Assets, Contingent Assets and Contractual Rights Issues Analysis August 2014 Prepared by the staff of the Public Sector Accounting Board
Table of Contents Paragraph Introduction....01-.02 Application....03 Background....04-.06 Assets....07-.22 Control....07-.17 Restricted assets....09-.10 Government transfers....11-.17 Disclosure....18-.22 Contingent assets....23-.31 Definition....23 Guidance....24-.25 Disclosure....26-.31 Contractual rights....32-.42 Definition....32-.36 Guidance....37-.38 Disclosure....39-.42 Other general comments....43-.45 Scope....43 Impact of other projects....44-.45 Assets, Contingent Assets and Contractual Rights 1
Introduction 01. This Issues Analysis is a supporting document to Public Sector Accounting Board s (PSAB) Exposure Draft, Assets, Contingent Assets and Contractual Rights. It provides information on how significant matters arising from comments received on PSAB s Statement of Principles have been dealt with in the Exposure Draft. Amongst other matters, it addresses: (a) alternative views on the issues dealt with in the proposed standards; and (b) the view taken by the Board, with appropriate reasons for taking that position. 02. The analysis is not issued under the authority of PSAB. Prior to approving the final standards, the Board will review and deliberate responses to the Exposure Draft. Application 03. The Exposure Draft proposes three general application standards. A general application standard is contrasted with a specific application standard for an individual financial statement item. Both form part of generally accepted accounting principles but differ in the breadth of their applicability. A general application standard operationalizes in a broadly applicable fashion the concepts in the conceptual framework. A general application standard is useful when a specific application standard does not exist and GENERALLY ACCEPTED ACCOUNTING PRINCIPLES, Section PS 1150, requires a chosen accounting treatment to be consistent with the conceptual framework. A general application standard may also be useful when a specific application standard exists; however, it does not directly address the financial statement issue at hand. Background 04. PSAB issued a Statement of Principles in August 2013. Respondents were generally supportive of the proposed principles on assets, contingent assets and contractual rights. 05. Three major issues were raised by respondents to the Statement of Principles: (a) the adequacy of the guidance on control; (b) the effort required to disclose unrecognized assets; and (c) the cost and auditability of disclosing contractual rights. 06. Many respondents suggested it would be helpful if the scope of the proposals included accounting for intangibles, inherited natural resources and Crown lands, and art and historic treasures. Respondents also raised concerns with regards to the impact of other ongoing projects on the proposals in the Statement of Principles. 2 Issues Analysis
Assets Control 07. The guidance on control received the most comments and suggestions for improvement. The main issues raised by respondents were whether: (a) restrictions on the use of an economic resource negate the public sector entity s control of the economic resource; and (b) removal of the term directly from the guidance on control would lead to ambiguity regarding control of the economic resource in the case of government transfers. 08. Some respondents also provided suggestions for explaining each aspect of control and for adding examples that would clarify the guidance. These suggestions are reflected in the Exposure Draft. Restricted assets 09. One respondent indicated that the proposed guidance on control may cause confusion when considering assets that have external restrictions placed on their use. The guidance requires that the entity be able to determine how the economic resource will be used, while the purpose of external restriction is to provide a limit on their use. 10. PSAB concluded that the characteristic to be able to determine how the economic resource will be used should not be included in the guidance on control. While this feature may be an indication that control exists, it creates confusion in the case of restricted assets. Also, the control guidance remains strong without this added requirement. This is because the essence of an asset is its future economic benefit and the ability to regulate or restrict access to that benefit. Being exposed to risk of loss is also an essential characteristic of control. All three requirements are met when considering restricted assets. That is, the entity holding a restricted asset can benefit from them (use them to provide services), deny or regulate access to that benefit by others (decide who receives the benefit), and is exposed to the risk of loss (for example, incur a loss from investing the asset). Government transfers 11. The existing guidance on control in FINANCIAL STATEMENT CONCEPTS, paragraph PS 1000.38, provides that the government controls an asset to the extent that it can benefit directly from the asset and generally can deny or regulate access to that benefit by others. 12. The Statement of Principles proposed to remove the term directly from the guidance on control in order to eliminate confusion as to who benefits directly. For example, in the case of a bus, the benefit to the public is the transportation service, Assets, Contingent Assets and Contractual Rights 3
while the benefit to the public sector entity is the ability to meet its objectives of service provision. Both the public and the public sector entity benefit but in a different way. PSAB also concluded that this proposal would not affect the robustness of the guidance on control. 13. One respondent was concerned that the proposed removal of the term directly from the control guidance may lead to ambiguity regarding how to account for transfer payments. The respondent believes that it could be argued that transfer payments represent a prepaid asset of the transferring government. Another respondent was of the view that the removal of the term directly may cause issues with determining whether the recipient has an asset. 14. PSAB is of the view that the removal of the term directly from the guidance on control does not affect the guidance on government transfers. This is because the Assets Section does not deal with specific types of assets such as government transfers. It also does not override any standard in the CPA Canada Public Sector Accounting (PSA) Handbook. Consequently, the guidance in GOVERNMENT TRANSFERS, Section PS 3410, should be consulted to determine how to account for transfer payments. 15. Further, the transfer is not an asset of the transferor but is an asset of the recipient. The reasons are: (a) The recipient receives an economic benefit from the transfer. This is because the recipient provides the good or the service. (b) The recipient denies or regulates access to the benefits from the transfer. The transferor may have set certain parameters around the transfer; however, the recipient determines who will receive access to those benefits, based on those parameters. (c) The recipient is exposed to the risk of loss related to the transfer. The recipient is responsible for the transfer and is exposed to any losses associated with it (for example, investment losses). 16. The Basis for Conclusions to government transfers supports this by stating: The new standard does not allow transferring governments to recognize any types of transfers as assets regardless of whether they are preflowed or not. This view is based on the fact that the transferring government does not receive economic value in return that can be recognized as an asset. 17. The removal of the term directly from the guidance on control does not need to result in the removal of this term from the guidance in GOVERNMENT TRANSFERS, paragraph PS 3410.13. This guidance provides that a transferring government does not receive a direct economic benefit that it can control in exchange for a transfer, as is required by the definition of an asset. This statement is there to emphasize that the transferor does not receive a benefit. 4 Issues Analysis
Disclosure 18. The Statement of Principles proposed that the nature of all unrecognized assets should be disclosed in the notes together with the reason(s) why. This disclosure requirement was meant to capture all those items that meet the definition of assets but are not recognized because they cannot be measured or their recognition is prohibited by the PSA Handbook. The proposal was thought to provide useful and relevant information on economic resources available to public sector entities and balance the disclosure of all unrecognized liabilities in LIABILITIES, Section PS 3200. 19. Although most respondents agreed with the proposed disclosure requirements, some respondents, including those that agreed with the proposals, have raised issues. The main concerns included the amount of work required to complete the disclosures and the lack of guidance on certain types of assets (for example, intangibles). Those respondents proposed to limit the disclosure requirements to: (a) specific guidance on materiality; (b) only those unrecognized assets that are not reasonably measurable; or (c) making them desirable rather than required. 20. Adding the concept of materiality to the disclosure requirements in order to scope out disclosure of insignificant items was considered to be unnecessary. This is because general guidance on materiality already exists in the PSA Handbook. Changing the disclosure requirements to desirable disclosure may lessen the burden for some organizations but would result in lack of comparability. Limiting disclosure to only those that are not measurable may result in a very narrow scope because there may not be many assets that cannot be measured. 21. However, the Board recognizes stakeholders concerns with respect to the scope of the proposed disclosures. As a result, the Exposure Draft proposes that the disclosure requirements be limited to the types of assets that are not recognized rather than their nature. In the PSA Handbook, disclosure of nature generally involves providing a broad description of an item, whereas disclosure of the type of assets would limit disclosure to the asset categories (for example, intangibles, Crown lands, heritage assets) that have not been given an accounting recognition. 22. Disclosure of the types of assets that are not recognized is already practiced by some public sector entities and should address concerns with regards to the extent of effort required. In addition, it would provide useful information about the types of assets not recognized by entities and, hence, assist in understanding the resources available to public sector entities. Assets, Contingent Assets and Contractual Rights 5
Contingent assets Definition 23. All respondents agreed with the proposed definition of contingent assets. One respondent suggested improving the definition by replacing the term possible resources that may result in future economic benefits with possible assets. PSAB agreed with this suggestion as it simplifies the wording and does not change the intended meaning. Another respondent s suggestion to delete the last sentence of the definition on the grounds that the meaning is already captured in the previous sentence is not reflected. PSAB is of the view that the inclusion of the sentence Resolution of the uncertainty will confirm the existence or non-existence of an asset provides an important message that may not be apparent unless clearly stated. Guidance 24. The guidance on contingent assets was developed in order to enhance users understanding of what items meet the definition. Most respondents are pleased with the guidance and find it useful. One respondent thought that accounting for contingent assets has never been a contentious issue and, hence, the proposed guidance is neither detrimental nor does it add value. 25. Some respondents, who agreed with the proposed guidance, asked for further examples to be included in the guidance. Two examples are provided. Further examples may make the guidance on contingent assets prescriptive rather than principles based. One respondent also suggested ensuring that the example of tax receivable is an appropriate example of measurement uncertainty. Tax receivable is an example of measurement uncertainty rather than existence uncertainty as there is nothing uncertain about whether the asset exists. The past transaction giving rise to the asset has already occurred. This example is consistent with the example provided in TAX REVENUE, paragraph PS 3510.23. Disclosure 26. Most respondents agreed with disclosure of contingent assets. This is because contingent assets do not meet the assets definition, benefits of recognition do not outweigh the risks/costs and because of conservatism. However, some respondents were of the view that contingent assets that are virtually certain should be recognized. This is because there are circumstances under which recognition prior to the confirming future event would be appropriate (i.e., the bridge example in the Statement of Principles). Further, this would result in accounting standards for contingent assets and contingent liabilities that would be slightly more neutral. One respondent did not support any reporting of contingent assets on the grounds that PSAB should preserve the principle of conservatism. 6 Issues Analysis
27. Respondents were also asked to consider whether they agree with limiting the recognition of contingent assets to cases where a contingent asset may be recognized as part of a reduction to a related contingent liability (see CONTINGENT LIABILITIES, paragraph PS 3300.25). Most respondents agreed with this treatment. Some supported it by stating that recoveries are often elements of contingent liabilities and not a separate transaction distinct from the occurrence of the obligation. 28. However, some respondents were of the view that the criteria to recognize a contingent asset as part of a reduction to a contingent liability should be subject to a higher threshold (i.e., virtual certainty). This is because, in substance, a contingent asset that is disclosed and a contingent asset that is recognized as part of a reduction to a related contingent liability have the same economic characteristics. Therefore, including a contingent asset that is likely but not virtually certain as a reduction to the contingent liability is inappropriate since it is too far removed from the notion that the entity has present control of a resource. One respondent thought that contingent assets should only be disclosed regardless of the circumstances. 29. PSAB has considered at length whether there is some threshold (i.e., virtual certainty) at which contingent assets should be recognized. The arguments supporting and opposing recognition of contingent assets, as provided by the respondents, have been considered by the Board. Given that contingent assets do not meet the assets definition and because of the concerns surrounding their recognition, PSAB is of the view that contingent assets should only be disclosed. This treatment still provides relevant and reliable information for accountability and decision-making purposes while addressing the risks associated with the realization of contingent assets. 30. The issue of whether it is appropriate to reduce a likely contingent liability with a likely contingent asset leads to broader considerations. That is, in addition to considering the appropriateness of the threshold (likely vs. virtually certain), it is important to determine whether netting of a contingent asset against a related contingent liability is appropriate. Given the number of Handbook Sections affected by this issue, the decision of whether netting is appropriate is outside the scope of this project. 31. One respondent suggested that reporting of contingent liabilities should result in a symmetrical reporting for contingent assets. For example, in the case of government transfers, the transferee should not disclose a likely contingent asset if the transferor did not record a likely contingent liability. PSAB is of the view that when an entity considers whether it has a contingent asset or a contingent liability it looks at its own set of facts. These facts may be different for one entity than for the other and may result in dissimilar reporting. Therefore, although symmetrical accounting may be logical in some cases, it may not always be appropriate. Assets, Contingent Assets and Contractual Rights 7
Contractual rights Definition 32. In determining the definition of contractual rights, consideration was given as to which contractual rights should be within the scope of the proposed standard. PSAB was of the view that the scope should be limited to only those contractual agreements that will result in additional resources available to the entity. This was accomplished by defining contractual rights as rights that will become assets and revenue when the terms of the contracts or agreements are met. Most respondents agreed with the proposed definition. 33. PSAB did not consider the inclusion of the term revenue in the proposed definition redundant, as suggested by one of the respondents. Omitting this term would result in capturing all those contractual agreements that result in an asset but not necessarily in additional resources, making the disclosure requirements less useful and more onerous. 34. In addition, in order to convey that assets and revenue may be realized in different periods, the phrase in either the same period or different periods was added to the definition. One respondent was of the view that this concept is sufficiently conveyed in the rest of the definition and it seems to be complicating the definition. PSAB agreed and removed it from the definition. 35. PSAB also considered a respondent s suggestion to expand the definition of contractual rights to include those cases that result in assets and a reduction of expenses. This situation would lead to an overall increase in economic resources to the entity and, hence, be consistent with the intended scope of this Section. However, PSAB could not think of any common examples to support this proposal. Therefore, it was thought that there may not be much value in expanding the definition and that such a change may result in confusion. 36. PSAB also agreed with a respondent s suggestion to remove the expression legally enforceable from the definition. Contractual agreements are legally enforceable in any event. This concept is sufficiently conveyed in the supporting guidance. Guidance 37. Most respondents found the guidance on contractual rights useful. Some respondents provided additional suggestions, which included an improvement to the decision tree by adding a decision box on whether a contract exists. Another suggestion related to providing additional practical examples of contractual rights. Those suggestions are reflected in the Exposure Draft. 38. As indicated by a respondent, entering into a contract may constitute the past event that gives rise to an asset. Those cases are outside of the scope of the proposed standard and were clarified in the Statement of Principles. Specifically, the guidance 8 Issues Analysis
provides that derivatives are unlike contractual rights where the asset does not exist until the good or service that is the object of the contract is provided. The guidance does not specifically explain why derivatives are assets, as suggested by a respondent, since this has already been addressed as part of the Financial Instruments project. Disclosure 39. Although the majority of respondents supported the proposed disclosure requirements on contractual rights, some have raised issues. The main concerns included cost as well as potential auditability issues. To address these matters, respondents proposed imposing further limits on the disclosure requirements. Options provided include: (a) imposing clear materiality limits; (b) limiting disclosure to non-exchange transactions; (c) scoping out government transfers and financial instruments; (d) limiting disclosure to new or non-recurring items; and (e) providing limits similar to those included in contractual obligations. 40. The Board considered all of these options. Materiality limits may help clarify specific circumstances, however, are not necessary as guidance on materiality already exists in the PSA Handbook. Limiting disclosure to non-exchange transactions only or scoping out government transfers and financial instruments may result in omission of significant contractual rights and, hence, not provide users with useful information about economic resources available to the organization in the future. 41. PSAB recognizes respondents concerns and concluded that guidance similar to that included in CONTRACTUAL OBLIGATIONS, paragraph PS 3390.10, would be appropriate, and would address stakeholders concerns with respect to the scope of disclosures. Therefore, in addition to requiring disclosure of contractual rights, the Exposure Draft provides factors to consider when determining contractual rights that would be disclosed. The limit of new or non-recurring items, suggested by one respondent, is a subset of these factors. 42. PSAB is of the view that disclosure of contractual rights improves the predictive value and, hence, results in better information for accountability and decisionmaking purposes. In addition, it complements the disclosure requirements of contractual obligations and thereby contributes to a more balanced view of a public sector entity s future revenue and expenditures. Assets, Contingent Assets and Contractual Rights 9
Other general comments Scope 43. Many respondents considered that it would have been helpful if the Statement of Principles included guidance on the recognition of intangibles, inherited natural resources and Crown lands, and art and historic treasures. In addition, some respondents suggested adding guidance on specific types of assets. As indicated in the Statement of Principles, these items are outside the scope of the Assets project. However, respondents have been given an opportunity to express interest in these specific topics by responding to PSAB s 2014 Project Identification Survey. Impact of other projects 44. One respondent expressed concern over the potential impact of the Concepts Underlying Financial Performance project on the proposals in the Statement of Principles. PSAB previously made a decision not to stop the progress of its projects in view of the ongoing Conceptual Framework project. 45. Another respondent was of the view that PSAB should not move forward with the Assets project until a link between GOVERNMENT TRANSFERS, Section PS 3410, and CONTINGENT LIABILITIES, Section PS 3300, is established, or the issue of when a transfer is authorized is resolved. The purpose of the proposed Assets, Contingent Assets and Contractual Rights standards is to provide general guidance on these topics. Any specific issues relating to government transfers will be reviewed separately. 10 Issues Analysis
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