In 2011 the accounting landscape in Canada changed with the introduction of Accounting Standards for Private Enterprises (“ASPE”). ASPE introduced a new set of accounting guidelines for privately held Canadian companies.
When ASPE was introduced, many of the differential reporting options available under the old accounting standards were incorporated as accounting policies in ASPE. One of these options being the measurement and classification of preferred shares issued in a tax planning arrangement. In accordance with ASPE Section 3856, preferred shares issued in a tax planning arrangement under Sections 51, 85, 85.1, 86, 87 or 88 of the Income Tax Act (Canada), are measured at the shares par value as a separate line item in the equity section of a company’s balance sheet. Disclosure of the redemption amount is required. Without this accounting standard, redeemable preferred shares would meet the definition of a financial liability and would be measured at fair value. In the case of a redeemable preferred share, fair value is generally equal to the redemption amount.
The Accounting Standards Board (“AcSB”) identified a number of issues that have arisen in respect of redeemable preferred shares and have decided to re-examine the accounting standard. An Exposure Draft was released in October 2014 describing the proposed changes. Essentially the Exposure Draft proposes to remove the requirement that preferred shares issued in a tax planning arrangement be reported at par value in the equity section of a company’s balance sheet. This would result in these preferred shares being presented as a liability on the company’s balance sheet and stated at redemption value. The company would be required to make this change retroactively. The difference between the original par value of the preferred shares and the redemption value would be recorded as a separate component of equity on the balance sheet.
The AcSB’s position is that redeemable preferred shares are obligations to be paid in the future and therefore meet the definition of a liability. The AcSB consulted multiple lenders and most agreed that redeemable preferred shares issued in a tax planning arrangement should be treated as liabilities as those shares represent a claim on the resources of the entity.
Since October 2014, the AcSB has received mixed comments from accounting practitioners and other stakeholders on the proposed changes. Many respondents noted that the Exposure Draft proposal was based on discussions with creditors and that other users to the financial statements should be consulted as well. The Exposure Draft was initially meant to come into effect for fiscal years beginning on or after January 1, 2016. As a result of the feedback received from stakeholders, it was decided that the effective date for any such change in the accounting standard would be no earlier than January 1, 2018. Currently the AcSB is working with stakeholders to develop a revised standard and they are discussing the possibility of the requirement to classify redeemable preferred shares as a liability but allowing some exceptions. These exceptions might be in estate freeze transactions where there is no change in control of the company.
This change in accounting standard could have a significant effect on the balance sheet of many companies that have issued preferred shares as part of a tax plan, estate freeze or similar transaction. It would result in a significant addition to the company’s liabilities and a corresponding decrease in equity. This can have a significant impact on debt covenants in particular requiring a change in the debt covenant calculation to be negotiated with the company’s banking institution.
Welch continues to monitor this project with a high level of interest and concern as it impacts a significant number of our clients.
If your company has issued redeemable preferred shares, contact your Welch advisor for how this might impact your company.