Background
Section 5(4)(b) of the AWA
requires that the disclosure document include “financial statements as
prescribed”. Section 3 of the Regulations
defines these financial statements as follows:
(a) an
audited financial statement for the most recently completed fiscal year of the
franchisor’s operations, prepared in accordance with generally accepted
auditing standards that are at least equivalent to those set out in the Canadian Institute of Chartered Accountants
Handbook;
(b) a
financial statement for the most recently completed fiscal year of the
franchisor’s operations, prepared in accordance with generally accepted
accounting principles that are at least equivalent to the review and reporting
standards applicable to review engagements set out in the Canadian Institute of Chartered Accountants
Handbook;
The
Regulations then go on to identify certain exceptional circumstances in which
such financial statements are not required to be disclosed.
Two types of standards
There are two
types of standards that apply to financial statements.
The first are
accounting standards, which govern
how various transactions should be recorded in a company’s books and reported
on its financial statements. For example, should an expenditure be capitalized
(i.e. recorded as the purchase of an asset on the balance sheet), or should it
be expensed (i.e. shown as a deduction on the income statement)? Different sets
of accounting rules (e.g. Canadian generally accepted accounting principles (“GAAP”),
US GAAP, International Financial Reporting Standards (“IFRS”)[1]) will have different
standards or rules for how various transactions should be recorded.
The second
are auditing standards, or (more properly) assurance
standards. These speak not of the content of the financial
statements, but rather of the degree of investigation undertaken by the
external accountants in verifying and providing assurance that the financial
statements are not materially misstated. The highest level of assurance is an
audit, which provides a positive level of assurance that the financial
statements are not materially misstated. Below the level of an audit is a review
engagement, which provides only negative assurance (“nothing has come to our
attention that causes us to believe that the financial statements are not
prepared, in all material aspects, in accordance with (insert name of
applicable financial reporting framework…”). Review engagements consist only of
inquiries and discussion with management and analytical procedures.
Section 3(a) of the Regulations
The phrasing
of section 3(a) is unclear. The regulation begins by speaking of how the franchisor’s financial statements are “prepared”. However, financial statements are “prepared” by its management, not its external auditors. When section 3(a) therefore speaks of how the financial statements were “prepared”, it is presumably a reference to the content of the financial statements, and in particular the accounting rules that were followed in presenting items on the statements. But section 3(a) does not tell us which accounting standard must be used. For example, Canadian GAAP? US GAAP? IFRS? Section 3(a) does not say.
What section
3(a) does say is that the financial
statements must be “in accordance with generally
accepted auditing standards that are
at least equivalent to those set out in the Canadian Institute of Chartered
Accountants Handbook”. "Auditing” standards, not “accounting”
standards. There is no reference to Canadian GAAP in section 3(a).
Therefore, one possible reading of section 3(a)
might therefore be that if financial statements were prepared based on some
foreign set of accounting standards – even if they are completely different
from Canadian accounting standards - but were audited to a degree of assurance equivalent
to a Canadian audit engagement, those financial statements would be acceptable.
Section
3(b) of the Regulations
Section 3(b) is also imprecise, but for a different
reason. It speaks of statements
“prepared in accordance with generally accepted accounting principles that
are at least equivalent to the review
and reporting standards applicable to review engagements set out in the Canadian
Institute of Chartered Accountants Handbook”.
Breaking this down, this section begins by describing
GAAP - accounting principles - but then goes on to refer to those standards as
being equivalent to the “review and reporting standards” (i.e. assurance
standards) that apply to review engagements. Again, it mixes apples and oranges
in comparing accounting standards to assurance standards. But there is – if one
applies some syntactical reengineering – at least more of a suggestion here
that we are concerned with the accounting standards being used in the financial
statements as well as the level of assurance being provided, and that if the
accounting standards are radically different from those used in Canada, the disclosure
may be deemed insufficient.
Towards
an Interpretation (?)
What is one to make of this terminological hodge-podge?
It may make sense to step back to examine the issue from first principles.
It makes ample sense to speak of equivalency
between assurance standards. Assurance standards will be universally applicable,
regardless of the particular accounting standards to which they are applied.
One can apply Canadian audit standards to a US GAAP financial statement, an
IFRS financial statement, or any other type of financial statement.
However, what does it mean for one accounting
standard to be “at least equivalent” to another? Does it mean that the treatment
of the franchisor’s financial transactions must be equivalent and identical
under US and Canadian accounting standards, and therefore that a US and
Canadian financial statement will look exactly the same before the US financial
statement can be included in an Ontario disclosure document? This seems
unlikely because, if so, what does the phrase “at least” mean? Either the two statements are equivalent or
they are not; there are no degrees of equivalency under this definition. To say
something must be “at least equivalent” implies that it can also be “more than
equivalent” (which has an Orwellian ring to it), or “better”. How can one financial statement be “better” than the
other?
Perhaps we can suggest an alternate explanation.
Suppose that a certain expenditure is deemed to be an expense under US GAAP but
a capital purchase (i.e. an asset) under Canadian accounting standards.
Assuming all other transactions are treated identically, the US financial
statement will show the franchisor to be in a worse financial position than the
Canadian statement; they will show the franchisor as having fewer assets and
less net income.
Suppose the franchisor is shown the US financial
statement and proceeds, nonetheless, to purchase the franchise. It would be
illogical for the franchisee to argue that, had it been provided with the
Canadian statement it would not have bought the franchise, because the Canadian
statements would show a rosier financial picture than their US counterparts. If
the situation were reversed, however, such an argument might be plausible.
Possibly, the degree of difference between the two versions might dictate whether a rescission remedy
would be available under 6(1) or 6(2) of the Arthur Wishart Act,
although what the relevant degree of difference would be is, to say the least, unclear.Conclusion
Section 3 of the Regulations to the Arthur
Wishart Act uses inconsistent terminology, and its intent is – at least in
my layman's reading – murky. It is clear that the financial statements contained in a
disclosure document must be either audited or reviewed, and the US and Canadian
standards in this regard are essentially the same. As for whether US GAAP is an
acceptable basis on which to present the financial statements – I honestly don’t know.
[1] IFRS are the financial reported standards currently in place for Canadian public companies, having replaced Canadian GAAP several years ago.
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