1. Clarification on applicability of IAS- 41 “Agriculture” on Poultry Industry
Enquiry:
We are thankful for referring ICAP Selected Opinion No. 1.10 of Volume 19 (XIX) dated November 08, 2013.
In this regard, it is submitted that in the enquiry, three questions were raised, which are being reproduced for your kind consideration:
| I) | Whether the cost of breeding the bird is to be treated as biological asset or inventory? |
| 2) | If it is treated as biological assets at what cost it should be recognized? |
| 3) | How the cost of biological assets is to be charged cost of production? |
Considering the above question raised, the opinion provided by learned Committee is clear regarding Question 1, however, Question 2 & 3 are answered in generality.
In this regard, you are requested to kindly provide specific answers to Question 2 & 3 above and provide the guidance on accounting treatment of “biological assets” in financial statements i.e. how biologicalasset is to be recognized and how biological assets will be consumed over its useful life, whether on cost or fair value less cost to sell and how to charge biological assets to cost of production/sales.
Opinion:
The Committee noted the following opinion regarding Question 1 provided by earlier Committee:
As regards to other two questions, the Committee would like to draw your attention to the following relevant paragraph of IAS 41: (underline is ours)
26. A gain or loss arising on initial recognition of a biological asset at fair value less costs to sell and from a change in fair value less costs to sell of a biological asset shall be included in profit or loss for the period in which it arises.
51. The fair value less costs to sell of a biological asset can change due to both physical changes and price changes in the market. Separate disclosure of physical and price changes is useful in appraising current period performance and future prospects, particularly when there is a production cycle of more than one year. In such cases, an entity is encouraged to disclose, by group or otherwise, the amount of change in fair value less costs to sell included in profit or loss due to physical changes and due to price changes. This information is generally less useful when the production cycle is less than one year (for example, when raising chickens or growing cereal crops).
The first part of para 26 explains gain/loss on initial recognition of a biological asset (procreation/ new breed). Whereas, the second part about the changes in fair value less costs to sell of biological assets, represents the difference/changes in value from period to period, normally on an aggregated basis. Changes in fair value may be due to both physical changes and price changes in the market. A reconciliation of changes in the carrying amount of biological assets between the beginning and the end of the period is also required under IAS 41 para 50.
In light of above, the Committee is of the view that fair value and physical changes are required to be taken to P&L account.
(November 07, 2016)
2. Applicability Of IAS- 41 “Agriculture” on Poultry Industry
Enquiry:
We are very thankful for your prompt response regarding the above captioned subject in which the concerned personnel had referred to Selected Opinion Volume 19 (XIX) Reference Accounting 1.10 dated November 08, 2013.
In this regard, it is submitted that in the enquiry, three questions were raised which are being reproduced for your kind consideration:
| I) | Whether the cost of breeding the bird is to be treated as biological asset or inventory? |
| 2) | If it is treated as biological assets at what cost it should be recognized? |
| 3) | How the cost of biological assets is to be charged cost of production? |
Considering the above question raised, the opinion provided by learned committee is clear regarding Question 1, however, Question 2 & 3 are answered in generality.
In this regard, you are requested to kindly provide specific answers to Question 2 & 3 above and provide the guidance on accounting treatment of “biological assets” in financial statements i-e. how biologicalasset is to be recognized und how biological assets will be consumed over its useful life, whether on cost or fair value less cost to sell and how to charge biological assets to cost of production/sales.
Opinion:
The Committee noted the following opinion regarding Question 1 provided by earlier Committee:
As regards to other two questions, the Committee would like to draw your attention to the following relevant paragraph of IAS 41: (underline is ours)
26 A gain or loss arising on initial recognition of a biological asset at fair value less costs to sell and from a change in fair value less costs to sell of a biological asset shall be included in profit or loss for the period in which it arises.
51 The fair value less costs to sell of a biological asset can change due to both physical changes and price changes in the market. Separate disclosure of physical and price changes is useful in appraising current period performance and future prospects, particularly when there is a production cycle of more than one year. In such cases, an entity is encouraged to disclose, by group or otherwise, the amount of change in fair value less costs to sell included in profit or loss due to physical changes and due to price changes. This information is generally less useful when the production cycle is less than one year (for example, when raising chickens or growing cereal crops).
The first part of para 26 explains gain/loss on initial recognition of a biological asset (procreation/ new breed). Whereas the second part about changes in fair value less costs to sell of biological assets represents the difference/changes in value from period to period, normally on an aggregated basis. Changes in fair value may be due to both physical changes and price changes in the market. A reconciliation of changes in the carrying amount of biological assets between the beginning and the end of the period is also required under IAS 41 para 50.
In light of above, the Committee is of the view that fair value and physical changes are required to be taken to P&L account.
(November 07, 2016)
3. Biological Assets under lAS 41
Enquiry:
The Company is engaged in poultry business i.e. breeding the birds, selling the eggs and then bird is sold. The whole life of the bird is two years and in two years it lays eggs eighteen months. Please give your opinion regarding the followings:
Whether the cost of breeding the bird is to be treated as biological asset or inventory?
- If it is treated as a biological asset at what cost it should be recognized?
- How the cost of biological asset is to be charged cost of production?
Opinion:
The Committee considered your queries and its views on each question are as follows:
1. Your attention is drawn to the paragraph 10 of lAS 41 ‘Agriculture’ which says that:
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.
In view of the above, the cost of breeding the birds will be capitalized as a biological asset till such time the birds start producing eggs Subsequent costs, incurred after production of eggs, are cost of sales and will be charged to profit and loss.
(November 08, 2013)
4. Opinion on valuation of Biological Assets applying IAS 41
Enquiry:
Our client (the Company), a subsidiary of a Limited Company, is engaged in the business of manufacturing, processing and selling dairy food products. The Company is to import dairy cattle from Australia and has also planted fodder/crops mainly as feedstock for the dairy cattle.
The dairy cattle as well the crops fall under the definition of biological assets, the recognition and measurement (valuation) thereof for accounting purposes have been discussed in International Accounting Standard 41 – Agriculture.
However, as there is no active market (formal/organized) for dairy cattle in Pakistan, even of local breed let alone that of Australian, the Company would like to confirm the accounting policy that it has formulated in the light of IAS – 41 for adoption.
An analysis of the options/alternatives discussed in the IAS – 41 is as follows:
Options available to an entity in the absence of an active market
The following methods for determination of fair value, as an approximation thereof in the absence of an active market , has been prescribed in paragraph 18 of IAS 41, if such data is available:
a) 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 balance sheet date;
b) market prices for similar assets with adjustment to reflect differences; and
c) 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.
In addition to the above, paragraph 20 and 21 of IAS – 41, in certain circumstances, also allows the discounted cash flow method:
Para 20:
In some circumstances, market-determined prices or values may not be available for a biological asset in its present condition. In these circumstances, an entity uses 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 21:
The objective of a calculation of the present value of expected net cash flows is to determine the fair value of a biological asset in its present location and condition. An entity considers this in determining an appropriate discount rate to be used and in estimating expected net cash flows. The present condition of a biological asset excludes any increases in value from additional biological transformation and future activities of the entity, such as those related to enhancing the future biological transformation, harvesting, and selling.
ASSESSMENT OF EACH OPTION
a) use of the most recent market transaction price
The Company is of the view that this option is not suitable, as currently there are very limited willing buyers locally, if any, of the Australian breed and the fact that the data for such transactions are not readily available, not to mention the reliability thereof. Further, the Company believes that no one will sell its biological assets, imported by it, under the normal circumstances i.e. when the asset is in good healthy condition and is producing milk as per the required / expected standards. In these circumstances, it would be difficult to substantiate or accept the transaction price which could well be that of ‘unwanted’ assets, as a basis to determine fair value of assets held by the Company in good condition.
b) market prices for similar assets adjusted to reflect differences
Keeping in view the Company’s specific situation and the dairy cattle market in Pakistan, this method seems more appropriate than others. With some modifications as more fully explained in the following paragraph, this is our recommended method.
c) sector benchmarks such as the value of cattle expressed per kilogram of meat
We consider that this option is not an appropriate method for determination of fair value of biological assets being maintained by the Company to produce milk. This method is appropriate for consumable assets (e.g. beef cattle or crops for harvest say wheat), as opposed to bearer assets (e.g. dairy cattle or fruit trees).
d) discounted cash flow method
This method, however, is not mentioned in IAS 41 – para 18 but only in para 20 as a method only to be used to determine a fair value if there is no market at all which can be used as a point of reference. In other words, IAS – 41 makes it clear that it is preferable to use one of the methods in para 18 before defaulting to the last available valuation method i.e. DCF.
Given that there are considerable active markets for dairy cattle/biological assets across the globe, we believe it would not be appropriate to estimate a fair value solely on the basis of a discounted cash flow calculation. However, a discounted cash flow calculation may prove a useful tool to support any fair value estimated using alternative valuation methods described earlier.
Our recommended method
Based on the discussion/analysis of the various methods available considering that there is no active market in Pakistan, in our view a modified method, as explained below, which would basically falls with the boundaries of one of the preferred method stated in para 18(b), Market prices for similar assets adjusted for differences, would be appropriate.
IAS – 41 prefers that the fair values be representative of an active market as much as possible, if not the actual market price itself. Therefore, as there is an active market of the Company’s cattle in Australia, it would be appropriate for the Company to use the price quoted in those markets as a reference point which then can be adjusted for factors such as difference in expected milk yield, fertility, estimated residual value etc, of any, for maintaining these assets in Pakistan.
However, in this connection management should ensure that the appropriate number of independent quotations (say 3 to 5 quotations) is obtained from the active markets in Australia. Further, the quotations should be specific and cater to the individual class of each category of biological asset, showing values based on breed, age, number of lactations and other material specifications.
The Company’s management is of the opinion that once the Australian breed settles in Pakistan there are no material differential factors i.e. the cattle is expected to perform in the local environment (milk yield and fertility) as they would in Australia, given that the right environment (management thereof) is provided to them.
Further, until such time as there is an active market in Pakistan, it may be reasonable to include the cost (transportation etc.) of bringing the asset to Pakistan in the fair value of the asset. This is because to give a reasonable approximation of what a market price in Pakistan might be. In other words one needs to consider at what price, the Company might sell the asset to another party in Pakistan, as there is a restriction on re-export out of Pakistan, so the only parties to whom the Company can sell the biological asset will be other parties within Pakistan. The Company should consider whether, if they made such a sale, they would charge on the costs of bringing the asset to Pakistan to their customer by increasing the sales price. Therefore, it may be reasonable to include the cost of bringing the asset to Pakistan in the fair value of the asset. This is supported by the fact that, until there is an active market in Pakistan, any other entity in Pakistan wishing to purchase cattle would have to either purchase it from entities currently operating (inclusive of transportation costs) or would have to incur the cost of purchasing cattle from the market in Australia plus the cost of transporting that cattle to Pakistan.
However, if an active market develops in Pakistan over the time, the valuation method should be changed to the prices quoted in that market.
VALUATION OF FODDER (CROPS / FEED STOCK)
IAS – 41 is applicable to biological assets (which includes trees, plants, bushes etc.) and to agriculture produce, which is the harvested product of the entity’s biological assets. However, IAS – 41 does not apply to agriculture produce after the point of harvest and it is most likely that such agriculture produce which has been harvested will be inventory under the scope of IAS – 2 ‘Inventories’.
Para 17 of IAS – 41 requires that, ‘If an active market exists for a biological asset or agricultural produce, the quoted price in that market is the appropriate basis for determining the fair value of that asset. If an entity has access to different active markets, the entity uses the most relevant one. For example, if an entity has access to two active markets, it would use the price existing in the market expected to be used.’
Further para 32 of IAS – 41 requires, ‘In all cases, an entity measures agricultural produce at the point of harvest at its fair value less estimated point-of-sale costs. This Standard reflects the view that the fair value of agricultural produce at the point of harvest can always be measured reliably.’
As evident from the above, the agriculture produce at the point of harvest should be measured at the fair value, because there is a presumption in IAS – 41 that fair value of agriculture produce at the point of harvest can always be measured reliably. This can be done by the Company by obtaining quotes from the market for such fodder/feed stock at the point of harvest, which we understand are readily available, and valuing these accordingly.
However, there may be a case that there is a lack of an active market for partly grown fodder / feed stock and very few sales of part-grown fodder/feed stock i.e. there is no market based fair value available. In such cases, the Company should follow the discounted cash flow method for such partly grown fodder / feed stock. The crops / fodder being planted by the Company are mostly for use as cattle feed (internal consumption), and have a very short biological transformation and consumption cycle. Therefore these can be carried at cost rather then using the discounted cash flow method.
As stated earlier, once harvested, the crops fall outside the scope of IAS – 41 and are dealt with by IAS 2 – ‘Inventories’. This means that the crops harvested and in hand as at year end would be measured at the lower of cost and net realizable value. The cost being the fair value less estimated point-of-sale costs at the point of harvest, as stated in para 13 of IAS -14 which states, ‘Agricultural produce harvested from an entity’s biological assets shall be measured at its fair value less estimated point-of-sale costs at the point of harvest. Such measurement is the cost at that date when applying IAS 2 Inventories or another applicable Standard.’
Opinion:
Your attention is drawn to the following paragraph of IAS 41:
12 A biological asset shall be measured on initial recognition and at the end of each reporting period at its fair value less estimated point-of-sale costs, except for the case described in paragraph 30 where the fair value cannot be measured reliably.
30 There is a presumption that fair value can be measured reliably for a biological asset. However, that presumption can be rebutted only on initial recognition for a biological asset for which market-determined prices or values are not available and for which alternative estimates of fair value are determined to be clearly unreliable. In such a case, that biological asset shall be measured at its cost less any accumulated depreciation and any accumulated impairment losses. Once the fair value of such a biological asset becomes reliably measurable, an entity shall measure it at its fair value less estimated point-of-sale costs. Once a non-current biological asset meets the criteria to be classified as held for sale (or is included in a disposal group that is classified as held for sale) in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, it is presumed that fair value can be measured reliably.
Fair value versus cost
B13 The Standard requires an entity to use a fair value approach in measuring its biological assets related to agricultural activity as proposed in the DSOP and E65, except for cases where the fair value cannot be measured reliably on initial recognition.
From the above paragraphs it is clear that IAS 41 requires all the biological assets to be measured at fair value except in the circumstances where neither does active market exist nor the alternative estimates of fair value is reliable as referred to in the above paragraph 30 of IAS 41.
In view of the above the Committee is of the opinion that the method recommended in your enquiry for determination of fair value of dairy cattle may be considered as appropriate provided the fair value measured under the aforesaid method is not unreliable.
(December 26, 2008)
5. Accounting Treatment of Standing Crops
Enquiry:
BACKGROUND
The company belongs to the sugar industry. In the recent past, many sugar companies have entered into corporate farming for procurement of sugarcane in view of practical difficulties in securing quality sugarcane in the recent period. Accounting year of Sugar industry ends on September 30 every year.
Sugarcane is a crop of longer duration i.e. 14 – 16 months. Normally it is sown in as per following norm:
Sowing Period Harvesting Period (Estimated) Duration in Months
September November 15
February March 14
Clearly in every case, the crop takes more than one accounting year from sowing to harvesting. Crushing season of a mill is normally from November to April every year.
TREATMENT REQUIRED BY IAS 41
There is no change proposed as a result of overall revision of IAS. IAS 41 is applicable from the periods beginning on or after January 01, 2003. However ICAP has not adopted this standard and it is stated that this standard would be considered for adoption in due course of time.
IAS 41 requires that a biological asset should be measured on initial recognition and at each subsequent balance sheet date at its fair value less estimated point of sale costs.
Exception to this rule is only available when only little transformation has taken place or fair value can’t be measured.
Although the IAS 41 is not applicable is Pakistan, yet we have to match over costs with related revenues. So recording of the asset is necessary.
One example may illustrate the issue:
Suppose a company has sugarcane September sowing crop of 10,000 acres in year XO which would be harvested in November X1. As at balance sheet of September 30, X1, the company has incurred the following expenditure:
Total expenditure 25,000 per acre for 10,000 acres Rs. 250 million
As for estimate of fair value there are two uncertainties involved. One is the price of sugar cane which is government support price announced in November every year when the accounts are in the final stage. Second is per ton yield of sugarcane, which is finalized even in Dec/Jan X1. So both factors are uncertain and even yield would be calculated separately for each land portion.
In the above situation, it is difficult to estimate fair value. But the practical difficulty in taking cost as value of standing crop is the fact that actual revenue may be less than cost and further it would be very difficult to get these standing crops physically verified by the external auditors.
We are open to any guidance issued by ICAP. However we suggest that auditors on their physical verification at balance sheet date should just take an overview of the crop. The crop may be taken at cost and subject to latest available evidence up to the finalization of financial statements.
Please advise us in the following specific matters so that we may plan well in time accordingly:
1. Whether our assumption that fair value cannot be measured reliably
is valid or not ?
2. What method is to be adopted for valuation of standing crops?
3. Given the fact that our sugarcane crop is located at nearly 40-50
different locations, to what extent we are required to satisfy
our auditors?
Opinion:
First of all the appropriate Committee of the Institute would like to inform you that the compliance of IAS 41 is not mandatory as Securities and Exchange Commission of Pakistan has not yet notified the said standard. In view of this the Committee is of the opinion that until IAS 41 is notified, you have an option to either comply with the requirements of IAS 41 or use any other method for the valuation of biological or agriculture assets which is appropriate and reflects a reliable estimate of fair value.
However, the Committee is also of the view that as there is no other guidance available with regard to the valuation of biological or agriculture assets, it is therefore strongly recommended to comply with the requirements of IAS 41 as far as possible.
With regard to your first query the Committee would like to draw your attention towards the following paragraphs of IAS 41 ‘Agriculture’:
12. A biological asset shall be measured on initial recognition and at each balance sheet date at its fair value less estimated point-of-sale costs, except for the case described in paragraph 30 where the fair value cannot be measured reliably.
13. Agricultural produce harvested from an entity’s biological assets shall be measured at its fair value less estimated point-of-sale costs at the point of harvest. Such measurement is the cost at that date when applying IAS 2 Inventories or another applicable Standard.
Inability to Measure Fair Value Reliably
30. There is a presumption that fair value can be measured reliably for a biological asset. However, that presumption can be rebutted only on initial recognition for a biological asset for which market-determined prices or values are not available and for which alternative estimates of fair value are determined to be clearly unreliable. In such a case, that biological asset shall be measured at its cost less any accumulated depreciation and any accumulated impairment losses. Once the fair value of such a biological asset becomes reliably measurable, an entity shall measure it at its fair value less estimated point-of-sale costs. Once a non-current biological asset meets the criteria to be classified as held for sale (or is included in a disposal group that is classified as held for sale) in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, it is presumed that fair value can be measured reliably.
The Committee is, therefore, of the opinion that you should be guided by the above paragraph of IAS 41. Further guidance may also be obtained from paragraph 17 to 20 of IAS 41.
With regard to your 3rd query the Committee would like to draw your attention towards the following paragraphs of ISA 501 ‘Audit Evidence –Additional Considerations for Specific Items’:
PART A: Attendance at Physical Inventory Counting
4. Management ordinarily establishes procedures under which inventory is physically counted at least once a year to serve as a basis for the preparation of the financial statements or to ascertain the reliability of the perpetual inventory system.
5. When inventory is material to the financial statements, the auditor should obtain sufficient appropriate audit evidence regarding its existence and condition by attendance at physical inventory counting unless impracticable. Such attendance will enable the auditor to inspect the inventory, to observe compliance with the operation of management’s procedures for recording and controlling the results of the count and to provide evidence as to the reliability of management’s procedures.
6. If unable to attend the physical inventory count on the date planned due to unforeseen circumstances, the auditor should take or observe some physical counts on an alternative date and, when necessary, perform tests of intervening transactions.
7. Where attendance is impracticable, due to factors such as the nature and location of the inventory, the auditor should consider whether alternative procedures provide sufficient appropriate audit evidence of existence and condition to conclude that the auditor need not make reference to a scope limitation. For example, documentation of the subsequent sale of specific inventory items acquired or purchased prior to the physical inventory count may provide sufficient appropriate audit evidence.
Though the above paragraphs are not meant for the physical verification of biological and agriculture assets, the guidance may be taken from them.
(August 13, 2005)