The required adoption of International Financial Reporting Standards (IFRS) by Canadian reporting issuers is presenting difficult issues for utilities and other participants in rate-regulated industries which could result in significant asset write-downs and impairments.
Rate-regulated sectors are characterized by large upfront investments and regulatory restrictions regarding the prices that can be charged to customers for services or products. Under Canadian GAAP, rate-regulated entities were entitled to account for the uncertain impact of rate regulation through the recognition of regulatory assets and liabilities (which were generally presented in the financial statements of Canadian GAAP issuers as deferred charges and credits). As of yet, there is no corresponding IFRS regarding rate-regulated activities and accounting. Without such a standard, a transition to IFRS may result in the write down of an issuer’s regulatory assets and liabilities.
In July 2009, the International Accounting Standards Board (IASB) issued an Exposure Draft that would establish how assets and liabilities resulting from rate-regulated activities should be recognized and measured. The draft standard contained in the Exposure Draft provides that if (x) an authorised body (the regulator) establishes the price an entity must charge its customers for the goods or services provided by the entity, and (y) such price (the rate) is designed to recover the specific costs incurred by the entity in providing the regulated goods or services and to earn a specified return, then the regulatory assets and liabilities would be measured at the current value expected from cash flows to be recovered or repaid under regulations (adjusted to take into account their likelihood of being realized). This Exposure Draft and draft standard remains subject to continued public consultation.
As a result of the uncertainty regarding the timing and outcome of the IASB process, and the potentially adverse impact of transitioning from Canadian GAAP to current IFRS, certain Canadian rate-regulated issuers have elected to adopt U.S. GAAP, which allows for the continued recognition by an issuer of regulatory assets and liabilities, instead of IFRS. Others have elected to defer adoption of IFRS for a year to financial periods beginning on or after January 1, 2012 (as permitted by the Canadian Accounting Standards Board and the Canadian Securities Administrators).
U.S. GAAP reporting is generally permitted under Canadian securities laws and TSX rules for issuers that are subject to reporting obligations under U.S. securities laws. Most rate-regulated issuers that are already reporting issuers in the United States may simply elect to start preparing their financial statements in U.S. GAAP instead of IFRS. For companies considering accessing the U.S. capital markets through a registered offering of securities, or other transactions that would result in them becoming U.S. reporting issuers, a transition to U.S. GAAP may be a preferable alternative to IFRS reporting. The Canada / U.S. Multijurisdictional Disclosure System (MJDS) continues to afford Canadian issuers with an established reporting history and public float with an efficient and cost-effective means of accessing the U.S. capital markets. Under MJDS, a Canadian issuer is able to use a prospectus prepared under Canadian securities law requirements to register securities for sale in the United States, and that prospectus will generally only be subject to review by the Canadian securities regulators and not the SEC. Once the issuer has become a U.S. reporting issuer through an SEC registration, it is usually possible to use MJDS to satisfy ongoing SEC reporting obligations through Canadian disclosure documents, with relatively limited additional disclosure requirements.
For an issuer considering a U.S. financing transaction or otherwise becoming a U.S. reporting issuer, it is important to confirm early in the process that the auditor meets the SEC’s independence requirements. These requirements must have been met for at least the most recent year’s audited financial statements. An issuer will also generally require a reconciliation of its Canadian GAAP financial statements to U.S. GAAP for its two most recently completed fiscal years (while currently there is an exception to the reconciliation requirements for investment-grade securities, the SEC has recently announced plans to eliminate it). Upon becoming a U.S. reporting issuer, the issuer will also become subject to most of the requirements of the Sarbanes-Oxley Act, including the Section 404(b) requirement for annual auditor attestations of internal control over financial reporting (subject to first-year transitional relief for new registrants), which remains one of the most significant differences between ongoing public company compliance obligations in Canada and the United States.