Agriculture needs an accounting standard

As 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.

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 into these businesses in big way, thanks to the thrust on retail, dairy, horticulture, etc.

IAS 41 requirement
International Accounting Standard 41 (IAS 41) prescribes the accounting treatment for agriculture, which includes biological transformation of living animals or plants for sale into agricultural produce or 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 cases.
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, the International Accounting Standard Board (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.

Fair value challenge
When IAS 41 was issued it met with severe criticism because many agricultural assets are simply not subject to reliable estimates of fair value. For instance, a colt 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 can 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, 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.

Homogeneity of assets
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 assets.
IAS 38, on intangible assets, allows such assets to be carried at re-valued amounts. However, for intangible assets to be carried at re-valued amounts IAS 38 imposes a 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.
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 reliably results, the ICAI should develop a standard based on the historical cost model.