View on the concept of financial accounting for agriculture and problems of IAS 41 application

Danil Prokopovich, 2 Jun, 2012, IFRS

D.Prokopovich – View on the concept of financial accounting for agriculture

The following theses were presented at the third meeting of the IASB Emerging Economies Group on 28-29 May 2012 and can be useful in further work on improvements of IAS 41 “Agriculture”.

Preface.

First of all, we should thank the Asia-Oceanian Standard Setters Group (AOSSG) for its initiative to address this important subject. Particularly for Russia the agricultural sector is historically the major area of economic activity and peoples’ life. And we can say with confidence that it will be among the main points of growth and investments during the under-going development of national economy.

The discussion of the raised questions should be a necessary step in further elaboration of high-quality accounting and reporting standards for agriculture in order to make then broadly applicable by preparers and helpful for users of financial statements.

Basis of classification.

It must be recognized that accounting for agriculture should reflect the following characteristics of biological assets:

nature and the stage of agricultural cycle;

- purposes of management and business model of generating future cash flows.

In this sense we should agree with advocates of different accounting treatment for plant and animals (flora and fauna) and note that many issues in elaboration and application of accounting standards for agriculture are caused by the attempts to implement the unique approach to such different subjects.

It is also necessary to stick to the main approach realized in IFRS under which the accounting should be based not only on characteristics of items but also on its purpose and business model of generating future cash flows. It means that it is necessary to use the most appropriate accounting model that can better reflect and measure the amount, timing and uncertainty of future cash flows, and performance for a period.

Scheme of accounting models for biological assets.

Based on aforesaid the following classification of biological assets with corresponding accounting models will be appropriate (see the table below).

Nature, cycle, purpose of biological assets	Examples	Accounting, measurement	Accounting unit

Short-term breeding of animals
Animals growing for being consumed as agricultural produce within 12 months	livestock raised for meet, pigs, birds, fish, silkworm	Fair value less costs to sell, to profit	herd/cycle
Animals growing for sell within 12 months	merino sheep, pigs, calf	Fair value less costs to sell, to profit	herd/cycle

Long-term breeding of animals
Animals growing for being consumed as agricultural produce within more than 12 months	livestock raised for meet	Fair value less costs to sell, to profit	head as a unit or as a component of herd
Animals growing for sell within more than 12 months	thoroughbred	Fair value less costs to sell, to profit	head as a unit or as a component of herd
Animals held for bearing agricultural produce within more than 12 months – BBA	dairy cattle, merino sheep, laying hens	Fair value, to other comprehensive income. Transfer of revaluation to the profit upon the sell. Application of IFRS 5.	head as a unit or as a component of herd, or herd (as appropriate)
Animals held for procreation of other animals within more than 12 months – BBA	pedigree cattle	Fair value, to other comprehensive income. Transfer of revaluation to the profit upon the sell. Application of IFRS 5.	head as a unit or as a component of herd

Short-term growing of plants
Plants growing for being harvested within 12 months	crops such as wheat and rice, vegetables, annual gasses and flowers	Work-in-progress at cost of cycle until harvest. The agricultural produce at fair value (except for auxiliary agricultural produce for internal use – at cost)	field/cycle
Plants growing for sell within 12 months (rare cases)	planting stock	Fair value, to profit	field/cycle

Long-term growing of plants
Plants growing for being harvested within more than 12 months	trees for lumber	Fair value, to profit	field
Non-mature plants cultivated for bearing agricultural produce within more than 12 months – BBA	fruit and olive trees, oil palms trees, cork trees, tea bushes, grapevines, cotton plants, sugarcane, permanent gasses and flowers	Fair value, to other comprehensive income. Transfer of revaluation to the profit upon the sell. Application of IFRS 5.	field
Mature plants cultivated for bearing agricultural produce within more than 12 months – BBA	fruit and olive trees, oil palms trees, cork trees, tea bushes, grapevines, cotton plants, sugarcane, permanent gasses and flowers	Application of IAS 16 with or without revaluation model (where appropriate). Transfer of revaluation to the profit upon the sell. Application of IFRS 5.	field
Plants growing for sell within more than 12 months (rare cases)	planting stock	Fair value, to profit	field/cycle

Accounting for Bearer Biological Assets.

It total we can agree with the definition of Bearer Biological Assets (BBA) proposed by the AOSSG as biological assets that (a) are cultivated for use in the production or supply of agricultural produce to others; and (b) are expected to be used during more than one period.

It will be reasonable as well to expand this definition so to include also animals. But in this connection the different nature of BBA-animals and BBA-plants should be mentioned that could raise the need of different accounting treatment.

The economic nature of BBA-plants (e.g. gardens, plantations, vineries) is more similar to real estate or land improvements. And so BBA-plant should be accounted for correspondently. When the BBA-plant is mature and does not undergo a major biological transformation (except deterioration) it should be measured and accounted for according to the IAS 16 with or without revaluation model (where appropriate).

The economic nature of BBA-animals (e.g. productive cattle) is contrary more similar to goods. They are more liquid. And we can recall that historically and even up today in many cultures the livestock is considered as measure (and mean of accumulation) of wealth. That is why we propose to measure the mature BBA-animals at fair value even when they are no longer undergo a major biological transformation.

Revaluation differences on BBA.

It will be in line with the main idea of IAS 41 that not-mature BBA (both plants and animals) undergoing a biological transformation should be accounted at fair value in order to reflect the performance of agricultural activity for the period.

But in this connection we propose to recognize the difference in fair value as other comprehensive income. Because, taking into consideration the purpose and business model, such revaluation difference should be seen as unrealized in the reporting period and will be realized in subsequent periods during the use or upon sell of the BBA.

So, with the use of the possibility of other comprehensive income, from one side the results from biological transformation will be recognized and the asset will be reflected in financial statements at fair value, and from other side this profit (or loss) will be reflected as not realized in the reporting period.

We also propose to transfer the accumulated revaluation difference of BBA (mature and non-mature, plants and animals) into the financial result from their disposal upon the disposal. So to fully reflect the financial results of the agricultural activity in the period they are realized.

Dual-purpose biological assets.

We propose not to provide special requirements on dual-purpose biological assets and allow to the preparers choose the appropriate accounting model (one of the proposed – i.e. as BBA or as CBA) depending on the predominant use of each biological asset (or group). During further implementation regional accounting bodies can elaborate the appropriate solutions (guidance) for each specific case by summarizing and harmonizing the best practice of the region.

Unit of accounting.

The units of accounting of all biological assets should represent the same units in which they are controlled and managed by an entity (considering the modern technologies and practical expediency). E.g. the cattle is accounted by heads (separately or aggregated as components of herd), small animals could be accountant by herd, ages or cycles. Plants are usually accounted by fields or agricultural cycles. On this basis there should not be any major issue in accounting of replacement or disposal of units of biological assets.

Short-term growing of plants.

It is necessary to draw attention to practical inexpediency of measuring the fair value of plants undergoing the short-term agricultural cycle before being harvested. For example it could be sprouts of wheat, rise, potatoes, or annual gasses and flowers. For example in Russia as the end of the year we often have winter crops of wheat and rye. For these examples it is difficult to determine the fair value of these plants and for sure it will not reflect the amount of future cash flows.

So we propose that such short-term plants should be accounted according to IAS 2 as work-in-progress at the lower of cost and net realisable value. Herewith the costs should include all costs incurred from the beginning of the specific agricultural cycle, including the cost of soil treatment, seeds, fertilisers, plant protection and auxiliary plants.

Auxiliary agricultural produce for internal use.

There is a practice when the entities often grow plants as auxiliary agricultural produce for use in other cycles of agricultural activity. E.g.: grasses grown and harvested for fed to livestock (with or without interim treatment), plants grown as natural fertilisers. Obviously such biological assets separately will not generate future cash flows, and the results of their biological transformation should be transferred to subsequent agricultural cycles. As it is also practical inexpedient to measure the fair value of such plants, we propose to account them according to IAS 2 as work-in-progress at the lower of cost and net realisable value and to transfer their cost to the cost of subsequent agricultural cycles.

Measurement of fair value of accounting produce.

There is also a practice when the fulfilment of IAS 41 rule on measurement of fair value of agricultural produce at the point of harvest leads to misrepresentation of financial results from agricultural activity. For example in Russia at harvest time the market price for agricultural produce becomes significantly lower than in other time during the year. By measuring the fair value at these subnormal but market prices at the point of harvest the results from agricultural activity is deteriorated by results of changes in market prices. Normally the entities refrain from selling the agricultural produce at subnormal prices and sell it subsequently at normal prise. But in the financial reports instead of showing the normal (economically expected) results from agricultural activity and the residual result from trading operation they are reflected vice-versa.

In other cases the fair value of agricultural produce could not be measured reliably at the point of harvest but only after subsequent treatment (e.g. the potatoes being harvested in wet weather have to be sorted out and separated from mud).

So we propose to provide in IAS 41 the possibility to subsequently adjust the measurement of fair value of agricultural produce during some reasonable period after the point of harvest or to measure it at a later point of time.

Special guidance on fair value measurement.

We should agree that there is a necessity to elaborate more detailed and specific guidance on measurement of the fair value of biological assets and biological produce, including the methods of segregation of fair value in situation where it could be determined only for a group of assets which contain both: biological and non-biological assets.

© Danil Prokopovich
ACCA, CGA, CIPA, Ph.D, auditor
chairman of IFRS committee at the Institute of Professional Accountants and Auditors of Russia, member of National Accounting Standards Board (Russia), partner of National Audit Corporation