3 rd quarter accounting, reporting and tax update october 4, 2006 seminar kpmg llp

3rd Quarter Accounting, Reporting and Tax UpdateOctober 4, 2006

Seminar

KPMG LLP

2© 2006 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Canada.

Agenda

John Gordon Introduction

John Gordon Internal Control Certification for Canadian Companies

John Gordon Trust Reporting Issues

Imam Hasan Financial Instruments

Dennis Auger Dividend Regime

Christina Comfort Accounting Future Tax Updates

Continuing professional education credit: You may qualify for up to 2 hours of professional education credit by attending this event.


New Partners/Senior Principals

Audit • Scott Olsson• Sophia Langlois

Tax • Jeff Tsuji

Advisory• Elaine Wong• Rhys Renouf

Internal Control Certification for Canadian Companies

John GordonPartner, Audit

403.691.8118

[email protected]


Internal Control over Financial Reporting Certification in Canada

• 2006 Requirements—CEO and CFO certify that they have– designed ICOFR for preparation of financial statements in

compliance with GAAP

– disclosed in the MD&A material changes in ICOFR during a quarter (starting Q4 2006)

– evaluated the effectiveness of ICOFR and disclosed in MD&A conclusions (anticipated as early as 2007)


Internal Control over Financial Reporting Certification in Canada (cont’d)

• Future Requirements—CEO and CFO certify that they have– evaluated the effectiveness of ICOFR and caused the company to

disclose in its MD&A the conclusions about the effectiveness of ICOFR (anticipated as early as 2007 for December 31 year ends)

• Applies to all issuers, excluding investment funds, with no phase in


CSA Staff Notice 52-316

• Can still certify design even though a weakness in design has been identified—disclose enough information about the identified weakness to present an accurate and complete picture

• The conclusions about the effectiveness of disclosure controls and procedures (DC&P) should include disclosure of identified weaknesses

• Remediation, or the reason for not planning to remediate a weakness, should be disclosed

Internal Control Reporting Requirements Information and Sharing Session—Friday, October 20, 2006

Trust Reporting Issues

John GordonPartner, Audit

403.691.8118

[email protected]


Trust Financial Reporting Matters

Agenda

• Disclosure Issues

• Stock Based Compensation—Fair Value

• Retained Earnings versus Accumulated Distributions


Disclosure Issues

• Canadian Securities Administrators review of Trust Issuers

• Forty-five Trust Issuers

– Seven issuers re-filed or filed for the first time

– Thirty-one committed to change future filings


Disclosure Issues

• Significant Disclosure Issues

– MD&A disclosure

– Non-GAAP financial measures

– Goodwill

– Executive compensation

– Timely disclosure

– Material contracts


Stock Based Compensation—Fair Value

• Able to measure?

• Intrinsic versus Option Pricing model

• Black Scholes versus Lattice model

• SEC perspective

• Impact of FAS 143R


Retained Earnings versus Accumulated Distributions

• Accumulated earnings and accumulated distributions

• Required by CICA HB 1400

• ASC continuous disclosure review program

• Variety of practice continues

Imam HasanPartner, Audit

403.691.8034

[email protected]

Financial Instruments


New Canadian standards

• New Canadian standards include:– CICA HB 1530, Comprehensive Income

– CICA HB 3855, Financial Instruments—Recognition and Measurement

– CICA HB 3865, Hedges

– Significant amendments to several other Handbook Sections and EIC Abstracts

• Effective date– Interim and annual financial statements, for publicly accountable

entities, for fiscal years beginning on or after October 1, 2006

• Transition– Retroactive application not permitted

– Each section contains detailed transition requirements


What to anticipate

• Virtually every entity will be affected in some way• Plenty of work to be done in advance of effective date• Earnings (and equity) may be more volatile—impact on

covenants• Certain exemptions and short cuts provided may not be the

solution you hoped for• Objective was to harmonize with US GAAP and IFRS

– At high level, standards are comparable to FAS 133 and IAS 39

– Still numerous differences in the details but standards allow for certain accounting policy elections to avoid US GAAP differences


Overview of CICA HB 1530

• Other comprehensive income (OCI) is a “parking lot” for– Effective portion of gains/losses on cash flow hedges– FX gains/losses on translation of self-sustaining foreign

operations– Unrealized gains/losses on available-for-sale financial

assets– Appraisal credits and donations from non-owners

• Statement of comprehensive income must be displayed with same prominence as other financial statements

• Components of OCI and Accumulated OCI must be presented in both annual and interim financial statements



• Applies to– All types of financial instruments held by entity with limited

exemptions– Contracts to buy and sell a non-financial item that can be

settled for cash (e.g. certain commodity contracts) • except contracts entered into for the purpose of the

receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale or usage requirement, for which the entity has made an election

• Provides a definition of a derivative• Provides guidance on separating an embedded derivative from

the host contract in a hybrid instrument



• Provides guidance on the classification of four categories of financial assets and two categories of liabilities that will govern their subsequent measurement

• All financial assets and financial liabilities, including derivatives, should be recognized on the balance sheet at fair value when the entity becomes party to the contractual provisions of the instrument

• Generally requires derivatives and embedded derivatives to be measured at fair value through the income statement

• Held-for-trading financial assets and liabilities and available for sale securities are subsequently measured at fair value


Derivatives

• Derivatives are financial instruments or other contracts with all of the following characteristics

– value changes in response to a change in a specified underlying

– requires little or no initial net investment

– is settled at a future date

Type of Contract Underlying Variable

Commodity price swap

Commodity prices

Interest rate swap Interest rates

Currency forward contract

Currency rates

Purchased or written stock option (call or put)

Equity prices (equity of another entity)

Examples:


Embedded derivatives

• How to identify– An implicit or explicit term in a contract that makes it behave like

a derivative

Instruments with

conversion Features

Instruments with

Contingent features

Instruments with option to extend the term of debt

Transactions in "third

currency"

Indexed-linked

payments


Overview of CICA HB 3865—What is new on hedges

AcG-13 CICA 3865

Designating non-derivatives as a hedging item

No restrictions F/X risk only

Accounting for hedging relationships

No guidance Prescribed models• Fair value• Cash flow• Net investment

Measure ineffectiveness Not recorded during hedge period

Record as it arises

Documentation requirements—measuring ineffectiveness

No documentation requirements

Describe methodology


Preparing for adoption

1. Analyze all key non-financial contracts to determine whether it’s a derivative– if contract is a derivative– mark to market– if qualify for “own-use” exemption and document

2. Identify and analyze all key contracts to determine if any embedded derivative requires separation

3. Initiate valuation process for derivatives4. Implement changes for all existing hedges.

– evaluate if hedging relationship still qualifies– documentation changes – method for measuring ineffectiveness

and accounting treatment– determine transitional journal entries

5. Determine components of other comprehensive income6. Review and classify all financial assets and liabilities

Dennis AugerPartner, Tax

403.691.8385

[email protected]

Dividend Regime


New Eligible Dividends—Background

• On November 23, 2005 the Liberal government announced after a review of Income Trusts that it would instead reduce the personal tax on dividends to eliminate inherent double taxation

• The Conservative government’s May 2, 2006 budget stayed the course and introduced an enhancement to dividend tax credit for certain “eligible” dividends

• On June 29, 2006 draft legislation on new “eligible dividends” was released


New Eligible Dividends—Provincial Response

• To date 4 provinces (Manitoba, Ontario, Quebec and Alberta) have decided on their tax rates for qualifying “eligible dividends”


Eligible Dividends—Overview

• The draft legislation allows eligible dividends to be paid after 2005 by a corporation resident in Canada to individual shareholders resident in Canada

• An eligible dividend is now grossed-up 45 percent (versus 25 percent) and the federal tax credit is now 11/18 of the gross-up (versus 2/3)

• The dividend payor must specify to the recipient that the dividend is eligible


Eligible Dividends—Scheme of Draft Legislation

• The draft legislation essentially comes at the eligible dividend definition from two different perspectives depending upon the status of the dividend payor

• A Canadian Controlled Private Corporation (“CCPC”) must determine if it has a General Rate Income Pool

• A non-CCPC (that is a public company) must determine if it has a Low Rate Income Pool


Eligible Dividends—CCPC’s and General Rate Income Pool

• A CCPC can pay an eligible dividend as long as it has a general rate income pool

• So a CCPC can pay an eligible dividend as long as it has a general rate income pool and does NOT have to pay out of low rate or investment income retained earnings


Eligible Dividends—CCPC’s and General Rate Income Pool

• General rate income pool – is calculated at the end of the year – It is defined by formula in the draft legislation – The balance can be described as

• Opening balance

• Plus: 68 percent (taxable income—small business income—investment income)

• Plus: Eligible dividends received

• Less: Eligible dividends paid

• Think of it as income subject to normal business tax rates assuming a 32 percent tax rate.


Eligible Dividends—Non-CCPC’s and Low Rate Income Pool

• A public company can pay an eligible dividend as long as it does NOT have a low rate income pool

• If it has a low rate income pool, the public company must first eliminate the pool by paying ineligible dividends

• Generally for most public companies, they should not have a low rate income pool unless perhaps they purchased a CCPC or were formerly a CCPC themselves


Eligible Dividends—Non-CCPC’s and Low Rate Income Pool

• Low rate income pool – is calculated during the year

– It is defined by formula in the draft legislation

– The balance can be described as • Opening balance • Plus: 80 percent preceding year’s investment income if CCPC

in prior year• Plus: 80 percent preceding year’s small business income if CCPC

in prior year• Plus: Non-eligible dividends received• Less: Non-eligible dividends paid


Eligible Dividends—Penalty for Ineligible Dividends

• There is a penalty equal to 20 percent of any excess dividend designation payable by the payor

• Corporation that inadvertently pays an excess dividend can elect to treat the excess as an ordinary dividend

• All shareholders are deemed to have received an ordinary dividend and must concur with the election


Eligible Dividends—Comparison of rates

2005 2006 2010

Ontario 31.33 25.00 22.30

Manitoba 35.08 23.78 23.78

Alberta 24.10 18.13 14.50

Quebec 32.80 29.70 29.70


Non-Eligible Dividends—Comparison of rates

2005 2006 2009

Ontario 31.33 31.33 31.33

Manitoba 35.08 35.24 36.74

Alberta 24.10 24.58 27.71

Quebec 32.80 36.30 36.30

Accounting Future Tax Updates

Christina ComfortSenior Manager, Tax

403.691.8071

[email protected]


Agenda

• Accounting for Future Income Taxes– FASB Interpretation No. 48 (“FIN 48”): Accounting for Tax

Uncertainties

– Interim Period Reporting and Effective Tax Rate Forecasting

• Legislative Matters– Flow Through Shares and Charitable Donations


FIN 48: Accounting for Tax Uncertainties

• Establishes a new threshold for recognizing the benefits of tax-return positions in the financial statements and requires additional disclosure in the notes to the financial statements regarding uncertain tax positions

• Effective as of the beginning of the first annual period beginning after December 15, 2006

• Applies to all tax positions accounted for under FAS 109, including tax positions acquired in a business combination



• Mandates a two step approach in accounting for uncertainty in income taxes

– First, determine whether the benefit should be recognized

– Second, if recognition threshold is met determine measurement of benefit



• Step One: The Recognition Criteria– The new threshold for recognition = “more likely than not” (“MLTN”)– The analysis must assume the taxing authorities will examine the

position and have all relevant information available to them

• Step Two: Measurement of the Benefit– If recognition threshold is met, recognize the largest amount of tax

benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information

– Each possible outcome is considered and a probability assigned – Negotiations and ability to settle may be considered at this stage

of the analysis



• Derecognition– After initial recognition if it becomes apparent the “MLTN” threshold cannot

be sustained on audit, the benefit of the tax position is derecognized – Use of a valuation allowance is not a permitted substitute for the

derecognition of a tax benefit

• Changes in Judgement– A change in estimate when the change is related to a prior annual period

and is recognized entirely in the interim period in which the change occurs

• Interest & Penalties– Interest and penalties must be accrued on the difference between the

amount claimed on the tax return and the amount recognized in the statements



• Disclosure Requirements

– Table in the notes to the financial statements disclosing the opening and ending balances of unrecognized amounts

– Amount of interest and penalties included in the income statement each period relating to the unrecognized benefits

– A description of open tax years by jurisdiction


Interim Reporting and Effective Tax Rate Forecasting

• The interim period is an integral part of the annual period— Interim periods do not stand alone

• Estimated annual effective rate is used to allocate annual income tax expense to the interim periods

• Estimated annual effective rate = estimated annual income tax expense

expected annual ordinary income



• Use of estimates/forecasts must be reliable– Effective budgeting system in place– Ability to identify material permanent differences– Includes all events expected to occur in the fiscal year affecting

income tax expense, except events not within managements control

Examples where estimates/forecasts may prove difficult:– Multiple significant permanent differences– Tax-exempt income– Negative annual estimated effective rate (i.e. where non-deductible

expenses exceed pre-tax losses)– Income and royalty trusts



Example

Alberta Co anticipates “ordinary income” of $100,000. All income is taxable in Alberta only at a 33% rate. Non-deductible permanent differences are anticipated to be $10,000. No temporary differences. Computation of the estimated annual effective tax rate applicable to “ordinary income” is as follows

Ordinary Income$100,000

Non-deductible permanent difference$10,000

Taxable Income$110,000

Estimated income tax expense (33% of $100,000)$36,300

Estimated annual effective tax rate ($36,000 / $100,000)36.3%



Ordinary Income Est’d

Annual

Tax

Reporting

Period

Reporting

Period

Y-T-D Eff’ve

Rate

Y-T-D Less:

Previous

Reporting

Period

Q1 $20,000 $20,000 36.3% $7,260 0 $7,260

Q2 $20,000 $40,000 36.3% $14,520 $7,260 $7,260

Q3 $20,000 $60,000 36.3% $21,780 $14,520 $7,260

Q4 $40,000 $100,000 36.3% $36,300 $21,780 $14,520

YE $100,000 $36,300



• Changes in tax laws or rates– If it changes taxes payable in the current period then it should

be reflected in the annual estimated effective rate

– If it changes future income taxes then it should be recognized in the interim period that includes the enactment

• Changes in valuation allowance– If it relates to deductible temporary differences and carry-forwards

arising in the current period it should be reflected in the annual estimated effective rate

– If it arises because of a change in judgment relating to the realizability of the future tax asset it should be recognized in the period in which the change in judgment occurs



Interim Note Disclosure

• Note disclosure on the future tax balances may not be necessary– At an interim date, a description of events and transactions that are

significant to an understanding of the changes in an enterprise's financial position and its performance since the end of its most recently completed fiscal year is sufficient.


Flow-through Shares and Charitable Donations

• The May budget increased the incentive to donate shares by eliminating the capital gain (excluding private foundations) on the disposition of those shares

• Additional incentive where the shares are flow-through shares of publicly traded entities

• Person making the donation deducts the CEE or CDE renounced by the corporation and gets a donation tax credit for the fair value of the shares

• Significantly decreases the after-tax cost of making the donation


Flow-through Shares and Charitable Donations

Example

Investment in flow through shares $10,000

Plus: Capital Gain on Disposition NIL

Less: Value of Tax Deduction (3,900)

Less: Value of Donation Credit (3,900)

After-Tax Cost of Donation $2,200


kpmg.ca

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. © 2006 KPMG LLP, a Canadian limited liability partnership and a

member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Canada.

3 rd quarter accounting, reporting and tax update october 4, 2006 seminar kpmg llp

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