When the accounting treatment becomes a key part of a business development, you immediately know that there is something wrong with the accounting. Possibly the best example of this was the fuss kicked up by some tech companies when expensing stock options was first mooted.
I remember one investor complaining at the time that the entire tech/venture capital industry was under threat. The idea that possibly the most vibrant start-up sector in the world was entirely based on misleading accounting was simultaneously hilarious and ridiculous. Granting stock options is obviously an employment cost, just like accruing a defined benefit pension. The ultimate cost to the employer may be uncertain, but both are seen by the employee as part of their compensation.
Bad accounting policies can work both ways. Companies are sometimes obliged by the small print in a standard to report profits that do not ‘faithfully represent’ the economics of a transaction, to paraphrase one of the aims of the International Accounting Standard Board’s (IASB’s) conceptual framework.
How would an accountant treat Hotblack Desiato’s decision to spend a year dead for tax purposes
This is especially true when a new business development occurs that is both multi-year and uncertain. Double-entry bookkeeping was not designed for complex uncertainty, and it can be quite entertaining watching the profession struggle to adapt.
I sometimes wonder how an accountant would treat Hotblack Desiato’s decision to spend a year dead for tax purposes in The Hitchhiker’s Guide to the Galaxy. Would one capitalise it as a deferred tax asset? How would one measure impairment?
Nature of contracts
This all leads me to the IASB’s recent decision to update the way ‘nature-dependent’ electricity contracts are treated. This is a classic case where the accounting was getting in the way of sensible business decisions.
Few things in life are more uncertain than the weather. Despite enormous advances in computing power, forecasting the weather remains very imprecise. Unfortunately, the future output of a wind or solar farm is almost entirely dependent on the weather.
The rapid development of affordable wind and solar power has been one of the most encouraging environmental advances of recent decades. I remember looking at cost projections for solar and wind about 20 years ago and thinking that this would never catch on. Fortunately, costs fell much faster than expected, hence the explosion in generating capacity.
Storing electricity in large quantities remains uneconomic and is likely to stay that way
The working life of a solar or wind farm is somewhere in excess of 20 years. The day-to-day output will be uncertain but the long-term output can be forecast with reasonable certainty. There is no shortage of clients who are happy in principle to sign long-term contracts that give the farm a guaranteed income stream. These contracts are crucial for getting the funding to build the farm in the first place.
This is where the accounting starts to get in the way. Storing electricity in large quantities remains uneconomic and it is likely to stay that way. Maybe hydrogen will come to the rescue, but that remains a tomorrow technology.
Before the revisions to IFRS 9 and 7, the only option was to treat these long-term supply agreements as derivative contracts, with unavoidable volatility in the income statement of the consumer. In a masterful piece of understatement, the IASB noted that ‘current accounting may not adequately capture how these contracts affect a company’s performance’. For big electricity consumers, doing the right thing from an environmental and financial perspective was potentially doing the wrong thing from an investor’s viewpoint.
I am often critical of the IASB for reacting slowly or failing to take investors’ needs into account. In this case I am happy to compliment the board for responding rapidly to a real problem that threatened to make wind-farm funding harder to secure. Maybe Mr Desiato’s turn will come, too.
