InnovaDerma (IDP): Accounting issues in hindsight

Always useful to study accounting issues to see if they could have been spotted at the time, and so perhaps help us avoid investment trouble in the future.

Micro-cap InnovaDerma is set to register prior-year adjustments of £8.9m:

"As previously announced the Company has been undertaking a comprehensive impairment review and validation exercise with regards to all assets held on the balance sheet. As part of this, the new executive management team have reversed the accounting treatment incorrectly adopted by the previous executive management team and their auditors in relation to the capitalisation of internally generated intangible assets; specifically marketing costs relating to customer acquisition. In reversing the accounting treatment, the marketing costs will now be included in the calculation of the Company’s EBITDA and consequently this reduced the Company’s EBITDA by circa £0.6 million.

In addition to the above accounting policy change, the balance sheet review identified further goodwill and other balance sheet write downs that will require non-cash prior year adjustment to the 2020 accounts. The total of these prior year adjustments is circa £8.9 million. These include:

  • Incorrect adoption of accounting standards relating to marketing cost and product development amortisation (£3.0m)

  • Goodwill write-down of acquisitions where brands were not adequately supported by the previous executive management team (£4.0m)

  • Overstated inventory position due to incorrect accounting treatment including inventory write down of out-of-date stock which should have been written off in prior years (£1.5m)

  • Additional assets written off (£0.4m)

With hindsight IDP’s intangible reporting seemed very peculiar. From the 2020 annual report:

Typically the intangibles note includes an amortisation charge for the year. But none was shown. The £1.23m difference between the total intangibles figures for 2020 and 2019 is very close to the £1.25m cash spent on intangibles (I suspect the small difference is due to currencies):

Conclusion: IDP was not amortising its intangible assets, which is confirmed by this cash flow note not showing an amortisation entry alongside the depreciation entry:

So for 2020, IDP had passed through intangible expenses of £1.2m without any associated charge to earnings. £1.2m is significant when revenue is £13m and the operating loss is £0.4m:

In retrospect, questions could have been raised about the lack of amortisation, and whether the approach flattered earnings and/or signalled the directors were optimistic on other matters. IDP will now write off almost all the £8m or so of intangibles.

With the inventory, the 2020 accounts show a £3.1m position:

But the inventory costs charged for the year were £4.1m. Arguably the year-end stock position will sit in the warehouse for 9 months before being sold (£3.1m/£4.1m*12months). True, the pandemic might have skewed the year-end position, but 9 months is a long time to hold finished goods and could have led to earlier questions about the potential for outdated stock. IDP will now write-down stock by 50% to £1.5m.

IDP’s new management has replaced the auditor, too:

The appointment of Crowe follows the resignation of Elderton Audit UK (“Elderton”). The Board of InnovaDerma agreed with Elderton that the Company would be better served by auditors based in the United Kingdom where the Company’s Board, management team and principal operations are located.

A warning sign is an overseas auditor…

…when c80% of sales occur in the UK.

Maynard

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Just saying…