Valuation of biological assets

based on May 2009 IFRIC agenda decision:

by Ajith Ratnayake

IAS 41 Agriculture requires biological assets to be recognised at fair value, unless the fair value cannot be determined reliably. Determination of an appropriate discount rate is essential to ensure that the valuation is reliable. An inappropriate low discount rate can result in excessive and misleading ‘day one’ profits. This article explains the manner in which an appropriate discount rate could be selected based on the May 2009 IFRIC agenda decision.

IAS 41 Agriculture prescribes the accounting treatment for biological assets for financial statements prepared in compliance with International Financial Reporting Standards (IFRS).

It requires measurement of a biological asset at fair value less cost to sell, other than when fair value cannot be measured reliably. Changes in fair value less cost to sell are recognised in profit or loss. Fair value of an asset is the amount for which it could be exchanged between knowledgeable, willing parties in an arms length transaction.

Where market determined prices or values are not available, the present value of expected net cash flows from the asset discounted at a current market-determined rate is used to determine fair value.

The objective of a calculation of the present value of expected 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.

The IFRC agenda decision clarifies as to how this is done in practice.

IFRIC agenda decision

International Financial Reporting Interpretations Committee (IFRIC) is the Committee which provides guidance on financial reporting issues not specifically addressed in IFRSs. When IFRIC considers that guidance already available is sufficient to address an issue, IFRIC publishes an agenda decision which preparers can use to interpret the requirements. IFRIC agenda decisions are made after a due process which involves publication of a tentative decision, receiving views from the public, publication of views submitted in the website, and a formal decision at a meeting which is open to the public.

In May 2009, IFRIC published an agenda decision on the selection of a discount rate for biological assets. It stated that when an entity incurs an initial cost with respect to a biological asset, paragraph 24 of IAS 41 notes that cost may approximate fair value when little biological transformation has taken place since the cost was incurred. In these situations the IFRIC noted that the discount rate selected would be expected to result in a value that approximates that cost.

The IFRIC also noted that IAS 39 and other material recently published by the IASB provide extensive guidance on estimating fair values of assets that do not have readily observable prices in active markets that would also be relevant for biological assets.

(To be continued)