Agricultural accounting: Getting ready for the new fair value measurement

In recent quarterly growth and national accounts reports, agriculture appears to have been overtaken by the industry and services sectors as the economy’s growth drivers.

This notwithstanding, investors continue to see strong potential and numerous growth possibilities in agriculture, pointing to the modernization of farming techniques, improved weather-forecasting technology and demands for non-traditional agricultural products like biofuel. Investors will also require financial discipline if agricultural companies are to compete within the region or even globally.

It is timely then that International Financial Reporting Standard (IFRS) 13, Fair Value Measurements, becomes effective on January 1, 2013 for entities with biological assets and agricultural produce. IFRS 13 generally applies when another IFRS standard requires or permits fair value measurement and disclosures. The standards on agriculture require recognition of biological assets and agricultural produce at fair value less cost to sell, except in rare cases for biological assets where fair value cannot be measured reliably.

IFRS 13 clarifies “fair value” as the price that would be received in selling an asset, or paid in transferring a liability, in an orderly transaction between market participants at the measurement date. Clearly, this definition focuses on exit price.

OVERVIEW OF FAIR VALUE MEASUREMENT APPROACH

In measuring fair value of biological assets and agricultural produce, an entity is required to determine all of the following:

• The particular biological assets and agricultural produce that are the subject of the measurement -- An entity takes into account the same characteristics of the asset being measured that a market participant would take into account when pricing the particular asset (e.g., the condition and location of the biological assets or agricultural produce and any restrictions on the sale and use of these assets). Fair value measurement is therefore market-based and not “entity-specific.”

• Valuation premise that is appropriate for the measurement, consistent with the concept of “highest and best use” -- This considers a market participant’s ability to generate economic benefits when using an asset in the best way possible. It should be noted that the highest and best use concept is always considered when measuring fair value, even if the entity intends a different use.

• The principal market, or in its absence, the most advantageous market for the biological assets or agricultural produce -- The principal market, which the entity has access to, is the market with the greatest volume and level of activity for the asset. The most advantageous market is the market that maximizes the amount that would be received for the sale of the asset, after considering transaction and transport costs.

• The valuation technique(s) appropriate for the measurement, considering the availability of the data -- This data should represent the assumptions that market participants would use when pricing the biological asset or agricultural produce, and the level of the fair value hierarchy within which the inputs are categorized.

FAIR VALUE HIERARCHY AND VALUATION TECHNIQUES

IFRS 13 intends to increase consistency and comparability through a fair value hierarchy. This hierarchy provides three levels of categories for the inputs used in the valuation techniques. The highest priority is given to the unadjusted quoted price in active markets for identical assets (or liabilities) and the lowest priority is given to unobservable inputs.

Level 1 inputs are quoted prices in active markets for identical assets that the entity can access at the measurement date. This provides the most reliable evidence of fair value and is used without adjustment whenever available, with limited exceptions.

Level 2 inputs are other than quoted prices included within level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets either in active or inactive markets.

Level 3 inputs are unobservable inputs for the asset. Unobservable inputs are used to measure fair value to the extent that relevant observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset. An entity develops unobservable inputs using the best information available under the circumstances, which might include the entity’s own data, taking into account all information about market participants’ assumptions that is reasonably available.

IFRS 13 describes the three widely-used valuation techniques which an entity can consider in measuring its biological assets and agricultural produce.

• The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or group of assets.

• The cost approach reflects the amount that would be required currently to replace the service capacity of an asset. This is synonymous with the asset’s current replacement cost.

• The income approach converts future amounts (cash flows or income and expenses) to a single current (discounted) amount, reflecting current market expectations about those future amounts.

An entity may use any of the above valuation techniques appropriate to the circumstances and for which sufficient data is available to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs.

In some cases, a single valuation technique will be appropriate, whereas in other instances, multiple valuation techniques will be appropriate.

DISCLOSURE REQUIREMENTS

Adoption of IFRS 13 will result in more disclosures about an entity’s biological assets or agricultural produce. The objective is for the entity to disclose information that would help the users of the financial statements assess the following:

• for biological assets and agricultural produce that are measured at fair value on a recurring and non-recurring basis in the statement of financial position after initial recognition, the valuation techniques and inputs used to develop those measurements.

• for fair value measurements using significant unobservable inputs (Level 3, as discussed above), the effect of the measurements on profit or loss or other comprehensive income for the period.

Given that the mandatory implementation of IFRS 13 is less than a year away, affected entities should start assessing whether this new standard will change the amount recognized for biological assets or agricultural produce. If it does, management may have to consider its covenant compliance, remuneration plans, shareholder communications and analyst expectations.

Moreover, the significant increase in required disclosures and the changes in the way fair value is measured would require assessment as to whether the entity has the appropriate expertise, processes and systems to ensure compliance.

Alvin M. Pinpin is a Partner of SGV & Co.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.

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