Accrual Versus Cash Basis of Accounting in the Canadian COVID-19 Subsidy Programs*
Accepted by Andy Bauer. This paper has benefited significantly from comments by two anonymous reviewers and Andy Bauer (associate editor) as well as from participants at the 2023 CAAA Annual Conference. Financial support from the Social Sciences and Humanities Research Council (SSHRC) of Canada is gratefully acknowledged.
ABSTRACT
enThe principal eligibility criterion for the Canada Emergency Wage Subsidy (CEWS) during the COVID-19 pandemic was a reduction of at least a prespecified percentage in monthly revenues compared to the same months in the prior year, or compared to January and February 2020 (just prior to the launch of CEWS in March 2020). The revenues could be measured using accrual or the cash basis of accounting. Since subsidy applicants could choose the cash method of accounting and use January and February 2020 as reference periods, seasonal businesses that generated most of their revenues in January and February could claim subsidies without experiencing any reductions in revenue. We illustrate how a seasonal business with higher monthly accrued revenues compared to the pre-pandemic year could be eligible for CEWS by using the cash basis of accounting in the subsidy application even though it would not qualify using the accrual accounting method. It seems inequitable for business or wage subsidies to be based on the choice of accounting methods. There is no sound public policy reason to subsidize (or tax) one firm more than another just because they use a different method of accounting. Evaluating accounting methods embedded within government subsidy programs is an important endeavor to ensure neutrality and effectiveness of public spending programs.
RÉSUMÉ
frCOMPTABILITÉ D'EXERCICE ET COMPTABILITÉ DE CAISSE DANS LES PROGRAMMES CANADIENS DE SUBVENTIONS LIÉS À LA COVID-19
Le principal critère d'admissibilité à la Subvention salariale d'urgence du Canada (SSUC) durant la pandémie de COVID-19 était une réduction d'un pourcentage préétabli minimal des revenus mensuels par rapport aux revenus mensuels des mois correspondants de l'année précédente, ou par rapport aux mois de janvier et février 2020 (juste avant le lancement de la SSUC en mars 2020). Les revenus pouvaient être déterminés en recourant à une comptabilité d'exercice ou à une comptabilité de caisse. Puisque les demandeurs pouvaient choisir la comptabilité de caisse et utiliser les mois de janvier et février 2020 à titre de période de référence, les entreprises saisonnières qui récoltaient la majorité de leurs revenus en janvier et février pouvaient présenter une demande de subvention même si leurs revenus n'avaient pas diminué. Nous montrons comment une entreprise saisonnière dont les revenus mensuels étaient plus élevés par rapport à la période précédant la pandémie pouvait être admissible à la SSUC en recourant à la comptabilité de caisse dans la demande de subvention, mais ne l'aurait pas été si elle avait utilisé la comptabilité d'exercice. Il semble inéquitable que les subventions aux entreprises ou les subventions salariales se fondent sur le choix de la méthode comptable. Il n'existe aucun motif de politique publique valable de subventionner (ou d'imposer) davantage une entreprise qu'une autre pour la seule raison qu'elle peut utiliser une méthode comptable différente. Il est important d'évaluer les méthodes comptables associées aux programmes de subvention gouvernementaux pour garantir la neutralité et l'efficacité des programmes de dépenses publiques.
1 INTRODUCTION
Many governments in industrialized countries launched emergency subsidy programs for businesses and individuals at the onset of the global COVID-19 pandemic in March 2020. Such programs were designed to help “freeze” the economy and businesses until the health shock had been contained and then allow the economy and businesses to resume their normal activities. Canadian wage subsidies to businesses were often based on applicants demonstrating a decline in monthly revenues relative to the pre-pandemic period, where the pre-pandemic period could refer to monthly revenues from the same months in previous year or from the first 2 months of the 2020 calendar year. This paper demonstrates how the choice of accounting methods and baseline comparative periods could allow seasonal firms with no revenue reductions to qualify for COVID-19 pandemic subsidies.
The Canada Emergency Wage Subsidy (CEWS) was launched by the Canadian federal government as a wage subsidy for businesses experiencing at least a prespecified decline in monthly revenues during the COVID-19 pandemic. Businesses that retained their employees could apply for and receive CEWS on behalf of their employees. Businesses were strictly intended to be the conduit for the employees, and CEWS was only available for employees retained. While there was no requirement to renounce layoffs, firms did not receive CEWS for employees that were not retained. The wage subsidy was designed to flow through to the employees to ensure they had sufficient cash flows during pandemic restrictions when both supply and demand were curtailed for public health reasons. CEWS was designed to prevent job and income losses while the pandemic prevailed. Eligibility for CEWS did not require applicant firms to document that the decline in revenue was related to the COVID-19 pandemic, in part because it would have been almost impossible to establish such a causal link.
This study highlights a previously undocumented design flaw in the Canadian COVID-19 pandemic subsidy programs that enabled seasonal businesses that earned a significant majority of their revenue in the first 2 months of the year to be eligible for CEWS even if their revenues did not decline during the pandemic (or even if their revenues increased marginally). Seasonal firms could be eligible for CEWS in the absence of revenue decline (or with marginal revenue increases) if they used the cash method of accounting or switched to the cash method of accounting just before applying for CEWS. Since subsidy applicants could choose both the cash method of accounting and use January and February 2020 as reference periods, seasonal businesses that generated most of their revenues in January and February could claim subsidies even if they did not suffer any revenue decline.
During normal (non-pandemic) times, small firms may be incentivized to report their revenues on an accrual basis to smooth out monthly earnings and avoid paying larger monthly income tax installments in the first few months of the year. However, firms applying for CEWS were allowed to use the cash method of accounting for subsidy programs, even if they normally reported using accrual accounting, as long as they used cash accounting consistently thereafter for all subsidy application periods (even if they continued to use accrual accounting for other purposes, such as paying monthly income tax installments).
The accounting-based design flaw exposed in this study is more likely to be of concern only to small private businesses—both incorporated and non-incorporated. Larger, public firms are not likely to be too seasonal or too undiversified. The lack of data availability for private firms makes it difficult to assess the number of firms or the total amount spent by the treasury on firms that may have benefited from this design flaw. Nevertheless, it is important to identify the design flaw so that future government subsidy programs do not replicate it.
While the consistency principle in accounting standards often protects users of financial statements if firms change their reporting, the safeguard offered by consistency (in using cash basis or accrual accounting over consecutive subsidy application periods in this case) was inadequate to prevent undeserving firms (i.e., firms with no revenue declines) from receiving CEWS and would have remained inadequate even if the pandemic and the wage subsidy would have lasted longer. A better understanding of accounting principles used in wage subsidies or other public policy programs is essential in assessing who might benefit from such subsidies. Understanding the accounting principles and accounting measurement methods underlying subsidy programs will allow policy-makers to help businesses and the economy develop better fiscal antibodies more responsibly, more efficiently, and more equitably in time for the next pandemic.
This study extends the literature on how firms' resources may be determined in part by the accounting policy choices they make. Watts and Zimmerman (1990) review research studies that show how the choice of accounting policies is determined by managers' bonus plans and firms' debt covenants and political costs. Laux (2022) and Bao et al. (2022) offer more recent examples of how debt covenants and bonus plans can influence accounting disclosure, while Mawani and Fan (2023) document how dividend payouts may influence disclosure of the CEWS subsidy. Taylor et al. (2023) show how European banks undertook earnings management during the COVID-19 pandemic, while Wang et al. (2022) examine how firms adjusted their accounting conservatism in response to government support policies. This study extends this literature by illustrating how a seasonal private firm could choose the cash basis of accounting to apply for government wage subsidies to be eligible for and receive subsidies. It seems inequitable for business or wage subsidies to be based on the choice of accounting methods. There is no sound public policy reason to subsidize (or tax) one firm more than another just because they use a different method of accounting.
In addition to firms' choice of accounting policies, this paper also highlights the importance of involving accountants in designing subsidy programs that rely on accounting numbers. The reasonableness of eligibility rules and the compliance thereof by taxpayers are of vital interest to policy-makers and academic researchers. Evaluating accounting principles and measures embedded within government subsidy programs is an important endeavor to ensure accountability from program designers as well as to assess effectiveness and neutrality in public spending programs. Failure to understand the implications of cash versus accrual accounting methods of reporting may result in firms not experiencing revenue declines being eligible for subsidies. Easy-to-fix design flaws should be understood and resolved before similar large-scale subsidy programs are delivered again, in the event of another pandemic or similar macroeconomic crisis. If they are applicable to more than just a handful of firms, subsidy programs with a flaw identified in this study may incentivize businesses to seek professional consulting advice for maximizing COVID-19 pandemic subsidies. Payment of such consulting fees by employers would be a source of inefficiency or an unnecessary cost to society (often referred to as a deadweight loss by economists).
Public policy analysis requires trade-offs demonstrating a balance between avoiding complexity and not reaching businesses in need. Policy-makers need to design subsidy programs in a way that retains a simplicity of design while making it easy for deserving applicants—and difficult for undeserving applicants—to access the subsidies.
While a broad cross-sectional comparison of government subsidy programs is beyond the scope of this study, a limited comparison of CEWS to the Scientific Research and Experimental Development (SR&ED) program (also delivered via the tax pipeline) shows that CEWS seems to be the only large-scale program that allowed cash basis of accounting measurement.
Another example where a business could be eligible for CEWS despite not suffering any operational monthly revenue declines is as follows. Suppose a firm divested a division with at least 30% of total revenues in March 2020 (the start of the pandemic). Such a firm could be potentially eligible for CEWS for the duration of the program because its revenues may be 30% lower compared to January/February 2020 (assuming no new business expansion or revenue increases during the duration of the CEWS program). While the cost to the treasury of this feature is not estimable due to data unavailability, it seems feasible to design rules that exclude firms from being eligible for CEWS if they report lower monthly revenues due to divestments at the onset of the pandemic.
The rest of the paper is organized as follows. Section 2 discusses the details and implications of CEWS legislation. Section 3 profiles our hypothetical payroll software company and describes the subsidies it received based on its nondecreasing revenue profile. Section 4 discusses how the design flaws can be fixed, while Section 5 describes the difficulty in estimating the overall cost to the treasury of this accounting design flaw because of unavailable data. Section 6 describes new pandemic-related subsidy programs that were built on the same flawed accounting design, and Section 7 offers concluding remarks.
2 CEWS LEGISLATION AND DISCUSSION
CEWS Legislation
CEWS was delivered via the “tax pipeline” administered by the Canada Revenue Agency (CRA) as a deemed overpayment of Part 1 tax. This channel was expeditious since all businesses already had an account with the CRA, and subsidy amounts, once approved, could be deposited into the bank accounts linked with the taxpayers' accounts in a manner similar to any income tax refunds. The CEWS provision was added as a new section (125.7) of the Income Tax Act (ITA).
Subsection 125.7(4) of the ITA (Bill C-14, 2020) allowed entities to determine revenues in accordance with its “normal accounting practices”—an expression not defined in the Act nor clarified in the Government of Canada's (2020c) frequently asked questions. Subsection 125.7(1) defined qualifying revenue as “the inflow of cash, receivables or other considerations arising in the course of the ordinary activities of the eligible entity”—wording that is very similar to that found in Canadian Accounting Standards for Private Enterprises (ASPE). For the purposes of applying for CEWS, Bersenas and Weinrauch (2022) report that normal accounting practices did not have to conform to ASPE or IFRS typically used for financial reporting. Instead, CRA Document 2020-0855831E5 required “revenue” to satisfy “certain performance obligations [by the reporting entity] such as the sale of goods or the performance of services that would typically result in a corresponding inflow of cash, accounts receivable, or other consideration” (Tax Interpretations, 2020).
Subsidy Details
The CEWS program offered employers the greater of 75% of precrisis weekly wage and the actual weekly wage paid to the employee during the COVID-19 pandemic, up to a dollar limit of $847 per week per employee.1 Employers satisfying the requisite revenue reduction percentage (RRP) criterion for CEWS eligibility were often reimbursed 100% of wages paid if they offered reduced wages during the COVID-19 pandemic. For example, if the precrisis weekly wage was $1,000 and the weekly wage paid during the pandemic was $750 (presumably for less work during the pandemic), then the employer would be reimbursed 100% of the $750 weekly wage paid since it was not greater than 75% of the precrisis wage, as long as it was not greater than the weekly dollar limit.
Over the duration of the CEWS program, the Canadian government paid out $100.57 billion in wage subsidies for 5,069,960 approved applications (a 99.6% acceptance rate) from 460,120 unique private and public businesses (Government of Canada, 2020b). This program was offered for 21 periods of 4 weeks each. The high approval rate is not surprising since it was reasonably easy for applicant businesses to demonstrate the central criterion—namely, an RRP of varying amounts over time compared to the baseline period of the same month in the year before the pandemic (e.g., April 2020 vs. April 2019) or compared to the average of the 2-month period immediately preceding the pandemic (i.e., January and February 2020). Subsequent amendments introduced a sliding scale mechanism that made CEWS assistance scaled to the severity of the pandemic and the associated magnitude of monthly revenue declines.
Revenues Versus Income as the Benchmark Criterion
Using revenues rather than net income as the benchmark criterion for subsidy eligibility seems justified since the use of net income would have allowed businesses a lot more accounting discretion and slowed down applications. It is difficult for the CRA to easily and rapidly (for applications submitted every 4 weeks) detect small private firms that may potentially expense some outlays to reduce reported net incomes. For example, outlays for capital assets or future development normally require capitalization and subsequent amortization over the useful life. In such cases, auditors (normally focused more on monitoring inflated reported incomes) may have less time and ability to scrutinize firms that understate current period income (perhaps by assuming that current outlays will not have future economic benefits). Furthermore, many small businesses may not prepare monthly financial statements as part of their normal accounting, and the CEWS program did not want to impose any incremental compliance burden during the COVID-19 pandemic. Therefore, the wage subsidy relied only on revenue reductions (and not income reductions) as the central eligibility criterion.
However, failure to have any role for net income in the CEWS eligibility criteria could also have unintended consequences. Businesses could receive CEWS while reporting higher annual incomes just because their monthly revenue declines were fleeting. The general scenario for CEWS eligibility was a month-to-month slowdown in demand or supply for the firms' goods or services. However, CEWS could also be potentially engineered opportunistically to attain some “down time” for the employees over the duration of the CEWS program or to work on new product developments that could generate future revenues. While accounting principles2 require labor costs incurred for new product development to be capitalized instead of being expensed, the CEWS calculator did not differentiate between expensed and capitalized labor outlays. As an unintended consequence, CEWS may have incentivized and subsidized new product development and generation of future revenues instead of subsidizing current period labor costs during the pandemic.3 CEWS could also have contributed to making labor artificially cheap, perhaps temporarily discouraging new investments in technology.
Accrual Versus Cash Basis of Accounting Measurement
The CRA definition of revenues allowed the use of cash basis of accounting by CEWS applicants as long as firms used the cash basis of accounting or changed their normal accounting practice to cash basis of accounting just prior to their first CEWS application. The CEWS calculator on the CRA portal specifically allowed for revenues to be measured according to the cash basis of accounting (Government of Canada, 2020a). If the cash method for determining monthly revenues was elected, the ITA, Paragraph 125.7(4)(e), required the election to be applied consistently for all qualifying periods as described in Keung and Mah (2020).
The cash method of accounting may have facilitated small businesses that reported to their banks using the cash basis of accounting. However, firms using accrual-based reporting could also prepare financial statements using the cash basis for their bankers as well as for their subsidy applications.
The baseline of average revenue for January and February 2020 (the 2 months immediately prior to the pandemic) by which monthly revenue declines were assessed may have been initially justified for new businesses that were not in existence for much of 2019 and therefore did not have sufficient history of past revenues to have a 2019 comparator. However, when the CEWS legislation was rolled out, this baseline option was available to all firms—old and new—presumably in the interest of horizontal equity. It could be argued that having different subsidies for firms with different lengths of histories (as opposed to subsidies being dependent on revenue losses experienced) is inequitable. Similarly, initial discussions to allow the cash method of accounting to assess RRPs for CEWS may have been limited only to the few firms that use cash method of accounting for their regular reporting but was later extended to all firms, presumably on horizontal equity grounds.
The accrual accounting and the comparison baseline of the same period in 2019 were the default methods, while the cash method of accounting and the comparison baseline of the average revenues in January and February of 2020 were the alternate methods. However, deviating from the default methods required applicants to file formal elections specified under provisions of the ITA and signed by business officers.4
Context for Firms Applying for CEWS
Applying for CEWS on behalf of employees could be considered both a fiscally and socially responsible business practice. If firms found themselves eligible for higher subsidies under the cash method of accounting, they would be totally justified in using or switching to the cash method since it was explicitly permissible under the law. Eligible firms were likely compelled to apply for competitive reasons, especially if their competitors were also applying and receiving CEWS. In response to whether CEWS recipients that reported higher annual profits were justified in applying for CEWS, Corcoran (2021) argued that firms owed their allegiance to shareholders who were mobile and sought competitive returns on their investments. Such arguments are also used by tax advisors to justify why they take advantage of income tax legislation to legally minimize their income taxes, since otherwise they would face a cost disadvantage compared to their competitors. Tax avoidance does not require taxpayers to examine whether they need or deserve the tax deduction, or conversely, whether they need or deserve a tax subsidy like CEWS.5 For example, a firm experiencing a 30% economic (or accounting) depreciation rate may still choose to legally and ethically claim the maximum available 40% capital cost allowance (CCA) rate to remain competitive on tax costs with other firms in the same industry.6
Variance of Monthly Revenues
The amount of CEWS receivable depended on the variance of monthly revenues, even if annual revenues remain unchanged. Using the online CEWS calculator on the CRA website (Government of Canada, 2020a), Table 1 shows how firms with identical payroll costs, identical unchanged annual revenues, and identical unchanged annual net incomes received CEWS support ranging from $0 to $155,889.60, depending on the distribution or variance of monthly revenues.7 (Table 1 does not reflect our hypothetical firm, which is profiled in more detail in the next section.)
| Cash revenues concentrated in pre-pandemic months | Large component of cash revenues in first month of pandemic | Bulk of cash revenues later in post-pandemic period | Equal monthly cash revenues and closure during early pandemic periods | Equal monthly cash revenues pre- and post-pandemic | Monthly revenues under accrual accounting | |
|---|---|---|---|---|---|---|
| January | $200,000 | $25,000 | $30,000 | $70,000 | $50,000 | $41,667 |
| February | 50,000 | 25,000 | 30,000 | 70,000 | 50,000 | 41,667 |
| March | 25,000 | 200,000 | 30,000 | 60,000 | 40,000 | 41,667 |
| April | 25,000 | 50,000 | 30,000 | 0 | 40,000 | 41,667 |
| May | 25,000 | 25,000 | 30,000 | 0 | 40,000 | 41,667 |
| June | 25,000 | 25,000 | 30,000 | 0 | 40,000 | 41,667 |
| July | 25,000 | 25,000 | 30,000 | 0 | 40,000 | 41,667 |
| August | 25,000 | 25,000 | 30,000 | 60,000 | 40,000 | 41,667 |
| September | 25,000 | 25,000 | 30,000 | 60,000 | 40,000 | 41,667 |
| October | 25,000 | 25,000 | 30,000 | 60,000 | 40,000 | 41,667 |
| November | 25,000 | 25,000 | 30,000 | 60,000 | 40,000 | 41,667 |
| December | 25,000 | 25,000 | 170,000 | 60,000 | 40,000 | 41,667 |
| Total annual revenue | $500,000 | $500,000 | $500,000 | $500,000 | $500,000 | $500,000 |
| Total annual payroll | $359,736.42 | $359,736.42 | $359,736.42 | $359,736.42 | $359,736.42 | $359,736.42 |
| Annual net income before subsidies | $75,643.58 | $75,643.58 | $75,643.58 | $75,643.58 | $75,643.58 | $75,643.58 |
| CEWS received based on monthly cash revenues | $155,889.60 | $0 | $0 | $98,713.48 | $56,038.24 | $0 |
| CEWS received based on monthly accrued revenues | $0 | $0 | $0 | $0 | $0 | $0 |
| CEWS received as a percent of payroll | 43.3% | 0% | 0% | 27.4% | 15.6% | 0% |
- Notes: CEWS subsidies were determined based on the online calculator available on the CRA portal.
Using the cash method of accounting, seasonal firms with higher revenues in the baseline comparator period of January and February 2020 could demonstrate a higher RRP in subsequent months and therefore receive higher CEWS. The amount of support is directly related to the decline in monthly revenues compared to the baseline period of January and February 2020. The subsidy rules focused on monthly revenue declines instead of annual net income levels as the basis for “entitlement to receive subsidy” to emphasize the expected short-term nature of the programs.
CEWS recipients did not have to demonstrate the need for cash, and therefore the subsidy could result in higher reported income, higher dividend payouts, and/or higher executive compensation. Firms receiving CEWS could use their subsidy to increase payouts to employees (e.g., by increasing their hourly wage), customers (e.g., reducing prices), suppliers (e.g., accelerating payments), or shareholders (e.g., increasing dividends or share buybacks).
Brethour et al. (2021) documented that many CEWS recipients simply boosted their annual reported profits during the pandemic. One of the more extreme examples profiled was that of the Royal Ottawa Golf Club, which reported a surplus of $825,000 during the first year of the pandemic compared to $43,000 reported in 2019 fiscal year, as reported by Gatehouse (2020).
3 PROFILE OF THE CEWS APPLICANT AND RESULTING SUBSIDIES
We illustrate a hypothetical, but realistic, payroll software developer that employs five people (including the owner-manager) to update its single tax and pension software product, for which a new version is launched in late December each year in time for the new calendar/taxation year. It invoices customers in late December, and they all pay their invoices in January of each year, with a few late stragglers paying in February. In the remaining 10 months of each year, the business earns some revenue doing customized consulting work for its customers. During the pandemic, the number of subscribers renewing their software at the beginning of the year remained constant. The online consulting services during the pandemic months (March 2020 to December 2021) enjoyed a slight price increase during 2020, as well as an additional price increase in 2021. Since this slightly higher online revenue resulted from a price increase and not additional labor, the firm had sufficient labor capacity with the existing staff and did not have to hire more employees.
Given that the central criterion for CEWS was demonstrating a decline in monthly revenues, this payroll software company—at first glance—does not seem eligible for CEWS since monthly accrued revenues did not decline during the pandemic. However, the CEWS rules allowed businesses to report revenues using either an accrual or cash method of accounting if it was their normal accounting practice or became normal accounting practice just before the first CEWS application, and the method was used consistently over all subsequent subsidy periods.8
To recap the rules, businesses were eligible for CEWS if they could demonstrate an RRP decline ranging from 15% in the first period to 30% in Periods 2–4.9 The maximum amount of CEWS benefits was available for firms demonstrating an RRP of at least 70%.10 In later periods, subsidies were reduced for smaller revenue declines but maintained for larger revenue declines.
In the interest of offering businesses some certainty during the pandemic, the rules allowed an applicant to qualify for CEWS in a period if it also qualified for CEWS in the immediately preceding period. This safe harbor provision offered businesses a bit more certainty about their following period's CEWS receivable, and it meant that this hypothetical software firm would qualify for CEWS in January 2021 even though its consistently reported revenues under cash method of accounting were not lower than the baseline period of January/February 2020.
Table 2 describes how our profiled firm was eligible for CEWS in all 20 months of 2020 and 2021 during which the CEWS was offered despite enjoying same or higher actual annual revenues in every month compared to 2019. To be eligible for at least some level of subsidy, a business had to experience a RRP greater than 30%, a threshold that changed over time to reflect the severity of the pandemic.11 An applicant firm was eligible for maximum CEWS in a given period if it could demonstrate an RRP of at least 70% in Column 3 or Column 6 of Table 2 under either the accrual method or the cash method of accounting. In the case of our profiled company, the RRPs in Columns 3 and 6 of Table 2 exceed 70% in every period, except in January 2021. This hypothetical firm's eligibility for January 2021 was assured by the safe harbor provision described earlier.
| 2020 | 2021 | |||||
|---|---|---|---|---|---|---|
| (1) | (2) | (3) | (4) | (5) | (6) | |
| Month | 2020 cash revenues | 2020 accrued revenues | Cash basis RRP % compared to average of Jan/Feb 2020 | 2021 cash revenues | 2021 accrued revenues | Cash basis RRP % compared to average of Jan/Feb 2020 |
| January | $215,000 | $43,750 | N/A: pre-pandemic; CEWS not offered | $215,000 | $45,833.33 | See safe harbor provisiona |
| February | 35,000 | 43,750 | N/A: pre-pandemic; CEWS not offered | 35,000 | 45,833.33 | 72 |
| March | 27,500 | 43,750 | 78 | 30,000 | 45,833.33 | 76 |
| April | 27,500 | 43,750 | 78 | 30,000 | 45,833.33 | 76 |
| May | 27,500 | 43,750 | 78 | 30,000 | 45,833.33 | 76 |
| June | 27,500 | 43,750 | 78 | 30,000 | 45,833.33 | 76 |
| July | 27,500 | 43,750 | 78 | 30,000 | 45,833.33 | 76 |
| August | 27,500 | 43,750 | 78 | 30,000 | 45,833.33 | 76 |
| September | 27,500 | 43,750 | 78 | 30,000 | 45,833.33 | 76 |
| October | 27,500 | 43,750 | 78 | 30,000 | 45,833.33 | 76 |
| November | 27,500 | 43,750 | 78 | 30,000 | 45,833.33 | N/A: CEWS ended |
| December | 27,500 | 43,750 | 78 | 30,000 | 45,833.33 | N/A: CEWS ended |
| Total annual revenue | $525,000 | $525,000 | $550,000 | $550,000 | ||
- Notes: Since the RRP exceeds 70% in each of the 20 months of 2020 and 2021, the firm receives the maximum amount of CEWS in all months.
- a Under the “safe harbor” provision, the firm remains eligible for CEWS in January 2021 because it was eligible for CEWS in the immediately preceding month (December 2020).
Our hypothetical seasonal firm being eligible for maximum CEWS is a surprising result given that the firm enjoyed higher (or same) revenues compared to the same month in the previous year for all the subsidy periods. It illustrates an example of how a firm could benefit from the CEWS rules when its skewed annual revenues under the cash accounting method are earned almost entirely in the first 2 months of the year. While it is not easy to find out how many businesses were in this situation, such businesses can exist in the software licensing industry, in seasonal business such as ski resorts, and in some businesses selling annual subscriptions on a calendar year basis.
A design flaw like this can be expected for new subsidy programs designed in the rush of a pandemic lockdown. However, the design flaw identified here should have been detected and corrected for subsequent periods when several other features of the programs were fine-tuned. For example, the government introduced a new rule in late 2021 requiring businesses to repay CEWS if they also increased their executive compensation from the pre-pandemic levels. The subsidy rate as a function of the RRP changed several times to reflect the severity of the pandemic. The subsidy rate increased with RRPs to target businesses that were the hardest hit. However, the accounting-based design flaw described in this paper continued to potentially allow seasonal businesses that may not have suffered any decline in (annual or monthly) revenues to qualify for and receive subsidies.
Table 3 provides details on CEWS claims by our hypothetical payroll software developer for each 4-week period during 2020 and 2021 based on the online CEWS calculator.
| Year | Period | Start date | End date | CEWS received by period | Annual CEWS received |
|---|---|---|---|---|---|
| 2020 | 1 | March 15, 2020 | April 11, 2020 | $15,802.00 | |
| 2020 | 2 | April 12, 2020 | May 9, 2020 | 15,802.00 | |
| 2020 | 3 | May 10, 2020 | June 6, 2020 | 15,802.00 | |
| 2020 | 4 | June 7, 2020 | July 4, 2020 | 15,802.00 | |
| 2020 | 5 | July 5, 2020 | August 1, 2020 | 17,904.40 | |
| 2020 | 6 | August 2, 2020 | August 29, 2020 | 17,904.40 | |
| 2020 | 7 | August 30, 2020 | September 26, 2020 | 15,798.00 | |
| 2020 | 8 | September 27, 2020 | October 24, 2020 | 13,691.60 | |
| 2020 | 9 | October 25, 2020 | November 21, 2020 | 13,691.60 | |
| 2020 | 10 | November 22, 2020 | December 19, 2020 | 13,691.60 | |
| Total CEWS received in 2020 | $155,889.60 | ||||
| 2021 | 11 | December 20, 2020 | January 16, 2021 | 15,798.00 | |
| 2021 | 12 | January 17, 2021 | February 13, 2021 | 15,798.00 | |
| 2021 | 13 | February 14, 2021 | March 13, 2021 | 15,798.00 | |
| 2021 | 14 | March 14, 2021 | April 10, 2021 | 15,798.00 | |
| 2021 | 15 | April 11, 2021 | May 8, 2021 | 15,798.00 | |
| 2021 | 16 | May 9, 2021 | June 5, 2021 | 15,798.00 | |
| 2021 | 17 | June 6, 2021 | July 3, 2021 | 15,798.00 | |
| 2021 | 18 | July 4, 2021 | July 31, 2021 | 12,638.40 | |
| 2021 | 19 | August 1, 2021 | August 28, 2021 | 8,425.60 | |
| 2021 | 20 | August 29, 2021 | September 25, 2021 | 8,425.60 | |
| 2021 | 21 | September 26, 2021 | October 23, 2021 | 4,212.80 | |
| Total CEWS received in 2021 | $144,288.40 | ||||
| Total CEWS received over duration of program | $300,178.00 | $300,178.00 | |||
- Notes: CEWS subsidies were determined based on the online calculator available on the CRA portal.
The amount of CEWS subsidy received by this hypothetical payroll software business is clearly material. Table 4 highlights summary income statements to illustrate the magnitude of subsidies in relation to net income and payroll. Net income as a percentage of revenue increased from 15.5% before the pandemic to 48.5% and 48.4% in the pandemic years of 2020 and 2021, respectively. The CEWS program allowed our profiled company to report net income (after subsidies) that was 228% higher in 2020 and 243% higher in 2021 compared to the pre-pandemic net income of 2019. This firm netted more cash inflows from CEWS ($155,889.60 in 2020 and $144,288.40 in 2021) than it did from earnings on selling software ($98,768.58 in 2020 and $121,873.83 in 2021).
| 2019 | 2020 | 2021 | |
|---|---|---|---|
| Revenues | $500,000.00 | $525,000.00 | $550,000.00 |
| Payroll (including Canada Pension Plan and Employment Insurance premiums) | (357,818.91) | (359,736.42) | (359,756.17) |
| Rent | (27,120.00) | (27,120.00) | (27,120.00) |
| Other costs: 7.5% of revenues | (37,500.00) | (39,375.00) | (41,250.00) |
| Income before CEWS | 77,561.09 | 98,768.58 | 121,873.83 |
| Subsidy from CEWS | — | 155,889.60 | 144,288.40 |
| Income after subsidy | 77,561.09 | 254,658.18 | 266,162.23 |
| Income after CEWS as percent of revenues | 15.5 | 48.5 | 48.4 |
| Wage subsidy as percent of payroll | 0 | 43.3 | 40.1 |
- Notes: CEWS subsidies were determined based on the online calculator available on the CRA portal.
This example of our hypothetical firm is more egregious than the Royal Ottawa Golf Club example reported earlier. While the golf club enjoyed higher cash inflows and profits despite suffering a decline in revenue during COVID-19 lockdowns, the payroll software developer in this study never suffered any revenue decline nor anticipated a revenue decline in any month (when compared to the same month in previous year), and instead enjoyed higher revenues each month during the pandemic.
4 FIXING THE INEQUITY ACROSS ACCOUNTING METHODS
These design flaws could be easily fixed by requiring firms that report RRPs using the cash method of accounting to use only the baseline of the same period in 2019 (e.g., May 2020 vs. May 2019), or to not allow cash method of accounting for reporting RRPs, or both. Table 5 summarizes these options and the subsidies available under the different options. If our profiled company were to report monthly revenues on an annual accrual basis (Option A), it would report no decline in revenues and therefore not be eligible for any CEWS.
| Under CEWS rules as legislated | Option A: Comparison with baseline of monthly revenues computed under accrual accounting | Option B: Comparison with baseline of same month in 2019 | |
|---|---|---|---|
| Actual revenue reduction | None | None | None |
| Reported RRP satisfied? | Yes, in every month that CEWS was offered | No | No |
| CEWS receivable | $300,178 over duration of CEWS program | $0 | $0 |
- Notes: CEWS subsidies were determined based on the online calculator available on the CRA portal.
Alternatively, the CEWS rules could insist that applicants only have one choice for comparing monthly revenues with the same month in the previous non-pandemic year (Option B in Table 5). Under Option B, our hypothetical company would not be able to show any reduction in revenues during the pandemic, and thereby would not be eligible for CEWS.
For future subsidies, policy-makers may want to avoid determining the baseline (against which future revenue declines are assessed) as an average of a short horizon, except for firms that have no history beyond the months immediately prior to the pandemic. Instead, a 12-month rolling average of revenues for firms with sufficient history would serve as a more appropriate benchmark against which RRPs are determined. Firms with only 6 months of history, for example, could be asked to base their comparator over the 6 months. A longer horizon baseline would reduce the unintended consequences illustrated in this article.
5 ESTIMATING THE MACROECONOMIC COST OF THE ACCOUNTING DESIGN FLAW
Estimating the magnitude of seasonal firms claiming CEWS is difficult since such businesses are usually smaller, private corporations or unincorporated businesses that may not need to publicly report to any stakeholders. Research analysts such as Leung and Liu (2022) exclude seasonal businesses in determining the impact of CEWS on survival and growth of businesses. Leung and Liu (2022) claim that their estimates of growth and survival during the CEWS program were not impacted by the exclusion of seasonal businesses (see Footnote 11). On the other hand, Liu et al. (2021) document a substantial uptake of CEWS in the agriculture, forestry, fishing, and hunting industry, which may have a sizable number of seasonal businesses (see chart 1).
The inequity identified in this study is easy to fix and should be fixed since there is no sound public policy reason to subsidize (or tax) one firm with identical cash flows more than another just because they use a different method of accounting. While we cannot estimate the revenue loss resulting from the design flaw identified in this study, it likely contributed a small component to the overall cost of CEWS.
6 OTHER PANDEMIC-RELATED SUBSIDY PROGRAMS
- An average monthly revenue reduction of at least 40% for THRP and at least 50% for HHBRP over a 12-month period.
- A current month revenue loss of at least 40% for THRP and at least 50% for HHBRP.
Our hypothetical firm profiled would qualify under both these programs (assuming it satisfied industry classification and other minor conditions) for 11 out of the 12 months in 2021 since it could demonstrate (1) an average monthly RRP of greater than 50% over the corresponding 12-month period12 and (2) a current month RRP of at least 50% in 11 out of the 12 months. This establishes that the design flaw highlighted in this paper was not fixed in subsequently designed subsidy programs, and the hypothetical firm profiled in this study could have continued to qualify for subsidies under HHBRP and THRP if it satisfied the industry classification. Thus, the implications of this study extend beyond CEWS, but economy-wide estimates on the unintended costs to the treasury remain unknown due to data unavailability.
7 CONCLUDING REMARKS
Public health experts agree that another pandemic is inevitable (e.g., Williams et al., 2023). Public policy experts agree that government support programs ought to be and will be offered during such pandemics. Such new future pandemic support programs will inevitably look to past experiences with subsidies such as CEWS to see what worked and what did not work. This study documents a previously undocumented design flaw resulting in inequity across CEWS applicants based solely on the accounting method allowed.
This study illustrates how a firm that never experienced any decline in monthly revenues during the pandemic (compared to the same month in the previous year) could be eligible for CEWS subsidies. While design flaws can be tolerated initially when programs are launched in a very short period during a lockdown, it is not excusable for a design flaw to remain uncorrected over the 20-month life of the programs, nor for such a design flaw to continue in new programs launched subsequently or in future pandemic relief programs. Future pandemics and public health restrictions, and the associated need for similar subsidies, could arise again in our increasingly interconnected world.
Potential solutions to this design flaw are not complex and easy to draft and administer. Policy-makers should not allow comparisons to the months immediately prior to the pandemic in case they end up being the months with disproportionally high revenues. Instead, monthly revenue reductions should be compared to the same months in the previous calendar year. Alternatively, the cash basis of accounting for subsidy programs could be disallowed unless the applicant business operates under cash accounting for all other purposes, such as regular quarterly tax filing and banking.
The CEWS program cost the federal treasury in excess of $100 billion over its life at a time of declining tax revenues and higher public health care costs. While most of this one-time cost may be warranted and justifiable during an unprecedented public health crisis, future subsidy programs should learn from this and all other design flaws of past subsidy programs.
In planning to arm ourselves with fiscal antibodies for the next pandemic, we should be more determined to detect structural flaws and design future subsidy programs on a more solid foundation. The reasoning and planning behind the design flaws described in this study could be repeated. An appropriate design for future subsidy programs should ensure that the subsidies flow through to firms in actual need and at a lower cost to the taxpayers. Post-mortem reviews of large subsidy programs should be heeded carefully if we are to avoid repeating the same mistakes and avoid unnecessary future drain to the taxpayers.
REFERENCES
- 1 The dollar limit of weekly CEWS support varied over time and approximated 75% of the $58,725 average annual wage of Canadians in 2020.
- 2 Accounting principles as set out in IFRS for Canadian publicly traded companies and ASPE for private entities.
- 3 While linkages to wages supported (or reimbursed) under the SR&ED program are beyond the scope of this paper, a cursory review of ineligible wages does not include subsidized wages (see Government of Canada, 2015).
- 4 Paragraph 125.7(4)(e) of the ITA required firms to make an election to choose between the cash method or accrual method of accounting, while Clauses 125.7(1)(b)(i)(A) and 125.7(1)(b)(i)(B) elections required firms to choose the appropriate “prior reference period” as a baseline for determining RRP (Bill C-14, 2020).
- 5 The SR&ED tax credit has given rise to an industry of consultants who may charge professional fees that are contingent on the amount of tax credits received.
- 6 Attempts by taxpayers to maximize CCA allows the government to accomplish its tax policy objective of incentivizing new investments with generous CCA.
- 7 This covers CEWS Periods 1–10, from March 15, 2020, to December 19, 2020.
- 8 Consistent measurement over time is considered a major safeguard in accounting since it often allows disclosure of an accurate trendline despite some measurement errors made consistently over time.
- 9 The minimum RRP for Periods 1–4 are in table 1, and for Periods 5–21 in table 2A, of Government of Canada (2020c).
- 10 The RRP at which maximum CEWS is available is described in Government of Canada (2020c, p. 86).
- 11 The minimum RRPs are listed in table 1 for Periods 1–4 and table 2A for Periods 5–21 in Government of Canada (2020c).
- 12 The 12-month baseline period for these two new programs is March 2020 to February 2021. In our specific case, the average 12-month RRP from Table 3 is ([78% × 10 months] + [−72% × 1 month] + [72% × 1 month]) = 780/12 = 65%. This exceeds 50% and therefore satisfies the first criterion for both programs.
