Financial Reporting Seminar – Accounting and Audit Update

1. Financial Reporting Seminar – Accounting and Audit Update

2. Agenda: • Introduction • What’s new? • Auditing Standards • Accounting Standards • International Financial Reporting Standards (IFRS) • Wrap –up and Questions

3. Introduction 14

4. Our Firm Experience • Largest professional services firm providing a full range of professional services. • Over 6,600 highly qualified professionals serve clients from offices in 46 Canadian cities • Deloitte is a leader in serving Higher Education institutions across North America. • Our Public Sector Group include research institutions, colleges, multi-campus systems, private and public universities, and a broad range of professional and other schools.

5. Speakers • Christopher Wiegand – Christopher is an audit partner in the Montreal office. He is the engagement partner on the audit of McGill University, and has quality assurance roles on audits of three other universities. He also has extensive experience with not-for-profit organizations. • Eric Girard – Eric is a senior manager specializing in the public sector. He is the engagement senior manager on the audit of University of Ottawa and has extensive experience with not-for-profit organizations. • Eric Graham - Eric Graham is the Ottawa leader of our Complex Accounting & Transaction Expertise group. In his role, Eric helps organizations understand complex financial accounting and disclosure issues.

6. What’s New in Auditing Standards

7. New Standards of Behaviour • The assurance practice now lives strictly according to rules • Compliance with those rules is the major challenge of auditing – and of those who associate with auditors in a multi-disciplinary firm • Day-to-day behaviour is driven by the objective of compliance – and the consequences of non-compliance

8. New Auditing Standards • Previously: • the auditor is permitted to rely upon the assumption of management’s good faith and integrity: • Now…

9. Fraud and Error • Error: an unintentional misstatement in financial statements, including the omission of an amount or a disclosure, such as: • A mistake in gathering or processing data from which financial statements are prepared; • An incorrect accounting estimate arising from oversight or misinterpretation of facts; and • A mistake in application of accounting principles relating to measurement, recognition, classification, presentation, or disclosure. • Fraud: an intentional act by one or more individuals among management, other employees, those charged with governance or third parties, involving the use of deception to obtain an unjust or illegal advantage. • Misstatements resulting from fraudulent financial reporting • Misstatements arising from misappropriation of assets [CICA Handbook]

10. Fraud and Error – Impact on the Universities • The primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and with management… • It is the responsibility of those charged with governance of the entity to ensure, through oversight of management, ….that the entity establishes and maintains internal control to provide reasonable assurance with regard to the reliability of financial reporting…and compliance with laws and regulations… • In exercising oversight responsibility, the audit committee or equivalent considers the potential for management override of internal controls or other inappropriate influence over the financial reporting process, such as efforts by management to manage earnings in order to influence the perceptions of analysts as to the entity’s performance and profitability.

11. Changes in Handbook Auditing Standards • Fraud and Error: • An auditor conducting an audit in accordance with GAAS obtains reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error… • An auditor considers the potential for management override of controls and recognizes the fact that audit procedures that are effective for detecting error may not be appropriate in the context of an identified risk of material misstatement due to fraud… • Members of the engagement team should discuss the susceptibility of the entity’s financial statements to material misstatement due to fraud… • That discussion occurs with a questioning mind, setting aside any beliefs that the engagement team members may have that management and the audit committee are honest and have integrity…

12. Changes in Handbook Auditing Standards • Specific risk areas: • Management override of internal controls • Journal entries and other “consolidating adjustments” to the statements • Complex transactions with no business rational • Biased accounting estimates • Material misstatements of revenue

13. Assurance Developments • A number of new assurance standards were issued or modified during 2005 in connection with an international audit risk project which has been in progress since 2001. • The changes in the assurance standards relate to the auditor's understanding of the entity and its internal control and are intended to achieve the following objectives: • Improve risk assessments and better link assessed risks of material misstatement to the auditor's evidence gathering procedures. • Ensure that Canadian standards are harmonized with the equivalent US and international standards. • The most significant changes include the performance of control testing on the design and implementation of controls each year on all significant business cycles and entity level controls. Additionally, changes have been made to audit planning standards, documentation standards and levels of substantive testing.

14. Assurance Developments

15. Changes to Auditing Standards • Previous standards required a basic understanding of the control environment sufficient to assess whether or not a control reliance audit approach would be employed. • New standards require an auditor to evaluate the design of internal controls over financial reporting and to determine if key controls have been implemented. • These new standards require the auditor to spend time evaluating key internal controls over financial reporting even when no reliance is contemplated.

16. Changes to Auditing Standards - Auditor Responsibilities • Auditors are now required to undertake an assessment of the design of key controls for the company including • entity wide processes; • business cycle processes; and • information technology processes • Requirements are regardless of whether we intend to rely on such controls in conducting our audit, as well as determine if the controls identified exist and are implemented. • The primary objective of these procedures is to identify any areas of risk that may be inherent in these processes so that we can appropriately plan the nature and extent of our audit tests.

17. Changes to Auditing Standards – Impact on the Universities • Management is responsible for preparing the financial statements in accordance with GAAP • In this regard, Management is also responsible for establishing and documenting internal controls to provide reasonable assurance around the reliability of • the financial reporting process; • the effectiveness and efficiency of operations; and • compliance with applicable laws and regulations.

18. Changes to Auditing Standards – Impact on the Universities How to efficiently prepare for those changes: • Meet with your auditors to determine the level of required documentation • Start early preparing the missing documentation • Ask your internal auditors to support you • Ask your external auditors for guidance

19. What’s New in Accounting Standards

20. Non-Monetary Transactions June 2005 • Section 3831

21. What has changed? • No culmination of the earnings process test – no more need to evaluate whether productive assets are “similar” • Definition of non-monetary transaction excludes reference to 10% maximum monetary consideration

22. Overview • Record non-monetary transactions at fair value unless: • Transaction has no commercial substance • Fair values not reliably measurable • Transaction is exchange of inventory • Transaction is non-monetary, non-reciprocal transfer to owners • Gains and losses recognized in net income

23. Commercial Substance Transactions have commercial substance if there is a: • Significant change in the configurationof cash flows OR • Theentity-specific valueof the asset received differs from the entity-specific value of the asset given up and the difference is significant relative to the fair values of the items.

24. Configuration of Cash Flows • Consider changes in timing, amount, or risk of cash flows • Significant change – matter of professional judgement

25. Entity-Specific Value • The present value of expected future cash flows from the continuing use of an asset and its ultimate disposal, or from settling a liability. • Value dependent on specific use to the reporting entity, not on how it could be used by others • When transaction has commercial substance, measure it at fair value rather than entity-specific value

26. Reliably Measurable Fair Values • When comparable market transactions do not exist, fair value is reliably measurable if: • Variability inrange of estimates not significant, OR • Probabilities can be assigned to each estimateand used in estimating fair value

27. Scope Exclusions • Business combinations • Employee future benefits • Transactions between related parties • Stock-based compensation payments • Contributions received by not-for-profit organizations

28. Disclosure - Non-Monetary Transactions • Nature of transaction • Basis of measurement and amount • Related gains and losses

29. Transitional Provisions • Transactions initiated in periods beginning on or afterJanuary 1, 2006 • Early adoption permitted for transactions initiated in periods beginning on or after July 1, 2005 • A transaction is initiated on earlier of: • Date a binding contract is executed, and • Date of the exchange • No retroactive application and no restatements

30. The New Financial InstrumentsStandards for NPOs • Section 3855, 3865, 4410

31. Overview of New Financial Instruments Standards for NPOs • Financial instrument framework has a broad scope that will affect virtually all entities. • Increased use of fair value measurement – potential impact is more volatility in the statement of operations. Now is the time to assess the potential impact. • Framework consists primarily of 3 new Handbook Sections, as follows: • S.1530, “Comprehensive Income” • S.3855, “Financial Instruments – Recognition and Measurement” • S.3865, “Hedges” • S.1530 will not apply to NPOs; instead S.4400 has been amended • Revenue, expenses, gains and losses recorded in statement of operations unless GAAP states otherwise. • Separate disclosure of items recorded directly to the statement of changes in net assets.

32. Effective date • Effective for financial statements relating to fiscal years beginning on or after October 1, 2006. • Deferral to fiscal years beginning on or after October 1, 2007 does not apply to not-for-profit organizations. • Earlier adoption is permitted, but only as of the beginning of a fiscal year and it requires adoption of all 3 components • There are decisions that need to be made as a result of this standard and possible documentation. Therefore, assessing the impact prior to the implementation date is recommended.

33. Transition With respect to transition to Sections 3855, 3865 and 4400: • Restatement of prior period financial statements is not permitted • All financial assets and liabilities at the date of adopting the new standards are classified and measured in accordance with the new standards • Qualifying hedging relationships at the date of adopting the new standards are accounted for in accordance with the new standards • Subject to the requirements of Section 4410 “Contributions – Revenue Recognition”, any adjustments to the previous carrying values of financial assets and liabilities at the date of adopting the new standards are included in the appropriate components of net assets at that date

34. Financial asset Cash Contractual right to receive cash or another financial asset to exchange financial instruments under potentially favorable conditions Equity instrument in another entity Financial liability A contractual obligation to: Deliver cash or another financial instrument Exchange financial instruments with another party under potentially unfavorable conditions What is a Financial Instrument? Under Section 3855: • A Financial instrument is “any contract that gives rise to a financial asset of one party and a financial liability or equity instrument of another party” • Some examples: Cash, A/R, portfolio investments, loans payable and receivable, capital leases, A/P, bank indebtedness, derivatives…etc. • Some examples of assets that are not financial instruments: inventory and prepaids

35. Sample Statement of Net Assets      

36. Active and frequent buying and selling – debentures, shares Short-term profit generation All derivatives Record at fair value Can irrevocably decide to designate any financial asset or liability as held for trading No reclassifications permitted in or out Financial Asset Classification Held for Trading Financial Assets

37. Assets with fixed and determinable payments – i.e. Bonds, and other debt instruments Holder must have the ability and intention to hold to maturity Record at amortized cost Reclassifications out are permitted under certain circumstances If “more than insignificant” sales occur: The company cannot use the “Held to Maturity” classification for two years All “Held to Maturity” assets must be reclassified as “Available for Sale” Financial Asset Classification Held For Trading Held To Maturity Financial Assets

38. Financial Asset Classification Held To Maturity Loans & Notes Receivable Held For Trading • Example: bank loans, A/R • Excludes debt securities • Record at amortized cost Financial Assets

39. Financial Asset Classification Held For Trading Held To Maturity Loans & Notes Receivable Financial Assets Available for Sale

40. Reclassifications Between Categories Held for Trading • NO reclassifications permitted in or out • Difference with US GAAP – in accordance with IAS Held to Maturity • Reclassifications out are permitted if they occur: • Within few months of maturity • After 85% of principal is collected • Due to isolated event beyond control of entity • If “more than insignificant” sales/reclassifications occur: • Company cannot use “Held to Maturity” category for two years • All “Held to Maturity” assets reclassified to “Available for Sale”

41. Classification of Financial Liabilities Financial Liabilities Held for Trading Other than Held for Trading • Fair value • Short-term profit making • Active and frequent buying and selling • Can irrevocably designate any financial liability as held for trading • E.g. all derivatives • Amortized cost • E.g. accounts payable, notes payable, bonds payable…etc

42. Reclassification of Financial Liabilities • NO reclassifications into or out of Held for Trading Liabilities • Difference with US GAAP – in accordance with IAS • Reclassifications may occur between Held for Trading financial assets and liabilities

43. The New Financial Instruments Standards, Assets and Liabilities, Changes in Value Under Section 3855, (subject to the requirements of Section 4410 “Contributions – Revenue Recognition”): • Trading assets and liabilities • All gains and losses (realized and unrealized) included in current period net investment income. • Held-to-maturity assets, loans and receivables and non-trading liabilities • Amortization of premium or discount in current period net investment income; and • losses on impairment of assets in current period net investment income. • Available-for-sale assets • Amortization of premium or discount in current period net investment income; and • unrealized fair value gains and losses included directly in current period changes in net assets, until the financial asset is derecognized/impaired.

44. Impacts of New Standard • Balance sheet and equity volatility as most investments will be at fair value • Significant impact on accounting systems • Fair value calculation • Keep a classification trail for all financials instruments

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

46. Definition of a Derivative • A derivative is a financial instrument or other contract with three characteristics Value changes with underlying variable Requires little or no initial net investment Settled at future date + + Financial Derivative OR Non-Financial Derivative

47. Examples: Lease Debt instrument Insurance contract Equity instrument Investment etc. Clause that affects payoff profile: Inflationary increases Conversion option etc. Embedded Derivatives Non-derivative host contract Hybrid Contract Embedded derivative

48. Non-traditional Derivatives and Embedded Derivatives • Need to review and inventory contracts • Difficult to identify • Look for unusual features in debt contracts, lease contracts, service contracts and other relationships

49. What’s up with IFRS

50. IFRS • What is IFRS? • Why change? • Why IFRS instead of US GAAP? • When is this going to happen? • How does this affect NPOs?