last issue, in anticipation of the adoption of International
Financial Reporting Standards (IFRS) on January 1, 2011, we
provided practical tips for publicly listed enterprises. In this
issue, we discuss how the adoption of IFRS might have an impact on
contracts that require a party to comply with Canadian generally
accepted accounting principles (GAAP) or, more significantly, that
require a party to meet financial tests that depend on financial
information prepared in accordance with GAAP. These circumstances
often arise in credit agreements.
It is important to note that GAAP will continue to exist after
January 1, 2011 and that it will still be appropriate to refer to
GAAP in agreements. What will happen on that date is that the
Canadian Accounting Standards Board will adopt IFRS, but in that
modified form it will still be GAAP. As a result, if the only
requirement in an agreement is that a party maintain financial
statements in accordance with GAAP, the adoption of IFRS will have
no impact. However, if, as is often the case, an agreement contains
financial tests, the adoption of IFRS may have a considerable
impact. For example:
Balance sheet restatements. Under IFRS, companies can
elect to show assets at fair market value rather than at cost. For
capital assets such as real estate, this can have a large impact.
These kinds of changes will affect balance sheet financial
covenants, such as debt-to-equity ratios.
Potential for more earnings volatility. Assets shown
at fair market value rather than cost will also impact the income
statement. As fair market value fluctuates over time, gains and
losses are to be reflected on the income statement. Although of a
non-cash nature, this may have an impact on how cash flow financial
covenants (such as Debt to EBITDA) will be drafted.
Asset recognition. Adoption of IFRS may result in
assets being recognized on financial statements that had not
previously been recognized, which in turn may result in an impact
on current ratios or quick-asset ratios. For instance, many capital
leases are not recognized on the balance sheet using GAAP. With
IFRS, there is greater potential for capital leases to appear on
the balance sheet, thereby increasing total assets.
Companies will be collecting data this year so that they can
provide IFRS-compliant comparative figures with their first
required IFRS financial statements in 2011. As such, they will have
made or will be making assessments on how IFRS will apply to the
company, and on which accounting policies will be used. With this
information in hand, companies should take the time this year to
review the effect of these adjustments on their credit
Any credit agreement entered into that contains financial tests
and that will be in existence after January 1, 2011 should
anticipate the accounting changes that the adoption of IFRS will
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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