Accounting for agriculture will change radically when companies will formulate accounting policy consistent with IAS-41 equivalent Indian Accounting Standard.
IAS 41 covers accounting for biological assets (living animals and plants), agricultural produce (harvested product) and government grants when those relate to agricultural activity. Thus, it covers a wide range of activities such as animal farming, dairy farming, forest plantations, viticulture, tea plantations, rubber plantations and horticulture.
IAS-41 requires that a biological asset should be measured on initial recognition and at the end of each reporting period at its fair value less costs to sell. Similarly, agricultural produce harvested from biological assets should be measured at fair value less costs to sell at the point of harvest.
Gain or loss on the initial recognition of a biological asset at far value less costs to sell should be recognised in profit or loss. For example, when a calf is born and it is initially measured at fair value, a gain arises. In certain situations a loss may also arise on initial recognition because costs of sale are deducted from the fair value to determine the amount at which a biological asset should be measured. Similarly, a gain or loss arising from the change in the fair value less costs to sell should be recognised in the profit or loss for the period.
Fair value
In most situations, observable prices in an active market are best estimates of the fair value. In absence of observable prices in an active market, fair value is estimated using market-based inputs. In absence of market-based inputs, fair value is the present value of expected cash flows from the asset discounted at a current market-determined rate.
Fair value is an opinion. Observed price in an active market is the price which equates demand and supply. Therefore, in a sense that reflects market consensus. When an economic model (e.g. present value model) is used, different experts might arrive at different values because their assumptions about future business environment might differ. Moreover, an expert cannot estimate the fair value. She estimates the range within which the fair value is expected to lie. Therefore, the process of estimating a single value, which can be used as the fair value for accounting purpose, is judgmental.
Issues
For most biological assets an active market is not available. Although, in certain cases, some market based inputs are available, they are inadequate. For example, current price of log is one of the many variables that determine the value of standing trees. In most situations, an economic model, without market-based inputs, is used to estimate the fair value of biological assets.
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Many associated with agricultural activities believe that fair value estimated as above is totally unreliable. However, IASB does not subscribe that view. There is a rebuttable presumption that the fair value of a biological asset can be measured reliably. However, if in rare situations, it can be justified that estimates of fair value are totally unreliable, the biological asset should be measured using the cost model.
Cost model
We may take the example of tea industry. The costs of extension planting (planting new bushes on new soil) are capitalised. Replanting expenditures are recognised as expense for the period. The argument in favour of this practice is that cost per year comes to around 2.5 per cent of the capitalised cost and therefore it is a fair proxy for depreciation of tea bushes. Similarly, rejuvenation expenditure and other expenditures incurred to maintain the tea garden are considered as revenue expenditure. Cost per unit of the green leaf is calculated by dividing the total expenditure charged to revenue by the volume of output. This accounting practice fails to present relevant information to users of financial statements. In some industries cost model also fails to recognise profit till the completion of the cycle from plantation of seedlings to harvesting, which may be as long as 50 years.
Conclusions
Both the fair value model and cost model are difficult to implement and lot of subjectivity is involved in measurement of biological assets. However, the fair value model is better than the cost model because it provides relevant information, which meets the threshold of reliability, while the cost model fails to reflect the correct financial position of the entity. The way forward is to choose the better model and to improve the same based on experience.
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