I wrote last April about valuing marijuana crops under IFRS, and I probably felt at the time that once would be enough, but the issue continues to have a visibility greatly out of proportion to its relative significance…
A couple of weeks ago, two high-profile articles appeared in the Canadian press within a day or two of each other, making similar points (not least because they both relied in large part on the perspective of our old friend Al Rosen, along with his son Mark).
This is from The Globe and Mail:
- In Canada, where 84 listed marijuana stocks have surged to a value of about $36.9-billion ahead of recreational legalization in July, companies abide by International Financial Reporting Standards. The guidelines favor a fair-value model used by the agricultural industry, which requires companies to place a value on plants while they’re still in the ground.
- That’s akin to counting your chickens before they’re hatched, leaving companies open to big write-offs and investors groping for financial clarity. It’s all crying out for more guidance and standardization from the country’s regulators, industry observers say.
- “It’s audited hallucinations,” said Al Rosen, founder of Toronto-based Accountability Research Corp., a veteran forensic accountant and a long-time critic of IFRS and its application in the cannabis industry. “The marijuana financial statements have absolutely nothing to do with reality.”
And this is from Macleans (which, by the way, also used the “counting your chickens” simile):
- It’s not that companies are intentionally duping investors—though there is ample opportunity for that, the Rosens argue. Instead, companies are trying to apply already-vague accounting rules to a new industry. Companies have to put a value on their marijuana plants for accounting purposes, even though pricing and future demand are not yet known. As a result, the Rosens charge, financial statements rely heavily on managers’ estimates, and are wildly inconsistent.
- “If investors are using the numbers at all, there’s a serious chance they’re being misled, or they’re misinterpreting the numbers themselves,” Mark says. The issue is compounded by the fact that valuations are soaring, and companies are trading based on future projections that may never materialize. “It’s just adding to all of the speculation around marijuana, and feeding the frenzy,” says the elder Rosen.
I wrote before about some technical aspects of the argument, so I won`t repeat all that here. The issue continues to preoccupy me less than it apparently does others, largely because it seems to me characterized by a certain amount of disingenuousness, inconsistency and special pleading. As I said previously, 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 less fair presentation than would be obtained by (presumably) recording it at an outdated cost value that contains no relevant information about future economic benefits. With that partly in mind, both articles suggest the problem might not be with IAS 41 as a whole but with its specific application to marijuana. As Macleans puts it:
- For mature agricultural industries, (the model) can make sense. The market for tomatoes is well-established, prices are not in dispute, and a producer can enter into future sales contracts. That’s not the case with recreational marijuana sales, an industry that doesn’t even exist yet. Prices, costs, sales volumes and the quality of inventory are still very much up in the air.
In technical terms, this only expresses the inherent limitations of fair value measurements based on “level 3” inputs. But any such measurements come festooned with disclosure about their possible variability and volatility. The younger Rosen’s caution – “If investors are using the numbers at all, there’s a serious chance they’re being misled, or they’re misinterpreting the numbers themselves” – seems primarily like an argument for capitulating to laziness and complacency.
Both articles note the use of non-GAAP measures to (as Macleans puts it) “more accurately represent margins,” both suggesting that Canadian regulators might step in to provide a standardized approach for such measures. This is especially rich for the Globe and Mail though, as it’s not long ago that it ran a bunch of articles pounding on the wickedness of non-GAAP measures, and anticipating with relish that “regulators are becoming more concerned about the way public companies are emphasizing to investors the results calculated using their own measures of financial performance at the expense of those based on standard accounting measures. By writing new rules about this, provincial regulators will gain new tools to crack down on companies that take the practice too far.” However, if Canadian regulators are meant to be working on limiting and “cracking down on” the use of such measures, it’s hard to see how they could simultaneously mandate a prescribed form of non-GAAP measure for a particular, narrow industry group.
The Macleans article in particular provides examples of useful supplemental disclosures provided by some industry participants, and it’s not hard to see how a zone of good conduct could develop around these and other ideas, with informed industry commentators helping engaged investors to understand how they work and to identify sub-standard reporters. But this wouldn’t do anything to help Rosen’s group of investors who likely aren’t “using the numbers at all,” or who would presumably continue to “misinterpret” these supplemental numbers just as willfully as they misinterpret everything else. Most certainly, regulators should use all of their influence and powers to shape effective disclosure practices and to sanction any accounting that does indeed amount to an unsupportable “hallucination.” But the continued yelling about the supposed wretchedness of IFRS in this area seems about as useful as old-time hang-wringing about reefer madness…
The opinions expressed are solely those of the author