How to Measure Fair Value in Agriculture – IAS 41 and IFRS 13

Agriculture is a huge sector, significantly contributing to the world’s GDP.

According to the World Bank, in 2018 the value added in the agricultural sector represented 10.39% on total GDP in average – which is HUGE!

After all, we all need to eat.

Besides its importance as an industry, agriculture is very interesting accounting subject.

Why?

Here, we are dealing with life. Animals, plants, biological transformation, you name it.

We are trying to capture life in the accounts.

While doing so, there are many burning questions and troubles because of life’s specifics. I tried to respond some of them in this article.

Yet still I receive questions related to valuation of agricultural assets – how to measure them? How to set their fair value?

I would sum up the whole valuation process into 2 steps:

1. Identify what TYPE of agricultural asset you have;
2. Measure it accordingly.

Let’s see.
 

What type of agricultural asset is that?

From the accounting aspect, you can have a few types of assets involved in agriculture and your primary goal is to identify what type it is.

It is very similar as with financial instruments – classify it first, apply appropriate standard and then measure it accordingly.

Different types of agricultural assets are shown in the following scheme:

How to measure different types of assets in agriculture?

I. Biological assets

By definition in IAS 41, a biological asset is a living animal or plant.

I find this definition vague, because not all living animals and plants automatically fall within the scope of IAS 41.

First of all, you need to ask yourself a question:

In other words, are you managing the biological transformation and harvest of biological assets for specified purposes?

• If yes, then OK, the biological asset falls within the scope of IAS 41. For example, fish that you are growing on a farm.
• If not, then the asset is outside of IAS 41 scope. For example, fish that you pick from the sea (you did not manage the biological transformation of wild ocean fish, did you?).

Another example is dog – holding a dog for breeding puppies is agricultural activity (IAS 41 applies), but holding a guard dog for security purposes is not (IAS 41 does not apply).

The second question to ask is:

Is the biological asset bearer or consumable?
 

Consumable biological assets

Consumable biological assets are those that will be either:

• Harvested as agricultural produce; for example farmed fish, hogs for meat, trees grown for lumber etc.; or
• Sold as biological assets; for example seedlings of apple trees, young puppies, etc.

Consumable assets fall within the scope of IAS 41 and shall be measured at fair value less cost to sell.
 

Bearer biological assets

Bearer biological assets are other than consumable biological assets, for example apple tree held for harvesting apple, or cattle for milk production.

Here, IFRS makes a distinction between bearer plants and bearer animals:

• Bearer plants fall within the scope of IAS 16; but
• Bearer animals fall within the scope of IAS 41.

In conclusion – basically all animals do fall within the scope of IAS 41, regardless whether they are consumable or bearer.

Therefore, you need to measure them at fair value less cost to sell as well.

With plants, you need to differentiate and correctly assess what they are. And, as this question requires special attention, I will make up a Q&A session soon on this point.

Bearer plants fall within the scope of IAS 16 and therefore they are measured either applying cost model or revaluation model.
 

II. Agricultural produce

Agricultural produce is the harvested produce of the entity’s biological assets.

Examples are apples, eggs, milk, or meat.

Be careful – products made from agricultural produce are NOT agricultural produce anymore; rather they are inventories, for example apple juice, cheese, salami, etc.

Also, some people get confused about living animals.

Imagine you have a chicken farm and raise young chicks for further sale.

These young chicks are NOT an agricultural produce. Instead, they are biological assets, because they are living animals (thus meet the definition of a biological asset).

Agricultural produce shall be measured at fair value less cost to sell at the point of harvest.

After this point, agricultural produce becomes inventories and you need to apply the standard IAS 2.
 

III. Agricultural land

I mention this asset just to include it here, but it should be crystal clear.

Agricultural land that you use for agricultural activity is definitely within the scope of IAS 16 and measured using cost or revaluation model.

It is NOT an investment property under IAS 41, because you are using it for agriculture (own revenue-generating activity).

How to measure fair value of agricultural assets

Once we have identified what to measure at fair value less cost to sell and when to measure it, we need to look at the standard IFRS 13 Fair Value Measurement.

Yes, IFRS 13 applies even here with its principles.

IFRS 13 contains fair value hierarchy that classifies inputs to use for setting the fair value and sets priorities of these inputs:

• Level 1 inputs: Quoted prices in active markets for identical assets on the measurement date. This is by far the most preferred and accepted method of measurement.
   
  However, you can apply this only for assets with active market for similar assets with the same condition.

  No problem for agricultural produce like raw milk, eggs or meat – usually there is a strong active market to derive the fair value of these assets.

  Also, no problem for consumable biological assets close to their sale or harvest date.

• Level 2 inputs: Other than quoted market prices within Level 1 that are directly or indirectly observable for the asset.
   
  Basically we are talking about market-determined prices where active market does not exist. Imagine that some asset would be so rarely traded that the last trade happened some time ago. You can use most recent price as the input to fair valuation – that’s basically level 2 input.
• Level 3 inputs: Unobservable inputs for the asset.
   
  In agriculture, Level 3 is used when there is no active market for the asset in its present condition (e.g. age, height, weight). In practice, companies use present value of cash flows generated by the asset as Level 3 input to valuation technique.

To sum it up, here’s the order of valuation techniques to use:

1. Market price for the identical asset in an active market at the reporting date (or at the harvest date, based on the type of an asset) – that’s Level 1.
2. Recent transaction prices for the identical assets when no active market exists – that’s Level 2.
3. Market price for similar assets in an active market – that’s Level 2.
4. Present value of future cash flows from the assets – that’s Level 3.
5. Cost as an approximation of fair value – that’s Level 3, too and it can be used only in some situations as described below.

What does it practically mean?

For harvested agricultural produce and some consumable biological assets, there is an active market with exactly the same assets in the same condition and you can take the market price as level 1 input into your valuation.

For most biological assets that take longer time to produce, to mature and will not be harvested or sold until some distant time in the future, active market does NOT exist and you need to apply discounted cash flow technique.

Let’s illustrate it in the example.
 

Example – fair value of biological assets by discounted cash flows

ABC is a company that grows eucalyptus trees for harvesting them and using them for production of pulp.

In 20X1, ABC planted 1 000 trees. Eucalyptus trees are mature and ready for harvest after 7 years.

At the end of 20X3, the market price of one mature eucalyptus tree is CU 3 000.

Each year, ABC incurs costs to grow the trees amounting to CU 100 per tree.

ABC uses the discount rate of 5% (being market rate of return).

The fair value of ABC’s trees was CU 1 850 000 at the end of 20X2.

Calculate the fair value of ABC’s trees at the end of 20X3.

For the sake of simplicity, we will ignore inflation and other economic parameters here. I want to show the basic mechanics to you.

ABC’s 1 000 trees will be ready in 20X8, so at the end of 20X3, we need to list all the cash flows in the years 20X4 to 20X8 as I have done here:

This is the fair value of one tree; ABC has 1 000 trees, so the fair value of all eucalyptus trees is 1 920 000 CU – pardon for rounding involved here.

The total change in FV of the trees is therefore CU 70 000 (1 920 000 less 1 850 000).

Two remarks to this example:

1. Don’t forget to deduct the cost to sell from this fair value. In the table, we included cash outflows related to cost to grow the trees, but not cost to sell, so just bear in mind that once you have your fair values, you need do take cost to sell into account.
2. IAS 41 encourages you to disclose the fair value change over the year and to split this change into:
   • Change in FV due to physical change (trees grow and thus their FV increases); and
   • Change in FV due to change in prices (market prices can change over time).

   This disclosure is especially important for biological assets with production cycle longer than one year (e.g. eucalyptus trees in this example).

How to set the cash flows from biological asset?

General rule in IFRS 13 says that you should include all directly attributable cash inflows and outflows to the asset.

Which ones?

This strongly depends on the specific activity you are doing, specific biological assets that you are measuring and yes, it requires some judgment from you.

Examples of cash flow are:

• Cash inflows from sale of an asset or agricultural produce in the future. You might estimate it based on:
  • assumed asset’s weight, age, volume, etc.; and
  • market prices of a specific biological asset or agricultural produce.

  For example, let’s say you take care of forest with trees that will be chopped for wood after some time. You can estimate future cash inflow from the forestry assets (trees) based on assumed volume (cubic meters) of wood harvested from the forest and market price of wood from similar trees.

  One big NO: do NOT determine the fair value based on future prices in your contracts.

• Cash outflows to grow the asset.

  Examples are numerous here: animal food, vaccination of animals, fertilizers, herbicides, labor cost and other.

  Two big NOs: Do not include income tax and financing cash outflows.

Any exceptions from setting fair value of biological assets?

Yes, there are two situations when you don’t have to set the fair value:

1. Cost as an approximation of fair value.

   You can use cost instead of fair value, but only when either:

   • Little biological transformation happened since initial costs were incurred – for example, you plant seedlings of trees very short time before the end of the reporting period.
   • The biological transformation does not have a material impact on price, for example the trees with long production cycle right after planting.
2. The fair value cannot be reliably measured.
   This is extremely rare because you can almost always measure the fair value for biological assets, either based on Level 1, Level 2 or Level 3 inputs.