When reading financial statements, I pay particular attention to costs that have been capitalized. Capitalizing costs boosts income in the short-term and is often a sign of aggressive accounting. I often use the shortcut “Crtl + F” to search for instances of capitalized costs in an annual report. However, it turns out that I don’t understand accounting rules such as absorption costing for inventory. Under US GAAP, Canadian GAAP, and IFRS… absorption costing is the only method allowed for valuing inventory. Companies must capitalize fixed manufacturing overhead (e.g. rent) into inventory. I wrongly assumed that footnotes describing this practice was a sign of unusually aggressive accounting (it isn’t).
On Tuesday, I attended a stock picking competition where 3 teams of MBA students (the finalists) analyzed an obscure and illiquid Canadian company called Buhler Industries (BUI.TO). It is from skimming through Buhler’s annual report (page 16 of the annual financial statements on SEDAR) that I erroneously thought that Buhler may have been inappropriately capitalizing overhead costs into inventory. From talking to others, it turns out that I’m not the only person who didn’t understand that Buhler management was simply following the rules. I suppose the lesson here is that there are so many unintuitive and/or complex accounting rules that most investors are not aware of all of them.
