Caught in the trap of IFRS, or: the suspicious mind of Al Rosen

Even by his standards, Al Rosen’s latest piece for Canadian Accountant, “How to detect two common IFRS investor traps,” is a major mishmash of mud-throwing, suspicion and paranoia, painting the IFRS reporting landscape as a defect- and crime-strewn wasteland, but providing little coherent advice on how to stay alive within it.

He builds the article around a highly artificial premise:

  • Assume that, 10 years ago, two companies were comparable in terms of market share, financing, and economic, political, environmental and other risks. Company A continued with U.S. GAAP reporting while Company B adopted IFRS.
  • Company B’s share price is now 30 per cent higher than Company A’s, yet nothing between the two companies changed much during the past 10 years. Which company would you invest in today? Is the higher share price justified or have investors been conned?

Obviously, the scenario is so contrived and meaningless that you can answer those questions any way you like. But anyway, down on paper, Rosen’s hypothetical company B looks better than company A in just about every respect – higher revenue, lower cost of sales, lower expenses, a significant income statement boost from “net asset fair value increase,” all leading to a vastly superior bottom line. Rosen’s notion seems to be that these differences are all due entirely or substantially to the different accounting conventions applied.  So for instance, this is what he says about revenue:

  • Revenue, for example, would have been bloated by including non-cash receipts that may really belong in future years, and would be unrealistic dollars.

If Rosen really believes that there are a significant number of IFRS-reporting entities for which 30% of their reported revenue (using the numbers in his example) consists of incorrectly accelerated non-cash receipts which would have been excluded under US GAAP, it’s time to start naming names and setting out evidence, not just relying on vague accounts of things that “may really” be otherwise. Equally as urgently, given his stated concern for how you, the reader, can “help yourself and family,” he needs to set out exactly how the reader might detect a heightened possibility of such matters. And, obviously, unless a company is building up massive bogus receivables, or other assets, or doing something strange which ought to be amply visible, it can’t always report 30% higher revenue under IFRS – some kinds of accounting differences, for two companies as similar as he posits, will just tend to wash out over time, but this kind of perspective is also absent from his article.  As I’ve said before, the way Rosen sets it out, the concerned reader seems to have no practical choice other than to avoid investing in IFRS-reporting entities altogether, which (among much else) would severely limit one’s ability to craft a globally diverse portfolio.

The section of the article relating to “hypothetical income tax” barely lends itself to even that much rational consideration:

  • Company B has an income tax cash expense of $32 million compared to $640 million of income before income tax. How could the Canada Revenue Agency have messed up so glaringly?
  • Actually, although some lawmakers may want to tax Company B’s $640 million, the figure is hypothetical. It is non-cash. Hence, Company B does not have the cash to pay tax on $640 million of alleged “income.” Yet Company B could receive a clean or standard form auditor’s report, apparently. In short, carefully analyze the tax expense figure in your search for financial trickery.
  • A variation of Company B’s financial reporting involves adding a non-cash lump-sum to the $32 million tax expense cash figure, so that the discrepancy from $640 million is not so obvious. To catch the magnitude of the added non-cash item, investors have to read the “tax note” to the financial statements. It should show how much cash was actually paid to CRA.

The implication seems to be that if a particular item in a period’s income statement isn’t taxable in that same period, then it must be in some sense bogus – a startling expression of submission to the taxation authorities. I assume that Rosen’s reference to a “non-cash lump-sum” is an attempt to bring in the concept of deferred tax without getting too technical about it, but by implying that an income statement may often be prepared on a taxes-payable basis (and that this will “apparently” receive a clean auditors’ report under IFRS), he muddies matters completely.  Basically, it’s impossible to extract any coherent message from this jumble. But again, if Rosen believes that investors should only invest in (say) companies for which the tax expense pretty much exactly corresponds to the before-tax bottom line multiplied by the effective rate, he should say so (such an investing strategy, of course, would cut quite deeply into the US GAAP reporting population as well)

The article continues with predictable swipes at the net asset fair value increase, along the lines we’ve covered before, and with other random warnings of the kind you can’t do anything with either. “Excessive dividends could be the commencement of a Ponzi scheme,” says Rosen blithely, just as it’s true that every example of a raised voice could be the commencement of a murderous rage. The article lays the groundwork for future accusations of culpability against management and auditors and others – “When multiple corrections eventually arrive, market losses will be in the multi-billions” – but if Rosen can indeed see this dark future so much more clearly than anyone else can, then perhaps he’ll be judged more at fault than those others when it finally arrives, for having expressed his insights so poorly…

The opinions expressed are solely those of the author

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