Our response to specific questions as well as general comments, are attached.

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Jemima Cooper
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February 20, 2004 E- Mail: ed.psector@cica.

Salole: I am writing in response to the Public Exposure Draft, Liabilities, Contingent Liabilities and Contractual Obligations, forwarded to Associates of the Public Sector Accounting Board

1 February 20, 2004 E- Mail: File: Ron Salole, Director Public Sector Accounting The Canadian Institute of Chartered Accountants 277 Wellington Street West Toronto Ontario M5V 3H2 Dear Mr. Salole: I am writing in response to the Public Exposure Draft, Liabilities, Contingent Liabilities and Contractual Obligations, forwarded to Associates of the Public Sector Accounting Board on December 1, Our response to specific questions as well as general comments, are attached. If you require further clarification regarding these comments, please call me at ( arn.vaniersel@gems8.gov.bc.ca ) or Kit Chapman at ( kit.chapman@gems7.gov.bc.ca ) Yours truly, Arn van Iersel Comptroller General Attachment

2 The Public Sector Accounting Board proposes to issue three new handbook sections, subject to comments received after exposure, on liabilities, contingent liabilities and contractual obligations for the Public Sector for comment. The Exposure Draft: amends the existing definitions of liabilities and commitments; defines contingent liabilities; provides general recognition, measurement and disclosure standards for each, where appropriate; and, provides guidance for applying the proposed standards. The Public Sector Accounting Board (PSAB) has asked answers to six questions. Our answers are shown in italics below. 1. Do you agree with the definition of a liability? No, we do not agree. We are opposed to the recognition of constructive and/or equitable obligations and feel they are too subjective and should be recognized only when the confirming legislation or a legal obligation is in place (such as a guarantee of debt or legislation is in place or has been tabled). If constructive and/or equitable obligations are to be recognized under the current provisions of the exposure draft a situation could arise where constructive and/or equitable obligations are expensed based upon the exercise of professional judgment as required by this section and subsequently de-recognized because the events anticipated under the constructive and/or equitable obligation did not actually transpire. As a result, the accumulated surplus/deficit of the government over time is correct; but is misstated for those periods of time that the constructive and/or equitable obligations were recognized and then reversed. In a recent circumstance, the province chose not to recognize a potential increased pension liability due to inflation even though it had actually paid the inflation increase in the past. The province chose this course because it was not obligated under the contract to make the contributions. The auditor felt the province had a moral obligation to record a liability. Under this current proposal the province may not have been able to maintain its position of not recognizing the liability. Subsequent events have confirmed the province's position. If the province had agreed with the auditor and recognized the liability, the province's accumulated deficit would have been overstated until the subsequent events confirmed the province's position and the increase to liability was reversed. We would like to submit the following scenario -- the accounting for the described transaction is not clear from the transaction. Shortly before an election, the government could approve a capital planning project and announce that a new municipal facility will be built in a particular location. The community in question then purchases and for the construction of the facility even though no formal funding agreement has been signed. Under the guidance provided, the government would most likely record a constructive liability for its share of

3 the facility's cost. However, the guidance provided does not allow for a change in government. It is entirely possible that the new facility was included in approved plans, ministerial letters and the detailed design partially completed. If a new government were elected and in its mandate stated that it would not build the facility, it would then reverse the constructive liability. Another issue -- it is not uncommon for a government to make promises (that could be interpreted as constructive obligations) but not act upon them for several or in some cases tens of years. Under the proposal of this Exposure Draft, the government could be required to recognize a constructive obligation. Another problem is the exposure draft does not identify where the debit part of the transaction should be recognized. If the constructive obligation is related to the construction of an asset, the government would be required to recognise an asset that in actual fact does not become an asset until it actually builds the asset. If the liability were for a transfer payment or other expense, the expense would be recognized in a fiscal period in advance of when the government actually recognized its obligation by legislation or other signed agreement/contract. Please note: We have concerns about the potential economic impacts and increased expenses that could occur from the recording of constructive and/or equitable obligations. The recognition of a multitude of constructive and/or equitable obligations could result in the situation where a government has recorded many liabilities, which will result in cash transactions that will occur in future years. As a result, the liabilities of the government will increase and this could result in a negative rating by bond rating services. In turn, this could cause the overall cost of the government's borrowing to increase. If constructive and/or equitable obligations are adopted by PSAB, we suggest the wording be changed from "the settlement of which is expected to result in the future sacrifice of economic benefits" to "the settlement of which will result in the future sacrifice of economic benefits." The existence of the liability is not a matter of opinion or expectation, but a matter of a payment that will be made. It is suggested that the word "sacrifice", which is used often in referring to a future transfer of value or a payment, does not have appropriate business connotations. Wording such as "transfer of value" or "relinquish" would be more effective. 2. Are paragraphs.20 and in the LIABILITIES proposals needed? These paragraphs are only needed if constructive and/or equitable obligations are included in the definition of a liability. Legal claims against governments are increasing for any and every kind of service or promise that may have been made, not made, once paid, or withdrawn. Eligibility for certain entitlements is a particular problem. Recent cases have been decided in favour of persons making claims for payment of disability costs that government previously funded or for disability costs similar to those funded in the past. The use of wording that includes "valid expectations" and the concept of "equitable obligations" in the definition of present obligations adds a new realm of possibilities that may add significantly to liabilities recorded. More practically, the wording opens doors to new litigation possibilities that would not be desirable, reasonable or practical.

4 3. Do you think disclosure of measurement uncertainty should apply to all items recognized in the financial statements? Partially. Disclosure of measurement uncertainty should apply to all material items recognized in the financial statements that are subject to material shifts in value (see s1508 below). PSAB states that a "government financial report should present information that is useful in evaluating the government's financial condition at the end of the accounting period and its financial performance during the accounting period." Therefore, it is important for government to disclose all items that could have a material effect on that report. S 1508 of the Handbook paragraphs requires that, if significant, the nature and extent of a measurement uncertainty should be disclosed when it is reasonably possible that the recognized amount could change by a significant amount within the near term, except when disclosure of the amount would have a significant adverse effect on the entity. When the recognized amount is not disclosed, the reasons for non-disclosure should be indicated. If constructive and equitable liabilities are to be disclosed, they should be disclosed separately from the current category and preferably disclosed in notes. There should be two types of liabilities: the current category that is called accounts payable and a new category called accrued liabilities and constructive and/or equitable obligations. It is preferred that constructive and/or equitable obligations be disclosed in the notes as obligations rather than being recorded as liabilities. The amount of uncertainty with respect to constructive and equitable obligations makes this treatment more preferable. 4. Do you agree that a contingent liability should be recognized when it is likely that the future confirming event will occur? We agree that a material contingent liability should be recognized when it is likely that the future confirming event will occur. Current practice by the government of British Columbia is that contingent liabilities are accrued when it is likely that a loss amount will be payable and the amount can be reasonably estimated. Possible contingent liabilities are listed, analyzed by both legal and accounting professional, a risk analysis is concluded and the future events that will likely confirm a liability where the amount can be estimated are recorded. Our current practice follows private sector Generally Accepted Accounting Principles (GAAP) that we feel is adequate. 5. Do you agree that an accrued contingent liability should be derecognized when it is determined that the future confirming event is unlikely to occur? We agree that an accrued contingent liability should be derecognized when it is determined that the future-confirming event is unlikely to occur. In order for a contingent liability to be recognized there must be an expected future event that will resolve the uncertainty and confirm the existence of a liability. If this were not likely, then no contingent liability exists and to leave it accrued would result in an overstatement of liabilities.

5 In the event that an amount has been recognized as a constructive and/or equitable obligation and when it becomes evident that the conditions that made the amount be recognized no longer apply, it should be derecognized. 6. Do you agree that the nature, extent and timing of expenditures related to contractual obligations should be disclosed? No, we do not agree. We feel this section should state the nature, extent and timing of expenditures related to constructive obligations should be disclosed with respect to non-routine, material long-term obligations. For example, a $50M per year P3 arrangement with a term of 30 years. If there are offsetting arrangements, they should be disclosed consistent with other reporting standards. We are concerned that without specifying the level of materiality, governments will be required to implement systems that will track the amount and timing of a multitude of contracts that extend beyond the end of the financial statement date. General Comments: Although not disagreeing with the principle that government should be held to a higher standard of disclosure than private sector entities, we note the requirements for contingent liabilities are higher for PSAB than private sector GAAP. For contingent liabilities, paragraph.25 states, "The following information should be disclosed " while section 3290 of the CICA Handbook states "disclosure of may be desirable." PSAB section 1200 provides guidance on the function and purpose of financial statements. We feel the recognition of constructive and equitable obligations as liabilities is contrary to this guidance for in the following respects: Paragraph.004 states that financial statements should communicate information that is relevant, reliable, comparable, understandable and clearly presented. Constructive and equitable obligations may fail, as the information related to them may not be reliable, understandable or clearly presented. Paragraph.016 financial statements should be presented such that significant information is readily understandable. Recognizing constructive and equitable obligations as liabilities may be potentially misleading because there is no absolute assurance the liabilities will be acted upon. Paragraphs.26 and.27 require that the substance of transactions and events be presented in accordance with their financial reality. It may be difficult to account for constructive and/or equitable obligations in accordance with their financial reality, as there may not have been a transaction or event to confirm the existence of a liability. In respect of constructive and equitable obligations, there may only have been discussion.

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