Accounting hash?: marijuana crops and IAS 41

A recent National Post article provides a rare example of a technical accounting issue catching the mainstream media spotlight.

Written by Sunny Freeman, it’s titled “’Biological assets’: Accounting rules are adding haze to marijuana company financials.” Here are some extracts:

  • “If the accounting regime that governs Canada’s burgeoning marijuana industry seems a little hazy to you, you’re not alone: Some publicly-traded cannabis companies aren’t entirely sure what to make of it either.
  • Under International Financial Reporting Standards (IFRS), marijuana producers must use an accounting practice unique to the agricultural sector that pre-books income for crops as they grow.
  • The ‘biological asset’ rule credits the value of product that is growing at fair value minus selling costs and reports that figure on the income statement.
  • The changes in fair value are not counted as revenue, but as a reduction in the cost of sales, which as a result boosts the bottom line.
  • That means a company can report net income in a quarter in which they grew or harvested marijuana, but had no sales to speak of.
  • ‘If you polled the LPs almost every single one would say they prefer not to do it,’ says Maruf Raza, national director of public companies at accounting firm MNP, who gave a presentation on how to navigate the complex agricultural accounting standards to some 30 licensed producers last month.
  • ‘A lot of these rules are actually creating an accounting burden on these LPs because they have to spend time to value (the crops), to hire experts.’
  • But the potential for confusion, especially for retail investors — not to mention the danger that booked net income may never actually materialize, resulting in a future loss — has some calling on marijuana companies to take it upon themselves to be more transparent.
  • Three of Canada’s largest medical marijuana companies — Canopy Growth Corp., Aphria Inc. and Aurora Cannabis Inc. — neglected to point out the impact of biological assets in their press release highlights of their most recent quarters, though they did elaborate on those impacts in their management discussion and analysis document….

The article says that MNP’s Raza “is working with producers to develop an industry-wide non-IFRS metric that would help investors compare apples to apples. He points to other sectors such as real estate investment trusts that have created similar industry-specific gauges to address situations when traditional accounting metrics paint an incomplete picture.”

Leaving aside the clear missed opportunity embodied by “apples to apples” (roach to roach?), this only demonstrates yet again, I suppose, that non-GAAP measures are the assumed answer to just about every problem. One imagines though that standard-setters might tear their hair out at that last sentence in particular, out of damned-if-you-do-damned-if-you-don’t frustration. I’ve written a couple of times (most recently here) about criticisms of IFRS financial statements for not reflecting internally-generated intangible assets and similar sources of ongoing value. IAS 41 reflects a modest attempt to head off such criticisms for one particular category of activity, but then gets slammed anyway. It’s certainly a bit hard to follow how reflecting a key asset at its fair value, regardless that the measure entails some estimation uncertainty, somehow contributes to a more “incomplete picture” than would be obtained by omitting it.

The IASB actually considered this broad question fairly recently, in the context of the “bearer plants” amendments to IAS 41, to exclude those items from the standard and allow the use of the IAS 16 cost model. Some respondents to the exposure draft suggested at that time that other categories of biological asset, such as growing plants, might also be excluded from the standard for one reason or another. The Board side-stepped the issue, saying “that such requests for an expanded scope would increase the complexity of the project and raise conceptual issues that did not belong in a limited-scope project but instead in a comprehensive review of IAS 41.” A couple of members dissented from those amendments, setting out in some detail their belief that fair value measurement is no less relevant to bearer plants than to any others. Anyway, it looks like IAS 41 in its current form is here to stay for the foreseeable future.

The article cites the way that a “company can report net income in a quarter in which they grew or harvested marijuana, but had no sales to speak of,” as if this were an obvious flaw in the accounting. The counterpoint of course, as IAS 41.B14 puts it, is that “fair value changes in biological assets have a direct relationship to changes in expectations of future economic benefits to the entity.” But according to the National Post article, this only amounts in the real world to marijuana producers having “criticisms levied at them for ‘front-loading’ income.” It appears then that we’re still in a cash-is-king world where no one truly expects the statements to make any real contribution to forming such expectations about future economic benefits. But, as so often, this seems to speak much more to the limitations of investors and other users than to those of the financial statements themselves…

(For an earlier, lighter take on marijuana and IFRS, see here)

The opinions expressed are solely those of the author

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