High hopes for canna-business

Canada’s growing cannabis industry is raking in the green. But has valuation gotten out of control?

Good judgement, professional skepticism and skills in valuation are critical to achieving high standards in audit and maintaining confidence in financial reporting. However, that’s easier said than done, and nowhere is this truer right now than in the Canadian cannabis sector.

A young industry

Over the last year, Canada has become a global leader in cannabis. We’re one of the first countries to legalize it for both recreational and medicinal use – and ecommerce is an important component of the market, particularly in provinces like Alberta, B.C. and Ontario. But this move has created a need for increased investor clarity about the sector, where valuation is driving growth.

In general, a lot of assumptions about business and finance underpin valuation, but financial reporting in particular is harder for digital companies and burgeoning industries. Many of our current models struggle to capture principle value and intangible assets in financial statements. For companies like Uber or Airbnb, that may mean having no traditional inventory or property holdings to report. In the cannabis sector, the challenges are equally complex and tend to revolve around the valuation of biological assets and inconsistencies as companies navigate how to apply accounting standards in a new and shifting context.

High value vs. fair value

Canna-business challenges also provide prime opportunities for positive change, though. The accounting profession is poised to influence current valuation practices now, as well as shape what the sector can become in the future. That’s why CPA Canada set up a task force to thoroughly explore the cannabis industry’s distinct auditing and reporting challenges.

The three mandates of our task force are to:

  • Maintain an active forum for firms and practitioners to discuss financial reporting in the sector
  • Raise awareness of new issues when applying account and auditing standard to canna-business
  • Develop practical guidance that will support CPAs on the frontlines of cannabis accounting

Improving transparency in financial statements is a key area that the task force will be examining together, but it’s an area of business you can start making a difference in today once you have some of the right training under your belt.

While cannabis companies are subject to IAS 41 Agriculture, we’re seeing a lack of consistency in application thanks to the young industry status and a gap in specialist advisory services like valuation for financial reporting. There are only a few public agricultural businesses that apply IFRS too – most are private – so it’s hard for newcomers to learn by example. But going public is a must for cannabis companies as resource-intensive enterprises to ensure capital flow for indoor crops, hydration, lighting systems and more.

To see the high value versus fair value dilemma in action, consider how canna-businesses account for the fair value of biological assets under IAS 41 Agriculture. It’s a hazy estimation-driven exercise because there’s measurement uncertainty in balance sheets and income while cannabis plants are growing.

Cannabis can’t be benchmarked against historical trends the same way that mature agricultural industries with well-established markets and prices are, like wheat or tomatoes. “Companies have to put a value on their marijuana plants for accounting purposes, even though pricing and future demand are not yet known,” says Mark Rosen of Accountability Research Corp.
And when industry norms for everything from regulation to sales volumes are still up in the air, it’s difficult to evaluate future performance – which introduces valid concerns about overstating profitability or the potential for a misleading valuation, however unintentional.

The future of cannabis valuation

Ultimately, adopting best practices in valuation are beneficial for everyone in the cannabis industry. While there’s no singular quick fix in a rapidly evolving sector, but establishing better guidelines for how Canadian companies are required to report and what information they provide will have an impact.

CPAs like you hold the power when it comes to leading efforts in transparency for financial statements. Applying up-to-date knowledge of valuation can inspire better outcomes and more consistency for entrepreneurs, governments and investors across the canna-business landscape.
In practice, that means you spending less time on guesswork about cannabis earnings, which leads to less financial risk for your clients if that guesswork misses the mark. As for the end game – why not more sustainable growth and a stronger, stable cannabis position in the marketplace? When you help your clients raise standards, other firms will be compelled to follow suit if they want to capture ongoing investment – no high hopes or inflated valuation necessary.

Whether you’re a professional accountant in the cannabis industry or you’re simply looking to improve your skills in valuation regardless of sector, our new Valuation for Financial Reporting (VFR) Certificate, jointly presented by CBV Institute, will set you up for success.
It’s a comprehensive two-part program designed for CPAs and other financial leaders who are responsible for VFR activities. Study online at your own pace and earn 16 CPD hours.