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              Accounting for Agricultural Operations

T       he accounting profession
        has provided only limited
        industry specific guidance
for agricultural issues. “State-
ment of Position 85-3, Accounting by
                                                 -Rajkumar S. Adukia

                                             (The author is a Central Council
                                            Member, ICAI. He can be reached
                                                                                    financial statements, which
                                                                                    was almost unheard of ten
                                                                                    years ago, is still in general
                                                                                    use by only a small percent-
                                                                                    age of full time, commercial
Agricultural Producers and Agricul-          at            farms.
tural Cooperatives”, issued by the           Agriculture has played a ma-        2. The primary external user of
American Institute of Certified              jor role in the Indian econ-           farm financial statements has
Public Accountants (AICPA) in                omy since its formation.               been the agricultural lending
April 1985 provides accounting               As an industry, it is unique           community, using the state-
guidance for inventories, devel-             because of the large num-              ments as one of the key in-
opment costs of land, perennial              ber of participants and the            dicators of financial position
                                             diversity of individual firm
crops, and breeding livestock.                                                      and financial performance.
                                             production, financial, and
The related “Audit and Account-                                                     Because of the minimal ca-
                                             marketing characteristics.
ing Guide”, issued by the AIC-               The industry comprises pri-
                                                                                    pabilities of farm record
PA with conforming changes as                marily small, family-owned
                                                                                    keeping systems, lenders are
of May 1, 1993, covered a few                firms. The complexity of fi-           forced to focus their analysis
additional issues, including ac-             nancial transactions and the           on the information that can
counting for income taxes and                volatility of market prices            reasonably be obtained from
government programmes. Un-                   have dramatically increased            the farmer. Since few non-
fortunately, the examples of fi-             the focus on farm financial            cash transactions (e.g., per-
nancial statements included in               reporting.                             petual inventories, charge-
the Guide were very summarised                                                      off of pre-paids, accrual
and of limited use to agricultural                                                  of liabilities) are recorded
producers and lenders for ana-             agricultural producers that rep-         by the farmer, a cash-based
lytical purposes.                          resent substantial deviations            system is the primary source
    The primary forces behind              from GAAP. The reasons for               of information on net cash
the evolution of farm finan-               this diversity are varied, but can       income. Further, since peri-
cial reporting and analysis have           be related to three fundamental          odic balance sheets are usu-
been the agricultural lending              characteristics of agricultural          ally not compiled, the lender
community, accountants, finan-             operations:                              is forced to accept a balance
cial analysts, and the land grant          1. Since many farm operations            sheet as of the loan applica-
universities. The definitions and               are single-family operations,       tion date because that is the
processes used by these individ-                with the owners having limit-       only way to verify the accura-
uals, while consistent at a very                ed training in finance and ac-      cy of inventory and liability
basic level, were not subjected                 counting, the record keeping        amounts. The result is a set
to any formal attempt at consis-                systems that developed over         of financial statements that
tency and standardisation. Even                 the years had basic design          are not interrelated and pro-
though the potential benefits of                objectives of simplicity and        vide only a minimal amount
achieving consistency have long                 ease of use. These systems          of information regarding
been acknowledged, previous                     are predominantly cash-             the financial position and fi-
attempts have had only limited                  based systems that focus on         nancial performance of the
success.                                        generating certain amounts          agricultural producer.
                                                of production information.       3. The primary focus in the
Diversity of Practice                           A complete, double-entry            preparation of financial
   Presently, there are a number                system of accounting with           position (balance sheet)
of accounting practices among                   the periodic generation of          and owner equity calcula-

1440 The Chartered Accountant April 2006
     tions has been on market         and lenders today are, in fact, ab-         sets are not those harvested from
     value rather than histori-       breviated accounting systems.               unmanaged sources. Rather they
     cal cost or other valuation          International Accounting Stan-          are the product of controlled
     methods.                         dard IAS 41, Agriculture, is the            processes by an entity to manage
    This focus has become neces-      first standard that specifically            their growth and maturation. As-
sary because of:                      covers the primary sector. The              sets such as wine that are subject
(a) the lender’s need to deter-       Standard becomes operative for              to a lengthy maturation period
     mine the reasonableness of       annual financial statements cov-            are not biological assets. These
     collateral values;               ering periods beginning on or               processes are analogous to the
(b) the lack of records to track      after 1st January 2003. IAS 41              conversion of raw materials to a
     and accumulate historical        introduces a fair value model to            finished product rather than bio-
     costs;                           agriculture accounting. This is a           logical transformation.
(c) the hybrid nature (personal       major shift away from the tradi-                Biological assets may be sold,
     and business) of many farm       tional cost model widely applied            transformed into agricultural
     financial statements;            in primary industry.                        produce, or into additional bio-
(d) the dramatic increase in              Agricultural activity is a spe-         logical assets. IAS 41 will partic-
     investment in capital as-        cialised activity defined as an             ularly impact those agricultural
     sets during a period of time     entity’s management of the bio-             activities where the income-pro-
     when the value of these as-      logical transformation of biologi-          ducing biological assets are ex-
     sets was appreciating sub-       cal assets for sale, into agricultural      pected to have economic lives
     stantially, causing the true     produce or into additional bio-             that stretch beyond one account-
     value of these assets to bear    logical assets. A diverse range of          ing period.
     little resemblance to their      activities fall under agricultural              IAS 41’s recognition and mea-
     historical cost, adjusted for    activities. Examples are raising            surement rules should be applied
     depreciation.                    livestock, forestry, annual or pe-          as follows:
    A number of changes have
taken place in agriculture that
                                       The following are examples of each category of biological assets.
have increased the need for more
complete and accurate farm finan-       Biological     Biological as-        Agricultural             Additional
cial information. These changes           assets        sets for sale          produce            biological assets
include increased volatility in net    Dairy cattle Livestock           Carcass/Milk/Hides Calves
income, increased complexity of        Sheep         Livestock          Carcass/Wool             Lambs
the financial structure of farm        Trees         Trees              Logs/Rubber              Saplings/Seeds
operations and their accounting        Vines         Vines              Harvested grapes         Saplings/Seeds
transactions, and more stringent
                                       Fruit trees   Fruit trees        Harvested fruit          Saplings/Seeds
loan review requirements for
lenders. Lenders, accountants,
academicians, and others in the       rennial cropping, cultivating or-           l    biological assets for sale
agricultural finance field have re-   chards and plantations, floricul-                should be accounted for in
sponded to this need with count-      ture and aquaculture (including                  accordance with IAS 41 up
less educational programmes,          fish farming). Common feature                    to the point of sale;
software packages, forms, and         of agricultural activities are ca-          l    additional biological assets
other tools to assist the farmer      pability of change, management                   should be recognised as bio-
in providing complete informa-        of change and measurement of                     logical assets at the point of
tion. In most cases, however,         change. Managing recreational                    generation; and
these tools are designed to pro-      activities such as zoos and game            l    agricultural produce should
vide more detailed information        parks is not agricultural activity.              be recognised as inventory
by not imposing greatly different         Biological assets are living                 at the point of harvest.
recordkeeping requirements or         animals or plants, such as sheep,
accounting system changes on          trees and vines. Agricultural               Coverage of the Standard
part of the farmers. Therefore,       produce such as wool, logs and              IAS 41 applies to:
the “financial statements” that       grapes is the harvested product             1. Biological assets (living
are being used by many farmers        of biological assets. Biological as-           plants or animals – for ex-

                                                                               April 2006 The Chartered Accountant   1441
     ample, trees in a plantation          l    IAS 18, Revenue, in respect      measured, at the point of har-
     or orchard, cultivated plants,             of revenue arising from the      vest, at fair value less estimated
     sheep, cattle) related to man-             initial recognition of agri-     point-of-sale costs. The point
     aged agricultural activity (for            cultural produce, and initial    of harvest represents the tran-
     example, raising livestock,                recognition and changes          sition between accounting for
     forestry, annual or peren-                 in fair value of biological      agricultural produce assets un-
     nial cropping, fish farming),              assets;                          der IAS 41 and IAS 2. Fair val-
     that are in the process of            l IAS 20, Accounting for Govern-      ue less estimated point-of-sale
     growing, degenerating, re-                 ment Grants and Disclosure of    costs at the point of harvest
     generating and/or procreat-                Government Assistance3;          forms ‘cost’ for the purposes
     ing and which are expected            l IAS 36, Impairment of Assets,       of IAS 2. Point-of-sale costs
     to eventually result in agri-              when biological assets are       include commissions to bro-
     cultural produce (the har-                 measured at fair value.          kers and dealers, levies by regu-
     vested product of biological          The main issues addressed by IAS 41   latory agencies and commodity
     assets);                              are:                                  exchanges, and transfer taxes
2. Agricultural produce at the             l When should a biological            and duties. Point-of-sale costs
     point of harvest.                          asset or agricultural produce    exclude transport and other
IAS 41 does not apply to:                       be recognised on the balance     costs necessary to get assets to
1. Agricultural produce after                   sheet?                           a market.
     the point of harvest, for             l At what value should a                  IAS 41 contains a rebuttable
     example: wool, meat, fruit,                recognised biological asset      presumption that fair value can
     rubber, logs that are pro-                 or agricultural produce be       be established for all biological
     cessed subsequently (IAS 2,                measured?                        assets and agricultural produce.
     Inventories, applies);                l How should the differences          Only on the initial recognition
2. The land on which the bio-                   in value of a recognised bio-    of such assets can the presump-
     logical assets grow, regener-              logical asset or agricultural    tion be rebutted because of:
     ate and/or degenerate (IAS                 produce between two bal-         l the lack of market-deter-
     16, Property, Plant and Equip-             ance sheet dates be account-          mined prices;
     ment, IAS 17, Leases, or IAS               ed for?                          l values that are not otherwise
     40, Investment Properties, ap-            Recognition: IAS 41 speci-             available;
     plies as appropriate);                fies the usual tests in order that    l alternative estimates of fair
3. Any intangible asset associ-            a biological asset or agricultural         value that are clearly unreli-
     ated with the agricultural ac-        produce be recognised on the               able
     tivity, for example: licenses         balance sheet, namely:                The estimation of fair value can be de-
     and rights (IAS 38, Intangible        l Control: The enterprise             termined by reference to:
     Assets, applies);                          must have ownership or           l the quoted price in an active
4. Agricultural activity that                   rights of control akin to             market for the particular bio-
     is not managed, for exam-                  ownership that result from a          logical asset or agricultural
     ple: harvesting from ocean                 past event;                           produce (most likely for con-
     fishing;                              l Value: Future economic                   sumable biological assets);
5. Minerals, oil, natural gas and               benefits are expected to         l market-determined             prices
     similar non-regenerative re-               flow to the enterprise from           or values (for example, the
     sources (not yet covered by                its ownership or control of           most recent market transac-
     IAS).                                      the asset;                            tion price or sector bench-
   The following accounting                l Measurement: The cost or                 marks) when an active mar-
standards specifically do not ap-               fair value of the asset must          ket does not exist; or
ply to biological assets related to man-        be measured with reliability.    l the present value of ex-
aged agricultural activity because of          Measurement: Biological                pected net cash flows from
the specific coverage in IAS 41:           assets should be measured ini-             the asset when market-de-
l IAS 2, until beyond the                  tially, and at each balance sheet          termined prices or values
     point at which agricultural           date subsequently, at fair value           may not be available for a
     produce is harvested;                 less estimated point-of-sale               biological asset in its pres-
l IAS 16, IAS 17, IAS 40;                  costs. Agricultural produce is             ent condition (see the for-

1442 The Chartered Accountant April 2006
     estry example later in this    independent valuations but in                  Assuming immaterial cash flow
     article).                      such cases where fair values                between now and the point of
    The Standard offers the fol-    are otherwise difficult to de-              harvest, the fair value (and there-
lowing guidance on determina-       termine, it may be possible and             fore the amount reported as an
tion of the discount rate: “The     appropriate to apply IAS 36 to              asset on the balance sheet) of the
objective of a calculation of the   determine both the value in use             plantation is estimated as follows:
present value of expected net       and the net selling price of the               As on 31 December 20X1:
cash flows is to determine the      asset and to use the higher of              17,100 ÷ [(1+6%)^20] = 5,332.
fair value of a biological asset    the two amounts to represent                   As on 31 December 20X2:
in its present location and con-    valuation.                                  16,500 ÷ [(1+6%)^19] = 5,453.
dition. An enterprise considers         When the presumption that
this in determining an appropri-    fair value can be established is            Gains and Losses
ate discount rate to be used and    rebutted, and until such time as                At initial recognition, the fair
in estimating expected net cash     a fair value becomes measurable             value (less estimated point-of-
flows. The present condition        with reliability, the asset is carried      sale costs) of a biological asset is
of a biological asset excludes      on the balance sheet at cost less           reported as a gain or loss in the
any increases in value from ad-     any accumulated depreciation                income statement. A loss may
ditional biological transforma-     and any accumulated impair-                 arise on initial recognition when
tion and future activities of the   ment losses. IAS 41 contains ad-            the estimated point-of-sale costs
enterprise such as those related    ditional disclosure requirements
to enhancing the future biolog-     in such a situation.
ical transformation, harvesting,        Example 1: Establishing fair              The difficulty in es-
and selling.”                       value when market-determined                  tablishing the fair
    The Standard specifically       prices or values may not be avail-            value of a biological
requires that fair value not be     able for a biological asset in its            asset increases when
determined by reference to a        present condition:                            the asset is a bearer
future sales contract. Contract         As on 31 December 20X1, a                 asset, which itself
prices are not necessarily rel-     plantation consists of 100 Pinus              will not eventually
evant in determining fair value,    Radiata trees that were planted               become agricultural
because fair value reflects the     10 years ago. Pinus Radiata takes             produce.
current market in which a will-     30 years to mature, and will ulti-
ing buyer and seller would enter    mately be processed into build-
into a transaction. As a result,    ing material for houses or furni-           exceed the fair value of the asset
the fair value of a biological      ture. The enterprise’s weighted             in its present state. The change in
asset or agricultural produce is    average cost of capital is 6% p.a.          fair value (less estimated point-
not adjusted because of the ex-     Only mature trees have estab-               of-sale costs) of a biological as-
istence of a contract.              lished fair values by reference to          set between two balance sheet
    The difficulty in establish-    a quoted price in an active mar-            dates is reported as a gain or loss
ing the fair value of a biologi-    ket. The fair value (inclusive of           in the income statement.
cal asset increases when the        current transport costs to get                  A gain or loss arising on initial
asset is a bearer asset (which      100 logs to market) for a mature            recognition of agricultural pro-
itself will not eventually be-      tree of the same grade as in the            duce at fair value less estimated
come agricultural produce)          plantation is:                              point-of-sale costs is included in
and the more long-lived the as-         As on 31 December 20X1:                 net profit or loss for the period
set is. For example, in the es-     171                                         in which it arises. Referring to
tablished vineyards in France,          As on 31 December 20X2:                 the forestry example above, the
grapevines have long lives and      165                                         difference in fair value of the
it is not uncommon to have              As on 31 December 20X1,                 plantation between the two bal-
productive vines that are over      the mature plantation would                 ance sheet dates is 121 (5,453
100 years old which are capable     have been valued at 17,100.                 - 5,332), which will be reported
of continued production for a           As on 31 December 20X2,                 as a gain in the income state-
similarly long time. The Stan-      the mature plantation would                 ment (regardless of the fact that
dard does not require external      have been valued at 16,500.                 it has not yet been realised). The

                                                                             April 2006 The Chartered Accountant   1443
aggregate gain of 121 is attrib-           formance and future prospects,       l    restrictions on title, pledges
uted to two factors:                       particularly when there is a              and commitments in respect
1. The effects of change in                production cycle of more than             of biological assets;
      market price; and                    one year.                            l financial risk management
2. The          physical     change                                                  strategies related to agricul-
      (growth) of the trees in the         Government Grants                         tural activity;
      plantation.                             The recognition of govern-        l a reconciliation of changes
The aggregate gain is analysed as fol-     ment grants related to a bio-             in the carrying amount of
lows:                                      logical asset differs, depend-            those biological assets.
1. The price change, which                 ing on whether the grant is             For biological assets measured
      represents, at the biological        conditional or unconditional.        at cost less any accumulated de-
      asset’s state as at the previ-       An unconditional grant that          preciation and any accumulated
      ous balance sheet date: the          relates to an asset should be        impairment losses, the Standard
      value of the biological asset        recognised as income when            requires the following additional
      at prices prevailing as at the       it becomes receivable. Where         disclosures:
      current balance sheet less the       there are conditions associated      l a description of those bio-
      value of the biological asset        with a government grant, such             logical assets;
      at prices prevailing as at the       as the entity engaging or not        l an explanation of why fair
      previous balance sheet date:         engaging in a particular activity,        value cannot be measured
      = (16,500 ÷ [(1+6%)^20])             then the entity should recog-             reliably;
      - (17,100 ÷ [(1+6%)^20]) =           nise the grant when the condi-       l the range of estimates with-
      5,145 - 5,332 = 187 (loss).          tions are met.                            in which fair value is highly
2. The physical change, which                                                        likely to lie (if possible);
      represents, at current prices:       Disclosure                           l the gain or loss recognised
      the value of the biological             Extensive disclosure is re-            on disposal of those biolog-
      asset in its state as at the         quired by IAS 41, including:              ical assets;
      current balance sheet less           l the aggregate gain or loss         l impairment losses (if any),
      the value of the biological              for the period on:                    reversals of impairment
      asset in its state as at the             – initial recognition of              losses (if any) and deprecia-
      previous balance sheet date:                  biological assets;               tion expense;
      = (16,500 ÷ [(1+6%)^19])                 – initial recognition of         l the depreciation method
      - (16,500 ÷ [(1+6%)^20]) =                    agricultural produce;            used;
      5,453 - 5,145 = 308 (gain).              – change in fair value less      l the useful lives or the depre-
    IAS 41 requires disclosure of                   estimated point- of-sale         ciation rates used;
the aggregate gain or loss aris-                    costs of biological as-     l the gross carrying amount
ing during the current period on                    sets;                            and the accumulated depre-
initial recognition of biological          l a description of, and the na-           ciation at the beginning and
assets and agricultural produce                ture of its activities involv-        end of the period.
and from the change in fair val-               ing, each group of biological       In addition, if the fair value
ue less estimated point-of-sale                assets;                          of biological assets previously
costs of biological assets. In             l non-financial measures or          measured at cost less any accu-
recognising that reporting the                 estimates of the physical        mulated depreciation and any
aggregate gain or loss according               quantities of agricultural       accumulated impairment losses
to its distinct causes may not be              produce output for the pe-       subsequently becomes reliably
practical in all circumstances,                riod and biological assets as    measurable, an enterprise should
the Standard does not require                  at balance sheet;                disclose a description of the bio-
reporting of the gain or loss on           l methods and significant as-        logical assets, an explanation of
a disaggregated basis (that is,                sumptions in determining         why fair value has become reli-
analysed between the gain and/                 fair value;                      ably measurable, and the effect
or loss due to price and physi-            l the fair value less estimated      of the change Disclosure is also
cal factors) but encourages such               point-of-sale costs of agri-     required in respect of govern-
disclosure because it is useful in             cultural produce harvested       ment grants relating to managed
appraising current period per-                 for the period;                  agricultural activity. r

1444 The Chartered Accountant April 2006

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