CPA Canada’s IFRS Discussion Group recently discussed a topic that’s quite widely applicable, but doesn’t get mentioned that often…
Here’s how the meeting report summarized the background:
- Entities sometimes incur liabilities that they are unable to pay for a period of time. The unpaid amount may be subject to a statute of limitations that prevents creditors from taking further legal action against the entity. A statute of limitations is a law passed by a legislative body to set a maximum time after an event within which legal proceedings may be initiated. The unpaid amount may also be referred to as a “statute barred amount.”
Against this backdrop, the group considered the following fact pattern:
- An entity was not able to raise sufficient funds and, therefore, had to cease its operations. The entity failed to file its 2011 financial statements and was delisted in 2012. At the time of delisting, the entity had no assets and accounts payable of $500,000.
- During 2018, an investor group revived the entity by investing $200,000 to obtain a controlling interest in the entity and paid fees to revive the entity’s reporting issuer status. At the end of 2018, the entity had cash remaining of $100,000, $100,000 current liabilities and $500,000 related to the 2011 accounts payable amount, and expenses of $200,000.
- In 2019, the entity completed a reverse acquisition with a private entity. The accounts payable of $500,000 in 2011 is considered material to the combined entity.
- The entity operates in a jurisdiction where a two-year statute of limitations period exists. No creditor has taken action related to the 2011 accounts payable amount between 2012 and current date.
The group discussed whether in these circumstances the entity would be justified in removing the accounts payable from its financial statements. IFRS 9 says that “an entity shall remove a financial liability (or a part of a financial liability) from its statement of financial position when, and only when, it is extinguished — ie when the obligation specified in the contract is discharged or cancelled or expires.” This perhaps doesn’t technically apply here – the creditor may have lost the ability to take legal action, but that doesn’t mean the entity has been released from the obligation. On the other hand, if there’s no scenario under which the amount will ever be paid, it may not seem very meaningful to keep it on the balance sheet indefinitely.
The report indicates some support for both points of view, with some good points made along the way:
- While the statute of limitations period has lapsed, there’s still uncertainty as to whether the entity will pay the outstanding balance because it may do so to continue working with the supplier or for other business reasons.
- Obtaining a legal opinion may not be sufficient to support derecognition because the opinion may not necessarily capture all the circumstances surrounding the 2011 accounts payable amount. For example, the previous management group could have made oral promises to its creditors about repaying the financial liability when capital is raised, which could be relevant to whether the amounts are in fact statute barred.
- Even if some portion of the liability is retained on the balance sheet, it may be better reflected as a provision than a financial liability, reflecting that the contract under which it originally arose is no longer enforceable by law, as well as the uncertainty regarding the timing or amount of any ultimate payment. Alternatively, if the item is still regarded as a financial liability, the carrying amount may be sharply reduced to reflect the non-imminence of payment.
Overall then, the group certainly didn’t shut the door on eliminating or at least reducing the amounts, while laying out various reasons to move cautiously. Some members noted: “From an investor’s perspective, the existence of a liability may influence its decision-making process. For example, some members thought that an investor may be more likely to invest in an entity with no liabilities and be more skeptical of investing in an entity with a significant amount of liabilities. If the liability was derecognized, an investor would not be aware of the liabilities in which the entity has not paid.” That may be true, although some investors may admire a company that escaped reckoning with its liabilities as much as they distrust it (or so Trump’s career suggests anyway).
Dealing with small companies, something like the converse may often also be true – an entity may appear to be in a hopeless working capital position, and yet apparently capable of continuing in operations for the foreseeable future, perhaps through a combination of statute-barred liabilities which haven’t been derecognized, related party amounts subject to no particular settlement pressure, and other amounts which will inevitably be converted to equity when the parties get around to it. In such cases, it can be hard to discern the immediate liquidity story at the core of the official one, as the MD&A in such cases is frequently rather bland and unspecific. Even when it would surely serve the company’s own interest to write a better one…
The opinions expressed are solely those of the author