ACCOUNTING FOR BIOLOGICAL ASSETS
Objectives
Understand what types of assets can be classified biological assets and know the unique attributes of such assets Be able to explain why w hy net market value has been suggested by some researchers as the appropriate basis for valuation of biological assets pertaining to agricultural activity Understand the various issues associated with changes in the market value of biological assets, and explain when such changes in value should be recognised in profit and loss Be aware of some ongoing accounting debates in relation to biological assets and be able to evaluate the logic of the various arguments supporting or opposing particular valuation and disclosure approaches
Contents INTRODUCTION Importance Why the neglect! THE NATURE OF BIOLOGICAL ASSETS Definition Classification Characteristics ACCOUNTING FOR BIOLOGICAL ASSETS – AASB 141 Separate Standard Classification in Financial Statements Measurement Animals Plants Recognition and measurement of changes chang es in the carrying amount of biological assets CONCLUSION
Introduction Importance of SGARAs
The ABS statistics relating to the Agricultural, forestry, fishing and hunting sector show that: Agriculture made a direct contribution of about 3% of Gross Domestic Product over the past decade deca de agriculture and forestry and fisheries accounted for approximately 20% of exports in 2000/01 455.5 (59%) of available 768 million hectares of land in Australia, is connected w ith agriculture, excluding forestry. Australia's major exports over the last decade have been primary products (and minerals) such as wool, wheat, meat, sugar, timber (and by-products), horticultural products.
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Why the neglect!
One of the major contributing factors has been b een the different social environment in which primary production operates. Technically, this should not concern the accountant because it should not effect the accounting process. In practice - created a situation where Acc. for primary production/self-generating and regenerating assets generally did not progress far beyond the "corner store" type accounting, as farm businesses are frequently a family business and the farmer has, in the past at least, tended to have little contact with businessmen other than those also engaged in farming. Consequently, the major accounting reports are prepared for tax purposes and are generally irrelevant for farm management purposes. In addition, primary producers operate in an environment in which they cannot control and seldom influence produce prices. The primary producer has had no opportunity (or desire?) to undersell a competitor or struggle for a share of the market (e.g. farmer does not feel the need to know how much the growing of wool or wheat is costing, so that s/he can undersell or at least match the farmer down the road). The only avenue of control open to them is through costs of production and it is by no means evident ev ident to most primary producers how accounting can assist in this control.
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The nature of biological assets
Relevant standard is AASB 141 ‘Agriculture’ (released July 2004), replacing AASB 1037 ‘Selfgeneration and Regenerating Assets’ (SGARAs) The two standards are substantially the same Definitions “SGARA is Non-human living assets” - AASB 1037 ‘Biological asset is a living animal or plant’ - AASB 141 Para 5 Included: trees held as part of a forestry operation animals held as part of a livestock operation orchards and vineyards aquaculture and fishery holdings Definition of biological assets used in AASB 141 more restrictive than definition of SGARAs used in AASB 1037. Unlike AASB 1037, AASB 141 does not apply to: an investment in a forest as a carbon sink, which gives rise to carbon credits that can either be sold or used to offset pollution caused by the entity greyhounds, horses, pigeons, and whippets used for racing performing animals held by theme parks non-human living assets other than animals and plants, such as viruses and blood cells
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The nature of biological assets
SGARA / Biological Assets
Plant
Consumable
S/term Wheat
L/term Forests
Bearer
L/term Orchards
Animal
Consumable
S/term Slaughter
L/term Fatten animals
Bearer
L/term Breeders Dairy cattle Sheep for wool
AASB 141 adopts directly the definition of assets provided by AASB Framework (AASB 141, par. 10): An entity shall recognise a biological asset or agricultural produce when, and only when: (a) the entity controls the asset as a result of past events (b) it is probable that future economic benefits associated with the asset will flow to the entity; and (c) the fair value or cost of the asset can be measured reliably. ‘Agricultural activity’ is defined as ‘management by an entity of the biological transformation of biological assets for sale, into agricultural produce, or into additional b iological assets’ (Para 5) Agricultural produce’ is defined as ‘the harvested product of the entity’s biological assets’ (Para 5) ‘Harvest’ is the detachment of produce from a biological asset or the cessation of a biological assets life processes” (Para 5) See Table in Para 4, p.1041 of Handbook for distinction between Biological assets and Agricultural Produce
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Accounting for biological assets Key issues associated with SGARAs/biological assets
Since they are unique, do they need a dedicated accounting standard? How should SGARAs/biological assets be classified and presented in financial reports? How should SGARAs/biological assets be measured? When and how should revenue associated with SGARAs/biological assets be recognised?
Unique nature of SGARAs/biological assets
Natural capacity to grow and/or procreate directly d irectly impacts on value Great deal of increase in value owing to input of free goods Great deal of cost incurred early in the asset’s life but economic benefits derived much later Production cycle might be very long Not necessarily any relationship between expenditure on asset and ultimate return
Classification and reporting in financial reports
Prior to standard, various classification systems used Forestry was classified as: property, plant and equipment, separate class of ‘regenerative’ assets Livestock was classified as: inventory, current (intended for meat) and non-current inventory (intended for breeding) Comparability an important attribute of general-purpose financial reports
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AASB 141—Classification requirements
SGARAs required to be presented separately in the balance sheet Does not prohibit classification into current and non-current elements Classification as current and non-current will depend on management’s intentions
How should SGARAs be measured?
Prior to AASB 1037 ‘Self-generating and Regenerating Assets’, there was great variation in valuation methods For example, valuation of forests in Australia was don e on a historical cost basis, replacement-cost basis and/or a market value basis Refer to Exhibit 9.2 on page 345 - Some valuation policies po licies adopted in relation to forestry assets
Classification and reporting in financial reports
As indicated by Whittred et al. (2004) the study by (Herbohn et al. 1998)[1] indicates that: Survey 1990-1995 accounts of all 8 ASX listed Co.s involved in forestry to determine method used to value forestry assets how value changes are measured & recognised Balance disclosure of the classification Extent of non-financial disclosure Results: notable for extent of diversity 1 in 8 using solely HC 4 in 8 used net market value but only 1 of these 4 recognised the net Mkt value increments as an adjustment to periodic income. [1] Herbohn, K., Peterson, R. and an d Herbohn, J. (1998) ‘Accounting for forestery assets: Current practice and future directions’ Australian Accounting Review, May, pp54-66. Limitations in using the historical cost method in relation to SGARAs / biological assets include: ignores accretion in value through natural events ignores price changes it provides irrelevant information does not reflect relative values of comparable forests it does not satisfy management’s accountability obligations and provides irrelevant information on performance it ignores the value of native forests 7
Alternative measurement models problematic:
Net present value requires numerous decisions or estimates to be made Current market values are difficult to assess However: While the market can be volatile, market value reflects the actual economic value of the assets at at particular time and is considered appropriate There is an active market for livestock at all stages of development so this approach is easy and more reliable Net market value to be used to value SGARAs/biological assets as at the reporting date AASB 141 (par. 12): A biological asset shall be recognised on initial recognition and at each reporting date at its fair value less estimated point-of-sale costs, except for the case where the fair value cannot be measured reliably ‘Fair value’ less estimated point-of-sale costs is essentially the same as ‘net market value’ ‘Fair value’ is defined defined by AASB 141 para 8 as ‘the amount for which which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction’ Gains and losses associated with holding biological assets (AASB 141 , par. 26) to be included in the Income Statement: A gain or loss arising on initial recognition of a biological asset at fair value less estimated pointof-sale costs and from a change in fair value less estimated point-of-sale costs of a biological asset shall be included in profit or loss for the period in which it arises Point-of-sale costs (AASB 141, par. 14): includes commissions to brokers and dealers, levies by regulatory agencies a nd commodity exchanges, and transfer taxes and duties does not include transport and other costs necessary to get assets to a market Assessing fair value
AASB 141 requires that quoted prices from ‘active markets’ be used with deductions made for transaction costs such as costs associated with transportation to point of sale or sale yard commissions (Para 9) Active market defined in AASB 141 14 1 as a market where all of the following conditions exist: 8
the items traded within the market are homogeneous willing buyers and sellers can normally be found at any time prices are made available to the public AASB 141 states that where there is no active market for particular biological assets, an entity is to use one or more of the following, when available, to determine fair value: the most recent market transaction price , provided that there has not been a significant change in economic circumstances between the date of that transaction and the reporting date; market prices for similar assets with adjustment to reflect differences; and sector benchmarks such as the value of an orchard expressed per export tray, bushel, or hectare , and the value of cattle expressed per kilogram of meat. Where market-determined prices or values are not available for biological assets in their present condition, AASB 141 suggests that an entity use the present value of expected net cash flows from the asset discounted at a current-market-determined pre-tax rate in determining fair value (Para 20) Where biological asset is not separate from other assets AASB 141 (par. 25) states: Biological assets are often physically attached to land (e.g. trees in a plantation forest). There might be no separate market for biological assets that are attached to the land but an active market might exist for the combined assets , that is the value of the raw land and land improvements may be deducted from the fair value v alue of the combined assets to arrive at a fair value of biological assets
Should it still not be possible to measure fair value v alue reliably on initial recognition, AASB 141 requires biological assets to be measured at cost less any accumulated depreciation and any accumulated impairment losses Once the fair value of the biological asset can be measured reliably, the biological b iological asset is measured at the fair value, less point-of-sale costs (under AASB 141, p ar. 30)
When and how should revenue associated with biological assets be recognised?
AASB 141 (par. 26): A gain or loss arising from initial recognition of a biological asset at fair value less estimated point-of-sale costs and from a change in fair values less estimated point-of-sale costs of a biological asset shall be included in profit and loss for the period in which it arises
Accounting for Agricultural Produce
Agricultural produce of a biological asset is defined by AASB 141 as ‘the harvested product of the entity’s biological assets’ Includes fruit pulled from trees, wool shorn from sheep, felled logs, slaughtered livestock
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AASB 102 ‘Inventory’ requires inventory to be valued at the lower of cost and net realisable value— what is the cost of agricultural produce? AASB 141 (par. 13) states that agricultural produce harvested from an entity’s biological assets is to be measured at its fair value less point-of-sale costs at the point of harvest . Such measurement is the cost at the date when applying AASB 102 or another similar standard Disclosure
AASB 141 (par. 41) requires that an entity provide a description of each group of biological assets Par. Aus43.1 states: An entity shall disclose the nature of biological assets and an estimate or relevant indication of their physical quantity, separately classified between ‘plants’ and ‘animals’ and sub- classified as appropriate to the circumstances of the entity, showing separately those biological assets subject to a lease arrangement AASB 141 (Para 50) - ‘requires’ disclosures that reconcile the changes between the carrying amount of biological assets at the start and end of o f the current period which should include: In such cases, an entity is encouraged to disclose, by group or Gain or loss due to change sin fair value les POS costs; Increases due to purchases; Decreases due to harvest; Decreases due to sales of biological assets classified as held for sale; Increases due to business combinations; Net exchange differences on translation of the financial report into a different presentation currency or translation of a foreign operation into the presentation currency of the reporting entity; Other changes
Opposition to AASB 1037 and AASB 141
These standards have been the subject of sustained criticism from members of industries affected by them. Criticisms include: too academic provide ‘nothing positive’ for local companies make payout ratio look unfavourable alienate US investors conflict with activities aimed at harmonising Australian Accounting Standards with International Financial Reporting Standards—AASB 1037 released prior to international standard in this area 10
Examples Example 1: – Biological asset sold as living asset
Type of asset = forest Carrying amount (1.1.2007) = $100,000 Sold the asset (i.e. whole forest during the year) for $120,000 Journal:
Asset (forest) Dr 20,000 Reval. Increment (Rev) Cr 20,000 Update asset value to net realizable value Cash Dr Asset ( forest) Sale of standing forest for cash
120,000 Cr
120,000
Example 2: – Biological asset is converted into non-living produce without further generating capacity e.g. forest felled into logs or animals slaughtered for meat
Type of asset = forest Value of the total forest at Fair value (1.1.2007) $5M 1/40 of the forest was logged (during the year) Cost of logging $20,000 The logs were sold for $150,000 The forest was revalued again after logging and the value of the forest dropped by $115,000 (31.12.2007) Required: Journal entries to show the effect of transactions Show the net effect of these entries
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Journal entries:
Inventory of logs Dr Value of stock recognised as rev. Cr Cash Cr (1/40 of 5M =125,000 - 20,000 at NRV? Cash Sales revenue Cost of logs sold Inventory of logs
Dr Cr
150,000 150,000 Dr
Cr
Fall in value recongnised as an expense Forest Net Effect Revenue re recognised in in lo log in inventory Revenue from sales Cost of goods sold Revaluation decrement Profit from operation
125,000 105,000 20,000
125,000 125,000 Dr Cr
115,000 115,000
+ 1 0 5 ,0 0 0 + 1 5 0 ,0 0 0 - 125,000 - 115,000 15,000
Example 3: – Non-living produce sold off and Biological asset (bearer) retained to produce into the future
Type of asset = orchards Value of the total orchards (1.1.2007) at Fair Value $5M During 2005 fruits fruits were picked with with an estimated estimated market value of $500,000 Cost of picking $50,000 The fruits were sold for $510,000 The orchards were revalued again after the harvesting (31.12.2007) @ $5.2M Required Journal entries to show the effect of transactions Show the net effect of these entries
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Journal Bring stock into account at cost – what about at NRV? Inventory of fruit Dr 500,000 Value of Invt recognised as rev. Cr 450,000 Cash Cr 50,000
Record sale Cash Sales revenue
Dr Cr
510,000
Cost of fruits sold Inventory of fruits
Dr Cr
500,000
510,000
Journal Recognise the increase in asset value Orchards Dr Incr. in value recognised as rev. Cr Net Effect Revenue recognised when picked Revenue from sales Cost of goods sold Revaluation increment Profit from operation
500,000
200,000 200,000
+ 4 5 0 ,0 0 0 + 5 1 0 ,0 0 0 -500,000 + 20 0 ,00 0 66 0 ,00 0
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Summary
Main topic addressed in the chapter include: Accounting for biological assets that relate to agricultural activities Various arguments as to how these assets should be valued and disclosed were addressed Also considered were the unique accounting attributes of biological assets—living animals and plants Relative merits of historical cost vs market-based valuations were considered The chapter noted that accounting regulators have opted to adopt market-based/fair valuations for agriculture accounting standard The changes in market value v alue from one period to the next are treated as part of the entity’s profit and loss—a departure from conventional approached such as historical-cost A biological asset is measured on initial recognition and at each balance sheet date at its fair value less estimated point-of-sale costs. Agricultural produce harvested from an entity’s biological assets is measured at its fair value less estimated point-of-sale costs at the point of harvest. Point-of-sales costs include commissions, levies, and transfer duties and taxes. A gain or loss arising on initial recognition at fair value less point-of-sale costs and from a change in fair value less point-of-sale costs is included in profit or loss. An unconditional government grant related to a biological asset is recognised as income when the grant becomes receivable; a conditional government grant is recognised when the conditions attaching to the grant are met. IAS 41 specifies disclosures related to agricultural activity.
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