Standardized Income Trust Accounting Proposed

Although limited in clout, the Canadian Institute of Chartered Accountants (CICA) has proposed standard rules to make trust reporting more transparent, according to the Toronto Star. Income trusts have had been very popular, but intelligent comparison between trusts has been difficult, even for those carefully digesting financial reports and disclosures.

“Given the importance investors put on the measure of cash flow—the pricing of units tends to be off this measure—it should be a consistent measure,” said CICA President Kevin Dancy, speaking with the Toronto Star.

In income trusts, conventional businesses agree to pay a portion of profit or net after-tax income to shareholders by distributing dividends. The Toronto Star reports the CICA intends to ensure these businesses apply generally accepted accounting principles and practices (GAAP) in the preparation of their financial statements.

Dividend distributions are not taxed except as shareholder income. Some businesses pay more as distributions to investors than companies might report as earnings, out of rivalry with other similar businesses. It is known that some trusts have borrowed money, sold operations and even issued new shares to ensure cash distributions are kept up, as well as the price of shares, according to the Toronto Star.

Although corporations that distribute excess cash usually see their share prices fall after the distribution, shareholders may be deceived by these internal transactions. Rising energy prices and real estate and falling interest rates have had direct effects on the sustainability of the business and trust distributions. Current financial statements do not reflect these market forces now.

With a 31.5 percent tax on existing income trust distributions starting in 2011 being discussed in the Canadian Parliament, CICA’s proposed standards are important. Under their proposals, new trusts will be taxed starting next year. The Toronto Star reports these new practices will allow investors to assess these new taxes on the flow of income and require disclosure of management strategy for maintaining the trust, according to Dancy.

Diane Urquhart has been a voice warning of the need for these changes to add transparency to trust financial reporting. She would prefer to see provinces make income trust changes instead of the federal government. The Toronto Star reports the bottom line is that the trusts should not distribute more cash than profit realized by the business, excluding special distributions. She is an independent consulting analyst in Mississauga.

Deloitte reports that Paul Cherry, the Accounting Standards Board Chairman, commented on the importance of having standards governing the determination and presentation of distributable cash and actual cash distributions of income trusts, in a prepared statement. Net income and comprehensive income should be determined in accordance with best GAAP practices.

PricewaterhouseCoopers (PwC) has weighed in on income trusts as well, noting in a prepared statement that they have earned a central place in the Canadian economy. In their 2005 year-end survey of markets, high levels of activity in both traditional equities and income trusts were indicated. Income trust dominated the IPO market on the Toronto Exchange last year. These 40 trusts were worth $5 billion in value, amounting to a 61 percent increase in value over the value of income trust IPOs initiated in 2004.

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