IFRS – let’s head back to the future!

If I return so soon to the writings of Al Rosen (after doing so here and here), it’s not because I’m obsessed with him (please let that be true!) but because he’s perhaps the most prominent commentator in Canada on IFRS-related matters, and it all seems to warrant some response from someone (even if I have no illusions that any remarks I provide here will have any of the visibility of the original commentary). The latest object of interest, in Canadian Accountant, has the highly Rosen-esque title Time to Phase Out IFRS in Canada (when I first transcribed the title, I thought there might have been a question mark at the end, but this would have been untrue to his certainty on the matter). Perhaps I’ll start where he ends up:

  • Canada has an especially long history of financial failures, from financial institutions like Castor Holdings and Confederation Life, to rosy valuations of property utilized by corporations to cover up for non-receipt of cash interest and principal on mortgages. Investor losses are typically in the billions for such reported profit versus operating cash flow disassociations.
  • That history was ignored by the adopters and proponents of IFRS. Canada has repeatedly displayed a fondness for attracting new capital from unsuspecting people. Our assumption that an endless supply of victims exists is worthy of debate.
  • We should conclude that the foundations of IFRS are irreparable and a far too flimsy foundation upon which to build a future for financial reporting. We should accept that fact before millions of dollars in investment in the most Canadian recent fad goes “up in smoke.”

That last phrase is a reference to the article’s main focus of interest, the valuations of biological assets in financial statements of marijuana producers – I wrote about that issue here. As we covered before, it seems that the parameters and limitations of such asset valuations should be evident to anyone who’s paying attention (and changes in those asset valuations aren’t classified as revenue). The IASB would certainly argue that fair value measurement increases the prospective value of the statements, in that as IAS 41.B14 puts it, “fair value changes in biological assets have a direct relationship to changes in expectations of future economic benefits to the entity.”

But Rosen seems to disclaim this as a meaningful or valid objective for financial reporting:

  • Old Canadian GAAP recorded which horse won the race and by how much, which came second, and similar statistics. IFRS, in contrast, heavily leans upon speculation about which horse may win a future race, despite all the uncertainties that the future holds. The distinction is not trivial. IFRS is the exact opposite in evidence requirements to old Canadian GAAP, not a “mere extension.”

Although the point, and certainly the analogy, are overdone, we might allow that we know what he means. But what’s the point of poring over data about past races, if not to form a basis for expectations about future ones? And to that end, isn’t information about (say) changes in the jockey or in the climate or in the terrain just as relevant as cold data about those past races? Of course such information is all uncertain and there’s risk in how you interpret and apply it. But, in the classic formulation, if there were no risk attached, then how or why should the exercise ever generate a meaningful reward?

Other parts of the article sets out the same basic world view from a different angle:

  • Canadian GAAP… for many decades, was based on not recording and reporting unless high quality, third-party evidence existed. Only actual dollars of completed transactions were worthy of reporting. Yes, phony trades could occur but collusion would be required, and verification steps would have to be carried out.
  • In sharp contrast, IFRS encourages corporate management to record their chosen “value” of assets, and the corresponding income, without the need for a third-party sale, and confirmation of cash collection…
  • In essence, IFRS is an extreme example of rejecting traditional bargained measurements of what constitutes cash-verified income or profit. Cash interest received from having invested in a bond surely is evidence of earnings or income. Promises of future dividends form the basis of potential frauds and Ponzi schemes.

There’s something of a moral aspect to the argument, with its call for a return to a more austere, backward-looking approach to financial statements. Of course, on a very basic level, it’s not hard to argue how such an approach would reduce the likelihood of certain forms of error at least. But investing is inevitably about forming expectations, and this involves more than merely staring back at a rigorously-scrubbed past.

A Rosen-ish retreat in financial statements could be accompanied, I suppose, by more expansive MD&A or other supplementary reporting that incorporates fair value and other information excised from the statements, plainly labeled with cautions, caveats and the rest. Rosen seldom if ever addresses such possibilities, but his caustic references to “invent(ing) your own, hallucinated dollars of profit” don’t suggest he’d be happy with that either. Meaning, I suppose, that a lot of the forward-looking information currently provided by companies (in whatever document or medium) should simply be banished altogether. Perhaps these steps would indeed make certain risky entities less attractive to careless investors. But money has to go somewhere (other than into those bonds he mentions), and with the best will in the world, it’s truly hard to think through how such self-denial in reporting would contribute to a collective advance in rational capital allocation.

The opinions expressed are solely those of the author

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