Short-seller Carson Block’s Muddy Waters LLC says that believing commodity trader Olam International’s accounting requires a “leap of faith”. The ambiguity lies with the rules as much as the company.
A global accounting standard introduced in 2003 forces companies every three months to value living things from wheat crops to cattle, or so-called biological assets. As Singapore-based Olam branched out from being the world’s second-largest rice trader and acquired dairy farms and almond plantations, the company began to apply the rules that accountants themselves say are riddled with subjective assumptions on future prices, inflation, production and costs.
“It’s an accounting method that inherently introduces uncertainty,” said Ray Ball, an accounting professor at the University of Chicago Booth School of Business. “Some of these numbers are difficult to estimate. When there’s subjectivity, there’s always doubt in people’s minds.”
Block’s questioning of Olam’s accounting practices at a London conference on Nov 19 prompted the company to sue Muddy Waters and Block after its shares dropped 7%, erasing US$254 million ($310.9 million) in market value, and its benchmark bond lost as much as 8.5 cents on the dollar. Muddy Waters has yet to release the research report detailing its concerns over Olam’s accounting and operations.
According to Block, Olam uses an “aggressive” approach to reporting gains on biological assets, a valuation required by the more than 85 countries that adhere to the guidelines of the London-based International Financial Reporting Standards Foundation.
“It’s a leap of faith to think the company is being honest with its valuation” gains, Block told the Ira Sohn Investment Conference in London. Block said he had “shorted” Olam, seeking to profit by selling borrowed shares now and buying them back later at a lower price. Block’s doubts over Olam were echoed by John Armitage, co-founder of London-based Egerton Capital , who said at the conference that he is also betting against the company.
The IFRS rule on biological assets that Singapore and Olam follow are mandatory. The rule makes agriculture companies book earnings earlier than they would otherwise, Chicago professor Ball, who owns Olam shares, said.
It means a wheat producer needs to estimate the value of a crop before harvest and a cattle rancher the worth of a herd before slaughter. While the method does help to get a “best estimate of value” on partially grown plants and animals, its subjective aspect leaves companies open to questions on their appraisals, Ball said.
“It’s a terrible accounting standard, it shouldn’t be used at all,” said David Fergusson, a fund manager at Woodside Holdings Investment Management in Singapore, who doesn’t own Olam stock. “But, it’s not like the company has a choice.”
Reporting profits on living things came into effect in 2003, and the rules were amended twice since then, according to Deloitte Touche Tohmatsu’s website.
A company or its auditor picks an appraiser to estimate the worth of its plants and animals. The value is determined by subtracting the cost to sell the asset at the point of maturity from its so-called fair value, according to Deloitte. Gains and losses must be recorded in a company’s income statement.
For example, a cow bought at a cost of US$200 and fattened after a year may be valued at US$500, which would result in a biological asset gain of US$300. That gain is added to the profit and loss statement of that period and feeds into net income.