Now Available! Meeting Report from PSA Discussion Group Meeting – June 8, 2023

ITEMS PRESENTED AND DISCUSSED AT THE JUNE MEETING

Canadian Economic Overview and Potential Impacts to the Public Sector

As an introduction to support the two agenda topics of the meeting, CPA Canada’s Chief Economist, David-Alexandre Brassard, presented economic trends and considerations of potential impacts to the Canadian public sector. They include the following:

• The initial spike in inflation originated from an imbalance between the overall supply and demand in the economy. Constrained labour shortages remain prevalent while supply chain issues have recovered.
• The consumer price index (CPI),¹ which is a metric used to track inflation, remains elevated:
  • It reached 8.1 per cent in June 2021 and 4.3 per cent in March 2023.
  • The proportional increases of various items in the CPI calculation have fluctuated. Food prices remain disproportionately higher than other goods and services.² 
• Wages drive inflation as they are rising at a similar pace. Increased wages in part drive up consumption, contributing to the rise in inflation.
• Canadian banks project Interest rates will remain at 3 per cent or higher until at least 2025. This means debt will remain more expensive for an extended period.
• Inflation has increased revenue for many public sector organizations with nominal gross domestic product (GDP), outpacing real GDP due to inflation.³
• The Canadian economy has shown more resilience than anticipated. Recessionary trends remain and could prompt a mild recession or an economic slowdown in 2023 or 2024.
• Employment in the public sector has grown significantly compared to the rest of the labour market. This growth has varied by province.
• The retirement wave will continue to impact the labour market. This impact will be more pronounced for the public sector as the average retirement age is lower (62.7) than the private sector (64.7).
• Fiscal imbalances remain within the country as some provinces maintain an unsustainable amount of debt.

In summary, challenging economic conditions are expected to persist. Public sector organizations must assess financial reporting and disclosure requirements to ensure financial statements consider the implications of the current economic environment.

¹ The Bank of Canada uses the CPI to track how much the average Canadian household spends, and how those changes over time. Further details on how the CPI is used as a metric to measure inflation can be accessed found at the following link: Understanding the consumer price index – Bank of Canada “Understanding the consumer price index” on the Bank of Canada website.

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Impacts of Rising Inflation and the Economic Environment on Financial Reporting

The submission asked the Group to consider some of the key financial reporting areas that may be impacted by adverse economic conditions.

Group members were asked to share their views regarding measurement uncertainty and other disclosures, asset impairment, liability measurement, going concern, financial self-sufficiency of government business enterprises, and other matters outlined in the submission by considering the following:

• Potential issues faced by public sector entities because of the current economic climate.
• Financial and economic consequences that may need to be considered in financial reporting and disclosures of public sector entities.
• Topics that may require new or updated non-authoritative guidance or may suggest a possible future Public Sector Accounting Discussion Group topic.

One Group member noted that impacts of uncertainty are often reflected in budgets and annual reports (e.g., in the Financial Statement Discussion and Analysis) rather than the financial statements.

Group members discussed whether certain measurement attributes may not appropriately capture certain economic consequences, such as inflation. They shared the following:

• Replacement cost of infrastructure may need to be explored as a possible measurement attribute. Changes in inflation and economic circumstances accentuate the need to have a measurement attribute that may better reflect what it will cost to replace the service potential of significant infrastructure.
• Using historical costs in an inflationary environment may not accurately reflect current economic circumstances.
• Using replacement cost for key operational assets may require further guidance. A Group member noted PORTFOLIO INVESTMENTS, Section PS 3041, is clear in establishing loss in value and other than temporary decline requires a write-down of the assets. Other Group members noted that current economic conditions make it difficult to establish what may be deemed temporary versus permanent.

Some Group members remarked that the current inflationary projections remain mild when compared to the period of high inflation experienced in the 1980s, citing Craig Lord’s article for Global News, “Inflation in Canada soared 40 years ago. Is today’s price surge any different?” The Group discussed the following when contemplating the severity of the current economic climate:

• To avoid a panic reaction, the Group proposes not modifying or revising existing Public Sector Accounting Standards (PSAS). It remains important to monitor how standards are being applied in reflecting the financial position and results of public sector entities.
• Conditions may require organizations to apply or reassess the applicability of certain standards. The economic decline may still be in its infancy and organizations need to be proactive in appropriately reporting its financial risks.
• Relevant guidance already exists. The Group sees no glaring gaps in existing guidance.

The Group noted that government business enterprises (GBEs) may be the most vulnerable to the impacts of high inflation:

• GBEs are more susceptible to consequences resulting from challenging economic conditions.
• The economic downturn may impair the viability of some GBEs, and/or their financial self-sufficiency from revenue outside their controlling government’s reporting entity.
• Some GBEs have not recovered from economic consequences suffered from the COVID-19 pandemic. The current economic climate may further accentuate financial challenges many GBEs experienced. Drawing attention to current guidance is important.
• The Group reflected on its discussions in November 2019 and November 2018 involving the assessment of GBEs’ financial self-sufficiency. They noted that the guidance provided in addressing the effects of the COVID-19 pandemic would still apply to the current economic climate.

Most Group members indicated that many public sector organizations will need to assess how current economic conditions affect asset impairment. The Group discussed:

• Deferred maintenance is more prevalent during challenging economic times. Important infrastructure initiatives may be delayed or cancelled to the detriment of the service life of assets and needed replacements to deliver services.
• Impairment is primarily based on the service potential of assets. Government-owned or -leased buildings and other tangible capital assets may need to be reviewed for impairment. The Group discussed the need for disclosures should an asset be unlikely to meet its expected service potential. 

Many Group members noted challenges in applying an appropriate measurement attribute to reflect ongoing economic consequences and shared the following:

• Historical cost may need to be re-assessed as the required measurement attribute, especially for infrastructure assets.
• Measurement uncertainty is appropriately addressed in financial instruments. Disclosure requirements around liquidity, credit, and other risks are defined in existing PSAS. Public sector entities have improved their disclosures on adoption of the new financial instruments standard.
• Assumptions involved in measurement estimates may need to be reviewed. Changes in circumstances and uncertainty surrounding many economic factors may necessitate this review.

Some Group members noted that challenging economic conditions lead to difficulties in managing and maintaining infrastructure assets:

• Deferred maintenance should be tracked. Many organizations have delayed or deferred maintenance, which may not serve the public interest.
• Infrastructure deficits will become more pronounced under poor economic conditions. A few Group members noted that further disclosure should be provided in such instances, adding that such deficits risk becoming liabilities. Statement of Recommended Practice (SORP) 3, Assessment of Tangible Capital Assets, relates to reporting outside of financial statements, but applying it could provide useful disclosures about the condition of an entity’s assets.
• Many organizations are attempting to also address climate change in their asset management plans. Green infrastructure remains an area where further guidance is needed as organizations plan for addressing climate-related risks.
• Some assets can hold value or even be repurposed, in contrast with depreciated assets that are no longer of use. Public sector organizations may need to be creative in the future use of underutilized assets.

The Group discussed that public sector entities have social obligations in serving the public interest. In the absence of legal obligations, the public sector may still have social and ethical obligations to consider. Service levels may need to be upheld despite challenges posed by the economy. Note disclosures on programs and commitments that may not meet service requirements should be provided.

The Group discussed whether broader reporting would be beneficial in improving the stewardship of public sector organizations:

• One Group member noted that stewardship disclosures may be important to consider as the management of resources varies across organizations. Establishing key performance indicators would prove helpful in disclosing how organizations manage funds and plan, use, and track resources. SORP-2, Public Performance Reporting, relates to reporting outside of financial statements, but applying it could provide useful disclosures about key performance indicators of an entity.
• A Group member shared that Municipal Benchmarking Network Canada is an example of how funds may be managed differently across municipalities. Some organizations are already tracking performance and are integrating key performance indicators as part of their annual reports.
• Debt has become more expensive, and performance indicators around areas such as cash management would be of public interest. Some Group members reflected that such reporting be the responsibility of management and is unlikely to fit within the confines of accounting standards. However, the cash flow statement and the extent to which interest costs affect spending on programs provide good financial statement information relevant to cash management.

Ultimately, Group members concluded that existing accounting standards and guidance are adequate for considering the current economic conditions. While existing PSAS are sufficient, the application of existing standards may require further guidance. Reference could be made to the reporting and disclosure requirements of the subtopics from this discussion to highlight the issues public sector organizations face given the challenging economic outlook. The Group encouraged PSAB to consider issuing updated non-authoritative guidance to reflect the current economic environment, such as:

• the guidance issued in response to the economic impacts of COVID-19 in 2020; and
• the guidance on the financial self-sufficiency of GBEs.

² Statistics Canada, “Consumer Price Index, March 2023,” The Daily, April 18, 2023.

³ Government revenues, which mostly come from nominal measures such as personal and corporate taxes, have been higher than forecast.

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Auditor Reporting on Going Concern: Public Sector Considerations

This submission sought to gather feedback from Group members on the Canadian Auditing and Assurance Standards Board (AASB) Exposure Draft, “Going Concern,” based on the International Auditing and Assurance Standards Board’s Exposure Draft, "Proposed International Standard on Auditing 570 (Revised 202X) Going Concern and Proposed Conforming and Consequential Amendments to Other ISAs.” ISAs are adopted in Canada as Canadian Auditing Standards. The AASB’ Going Concern project page has up-to-date information. 

The Group was asked to consider this session as a public sector accounting roundtable on the AASB’s Exposure Draft.

Going concern can be an issue in the public as well as private sectors. The Public Sector Accounting Discussion Group and PSAB Chairs agreed that the Group could discussed the topic for two reasons:

• The topic overlaps with the new going concern text in the Conceptual Framework for Financial Reporting in the Public Sector and recently approved new reporting model, which the Board will issue as new FINANCIAL STATEMENT PRESENTATION, Section PS 1202, in the PSA Handbook in October 2023.⁴ So, this connects with PSAS and is relevant to the Board.
• It is important to include public sector perspectives in (existing and proposed) audit standards that, over and above PSAS requirements, impose requirements on the preparers of public sector financial statements (i.e., the going concern assessment and the period over which it should be done).

New text on the longevity of the public sector and going concern has been added to Chapters 2 and 9 of the Conceptual Framework⁵ and to paragraph PS 1202.25-32.⁶ This text provides context and requirements for going concern assessments in the public sector.

Financial statements are prepared on the assumption that the entity is a going concern. This means the entity will continue to operate, will realize assets and discharge liabilities, and will meet its statutory and other obligations (see paragraph 9.38 of the Conceptual Framework). However, some public sector entities may need to reassess this assumption given the current economic environment.

Roundtable discussion of the AASB’s Exposure Draft

Issue 1

Group members were asked to discuss:

• the requirements proposed in the AASB’s Exposure Draft;
• whether there are any concerns with the auditor’s report stating that the auditor:
  • has concluded that management’s use of the going concern basis of accounting is appropriate; and
  • has not identified a material uncertainty,
• what, if anything, should be mentioned in the audit report in the circumstance when a public sector entity:
  • transfers its assets, liabilities, and responsibilities to a recipient;
  • discontinues its operations; and
  • ceases to exist as part of a restructuring transaction. 

Group members were asked to share their views on the above points as to whether there are any concerns with the proposed requirement in proposed paragraph 33 of ISA 570.

33. If the auditor concludes that the going concern basis of accounting is appropriate and no material uncertainty exists, the auditor shall include a separate section in the auditor's report with the heading “Going Concern", and: (Ref: Para. A67–A68)
    1. State that the auditor: (Ref: Para. A69–A70)
       1. Concluded that management’s use of the going concern basis of accounting in the preparation of the financial statements is appropriate; and
       2. Based on the audit evidence obtained, has not identified a material uncertainty related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern.
    2. For an audit of financial statements of a listed entity, if events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern but, based on the audit evidence obtained, the auditor concludes that no material uncertainty exists:
       1. Include a reference to the related disclosure(s), if any, in the financial statements; and (Ref: Para. A71–A72, A78)
       2. Describe how the auditor evaluated management’s assessment of the entity’s ability to continue as a going concern. (Ref: Para. A73–A77)

Issue 2

Group members were asked to discuss any concerns with the proposed change in the commencement date of management’s 12-month going concern assessment from the financial statement date (i.e., year-end date) to the financial statement approval date given that PSAS do not specify the time period that a going concern assessment must cover.

Existing auditing standards on entities already impose a 12-month going concern assessment. The 12-month projection uses information known before the completion date of financial statements (i.e., the period within which subsequent events are considered for recognition or disclosures in accordance with SUBSEQUENT EVENTS, Section PS 2400). The AASB’s Exposure Draft proposals merely move the start date of that projection and assessment from the financial statement year-end date to the approval date.

The AASB Exposure Draft proposes extending the timeline over which management should conduct its going concern assessment. Paragraphs 21-23 of IAS 570 state:

21. If management’s assessment of the entity’s ability to continue as a going concern covers less than twelve months from the date of approval of the financial statements as defined in ISA 560, the auditor shall request management to extend its assessment period to at least twelve months from that date. (Ref: Para. A42)
22. If management is unwilling to make or extend its assessment when requested to do so by the auditor, the auditor shall discuss the matter with management and, where appropriate, those charged with governance. (Ref: Para. A43–A44)
23. In circumstances where the auditor believes it is necessary for management to make or extend its assessment and management is unwilling to do so, the auditor shall determine the implications for the audit. (Ref: Para. A45)

A going concern assessment covering 12 months following the financial statement approval date instead of the financial statement date may create inconsistencies across public sector entities. For example, the approval date can vary widely in the public sector. In the matter of public interest, interested and affected parties may benefit from more current information.

Group discussion

Group members noted that the longevity of public sector entities should be contrasted with that of private sector entities, indicating:

• Many public sector entities can raise and collect taxes. This ability means that public sector entities are less likely than private sector organizations to have going concern issues.
• By definition, government organizations are controlled by a government and form part of that government’s reporting entity. Consequently, for government organizations, management may not need to do a going concern assessment. There may exist both explicit and implicit guarantees of support provided by their controlling government. The submitter noted that auditors may need evidence of such guarantees to support their opinion that no material uncertainties exist.
• Chapter 9 of the Conceptual Framework indicates that for governments, the going concern presumption can only be rebutted by persuasive evidence to the contrary. The chapter also notes that the going concern presumption applies to government organizations in the same way it applies to the controlling government. However, government organizations may be discontinued or sold as governments look at alternative mechanisms for delivering services, and therefore, may not operate in perpetuity.

Group members also noted the following conclusions on the proposed requirements:

• Adding specifics to the auditor’s report on financial statements on going concern may not be required in the public sector as there have been few such issues in the past.
• Adding more targeted opinions may not be required. Such opinions will require additional work and costs and not add value in the public sector.
• The audit opinion may raise false flags and confuse financial statement readers. Many Group members questioned the relevance of having such a requirement for the public sector.
• RESTRUCTURING TRANSACTIONS, Section PS 3430, is sufficient. Group members found it difficult to identify examples of where a public sector entity would cease to exist outside of restructurings in the public sector.
• The requirement to report on material uncertainties appears to be counterintuitive to what is provided for in Section PS 3430 in instances where it is known that an entity is transferring its assets. The Section already requires such information be disclosed.
• Adding numerous matters in the main part of the audit opinion distracts from the fair presentation audit opinion. The proposal would increase audit costs and raises the risk for auditors of an expectations gap with what might be seen as a going concern guarantee. If there is an issue, it should be addressed in the key audit matters. Does the proposal represent a slippery slope toward more clutter related to specific items in the audit report?

One Group member shared that First Nations may differ from other public sector organizations as they depend on support from other levels of government. They noted that there are presumptions that governmental support continues under legal obligations and treaty rights. PSAB staff noted that new Section PS 1202 will explicitly recognize this aspect of the going concern presumption for Indigenous governments, noting that financial and other arrangements with other levels of government need to be considered.

Group members disagreed on the proposal to extend the timeline over which audit standards would require entities to prepare a going concern assessment. They noted the rarity of going concern issues in the public sector and the added costs from the additional work for both preparers and auditors, indicating the limited added value that would result. Some Group members also reflected on the differing financial statement approval dates in the public sector, noting the disparity in assessment periods that would exist. They acknowledged that having organizations follow the same timeline principles would allow consistency across the audit profession but saw no other benefit for the timeline extension in the public sector.

The Group reached a consensus that proposed requirements in the AASB’s Exposure Draft are likely unnecessary for public sector entities, given the rarity of going concern issues in the public sector. The Group concluded that the proposals could add more work and cost with limited valued for public sector entities. The additions to the audit report could confuse for readers of public sector financial statements. The Group concluded that existing PSAS are sufficient for addressing going concern questions in the public sector, especially given the guidance in the new Conceptual Framework and new Section PS 1202.

⁴ Material that links to the CPA Canada Handbook is available to subscribers only. However, all information needed to respond is provided in this Exposure Draft.

⁵ PSAB issued the new Conceptual Framework in the PSA Handbook in December 2022. It is effective for fiscal periods beginning on or after April 1, 2026. Early adoption is allowed but must occur at the same time as adoption of Section PS 1202, given the interrelationships between the two.

⁶ PSAB will issue new Section PS 1202 in the PSA Handbook in October 2023. Text is included in that standard on the context and requirements for going concern assessments in the public sector. Superseded FINANCIAL STATEMENT CONCEPTS, Section PS 1000, contains the only existing reference to going concern in PSAS; it will remain effective until April 1, 2026, or until the date an entity early adopts both the new Conceptual Framework and new Section PS 1202. Superseded paragraph PS 1000.63 contains the existing text on the going concern assumption.

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