In Part 1 of this two-part series, I discussed which elective to take as part of your CPA Canada PEP program. In here, I’ll speak about which role to take for CFE Day 2.

Understand the CFE

The CFE contains 3 separate exam days, with Day 2 requiring you to select a “role” of your choice. Day 1 and Day 3 don’t have roles.

Day 2 of CFE focuses on depth in Financial Reporting (FR), Management Accounting and your role area. Everyone is given the same case which has a common section (Financial Reporting and Management Accounting) and role section. 

There are four roles you can select for CFE Day 2:

• Assurance
• Performance Management (PM)
• Finance
• Tax

You are not required to choose a role that was one of your electives (eg. if your electives were PM and Finance, you can choose Assurance as your role). However, it’s not a smart idea to do that; it will be very hard for you to score Cs on a role that’s not one of your electives.

Here are factors to consider and my recommendation.

Assurance role

Pros

• This role is required for public practice licensing. If you are thinking of opening your practice down the road, this will be required when applying for the license with a few exceptions (check your provincial CPA website for specific requirements, for example Ontario’s is available here).
• It’s closely linked to Financial Reporting so it will help you prepare for Day 2 FR as well. For example, in recent CFEs there were FR issues in the Assurance role. Students who took Assurance as their role got extra practice from those FR AOs.
• Because of high volume of candidates that select this role, there will be more study material available as well as more potential study partners.
• There are a limited number of topics under Assurance role that can be tested, often less than other roles. For a list of sample topics, check out Part 1 of this blog series. 
• There is little quant analysis.
• The Assurance standards are available to you in the exam in the Handbook, which means you don’t have to memorize as much as with other roles.
• Most of the AOs can be answered in a template format, which makes it easier to get a C.

Cons

• If you don’t have audit work experience, the complex nature of assurance will make it difficult for you to get full understanding of topics. For example, writing procedures is a challenge for most candidates who have never worked in audit.
• Due to the high volume of candidates selecting this role (typically the default role for candidates in public practice) there will be more writers to compete against for depth. Since CFE is marked on a curve, you have a higher bar to pass.
• Assurance is a qualitative heavy exam. Most AOs will require clear, concise, and well-structured written responses to achieve C grade. If you have not worked in Audit or English is not your first language, this role may not be suitable for you.

Tax

Pros

• Similar to Assurance, this role is required for public practice licensing. Check your provincial regulations for specific rules.
• If you like “concrete answers” (eg tax payable calculation, employee benefits rules, tax formulas), as opposed to subjective answers (eg procedures, strategy, performance evaluation), you’ll succeed in this role because it will be clear what you are doing right or wrong.
• If you are currently working in tax (personal or corporate), you will have a better understanding of this role during Day 2.
• You are provided with the Income Tax Act (ITA) on the exam, which means you can look up topics that you are not sure about.
• If you have intentions to grow in a tax-related role in your career, this is a good opportunity to learn many technical subjects.

Cons

• Not a common role that students select. This means those who do select it are confident in their expertise, so you’ll have strong competitors to beat. There will also be fewer resources and study partners available as support due to low volume of students taking this.
• While you are provided with the ITA, this is often difficult to interpret and hard to rely on, which means there will be much more to memorize.
• You need to be very detail-oriented. You’ll find it takes longer to study Tax and perfect the Tax AOs than with other roles.
• Even if you have experience in either personal tax or corporate tax, it is unknown which AOs will come up on the exam, due to breadth of topics, so your experience may not be that useful.
• This role is heavy on technicals. You’ll have a lot to study and memorize for the CFE. 

Performance Management (PM)

Pros

• You won’t be competing with writers in public practice.
• If you are working in corporate and/or industry type role, you will have a better understanding of this role. For example, you probably had exposure to Excel quants analysis, like cash flows, DCF, contribution margin, break-even analysis, etc. This experience will help you solve AOs during the CFE.
• Taking this role will significantly help with Day 1. The CFE Day 1 has similar quants, like CM, NPV, breakeven, IRR, cash flows, etc.
• Taking this role will also help with Day 2 common area MA AOs, because PM has lots of MA AOs. This means you can study for both your role and MA AOs at the same time.
• Well-rounded with both quantitative and qualitative AOs.
• This role is less criteria-focused compared with Tax and Assurance. It will be easier for you to get Cs if memorization is not your strong skill.
• Most find the calculations to be more intuitive compared with a Finance role.

Cons

• Qualitative components are ambiguous and subjective. You’ll find it challenging to achieve depth and write at C level. For example, if you are asked to discuss the pros/cons of outsourcing, you need to provide specific factors and answer “so what”, “why” and “how,” which is difficult for most writers.
• You will not be provided with resources during the exam, such as the ITA/Handbook for Taxation and Assurance, so there is less to rely on and more to memorize.
• Common misconception that you will be tested just on qualitative AOs (such as pros/cons and SWOT). PM role includes several quant AOs, so time management and depth are often struggles for candidates who are not strong with quants.

Finance

Pros

• If you are currently working in finance type role, you will have a better understanding of this role for Day 2 and certain topics will be more intuitive for you.
• Similar to PM, taking this role can significantly help with Day 1 on the CFE, as the exams have common calculations and AOs.
• Could be helpful if you are interested in future plans to pursue the CFA designation.
• Suitable if you are strong with calculations because Finance role is quants heavy.

Cons

• There are lots of calculations and quants involved. It’s more technical than PM.
• Similar to PM, you will not be provided with resources during the exam, such as the ITA/Handbook for Taxation and Assurance, so there is less to rely on and more to memorize.
• Because this roles has several calculations, time management and depth are struggles for candidates. You will need to be very proficient with Excel and quants.
• Few individuals take this role (compared with PM and Assurance), so there could be fewer resources and study partners for support.

Which CFE Role to Choose?

I recommend Assurance or Tax for candidates working in public practice. Between the two, Assurance is preferred. It’s less technical, you can apply templates, there are more study partners available, and it will help you with FR AOs.

I recommend PM or Finance for candidates in corporate/industry. Between the two, PM is preferred because it’s less technical, more balanced with quant/qual, and prepares you better for Day 1.

You can also think back to your electives and choose the one you did better. For example, if you took PM and Finance, and did better in PM, then you should choose PM.

According to CPA Canada CFE Reports, Assurance and PM roles make up 90% of all writers. You can now see why more writers choose Assurance and PM compared to other roles. If you need coaching with the CFE, check out my CFE Review course which has 90%+ pass rate on the CFE.

If you’re at the point where you must choose on which elective to take as part of your CPA PEP, this means you have successfully completed Core 1 and 2. Congrats!

With no clear guideline on which elective module to select, it can be a daunting decision impacting your CPA journey. With both Core 1 and 2 exams behind you, you should now have some idea if you prefer Financial Reporting (FR), like in Core 1, or Management Accounting (MA), like in Core 2. This is a great way to narrow down the electives you should choose.

In this Part 1 of two-part series, I will discuss which elective to take as part of your CPA Canada PEP program. In Part 2, I discuss which role to take for CFE.

Here are the pros and cons of each of the four electives.

Assurance

Pros

• This elective is required for public practice licensing and will prepare you for choosing Assurance as your Day 2 role for the CFE. Make sure check your provincial CPA website for specific licensing requirements, for example BC’s is available here.
• There are a limited number of topics under Assurance that you can be tested on. For example, you’ll often see the following topics: 
  • Audit Planning Memo (APM) – CAS 315, 320, 330
  • Assertions (B/S, I/S)
  • Audit evidence – CAS 500
  • Procedures – CAS 510
  • Analytical Procedures – CAS 520
  • Special Reports – CAS 805, CSRS 4400, CSAE 3000/3001, CSAE 3530/3531
  • Reviews – CSRE 2400
  • Compilations – S9200
  • Going Concern – CAS 570
  • Control deficiencies (WIR)
  • Data analytics and information services (DAIS)
• If quants and long calculations are not your strong skills, this elective offers little quant analysis
• This elective pairs well with Financial Reporting, because topics such as materiality and procedures are closely linked to FR issues.
• Both FR and Assurance standards are available in the exam in the Handbook. This means you don’t have to memorize so much content as with PM or Finance, because you can look them up during the exam.
• Most of the AOs can be answered in a template format, helping you both write faster and achieve depth. I’ve written more about templates, such as WIR, SAPPY and RAMP here.

Cons

• Assurance is a qualitative heavy exam. Most AOs will require clear, concise, and well-structured written responses to achieve competent (C) grade. If you have not worked in Assurance or English is not your first language, this elective may not be suitable for you.
• Those who work in public practice will have practical day-to-day exposure to Assurance topics. Since PEP and CFE exams are marked on a curve, you’ll be competing with candidates working in public practice, so the passing standard will be higher.

Tax

Pros

• This elective is required for public practice licensing.
• Good for candidates that work with personal or corporate tax, because the technical topics will be known to you through practical job experience.
• Good balance of quantitative and qualitative.
• Very few individuals take this on the CFE. This creates a small group of candidates that you will be marked against if chosen as Day 2 role.
• You are provided with the Income Tax Act (ITA) on the exam, which means you can look up topics that you are not sure about. I’ve written more Tax elective tips here.

Cons

• This elective is heavy on the technicals. The CPA Canada Competency Map has 90 topics for Tax (compared with 25 topics for Assurance). This requires a lot of review on specific criteria, rates, formulas, etc.
• Unless taken as your Day 2 role on CFE, this elective will not prepare you for CFE, because Tax is tested at Core level in CFE (similar to the Core 1 Tax AOs). It will help you with CFE Day 3, but it is not required to successfully pass it.
• Very few individuals take this on the CFE. This means there will be fewer resources and study partners as support.
• Although the cases will focus on Taxation (minimum 50%), all prior learnings are also testable, i.e. Entry column, Cores 1 and 2 which makes the coverage of topics much broader.
• While you are provided with the ITA, this is often difficult to interpret and hard to rely on, which will require much more to memorize.
• Tax elective has the lowest pass rate among the four electives.

Performance Management (PM)

Pros

• Because you’ve just taken Core 2, many calculations are similar and still fresh in your mind. PM topics also have a similar quant and qual components as Core 2.
• Taking this elective will significantly help with Day 1 on the CFE. The CFE Day 1 has similar quants, like CM, NPV, breakeven, IRR, cash flows, etc.
• Good for individuals that are strong with Strategy & Governance AOs (can make up to 50% of the exam).
• Well-rounded exam with both quantitative and qualitative AOs.
• You won’t be competing with writers in public practice.

Cons

• Because this elective contains several calculations, time management and depth are often struggles for candidates.
• This elective does not prepare you as well for FR AOs on CFE (compared with Assurance elective). However, to pass CFE, depth in either FR or MA is sufficient. This means you can clear the CFE with depth in MA using your PM elective knowledge.

Finance

Pros

• Similar to PM, taking this elective can significantly help with Day 1 on the CFE, as the exams have common calculations and AOs.
• Because you would have just taken Core 2, some calculations are similar (though less than PM). 
• This elective is a great to teach you how to perform financial statement analysis on a case.
• Could be helpful if you are interested in future plans to pursue the CFA designation.
• Suitable for candidates that are strong with calculations as the exam is quants heavy.

Cons

• Because this elective can contain several calculations, time management and depth are struggles for most.
• Few individuals take this (compared to PM and Assurance), which means there could be fewer resources and study partners for support.
• There are lots of calculations and quants involved. I listed the full list of examinable topics for Finance elective here.

Which Elective to Take?

I suggest Assurance and Tax for candidates working in public practice. These align with your work experience, the template formats are easy to apply, and you’ll find the AOs more intuitive.

I suggest PM and Finance for candidates in corporate/industry. You won’t have to compete with writers in public practice, the AOs are well-rounded with quants/qual, and it’ll prepare you well for Day 1 of the CFE. You can also take the combination of Assurance and PM, if you are not comfortable with Tax or Finance.

If you work in corporate/industry and decide to take Assurance, I recommend to time it so that you take it in the Winter term. Since Winter term is the busy season for writers in public practice, you’ll be competing with corporate writers, not public practice writers, so your chances of passing are higher.

Due to the varying factors and conditions that are unique to individuals, you should also consider your personal circumstances. For example, consider your professional experience, career goals, strengths, weaknesses, comfort with quants vs quals, and what you scored well on in the Core exams (Core 1 vs Core 2). If you did well in Core 1, then Assurance and Tax are better suited for you. If you did well in Core 2, then PM and Finance are better for you.

If you decide to take Tax and Assurance electives, refer to the following article in terms of which elective is best to take first.

In Part 2 of this blog series, I discuss which role in CFE Day 2 is best to choose.

If you need coaching with the electives or CFE, check out my popular PEP courses and CFE Review.

Update: Please see this post for September 2022 CFE exam cases download: September 2022 CFE download

Similar to prior Common Final Exams (CFEs), the May 2022 CFE had Day 1, 2 and 3 cases.

The following Day 1 cases were tested:

• Creative Toys Inc. (CTI) v1 (Download)

The following Day 2 and Day 3 cases were tested in May 2022 CFE:

• Day 2 (Download)
  • Solitary Publishing House (SPH)  (300 minutes)
• Day 3 (Download)
  • Intelligent House Construction Inc. (IHC) (75 minutes)
  • Agro-Share Inc. (ASI) (85 minutes)
  • Waste to Chemicals Inc. (W2C) (80 minutes)

For the September 2022 CFE, the following Day 1 cases will be tested:

• Waste Disposal Inc. case (WDI) v3
• CanDo Fitness (CFL) v1

Where can I get the solutions?

I have written strong answers to May 2022 CFE cases. You can get from here. 

The “official” solutions will be released in Feb. 2023, per CPA Canada’s announcement. Note that this doesn’t include the Creative Toys Inc. (CTI) v1 case, which will be officially released in 2024. We currently have only the sample strong answer to CTI v1, which I’ve prepared and made available here.

Will I get these cases in Capstone 2?

If you are registered for the Capstone 2 module for Summer 2022, you will NOT receive these cases at the module. You should download using the links above. If you are someone challenging the exam, such as an internationally trained accountant applying under MRA/MOU, please also download using the links above.

How do I prepare for the CFE?

There are several prep methods for the CFE. You will need to focus on these three items:

1. Technical knowledge
2. Case writing skills
3. Strategy

I speak a lot about these items on my YouTube channel and webinars. You can check out my latest webinar.

Technicals:

• Know the key topics on each of the competencies
• Distinguish depth from breadth
• Debrief

Case writing skills:

• It’s all about following the CPA Way
• Know your case inside out
• Integrate throughout the case

Strategy:

• Prepare a study plan
• Obtain study materials
• Get support and resources

Pass the CPA Canada CFE Exam

I’m Gevorg. I’m an instructor and a CPA exam coach. If you want coaching with me, sign up for my CPA CFE Review Course, for a comprehensive prep package.

Special Reports are types of practitioner reports that are prepared in accordance with Generally Accepted Auditing Standards (GAAS). These reports elaborate and describe more information on accounts of items outside of a routine F/S engagement.

Related post: List of All Special Reports

Special reports can be on specified accounts, compliance/regulatory items, internal controls, historical financials, and so on. Understanding the different reports and which ones are most effective to choose under specific conditions will help you achieve C/CD in the Assurance elective module and Day 2 Audit role during the CFE.

Use SAPPY template

To achieve C/CD, you must address the different elements of the AO. For example, types of reports, assurance levels, user preferences, etc. To remember all the elements, use the “SAPPY” template.

SAPPY stands for: special reports, assurance levels, preferences of users, pros/cons, your recommendation.

Identify the special reports

First, you must list the special reports relevant for the company. For example:

• CSAE 3530 – Attestation engagements to report compliance
• CSAE 3531 – Direct engagements to report compliance
• CAS 805 – Audits of single F/S and specific elements, accounts or items of a F/S
• CSRS 4400 – Agreed-upon procedures engagement

You must know the different types of special reports to be able to list them. I suggest using the CPA Canada’s Learning eBook (Knotia) as a study resource. Knotia has common special reports with pros/cons of each. The following GevorgCPA article also provides a list of all special reports to know for CPA exams. For most AOs, listing 2 to 3 reports is sufficient for C. 

Assurance levels

Secondly, speak about the assurance levels. If it is a compilation, it provides no assurance. A review provides negative/limited assurance, and an audit provides positive/reasonable assurance. In your notes, make a list of special reports and their level of assurance from Knotia, and memorize them.

Pros and cons for each report

The next step is to discuss the pros/cons of each report. The most common factors to consider are the type of procedures performed, the level of work to be prepared (including timing), and the costs. Be sure to integrate case facts to make your response user-specific and discuss why it is an advantage or disadvantage.

• Procedures – An audit requires an understanding of the control environment and providing the strength of this environment, whether a reliance on control testing or a combined approach for procedures should be used. While an audit can use all types of substantive testing, a review engagement has only inquiry and analytical procedures. 
• Level of effort – An audit will require a significant number of hours to complete since there are more procedures to be performed. On the other hand, a review engagement requires substantially fewer hours and testing performed due to the limited assurance level. Discuss the level of efforts and how much time the auditor has for the engagement. This is why outlining the timeline as part of your case planning is critical.

Preferences of the users

Most students don’t reach C/CD in special report AOs because they don’t talk about the users. Make sure to list the users and their preferences, just like when you’re writing the materiality section of the Audit Planning Memo.  

For example, due to the increase in work performed and effort to complete the engagement, audits are more expensive. The users may not want this. The users may be struggling to collect their A/R from clients and may prefer a review for lower costs. On the other hand, the bank may require audit-level assurance to maintain the company’s loan. In this case, you need to list both users (company and the bank), and discuss which user’s preference takes priority (probably the bank). 

Provide your recommendation

Based on your analysis, suggest the report that best fits the users and their preferences. Think back to the pro/cons, the users, the timeline and financial constraints. These factors drive your recommendation. For example, when the users want a review of controls of the company, then the special report CSAE 3416: Reporting on Controls at a Service Organization should be recommended.

Special Reports Example

Issue statement

Issue: The shareholders of Company ABC are requesting an independent party to validate the CFO’s calculation of management bonus and issue a report with some type of assurance over the calculation amounts.

Step 1: Special reports

Special Reports:

• CAS 805: Audits of Single F/S and Specific Elements, Accounts, Items
• CSAE 3530: Attestation Engagements to Report on Compliance
• CSAE 3531: Direct Engagements to Report Compliance
• CSRS 4400: Agreed-upon Procedures Engagement (Tip: CSRS 4400 used to be called “Section 9100: Results of applying specific audit procedures to financial info”, until it was replaced with CSRS 4400 in Jan. 2022. In 2022 PEP and CFE exams, you can still speak about Section 9100. From Jan 1, 2023, and onwards, you must speak about CSRS 4400).

 Step 2: Assurance level

Assurance level

• CAS 805: Audit level
• CSAE 3530: Reasonable and limited (Tip: Reasonable level is the same as audit level. Limited level is the same as review level).
• CSAE 3530: Reasonable and limited
  
• CSRS 4400: None 

Step 3: Pros and cons

(Tip: Consider general benefits to each report as well as pros/cons against the other reports. Notice below how I used transition words, like “which makes” and “which meets” to link each point to impact on the company).

• CAS 805
  • Pros:
    • Appropriate as it would provide assurance on the values of the accounts used in the annual bonus calculation based on divisional profit margin growth.
  • Cons:
    • High level of assurance which makes this engagement costly as more work conducting procedures is needed to achieve this.

• CSAE 3530/3531
  • Pros
    • Concludes whether CFO’s statement/assessment of compliance is fairly stated, which meets the shareholders expectations.
    • Provides both reasonable and limited assurance, which is appropriate because shareholders want assurance over annual bonus amount.
    • It is less costly than CSRS 4400, because management’s statement can be used by the auditors.
  • Cons
    • Both the management and the practitioner could be required to assess the entity’s compliance, which makes it more time consuming for the company and therefore more costly.

• CSRS 4400
• Pros
  • Auditors would not perform all procedures that would be necessary in CSAE 3530/3531. They would perform only those procedures requested, which means the shareholder have input on the specific procedures, which would save time and money
  • Cost effective because it does not take as much time due to limited work performed.
• Cons
  • Auditors would report the results of the procedures, but would not provide opinion/assurance, which is against your preferences
  • It would be up to you to interpret the results of the findings and conclude on the schedule, while you may not have the expertise.

Step 4: Preferences of uses

• Shareholders: Concerned with the accuracy of the annual employee bonus.
• CFO: Concerned that the calculations comply with bonus standards and are valued correctly.
• Management: Concerned with receiving accurate bonus from Company ABC.

Step 5: Your recommendation

Recommendation: Based on the users and their preferences, CAS 805 seems most appropriate, given that it provides assurance over values and it has high level of assurance. Although CAS 805 is more costly than CSRS 4400, the company is in a strong cash position and can afford it.

(Tip: There is no right or wrong recommendation. As long as your recommendation links to users and their preferences, you can recommend whichever report makes most sense).

(Important note: Please don’t copy the above example and submit as your answer to a CPA case. You will be flagged for plagiarism and expelled from the CPA program.)

CSAE 3530/3531 vs CSAE 3000/3001

I often get asked from students what is the difference between CSAE 3530/3531 and CSAE 3000/3001. 

CSAE 3530 provides assurance on a statement of compliance prepared by the management, whereas a report under CSAE 3531 provides assurance on company’s compliance directly (rather than on a statement of compliance prepared by the management). In CSAE 3530, the management prepares a report and the auditors review it. In CSAE 3531, the auditors prepare the report themselves. For both CSAE 3530/3531, the level of assurance can be either moderate (limited) or high (reasonable), depending on the user preferences.

The difference between CSAE 3000 and 3001 is the same as the difference between 3530/3531. CSAE 3000 is based on the statement of compliance prepared by the management, while CSAE 3001 is based on the statement prepared directly by the auditors.

The difference between CSAE 3000/3001 and CSAE 3530/3531 is that CSAE 3000/3001 are high-level standards that include requirements that are not in CSAE 3530 or 3531. For example, planning, performing, documentation and reporting. I provide detailed breakdown of these special reports in my CAS Summary notes.

Conclusion

To get C/CD in special report AOs, you need to fully understand who the client is and who they will be reporting to. Sometimes the requireds may be unclear and confusing. Take the time to understand user needs and the different reports available to ensure your analysis hits depth. I coach special reports in-depth in my courses Assurance Lessons and CFE Review.

The following is a countdown to the May 2022 CFE results day, scheduled for August 12, 2022, at 7am PST.

Update: Results are now released: https://www.certificationenterprise.net/CPAcp/cpLogin.aspx

A few more weeks to go before the D-Day. I am sure there are pangs of nervousness, anxiety, excitement (that you can then enjoy free time), basically all the mixed emotions that are brewing. Completely understandable – just calm down, breathe. It’s completely fine – this too shall pass.

You cannot forget the months of hard work, sincerity and dedication you have put in for these 3 most important days. Hence, out of experience, I would love to share the do’s and don’ts of the week of the exam.

CFE Day 1

Remember, this is your first day of the exam and it’s 4 hours. Being the first day, it would not seem tiring to type on your laptop, but mentally it is draining, because you are tense before the exam.

So, take it easy and ensure:

• You sleep early the day before
• You don’t cram by going through a lot of your notes
• You pack your bags and keep it ready with all the food, documents, and stationery you may require for the exam
• You reach the exam center early so that you know your seating and the exact location.  This way, even if there are delays, it won’t stress you as you have enough buffer time.

CFE Day 2

This is an important day because Days 2 and 3 go hand-in-hand and they are both very technical. You need to know FR, MA and your role. Plus, you must pass Days 2 and 3 together, so it’s important to stay focused and be energetic. The night before Day 2, you may already feel exhausted as 4 hours of Day 1 had just gotten over and Day 2 is 5 hours, which can be tiring if you don’t get enough rest.

So before Day 2, ensure:

• You do not discuss Day 1 paper with others or go on Reddit
• You relax and take your mind off Day 1 exam
• You do not go through your notes. If you are not comfortable with this idea, go through your quick notes, flash cards and concepts that you want to just skim through before the big day. The idea is to refresh concepts, not bog down and panic
• You watch your favorite show, eat your favorite food and get fueled for the next day
• You get rest, because resting is super important for your mind to feel fresh the next day. You spent 4 hours looking at the screen in Day 1 and you still need to use your knowledge the next day. 

CFE Day 3

This CFE day is as critical as the first two. You cannot pass only Day 3, you must pass Days 2 and 3 together. But remember, 2 out of the 3 battles are done. You must give yourself credit for getting through Days 1 and 2.

So to go about Day 3, ensure:

• You go through only the non-role concepts, because you already covered your role for Day 2 (if you want to skip something)
• You get more rest. You need to switch between the cases in a smooth transition,  which is only possible if you are well rested
• You don’t forget your tea, coffee, and water bottle to fuel you for Day 3. I know you won’t have the time, but it can get overwhelming as you must solve multiple cases, so one or two sips in-between cases really helps!
• You don’t take the weights of Days 1 and 2 with you – leave it behind and go on Day 3 as a new day.

Stay calm through this process, so many of us have done it, you can too! Relax and remember a few more days before you are a free bird! Give it your all, in the end it’s just an exam – so enjoy the process and learn the most you can!

Good luck and smash it! – Leela

Author: Leela Pai, ICAI and successful CFE writer from Sep 2021

The structure of Canadian taxes is meant to charge the same level of income tax regardless of if it is earned through a salary or dividend on the individual and corporation level. This is known as integration. However, this is not a perfect model and there can potentially be a benefit to receiving one form of remuneration compared to another.

When assessing salary vs dividend AOs, CPA candidates should write a balanced qualitative analysis and demonstrate understanding on various tax topics. Several examples are provided below that can be used in determining your recommended structure.

Salary

Pros:

• Will provide a deduction in the calculation of corporate tax, therefore reducing the taxable income.
• You will receive payments from the CPP program later in life when you retire. This is an effective and stable form of pension planning.
• Generates earned income, which will create RRSP room. This will allow you to put funds aside for your retirement and receive a tax deduction in the year of contribution that will reduce your personal tax liability. Funds invested will compound tax-free while in the RRSP plan.
• Generates earned income for child care deduction purposes. This allows you to deduct childcare costs if you have children and meet the specific criteria. Being paid a dividend will not allow the same cost deductions.
• Allows you to qualify to claim non-deductible work expenses such as uniforms, home computers, etc. This is known as the Canada Employment Credit (CEC) and is a non-refundable tax credit designed to help employees.
• Creates more predictive and steady income. From a personal standpoint this can make obtaining loans, mortgages, etc. easier as the bank can assess your ability to comply with payment criteria. From a company perspective this is beneficial for planning monthly outflows.
• Deducting salaries payments from corporate taxable income can be used in tax planning to decrease income below the $500k small business limit to achieve a lower tax rate.
• Less tax planning works as taxes taken off automatically with a payroll/accounting system.

Cons:

• Included in employment income in the year received and taxed personally using increasing tax brackets.
• Requires payments into the CPP program (employer and employee portions). This could result in reduced net cash flow available due to CPP costs associated off of each salary payment.
• Reduces the financial results of a company as the salary payment represents an on-going expense. This could impact the company’s ability to obtain financing.
• Penalties are incurred for late payments for submitting income tax, CPP, EI, etc. for salary amounts.
• Need to determine a reasonable salary; otherwise amounts cannot be deductible and tax filings may be increased or may need to be amended for prior years.

Dividends

Pros:

• Capital gains produce amounts for a capital dividend account (CDA) balance. This can be paid out as a tax-free dividend.
• Generally, create less tax at the personal level. This will depend on numerous factors, including: whether the dividend is eligible or other-than-eligible, personal tax bracket, tax rates and tax credits.
• Interest and capital gain income earned from investments will be considered property income. This will be subject to additional refundable tax (ART), creating an RDTOH balance. In that case, by paying a dividend, the company will receive a dividend refund for paying the general corporate tax rate.
• Opportunity for income splitting can be achieved with two or more shareholders (i.e. husband and wife). Be mindful of new TOSI rules and discuss the implications if it applies.
• Net profit is not reduced by dividends, and they are not considered a business expense. Therefore, showing more favorable results which could be preferable when viewed by potential lenders or investors.
• Dividends can be declared at any time, allowing the owner to optimize their tax situation.
• Provides greater flexibility as dividends can be paid out based on how the business is performing.
• Dividends reduce an individual’s CNIL (cumulative net investment loss). When claiming the lifetime capital gains exemption (LCFE), CNIL will diminish the amount available. Receiving dividends as payments will reduce the existing CNIL balance and will increase the LCE available in the future.

Cons:

• Dividends are not deductible like salary payments, thus increasing taxable income for the company. However, dividends will be paid out of after-tax profits and be eligible for a dividend tax credit which, assuming integration is working, will offset the higher corporate rate of tax paid. Therefore, they reduce cash flow and do not decrease corporate income taxes.
• Does not generate RRSP contribution room and pensionable earnings for CPP.
• Issued and paid based on share ownership. This can become challenging to allocate different amounts of income to various shareholders.

Bonus

Pros:

• Bonuses declared at year-end create the opportunity for a personal tax deferral since the amount does not need to be paid for 6 months.
• Can often be directly deposited in RRSP, reducing the amount of taxes paid compared to receiving the bonus directly.
• The owner can set a bonus amount once the company’s earnings have been determined, ensuring the company maintains positive income. This also provides flexibility in the amount of bonus to be paid out.
• A CCPC can declare a bonus to reduce corporate profits, thus resulting in a lower tax rate.

Cons:

• If a bonus is declared and not paid right away, cash flow issues later could create difficulty in actual payment of bonus.
• Paying a bonus (like salary) comes with a higher cost, as employer and employee portions of CPP must be factored in.
• Personal tax rate on bonus is significantly higher than salary for example.

Conclusion

In CPA cases, recommending between paying out a salary, dividend or bonus is not a decision of exclusively picking one over the other. You should should recommend a variation between these alternatives that’s most optimal. For example, you can recommend the user to choose salary large enough to qualify for the maximum CPP benefits and RRSP room, to ensure effective retirement planning. Any excess beyond this amount can then be paid out in the form of a dividend. Deciding which combination will result in the least net taxes will be dependent on several other factors.

Valuation AOs come up on CPA Canada module exams all the time, starting with Core 1 and all the way to the CFE. Here’s a summary of the common valuation methods with examples.

Introduction

Valuation is required in situations where there may be:

• Proposed sale of business (both sale of shares or direct sale of net assets)
• Company wishes to go public and must set an issue price
• Division of assets needs to be determined
• Company needs to evaluate impairment or reorganization for tax purposes etc.

There are various valuation approaches, they are categorized to: Income-based, asset-based, and market-based.

Income-based approaches:

• Capitalized cash flow (CCF)
• Discounted cash flow (DCF)
• Capitalized earnings
• Discounted earnings

Asset-based approaches:

• Liquidation
• Adjusted net asset
• Replacement cost

Market-based approaches:

• Assets with an active market
• Comparable transaction (ie, earnings multiple approach)

In this blog, I’ll discuss the DCF and CCF (income-based), adjusted net asset (asset-based) and earning multiple (market-based) approaches.

Discounted Cash Flow (DCF)

When an entity is a start up and they don’t have positive cash flows, it would not be appropriate to use potential cash flows for valuation. Thus, a discounted cash flow (DCF) technique is used. To calculate  the DCF valuation, write out the annual cash flows in Excel and discount them to the present dollars.

Example:
Let’s assume the business will earn $100,000 in the current year and each year it will grow by 5%. We’re given the rate of return (ie, the WACC) at 15% per year. We will apply this discount rate to all future cash flows.

The equation would be:

 

 

 

 

 

 

As you can see, even if the actual cash flows will keep growing, the discounted versions of those cash flows will shrink over time, because the discount rate is higher than the growth rate. Therefore, the value of the company will be the total of all discounted cash flows.

Capitalized Cash Flow (CCF)

If an entity has consistent cash flows that are reflective of the future operations, an approach such as the capitalized cash flow (CCF) approach, based on historical cash flow, is appropriate. In this approach, the cash flows expected to occur consistently in the future are determined and a capitalization rate is applied to the expected future annual cash flow to obtain a value for the entity.

There are 2 steps to the CCF valuation process:

• Compute expected cash flows for a single period
• Divide cash flow from a single period by a capitalization rate

What’s really important here is the long term sustainable growth rate, where the Gordon Growth model is used. Hence we have to find the enterprise value and then deduct the interest bearing debt to arrive at the value of equity.

Here’s an example:

 

 

 

 

 

 

Notes:

• FCFF – Free cash flows
• WACC: Weighted Average Cost of Capital
• Gordon’s Growth Model —> P = D1/ (R-G)
• P = Stock’s price based off its dividends
• D1 = Stock’s expected dividend over the next year
• R = Required rate of return
• G = Expected dividend growth rate

Remember to reduce the interest bearing debt amount from the enterprise value above to come to the equity value.

Gordon Growth model is not tested at Core 1 or CFE Day 3 levels, but it is tested at Finance elective and CFE Day 2 Finance role levels. In Core 1 and CFE Day 3, you will be given the capitalization rate and you would need to apply it to the cash flows.

Adjusted net assets

Where the entity does not maintain active operations, or it has active operations but does not have excess earnings, the adjusted net asset approach is appropriate. Under the adjusted net asset approach, all assets are valued at their FMVs net of disposition costs. Liabilities are deducted and the tax consequences of selling the assets and settling the liabilities are adjusted for.

So this is a simple valuation technique. Simply write the total assets (at FMV), then deduct the liabilities, and the result is the value of the business.

Points to remember:

• Inventory adjustments should be based on FIFO
• PPE values may differ
• Intangible assets are often written off to zero
• Consider whether the payables will be fully paid and receivables fully collected
• Don’t forget to consider unrecorded liabilities or potential settlements

Earnings multiple

This is an approach based on historical earnings of the company. Earnings are multiplied by a multiplier to determine the company’s value. The earnings multiplier calculates the return an investor will get against the invested amount.

Example:
The share price of a company is now trading at $100 and its per share earnings is $10. The earnings multiplier will be 10. ($100/$10) It implies for $1 dollar earned by the company, an investor will give $10. This means the investor is paying 10 times the company’s present value. If the company’s earning multiplier is higher than that of industry average, the share price of the company is high.

In CPA Canada cases, you’re often given the multiplier, so you don’t have to calculate it. Instead, you should normalize the earnings (add/remove unusual transactions and amounts, such as one-time bonus, high manager salary, lawsuit, government grants, etc.) and multiply the adjusted earnings by the multiplier. This will give you the value of the business.

Hope this article was helpful and added “value” 😉

Happy Studying!
Leela

Author: Leela Pai, ICAI and successful CFE writer from Sep 2021

As you go through CPA Canada PEP and CFE technical review, you may notice the terms “provision” and “contingent liability”, specifically in your IFRS review (ASPE does not use the term provision).

Many candidates find it challenging to understand the relationship between provision vs. contingent liability, and how to effectively address these issues in CPA cases. In this blog, I’ll provide you simplified explanations to ensure you are assessing the correct criteria.

Liabilities

Before we differentiate provisions and contingent liabilities, let’s review the definition of liability. Under IAS 37, liabilities are defined as present obligations to a company that arise from past events, where the settlement is expected to result in an outflow of the company’s resources (i.e. cash).

Let’s look at an example of liability. Let’s say Company ABC got a loan of $50,000 from the bank that’s due in January of 202X. This is a present obligation, because the company has agreed to pay it back. This arose from the past event when the company signed the agreement to accept the loan. When the company pays back, there will be an outflow of cash.

Provisions

A provision is a liability that is uncertain in timing or amount. In our earlier example, Company ABC had to pay back $50,000 loan in January 202X. This was a liability, not provision, because both the timing (Jan. 202X) and amount ($50,000) were certain. 

Now, let’s say Company ABC sells its products with warranty. The amount of warranty claims and when they will be claimed are uncertain, thus this is a provision.

Provision is recognized when it meets all 3 criteria below:

• Present obligation for outflow of cash as a result of a past event
• Probable that it’ll have to settle the provision
• Amount can be reliably measured 

Let’s look at the details of each:

• An obligation exists when the company has no alternative to settling the obligation other than being enforced by the law.
• Probable means “more likely than not”. This means more than 50% probable.
• Provision is measured at the best estimate. In the case where there is a large possibility of outcomes, it’s estimated using the expected value method. When there is a range of possible outcomes and each point is just as likely as the other, midpoint of the range is used.

Under IFRS, a provision is required to be reviewed at the end of every reporting period. If the provision criteria is no longer met, it should be reversed.

Some examples of provisions include: 

• Warranty obligation
• Policy to make refunds to customers
• Onerous contracts
• Construction obligations to clean up land. 

These examples create an unavoidable outflow of resources and often require historical knowledge to record the estimated amount (i.e. warranty claim %).

For example, Company ABC sells dishwashers, each included with a legal warranty period of 2 years. Throughout these 2 years, Company ABC is required to remove all defects that existed at the time of the sale. It’s given that this is not a separate performance obligation. Based on historical evidence, Company ABC estimates $30K costs of repairs in the first year, and $10K in the second year. 

Let’s check if the 3 provision criteria are met:

• Present obligation for outflow of cash as a result of a past event
  • MET: Sale has occurred in the past and the company is obliged to fulfill the warranty.
• Probable that it’ll have to settle the provision
  • MET: This is unavoidable because the warranty agreement is in place.
• Amount can be reliably measured. 
  • MET: The company has historical knowledge that it needs to settle $30K in first year, $10K in the second year (Note: An item can be both “measurable” and “uncertain.” Measurable means that we can estimate the amounts (such as in this example), but the timing and the exact amounts may be “uncertain”).

Because Company ABC has an unavoidable obligation of uncertain timing/amount, this is a provision. (Note that this is also a liability because remember provision is a type of liability.)

Contingent liability

Simply put, if outflow is not probable, the entry is a contingent liability.

Contingent liabilities are possible (not present) obligations that will be confirmed by future uncertain events. Provision is of uncertain timing/amount, but it will happen (unavoidable), while contingent liability may or may not happen (avoidable).

The recognition criteria for contingent liability are as follows:

• Possible obligation that arises from past events
• Existence will be confirmed by occurrence or non-occurrence of uncertain future events not wholly in the control of the entity

Then discuss:

• Probable
• Measurable

While provisions are recorded in F/S, contingent liability is not recorded but disclosed, outlining the nature of the events, financial impact estimates, etc. If the probability of outflow is remote, the contingency doesn’t need to be disclosed.

For example, let’s say there is a pending investigation against Company ABC for possible health concerns at one of its facilities. Company ABC’s legal team believes the probability of being found in violation is likely low as the complaint is said to have come for a disgruntled former employee. No estimate of the amount is provided.

Let’s check if the 3 provision criteria are met:

• Present obligation for outflow of cash as a result of a past event
  • NOT MET: It’s a possible obligation, not present
• Probable that it’ll have to settle the provision
  • NOT MET: The lawyers believe that there is a low chance
• Amount can be reliably measured 
  • NOT MET: The amount is unknown

Because outflow of resources is not probable and no estimate is given, this is not a provision.  So let’s check the contingent liability criteria:

• Possible obligation that arises from past events
  • MET: It is a possible obligation as a result of a past health concern
• Existence will be confirmed by occurrence or non-occurrence of uncertain future events not wholly in the control of the entity
  • MET:  The payout for the lawsuit may or may not happen.
• Probable
  • NOT MET: There is low chance, per lawyers
• Measurable
  • NOT MET: The amount is unknown.

Therefore, this is contingent liability that should be disclosed.

Test Your Knowledge: Practical Example

For example, Company ABC has been engaged in a lawsuit where a customer had fallen on company property in January. As of April, it is unclear whether the Company will be required to pay settlement or not. << At this point, it represents a contingent liability (avoidable, may or may not happen).

As of June, Company ABC has been found guilty of the lawsuit against them, but it has not yet been determined if they will have to pay $50,000 or $150,000 and when. This will be determined at the next court date in July. << At this point, it represents a provision (unavoidable, will happen). If the amount or timing were known at this point, it would be classified as a liability.

Decision Tree

Below is a decision tree to help you understand and analyze this standard in CPA cases:

ASPE Differences

For review of contingencies under ASPE, check out ASPE 3290. Under ASPE, the following differences exist:

• The term contingent liability is used opposed to the term provision. 
• Contingent liability is to be recognized when the probability of an outflow is likely instead of probable.
• Instead of taking the best estimate or range for measurement, use the minimum amount.
• No requirement to review contingent liabilities at the end of each reporting period.

Overall, the key difference to keep in mind when reviewing an AO, is to remember that provisions are unavoidable and will happen, but the timing and amounts are uncertain. Contingent liability may or may not happen. Be sure to integrate case facts when assessing these criteria to achieve depth!

If you need support along the way, get in touch with our professional CPA coaching team.