Whose Problem is it when Accounting is Challenging?

Accounting for the Marijuana Business

Canada is in the process of legalizing marijuana. While this has a whole host of interesting public policy implications I’m going to use this big change to illustrate a purely business issue to do with problems in accounting. Accounting relies a lot on precedent. There is some logic to this, if a thing has worked relatively well why change? The problem is that this doesn’t do well with new challenges.

No one really knows how big the market will be but marijuana sales are expected to be significant enough to impact the national accounts. The market potential has spawned firms eager to make money off the new business. Where there are firms there are reports and accounting for the marijuana business is throwing up a whole host of problems that illustrate problems in the way accounting is performed. Sometimes problems will be caused by simple mis-reporting by managers in various venues, “..Canopy Growth Corp., have reported gross margins in excess of 100 per cent”. (Castaldo, 2018). This is not too surprising in a new industry. What is more interesting is the question of how the industry should be accounted for.

What are the assets worth?

The firms that will be supplying marijuana must have significant distribution operations. These are not trivial and could be the difference between a successful and an unsuccessful venture. This is extremely hard to account for. Perhaps more obviously the firms must have a lot of the raw material, plants. How much are these worth? To be honest no one really knows. In the article a forensic accountant seems to have a favoured solution — if I interpret him correctly — don’t assign any value to the plants because pricing and demand aren’t known.

This leads me to what I think is the most interesting part of the article, the headline: “Canadian marijuana stocks have a serious accounting problem.” What struck me is that the stocks don’t really have a problem. There may well be a bubble going on but it isn’t really the stocks that have the problem. It seems to me it is the accountants’ problem (and maybe investors). To be fair it is a tough problem and it is not accountants’ fault that, take your pick, either a) marijuana has been prohibited for years, or b) is now being legalized. That said the forensic accountant’s solution of just ignoring the problem and hoping it goes away doesn’t seem to be entirely satisfactory.

The most telling part of the article I believe was what the accountant said in respect of the accounting numbers: “”If investors are using the numbers at all, there’s a serious change they’re being misled…” “(Castaldo, 2018). If” is key, truth is that investors probably aren’t worrying too much about the accounting numbers. Although Marijuana investment is likely atypical this still suggests to me that long-term accountants have the problem. There is an awful lot of money spent on external financial reporting, if we aren’t convinced that investors are using it that is a problem.

Clearly the specific problem of marijuana stocks will fade over time as better information is gained on the industry but the problem of financial accounting often not being very useful seems likely to remain.

Read: Joe Castaldo (2018) Canadian marijuana stocks have a serious accounting problem, Canadian Business, January 24.