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Valuing agricultural assets
Agribusiness companies required to comply with Accounting Standards currently value agricultural assets at their fair value less cost to sell. The International Accounting Standards Board (IASB) is proposing to change this standard in regards to plants that bear produce (such as grape vines, fruit trees, rubber tree plantations and oil palms) so that produce-bearing plants are valued at cost less accumulated depreciation and impairment (as is the case for property, plant and equipment) with the output from these assets to be classified as inventory (and the accounting treatment being the lower of cost or net realisable value).
These changes would prevent potential distortions to financial reports from the fluctuations in fair value of bearer assets and give greater visibility over the cost to replace capital (by allowing depreciation and amortisation) and better reflect the productive lifetime of these types of assets.
Tendai Mkwananzi, an audit partner in Deloitte specialising in Agricultural companies is of the opinion that bearer plants should be measured at accumulated cost before being placed in production, in the same way as self-constructed items of machinery. However Tendai went on to say we believe that the scope of the amendments should be expanded to include bearer livestock. IASB acknowledged in their February 2014 meeting that this proposed amendment is a result of a limited-scope project and extending the cost model to bearer livestock would require comprehensive review in the absence of which there could be unintended consequences. IASB has tentatively decided not to extend the scope of this amendment to bearer livestock, which will continue to be measured at fair values less costs to sell under IAS 41.
What could this mean for you?
Currently, the accounting standards treat all biological assets in the same manner regardless of whether they are bearer or consumable biological assets; they are to be recorded upon initial recognition, and at the end of each reporting period, at fair value less costs to sell, except for when fair value cannot be reliably and accurately determined. Biological assets are recorded at fair value because the standard currently asserts that it is the most relevant measurement of biological transformation.
This has resulted in problems when valuing biological assets in instances where there is no longer significant biological transformation taking place and the biological asset approaches productive maturity. It is the contention of the IASB that in these situations, the biological assets are not dissimilar to plant and equipment used to manufacture goods. It is this rationale that has led the IASB to suggest that bearer plants be accounted for in the same manner pursuant to property, plant and equipment assets (IAS 16 / AASB 116) rather than at fair value as required under the agricultural asset standards (IAS 41). It is argued that IAS 41 should only apply to consumable biological assets as their biological transformation is more accurately reflected by fair value measurement whereas bearer biological assets are not.
An immediate benefit of measuring bearer biological assets at cost is the avoidance of distorted profits, often caused by changes in the fair value of bearer biological assets as they mature. According to a survey performed by the Malaysian Accounting Standards Board (MASB) many analysts did not find the presentation of changes in fair value for bearer biological plants to be useful. The IASB has relied on this information to propose that bearer biological plants be measured at accumulated cost even before they meet maturity as little value is gained from fair value information during the growth phase. This is despite the fact that bearer biological plants do go through biological transformation as they reach maturity. This biological transformation is analogised to the construction of assets, whereby all costs associated with the construction are capitalised to bring the asset in the condition necessary for use.
Any changes to the IAS are highly likely to be reflected in an updated Australian Accounting Standards Board standard AASB 141 Agriculture (AASB 141).
The potential impact to you will depend on your role in agribusiness:
Primary producer, Audit Committee member, director, investor or CFO – the valuation method used for biological assets may significantly affect the profit and loss results and balance sheet. Adopting the accumulated cost method is likely to reduce distortions in these reports. However any changes to accounting treatment need to be understood and quantified so that movements in profit and net assets caused by non-accounting factors are appropriately investigated and addressed.
Auditor or accountant – if the proposed amendments are implemented, they may be applied retrospectively. In addition, preparers will still have the choice of carrying the bearer biological plants at cost or fair value less accumulated depreciation and impairment losses, similar to the choice existing for property, plant and equipment under AASB 116. Whilst the choice will exist, it is expected that the cost model will be used more widely as it will do away the need to involve valuation specialists on an annual basis while depicting the nature of the asset better on the balance sheet (similar to plant and machinery used to manufacture inventory which are almost always carried at cost by entities).
Financier – reduced volatility in financial statements (as a result of the proposed changes) will need to be considered in the context of finance covenants. Covenants may need to be revised to account for the new valuation method, and again, this would be founded on a clear understanding of the accounting and non-accounting factors on the financial statements. Retrospective accounts would greatly assist this understanding and ensuring that appropriate covenants (for overseeing and monitoring credit risk) are in place. Cash is still cash, however, and would remain a key area of focus for financiers.
AASB 141 Agriculture is the accounting standard that specifically addresses accounting requirements for agricultural activity, being the biological transformation and harvest of biological assets for sale, conversion into agricultural produce or into additional biological assets. It is important to note that the standard does not cover products that are the result of processing after harvest; these are typically covered by AASB102 Inventories (IAS 2 Inventories).
A key issue to be addressed by the IASB is the proposed definition of a bearer plant. The proposal states that the following criteria must be met for a bearer plant to be classified as such and eligible for accounting under IAS 16:
(a) Must be used in the production or supply of agricultural produce
(b) Be productive for more than one period
(c) Not intended to be sold as a living plant or harvested as agricultural produce, except for incidental scrap sales [IASB tentatively decided at its February 2014 meeting to change this criteria to read as: “the likelihood of selling it as a living plant or harvesting it as agricultural produce, except for incidental scrap sales, is remote”].
Deloitte has provided feedback on the proposed amendments:
- Livestock - We argue that bearer livestock reflect many of the characteristics of bearer plants and as such, should qualify for accounting under IAS 16. Therefore, the amendments should be expanded to incorporate bearer livestock. This would be of particular relevant for livestock breeding operations (including commercial breeder stock, stud operators and dairy cows, for example)
- Plants - the subjective nature of when a bearer plant is considered “mature” may cause uncertainty when applying the standard in practice. Accordingly, we believe additional guidance should be provided for any finalised amendment
- Additional disclosure - the proposed amendments also suggest additional disclosure requirements for bearer plants under IAS 16, such as disclosures about age, productivity, physical quantities. However, bearer plants are not sufficiently different in nature in comparison with other classes of property, plant and equipment and therefore do not warrant additional disclosure.
At this stage a decision has yet to be made as to whether the proposed amendments will be adopted and
to what extent the content of comment letters would be reflected in a revised standard. IASB is expected to complete their deliberations on this limited-scope project in their March 2014 meeting (currently in progress with IAS 41 on the agenda for discussion in March 2014). The Due Process Oversight Committee meeting held last month and the recent feedback on the proposed changes from the European Financial Reporting Advisory Group would suggest that the proposed amendments are gaining traction and we urge agribusinesses and their advisors to be prepared.
This article was published in the Deloitte Agribusiness Bulletin. To subscribe please register here.