS 500 does not have a similar requirement, as this matter is dealt with in the
audit risk standards: Identifying and Assessing Risks of Material Misstatement
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Through Understanding the Entity and Its Environment (CAS 315) and The
Auditor’s Responses to Assessed Risks (CAS 330).

The IAASB comment period ended September 15, 2007.

Assuming there are no serious flaws identified in the comments submitted to the
IAASB, and no specific Canadian issues identified that affect ISA 500, it is expected
that CAS 500 will be effective for periods beginning on or after December 15, 2008.
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Auditing Accounting Estimates, Including Fair Value Accounting Estimates,
and Related Disclosures CAS 540

The AASB intends to replace sections 5305, Audit of Accounting Estimates, and 5306,
Auditing Fair Value Measurements and Disclosures, with a new Canadian Auditing
Standard that essentially adopts the revised and clarified ISA 540, Auditing
Accounting Estimates, Including Fair Value Accounting Estimates, and Related
Disclosures.

CAS 540 will contain requirements for greater rigour and scepticism in the audit of
estimates.

These requirements will focus on the auditor’s determination and documentation of
misstatements and indicators of possible management bias relating to individual
accounting estimates.

Key aspects of the revisions:
o
Risk assessment procedures — the auditor will have to obtain an understanding of
the processes, including relevant internal controls, used by management to make
accounting estimates.
o
The auditor will also have to review the outcome of accounting estimates made in
the prior period financial statements.
o
Estimation uncertainty is the susceptibility of a financial statement item to a lack
of precision in its measurement because the outcome of future events is not
known.
o
The auditor must use the information gathered from the risk assessment
procedures to determine which accounting estimates have high estimation
uncertainty and therefore require special audit consideration.
o
Misstatements — the difference between management’s and the auditor’s
judgment concerning the reasonableness of accounting estimates will be
considered a “known misstatement involving subjective decisions”.
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o
Therefore, the auditor must determine whether such a misstatement in fact,
exists.
o
Where an accounting estimate falls within a reasonable range of outcomes that is
greater than materiality, the auditor must determine whether the applicable
financial reporting framework requires disclosure of the estimation uncertainty
and, if so, to evaluate the adequacy of such disclosure.
o
Where the auditor has determined that an accounting estimate gives rise to a
significant risk, the auditor must consider how management has assessed the
effect of estimation uncertainty.
The auditor must evaluate whether the significant assumptions made by
management provide a reasonable basis for the accounting estimate; and
o
o
Where the auditor has determined that an accounting estimate gives rise to a
significant risk, the auditor must consider how management has assessed the
effect of estimation uncertainty.

The auditor must evaluate whether and how management has
considered alternative assumptions or outcomes, and why they have
rejected them.

The IAASB comment period ended April 30, 2007.

Assuming there are no serious flaws identified in the comments submitted to the
IAASB, and no specific Canadian issues identified that affect ISA 540, it is expected
that CAS 540 will be effective for periods beginning on or after December 15, 2008.
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Related Parties CAS 550

The AASB intends to replace section 6010, Audit of Related Party Transactions, with a
new Canadian Auditing Standard that essentially adopts the revised and clarified ISA
550, Related Parties.

CAS 550 would be consistent with the current perspective of section 6010 but would
be more explicit in what is required of the auditor.

CAS 550 will now require the auditor to:
o
Discuss with the engagement team specific consideration of the susceptibility of
the financial statements to material misstatement due to fraud or error that could
result from the entity’s related party relationships and transactions, and share
relevant information obtained about related party relationships with the
engagement team.
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
o
Obtain an understanding of the controls management has established to identify,
account for and disclose related party transactions, authorize and approve
significant transactions and arrangements with related parties, and authorize and
approve significant transactions and arrangements outside the normal course of
business.
o
Inspect bank and legal confirmations and minutes of meetings of shareholders
and those charged with governance for information that may indicate the
existence of related party relationships or transactions that management has not
previously disclosed to the auditor.
o
Consider any identified fraud risk factors (including the existence of a dominant
party) in relation to related parties in assessing the risk of material misstatement
due to fraud.
o
Treat as significant risks both identified significant related party transactions
outside the normal course of business and assertions made by management in
the financial statements stating that related party transactions were conducted
on terms equivalent or similar to those prevailing in an arm’s length or market
transaction.
o
Obtain sufficient appropriate audit evidence to support any assertion by
management that related party transactions were conducted on terms equivalent
or similar to arm’s length or under normal market conditions, and if such
evidence cannot be obtained, ask management to correct or delete the assertion.
o
Evaluate whether related party relationships and transactions could cause the
financial statements to fail to achieve fair presentation.
o
Include in the audit documentation the names of identified related parties and,
unless otherwise clear, the nature of the related party relationships.
o
For identified significant related party transactions outside the normal course of
business, assess their business rationale, evaluate whether the terms and the
way they have been accounted for are consistent with management’s
explanations and obtain evidence that they have been authorized and approved.
CAS 550 will also require that when a related party or a significant related party
transaction that management has not previously identified or disclosed to the auditor
is identified, the auditor must:
o
inquire as to why the entity’s internal controls over identification of related
parties, relationships and transactions failed;
o
perform appropriate substantive procedures to respond to risks relating to the
newly identified related party or significant related party transaction; and
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o
if the non-disclosure appears intentional, communicate this information to those
charged with governance and evaluate the implications for the audit.

The IAASB comment period ended June 30, 2007.

Assuming there are no serious flaws identified in the comments submitted to the
IAASB, and no specific Canadian issues identified that affect ISA 550, it is expected
that CAS 550 will be effective for periods beginning on or after December 15, 2008.
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Going Concern CAS 570

Some time in 2008, the AASB intends to issue a new Handbook section that will
provide guidance to the auditor when identifying and responding to events and
conditions that may cast significant doubt on an entity’s ability to continue as a going
concern.

This project has been percolating for more than four years.

This delay stemmed basically from two issues:
o
If/how to conform to US and/or IFAC standards; and
o
How to reveal the auditor’s belief that there may be a going concern problem
with the client.

Both SAS 59 and ISA 570 use an “emphasis of matter” paragraph in the auditor’s
report to report on the going concern issue.

This allows the auditor to avoid a qualified report and walk the fine line of being able
to report on the previous period’s results on a going concern basis, while at the same
time, suggest that future reports may not be able to do so.

Canadian standards currently prohibit the use of an “emphasis of matter” paragraph
in the auditor’s report.

This perspective is based on the premise that the auditor should issue the standard
three-paragraph unqualified audit report if the financial statements are prepared in
accordance with GAAP.

The AASB decided to make a made-in-Canada version, using section 5141 as the
basis for the direction taken.

An exposure draft was issued in August 2006, with the expectation that a Handbook –
Assurance section would be issued in conjunction with the AcSB’s proposed revisions
to section 1400.
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
In late February 2007, the IAASB issued an exposure draft proposing revising ISA
570.

In keeping with its February 2007 announcement that the AASB would adopt ISAs for
use in Canada, the AASB decided to suspend its earlier exposure draft and base
Canadian GAAS on revised ISA 570, when the revisions IAASB are completed.

CAS 570 will require that the auditor actively perform procedures to identify events
and conditions that may be indicative of significant doubt regarding the entity’s ability
to continue as a going concern.

The auditor must also evaluate management’s assessment of the entity’s ability to
continue as a going concern.

The period of assessment must be the same period that management uses, and it
should normally be twelve months.

If the auditor concludes that the going concern assumption is appropriate, but a
material uncertainty exists, then the auditor will have to determine whether the
uncertainty is properly disclosed.

If properly disclosed, then an unqualified opinion on the current period can be issued
along with an emphasis of matter paragraph.

If adequate disclosure is not made, then a qualified or adverse opinion will be
necessary.

The AASB will amend paragraph 5510.53 to require the inclusion of an emphasis of
matter paragraph in the auditor’s report when appropriate going concern disclosures
are made in the financial statements.

The IAASB comment period ended May 31, 2007.

Assuming there are no serious flaws identified in the comments submitted to the
IAASB, and no specific Canadian issues identified that affect ISA 570, it is expected
that CAS 540 will be effective for periods beginning on or after December 15, 2008.
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Written Representations CAS 580

The AASB intends to replace section 5370, Management Representations, with a new
Canadian Auditing Standard that essentially adopts the revised and clarified ISA 580,
Written Representations.

CAS 580 would be considerably different from section 5370 in its scope.
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
Section 5370 applies to all representations provided by management, whether written
or oral, explicit or implied, solicited or unsolicited.

CAS 580 will apply only to written representations that have been provided in
response to the auditor’s request.

CAS 580 will distinguish between “general written representations” and “specific
written representations” based on their subject matter.

Section 5370 does not include a similar distinction in written representations.

CAS 580 will require that the auditor disclaim an opinion if a general written
representation is not obtained.

Section 5370 permits the auditor to issue either a qualified opinion or a disclaimer of
opinion.

CAS 580 will require that the auditor determine the relevant parties from whom
written representations should be requested — generally, the CEO and/or the CFO.

Section 5370 requires only that written representations be obtained from
management.

Finally, section 5370 requires the auditor to obtain written representations for
matters that are material to the financial statements, matters that are significant to
the engagement, and matters relevant to management’s judgments and estimates
that are material to the financial statements.

CAS 580 will not require the auditor to obtain written representations from relevant
persons regarding specific assertions embedded in the financial statements; instead,
obtaining specific written representations will be a matter of professional judgment,
with one exception.

CAS 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates,
and Related Disclosures, will require that written representations be obtained from
management regarding the reasonableness of significant assumptions used by
management in making accounting estimates.

The IAASB comment period ended April 30, 2007.

Assuming there are no serious flaws identified in the comments submitted to the
IAASB, and no specific Canadian issues identified that affect ISA 580, it is expected
that CAS 580 will be effective for periods beginning on or after December 15, 2008.
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The Auditor’s Consideration of the Internal Audit Function CAS 610
109

The AASB intends to replace section 5050, Using the Work of Internal Audit, with a
new Canadian Auditing Standard that essentially adopts the revised and clarified ISA
610, The Auditor’s Consideration of the Internal Audit Function.

As noted in the segment addressing the move to ISAs, CAS 610 would be one of the
standards where content will be split due to the way the IFAC Handbook deals with
audit and assurance engagements.
o

Section 5050 applies to all audit engagements, including audits of financial
statements and other audits (such as value-for-money audits) — CAS 610 will
apply only to audits of financial statements and other historical financial
information.
Furthermore, section 5050 and CAS 610 will differ in scope and guidance for
engagements under the latter’s purview.
o
Section 5050 includes recommendations and guidance for practitioners to follow
when internal audit staff provide direct assistance to the auditor; this is outside
the scope of CAS 610.

Section 5050 states that the auditor’s report should not refer to the use of internal
audit work; CAS 610 is silent on this issue.

CAS 610 will require the auditor to obtain a sufficient understanding of internal audit
activities and their effect, if any, on external audit procedures, regardless of whether
the auditor plans to use the work of the internal auditor; section 5050 has guidance
on this matter, but no requirements.

The IAASB comment period ended March 31, 2007.

Assuming there are no serious flaws identified in the comments submitted to the
IAASB, and no specific Canadian issues identified that affect ISA 610, it is expected
that CAS 610 will be effective for periods beginning on or after December 15, 2008.
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