new CICA financial instrument standards – a nightmare?

In April 2005, the Accounting Standards Board issued CICA Handbook Section 3855, Financial Instruments – Recognition and Measurement, Section 3862 (on disclosures), Section 3863 (on presentation) (both which replace Section 3861, Financial Instruments – Disclosure and Presentation), along with two companion standards, Section 1530, Comprehensive Income, and Section 3865, Hedges. These standards triggered hundreds of pages of amendments to other Handbook sections (including a new one for equity – review that stock option accounting too!!) and are effective for fiscal years ending after October 1, 2007 (e.g. if your fiscal year is the calendar year, for the year 2007 you need to have adopted these new standards).

The purpose of the new standards is to bring Canadian GAAP for the recognition and measurement of financial instruments more in line with US and international GAAP.

Your auditor will most likely provide you with the following request:

• An analysis of what you have done to determine what financial instruments you have (e.g. cash, accounts receivable, convertible debt, etc.)
• How your financial instruments are classified (e.g. held for trading, available for sale, etc.)
• How the new Financial Instruments standards will affect your financial statements, your processes, controls, IT systems, etc.
• Measurement of the instruments at transition date (e.g. in the example given above it would be January 1, 2007) to ensure they are at fair value or amortized cost as relevant.
• Determine if any of your contracts have derivatives or embedded derivatives
• What disclosures you need

OK, don’t freak out.

Most small business tech companies hold only the most basic types of financial instruments (like trade receivables and payables) which are easily classified so the impact to financial statements is not that great (except for yet another note disclosure).

Other than the new measure Income – Comprehensive Income odds are you were already doing a lot of this. The new sections are really just about providing further clarity and disclosure around financial assets and liabilities and their fair value at the balance sheet date. They have defined “derivative” for the first time and expanded it into realms not normally considered a derivative in the truest sense so there is some requirement to brush up there. Also, if you hedge (e.g. foreign exchange) you will want to look at the minor tweaks in accounting (for the most part it is pretty much the same as the previous hedge accounting requirements).

Here are some sample note disclosures I recently put together for a client to get you started.

First, insert a narrative about the new standards and what they mean in general. Then include the following:

The Company has made the following classification for its financial instruments:

• Cash and cash equivalents are classified as “assets held for trading” and are measured at fair value at the end of each period with any resulting gains or losses recognized in the consolidated statements of operations;
• Accounts receivable and other accounts receivable are classified as “loans and receivables” and are held at cost;
• Accounts payable, accrued liabilities and loans payable on-demand are classified as “other financial liabilities” and are held at cost;
• Embedded non-financial derivatives are classified as “assets held for trading” and are measured at fair value with any resulting gains or losses recognized in the consolidated statements of operations.
• Convertible debentures are classified as “other financial liabilities“ and are held at amortized cost, which upon their initial measurement is equal to the fair value of discounted cash flows.

For those items held at cost the assumption is that the cost of the instrument is its fair value due to the short term nature of the instruments.

Obviously you will tailor yours to your unique circumstance (e.g. classifications, cost vs. amortized cost, etc.) but starting new note disclosures is always difficult. When in doubt check out a publicly traded company, similar to yours, to help give you guidance on writing your note.

PriceWaterhouseCoopers has a great summary for disclosure requirements relating to financial instruments which can be found at: http://www.pwc.com/ca/eng/ins-sol/publications/frn1207e.pdf