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March 2009

GAPs in GAAP – Accounting for Agriculture

By Dolphy D’Souza, Chartered Accountant
Reading Time 4 mins

Accounting Standards

IAS-41 prescribes the accounting treatment for agriculture,
which includes biological transformation of living animals or plants for sale,
into agricultural produce, or into additional biological assets. IAS-41 requires
measurement at fair value less estimated point-of-sale costs from initial
recognition of biological assets up to the point of harvest, except in rare

IAS-41 requires that a change in fair value less estimated
point-of-sale costs of a biological asset be included in profit or loss for the
period in which it arises. Under a historical cost accounting model, a
plantation forestry enterprise might report no income until first harvest and
sale, perhaps 30 years after planting. On the other hand, IASB believes an
accounting model that recognises and measures biological growth using current
fair values reports changes in fair value throughout the period between planting
and harvest.

Where market-determined prices or values are not available
for a biological asset in its present condition, IAS-41 requires use of the
present value of expected net cash flows from the asset discounted at a current
market-determined pre-tax rate in determining fair value.

When IAS-41 was issued it met with severe criticism because
many agricultural assets are simply not subject to reliable estimates of fair
value. Take for instance, a pony which is kept as a potential breeding stock,
grows into a fine stallion. The stallion starts winning race events. The
stallion earns substantial amount for its owner from breeding services. The
stallion gets older, his utility decreases. Eventually the stallion dies of old
age and the carcass used as pet food. At each stage in the life of the horse,
the fair values would change significantly, but estimating the fair values could
be extremely subjective and difficult. In many ways, the stallion reminds one of
fixed assets. Changes in fair value of fixed assets are not recognised in the
income statement, then why should the treatment be different in the case of
agricultural non-financial assets ?

Vineyards and coffee and tea plantations have similar
measurement issues. The relationship between the vines and coffee or tea plants
and the land that they occupy is unique and integrated. The vine or plant itself
has relatively little value. However, in conjunction with the land, they do have
value. Determining the fair value for a vineyard, coffee or tea plantation
involves estimating the production along with sales prices and costs for a
number of years in the future, together with estimating a terminal value and the
application of a discount rate to calculate the net present value — an
enormously complex and subjective task. The value of the vines and plants would
then have to be determined as a residual because it would be calculated by
deducting the value of the unimproved land and the value of the infrastructure
from the aggregate value. It is clear that the valuation, as a result of the
estimates and subjectivity, is open to substantial variability.

Because biological assets are subject to droughts, floods and
diseases, the unrealised gains arising from changes in fair value can give a
distorted picture of the financial results of the agricultural enterprise. It
could be misunderstood and may lead to inappropriate decision-making, such as
dividend declaration from unrealised profits. Another question about the
reliability of measurements relates to the homogeneity of the assets. During the
transformation process, it could be very difficult to determine the likely
quality. Even if the quality is known, estimating the price and the market where
the produce would be ultimately sold could become a challenge.

Although the recognition of unrealised gains and losses on
financial assets is achieving wider acceptance, the IASB has not yet put forward
any convincing arguments in favour of a fair value model for non-financial

IAS-38, Intangible Assets, allows intangible assets to be
carried at revalued amounts. However, for intangible assets to be carried at
revalued amounts, IAS-38 imposes strict criteria — an active market is
necessary, which requires items traded to be homogeneous, with willing buyers
and sellers normally being found at any time and prices being available to the
public. However, IAS-41 does not impose the same hurdles for agricultural assets
and requires them to be fair valued except in rare cases. The IAS-41 approach
therefore is inconsistent with other international standards.

In India, there is no accounting standard on biological
assets and agricultural produce. Accounting standard on agriculture is the need
of the hour as many Indian companies are venturing in these businesses in big
way due to thrust on retail, dairy, horticulture, etc. Given the criticisms on
fair valuation and the fact that commercial farming enterprises in India operate
as private companies and surely don’t need the additional cost burden that may
not produce reliable results, the ICAI should develop a standard based on the
historical cost model.

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