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IAS 41: Fair Value Measurement Issues in Agriculture

Go To List of IFRIC Issues Issue Description: IAS 41 requires biological assets and agricultural produce be recognised and measured at their fair value. In some cases, a present value technique is used to estimate fair value because markets do not exist. IAS 41 requires that the cash flows exclude "any increases in value from additional biological transformation". The issue initially addressed in this project is whether a fair value measurement objective can be achieved if these future increases are excluded. The project has broadened to address recognition and measurement issues under IAS 41. Discussion at the IFRIC Meeting September 2003 The IFRIC noted that the harvest value at the balance sheet date (which could be zero) will generally be less than fair value, which is the objective of IAS 41. On the other hand, the present value of cash flows expected from the harvest will not include the risks associated with the growth over the harvest period, and therefore will generally be greater than fair value. The IFRIC noted (considering these upper and lower barriers) that fair value will generally be a risk adjusted cash flow. These cash flows may or may not reflect the expected growth over the harvest period. The IFRIC also discussed whether an entity that has the legal obligation to replant (for instance, trees) after harvest should recognise a provision when the trees are planted for the first time. The IFRIC concluded that a provision should be raised for the obligation to replant when the tree is cut down for the last time. The IFRIC also noted other areas of concern in IAS 41 that seem to prevent a fair value measurement when estimating cash flows, such as the requirement in IAS 44.22 to exclude taxation issues and costs to replant assets from the estimated cash flows. The staff will prepare a draft interpretation for IFRIC consideration at a future meeting. Discussion at the December 2003 IFRIC Meeting There is general concern that paragraph 21 of IAS 41 is internally inconsistent. The first part of paragraph 21 clarifies the principle that the objective of the measurement is fair value. However, the second part, read literally, seems to require the exclusion of a major portion of the fair value calculation, potential future growth of the biological assets. There was general agreement among IFRIC members that the goal is fair value and therefore, the potential (risk adjusted) growth should be considered. The IFRIC concluded to request the IASB clarify this paragraph in its improvements to IAS 41. The IFRIC also discussed whether and when obligations to replant or restore land (for instance after deforestation) should be included in the cost of the assets produced today in accordance with paragraph 22 of IAS 41. Some IFRIC members believe a model similar to decommissioning in IAS 16 (and interpreted by IFRIC D2) should by applied, while other members believe an obligation to replant should not be recognised unless an obligation exists and that the asset should be subjected to an impairment test. This issue will be discussed at a future meeting. Discussion at the February 2004 IFRIC Meeting The purpose of this project is to provide the IASB with suggested wording to amend certain requirements and statements in IAS 41. The IFRIC discussed the appropriate method for determining fair value in measuring biological assets and agriculture produce in accordance with IAS 41. Particularly, the IFRIC discussed whether material selling costs should be included as a deduction in determining the recognised fair value of the assets. The IFRIC noted that selling costs are not included as a deduction in determining the recognisable value of financial instruments in accordance with IAS 39. However, the IFRIC determined that often agricultural assets cannot be sold in an active market without necessarily incurring selling costs, such as harvesting and transportation, and therefore such costs ought to be factored into the measurement of fair value. The IFRIC discussed the requirement of IAS 41.21 that 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, and that the present condition excludes any increases in value from additional biological transformation. The IFRIC discussed whether this means that the expected future biological transformation should not be considered in determining the fair value of the assets in their current state. The IFRIC determined that ideally the fair value of the assets should be determined as the discounted value of the expected future cash flows, with the discount rate used including the risk factors associated with the successful biological transformation required before the asset is readily marketable. The IFRIC also discussed the impact of future restoration obligations (such as replanting obligations) on the determination of fair value. The IFRIC concluded that where the restoration obligation will create an additional asset for the entity, it should be capitalised as part of the asset. Where the restoration provision does not result in an additional asset for the entity (for example, restoring leased land at the end of the operating lease), the cost should be expensed. In accordance with the IFRIC's previous decision, and the subsequent agreement of the IASB to that decision, the staff will bring an amended copy of IAS 41 to the next meeting for IFRIC's consideration. Discussion at the May 2004 IFRIC Meeting The IFRIC agreed to recommend to the IASB proposed improvements to IAS 41 to clarify the application of the fair value measurement objective. The IFRIC discussed certain aspects of the proposed changes: The IFRIC discussed whether to add the term "highest and best use" to IAS 41 to clarify that fair value should be the price an economically rational company would choose. For example, if the price for grapes used to make wine is higher than for grapes used as by-product, the entity should assume it would sell its grapes to the wine producers if possible (that is, the grapes are of quality for wine). There was concern about adding this phrase in the text of IAS 41 as it is generally only used for property valuations. However, there was general agreement on the principle. The IFRIC then discussed the question of what fair value should be assigned to the unripened grapes when only a market for ripe grapes exists. The IFRIC noted that a value of nil would generally not be appropriate in this case and that the value of the unripe grapes should be determined by reference to the price of ripe grapes. The IFRIC decided to ask the IASB for further assistance in trying to identify the correct market to be used in determining fair value when many markets exist. For example, if there is a market for 2 year old and 10 year old trees, which market should be used to value 1 year old trees – the value in 1 year or the value in 9 years? No conclusions were reached on this issue. The IFRIC noted that the issues discussed here are similar to the issues being discussed by the IASB in its discussions around "Day 1 profits" under IAS 39. Discussion at the November 2006 IFRIC Meeting The IFRIC continued its discussion on an issue relating to accounting for biological assets and agricultural produce. The IFRIC referred these issues to the IASB in May 2004, however the Board's agenda did not permit the referral to be discussed. In the meantime the IASB agreed to undertake a project on fair value measurement (FVM) which is likely to affect how the IFRIC should deal with the issues raised. The IFRIC's issues relate to paragraph 21 and 22 in IAS 41. Two questions have been addressed by the IFRIC as a result of the submissions it received: How should an entity account for an obligation to replant a biological asset after harvest? The IFRIC previously decided that it would not issue guidance on how to account for an obligation to replant a biological asset after harvest. What does the exclusion from taking into account increases in value from 'additional biological transformation' mean in the context of IAS 41.21? In particular, what is the implication of this exclusion where a valuation is based on forecast future cash flows (which can only be achieved after future biological growth)? At the November 2006 meeting the IFRIC focused the discussion on the content in paragraph 21 of IAS 41. IFRIC members supported removing the prohibition against taking into account future growth on biological assets. IFRIC members considered that market participants would take into account future growth when valuing these items and also commented that there are risk factors in future growth that should be considered when measuring those assets. The IFRIC then discussed whether agricultural assets should be measured according to its 'highest and best use in the most advantageous market', a principle that will feature in the forthcoming IASB Discussion Paper on Fair Value Measurement. IFRIC members were split; some members did not think the IFRIC should move forward with a measurement concept that has not yet been explored fully and adopted by the IASB, while others would include the concept as it is likely to survive in the FVM project. Paragraph 21 of IAS 41 refers to increases in value from 'transformation'. IFRIC members seemed to agree that the staff needed to clarify the underlying meaning of this concept. The IFRIC decided that it should continue the work on this issue as there appears to be widespread diversity in practice. The staff was directed to address the problems specifically with paragraph 21 in IAS 41, and consider if and how IAS 41 can be amended to address the concerns raised by constituents. Discussion at the January 2007 IFRIC Meeting At its November meeting, the IFRIC agreed to recommend to the Board that it amend IAS 41.21 to remove the prohibition on taking into account additional biological transformation when using discounted cash flows to measure the fair value of a biological asset. The staff presented a paper recommending the following amendments to paragraph 21 of IAS 41: An entity may use present value techniques 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. If so, an entity includes the net cash flows that market participants would expect the asset to generate in its relevant market. However, the present value does not include any cash flows from finance costs or income tax expense, or from re-establishing biological assets after harvest (for example, the cost of replanting trees in a plantation forest after harvest). An entity considers the risk associated with bringing the asset to the condition and location in which it will be sold in the relevant market 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. The discussion focused on the determination of the relevant market for immature biological assets which was the subject of the initial submission to IFRIC. The majority of the IFRIC members seemed to agree that an active scrap market is not the relevant market for immature biological assets if the biological asset is expected to be grown to maturity and to be sold in a market for mature biological assets. In this case a market for mature biological assets would be the relevant market. The IFRIC noted that paragraphs 17 to 21 of IAS 41 need to be read in context and that an additional amendment of paragraph 17 of IAS 41 might clarify this issue. It appeared that they recommended changing the first sentence of paragraph 17 of IAS 41 to something like: "If an active market exists for a biological asset or agricultural produce in its present condition, the quoted...". In addition a reference to this sentence should be included in paragraph 21 of IAS 41. Decision: Remove from IFRIC agenda. Issue to be considered in IASB's annual improvement process.