Evaluation of Biological Assets Problems and Solutions.doc

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Evaluation of Biological Assets: Problems and Solutions Sarmīte Rozentāle, Maira Ore idzeme !niversit" of A##lied Sciences, idzeme, $atvia

%&e c&ief #roduction elements of an agricultural enter#rise are its biological assets and t&e c&oice and #ractical a##lication of t&e evaluation met&ods, as t&e assets directl" affect man" as#ects: decision ma'ing of economic c&aracter b" t&e financial statement user, indicators of financial o#eration anal"sis, inter(com#arison of sector enter#rises, assessment of t&e com#an" value and ta)es on its economic activit", and statistical data of t&e agricultural sector* %&e aut&ors &ave used t&e discounted cas& flo+ -./0 as an alternative met&od and a model of s"stem d"namics* Suc& a s"stem d"namics met&od &as not been used for assessment of biological assets so far* 1n t&e o#erating #rocess, t&e com#an" ac2uires or loses #ossession of t&e resources* 1t is vital to anal"ze t&e resources to see +&et&er t&e" com#l" +it& t&e conce#t of t&e assets and t&e terms of recognition* 1t is necessar" for t&e same com#an" as +ell as for e)ternal users of financial statements to get true information about t&e business and t&e value of mone"* Biological assets ma" be recognized in t&e com#an"3s accounting onl" +&en it is  #redictable t&at future benefits associated +it& t&ese assets +ill flo+ into t&e enter#rise* 1t is also im#ortant t&at t&e fair value or t&e cost can be measured reliabl"*  Keywords: biological assets, assessment met&ods, fair value Introduction

Agriculture #rovides t&e #o#ulation +it& liveli&ood* 1t #romotes commercial activities and sustainable em#lo"ment in rural areas, t&us im#roving t&e living 2ualit" and retaining densit" of rural #o#ulation* %&e value of agriculture in t&e total net domestic #roduct 4-P0 of $atvia 'ee#s a gro+ing trend, and in 5676, it +as 7*89* rain cro#s and mil' are definitel" t&e most significant agricultural #roducts of t&e $atvian agriculture Ministr" of Agriculture of Re#ublic of $atvia, 56770* .om#re&ensive, ob;ective, and timel" information is vitall" im#ortant for a successful develo#ment of t&e national econom" in mar'et conditions* %&e main sources of information including agriculture are accounting statement data of t&e com#anies on #rocedures allo+ing t&e single(entr" accounting s"stem to be used b" sole traders, individual enter#rises, farms and fis&eries, and ot&er natural #ersons 5

carr"ing out an economic activit"? .abinet of Ministers, 5668a0 and .abinet regulation 4o* K67 from K

Ma" J, 566J, >regulations on sole traders3 financial statements? .abinet of Ministers, 5668b0* %&is normative legislation does not sti#ulate nor define re2uirements regarding t&e evaluation of biological assets* %&e accountants of ot&er agricultural enter#rises &ave to follo+ t&e re2uirements of t&e la+ on annual re#orts +&ic& &ave certain inconsistenc" and contradictions in com#arison +it& 1AS F7* .urrent assessment met&ods of biological assets for $R(registered agricultural enter#rises are &istorical cost accounting .A0 and fair value accounting /A0* 1AS F7 re2uires t&at biological assets s&all be measured at t&eir fair value less estimated sales costs from t&e initial recognition of t&e biological assets to t&e #oint of &arvest, e)ce#t cases +&en fair value cannot be measured reliabl" on t&e initial recognition* %&e fair value of an asset is based on its #resent location and condition* As a result, for e)am#le, t&e fair value of cattle at a farm is t&e #rice for t&e cattle in t&e relevant mar'et less t&e trans#ort and ot&er costs of getting t&e cattle to t&at mar'et 1nternational Accounting Standards .ommittee, 56660* $atvian agricultural com#anies sub;ected to t&e annual accounts la+ ma" evaluate t&eir biological assets b" t&e cost account met&od or a##l" t&e fair value met&od* %&e annual accounts la+ defines t&e cost account met&od in Section 5D, Part K, as follo+s: >.ost account is calculated b" summing t&e cost of ra+ materials and ot&er e)#enses directl" related to manufacturing t&e res#ective ob;ect* 1ndirect F

e)#enses ma" also be included in t&e cost account if t&e" refer to t&is #eriod of time? Su#reme .ouncil of Re#ublic of $atvia, 75a0* %able 5 s&o+s a com#arison of &istorical cost and fair value b" different criteria* %able 5 omparison of !alue alculation "et#ods .riterion alue calculation at t&e moment of recognition and eac& date of  balance -e#reciation

alue c&anges

Additional  #rovisions

istorical cost Purc&ase cost N  #urc&ase #rice  associated costs or  #roduction cost N direct costs  indirect costs 1s assessed 1n case of value decrease according to t&e lo+est value or in case of value increase according to t&e &ig&est value

 4one

/air value /air value N mar'et value Q calculated sales costs 1s not assessed 1ncluded in t&e  #rofit and loss account Active mar'et e)ists or it is  #ossible to state t&e fair value b" ot&er recognised met&ods

 Note. Source: %&e aut&ors3 o+n stud" based on t&e 1AS F7 and t&e annual accounts la+*

5

Retrieved from &tt#:LL+++*li'umi*lvLdoc*#&#idN7FJF6* K Retrieved from F

&tt#:LL+++*li'umi*lvLdoc*#&#idN78676fromNoff* Retrieved from &tt#:LL+++*li'umi*lvLdoc*#&#idNDDFD7*

%able K gives a com#arison of re2uirements of 1AS F7 and annual accounts regarding evaluation of  biological assets and evaluation of agricultural #roduce obtained from biological assets at t&e #oint of &arvest* According to t&e stoc' assessment #rocedures stated in Sections K6, K7, and K5 of t&e annual accounts la+, t&e #roduction obtained in t&e &arvesting #rocess or animal breeding or cessation of animal3s life #rocess s&ould be registered as #roduction cost* %&is is different from 1AS F73s >Agriculture? guidelines +&ic& #rovide an assessment of t&e agricultural #roduce obtained in t&e &arvesting #rocess to be assessed at t&eir fair value, +&ic& in furt&er records is treated as cost of  #roduction alniCa, 566D0* %able K  Re$uirements for Assessment of Biological Assets Ob;ect

1AS F7

Biological assets

/air value

Agricultural #roduce obtained from  biological assets at t&e #oint of &arvest

/air value, +&ic& in furt&er accounting is e2ualized to  #roduction costs

Annual accounts la+ /air value or &istorical cost

istorical cost

 Note* Source: %&e aut&ors3 o+n stud" based on t&e 1AS F7 and t&e annual accounts la+*

Regarding 1AS F7 a##roved b" t&e 1AS .ouncil in -ecember 56660, Elad maintained t&at it >mar'ed bot& a radical de#arture from t&e traditional accounting for biological assets and an earl" test of fair value accounting? Elad, 566FH as cited in /is&er, Mortensen,  Gebber, 5676, #* 70* >%&ere is an intense debate on t&e convenience of moving from &istorical cost account to t&e fair value #rinci#le? Argils, arcia(Blandon,  Monllau, 5677, #* J 80* >Economic realities and current develo#ments &ave made man" sc&olars +onder about +&et&er cor#orate re#orting s&ould be led b" mar'ets or b" regulators* Mean+&ile, t&e conce#t of fair value and its im#lementation ta'es t&e aut&ors even furt&er into an area +&ere management3s in#ut and disclosure ta'es on added significance? Bonaci  Strou&al, 5677, #* 7F0* 1nternational scientists3 cognitions on t&e advantages and disadvantages of t&e fair value met&od &ave been accumulated b" /is&er et al* 56760, Argils et al* 56770, and Bonaci and Strou&al 56770* G&ile anal"sing statements of t&eoreticians, t&e aut&ors &ave identified t&e follo+ing disadvantages of t&e .A model: 70 >1t fails to ade2uatel" account for t&e uni2ue re#roductive and natural transformational nature of biological assets? Argils  Slof, 5667H as cited in /is&er et al*, 5676, #* 50H 50 1t >ignores t&e realities of ra#idl"(c&anging mar'et values of farming assets? .o+an, 785H as cited in /is&er et al*, 5676, #* 50H and K0 /inancial statement users need a better assessment of t&e true #erformance and management of t&e firm t&an allo+ed t&roug& &istorical cost Argils et al*, 56770* As regards t&e advantages of t&e .A model com#ared +it& /.A, t&e" are t&e follo+ing: 70 /air valuation is sub;ected to more mani#ulation and is a #oorer measure of +ort& and #erformance t&an &istorical cost accordingl"H 50 >Accounting cannot com#ete +it& t&e mar'et in valuing a firm? Gatts, 566DH as cited in Argils et al*, 5677, #* 60H K0 >/air valuation does not necessaril" ma'e investors better off, and t&at its usefulness &as not been demonstrated? Ball, 566DH as cited in Argils et al*, 5677, #* 60H F0 >/air value accounting is liable to #roduce absurdities and misleading information, if it is based on e)#ectations t&at turn out to be false? Ra"man, 5668H as cited in Argils et al*, 5677, #* 60H and 0 /air value >in&erits more managerial mani#ulation and induces less efficient investment decisions t&an cost valuations? $iang  Gen, 5668H as cited in Argils et al*, 5677, #* 60* %&e aut&ors &ave s"stematised researc&ers3 o#inions of general assessment of /A model see %able F0*

%able F %eneral Assessment of F!A "odel Positive argument

/air value information en&ances decision usefulness and trans#arenc", as it is timel" reflected in current mar'et conditions /is&er et al*, 56760*

An asset is reflected in t&e  balance in its fair value, if its #rime cost is smaller t&an its mar'et #rice alniCa, 566D0*

%&e im#ortance of anal"tical financial information increases for its users uzmina, 566D0*

4egative argument /A comes at t&e e)#ense of reliabilit" and understandabilit", referring to t&e need to sometimes use some+&at arbitrar" mar'et(  based values t&at rel" on sub;ective means of establis&ment Barlev  addad, 566KH Penman, 5668H Benston, 566JH as cited in /is&er et al*, 5676, #* 70* o+ to determine t&e costs of ascertaining suc& values,  #articularl" for re#orting entities in t&e develo#ing countries /is&er et al*, 56760 %&e annual revaluation re2uirements im#osed b" 1AS F7 mig&t #rove difficult and e)#ensive, #articularl" in less develo#ed countries Elad, 566FH as cited in /is&er et al*, 5676, #* F0* %&e undesirable effects of increased volatilit" of t&e re#orted earnings /arg&er, 5667H Penman, 5668H as cited in /is&er et al*, 5676, #* 70* /air value does not al+a"s reflect t&e true economics of  business /is&er et al*, 56760* %&e e)tension of /A to a range of assets, industries, and countries &as raised concerns about t&e abilit" of one measurement s"stem to be all t&ings to all sta'e&olders, +it& man" of t&e 'e" re2uirements  being tailored to assets +&ere active mar'et is #revalent e*g*, financial instruments0 Penman, 5668H as cited in /is&er et al*, 5676, #* 70* 1ncreased com#an" income ta) ris' for small and medium com#anies, +&ere accounting is done mainl" for fair ta) calculation reasons alniCa, 566D0*

 Note. Source: %&e aut&ors3 o+n stud" based on s"stematised researc&ers3 o#inions*

A##lication of t&e #rinci#le of fair value allo+s #re#aring a &ig&er(2ualit" financial statement from t&e #oint of vie+ of financial management uzmina, 566D0* 1n t&e furt&er #rocess of anal"sis based on financial re#orting 2ualit" c&aracteristics, t&e aut&ors &ave s"stematised t&e main conce#ts of t&eoreticians regarding t&e assessment of biological assets* G&en #re#aring an annual re#ort, t&e agricultural com#anies s&ould reflect an ob;ective accounting value of a  biological asset on t&e balance and correctl" reflect t&e value c&anges in t&e #rofit and loss account so t&at t&e included information s&ould meet all t&e 2ualit" criteria: relevance, reliabilit", com#arabilit", and understandabilit"* %+o #rimar" criteria re2uired b" accounting standards are relevance and reliabilit" Argils et al*, 5677H false or misleading statements and a reduction in trusting t&e  #resentation of relevant financial information? /is&er et al*, 5676, #* F0* /or man" assets and obligations assessed b" /A, mar'et #rices are not available uzmina, 566D0* Problems of mat&ematical calculations of &"#ot&etical mar'et #rices fair value0 uzmina, 566D0* %&e accountants face t&e  #roblem of defining t&e mar'et values  ⎯ +&at e)actl" is it -efining t&e mar'et value is sub;ective to a certain e)tent -ziTuma, 56660*

 Note. Source: %&e aut&ors3 o+n stud" based on s"stematised researc&ers3 o#inions*

According to Bradbur" 566JH as cited in Bonaci  Strou&al, 56770: 1t is #ossible t&at re#lacement cost is a better measurement met&od on some dimensions, de#rival value is better on ot&er dimensions, and even &istorical cost is better on certain dimensions* %&us, it is still #ossible for fair value accounting to be, on average, t&e best* #* 70

%a'ing into account t&at none of t&e #reviousl" offered met&ods can be a##lied +it&out caution, t&e

aut&ors offer an alternative met&od for biological asset evaluation, namel", t&e discounted cas& flo+ -./0 met&od* Biological assets, for instance, a cattle &erd, are a long(term investment +it& an aim to gain #rofits in t&e future* %&e asset value is closel" connected +it& future revenues from t&e use of t&is asset* /rom t&is #oint of vie+, it ma" be considered as an investment #ro;ect* S#ecific #ro;ect evaluation met&ods e)ist for t&is #ur#ose, for instance, 4P, internal rate of return 1RR0, modified 1RR M1RR0, and t&e #ro;ect value indicators are lin'ed to t&e #ro;ect revenues Revenues s&ould e)ceed t&e cost of t&e #ro;ect0* Bot& 2uantitative and 2ualitative indicators are used for t&e #ro;ect evaluation* Uuantitative indicators reflect  #ro;ect e)#enses and e)#ected income in absolute terms, suc& as t&e mil' "ield #er "ear, feed costs, t&e number of units, veterinar" e)#enses, etc** %&ese criteria can be easil" set, tested, and evaluated* Uualitative criteria define t&e #ro;ect 2ualit" #arameters, suc& as t&e selection of a ne+ breed, etc** /or testing t&eir fulfilment, one needs more com#licated evaluation met&ods, for instance, observations, e)#ert evaluation, and testing* Recent findings in financial economics em#&asize t&e gro+ing role of cas& flo+ measures in com#an" valuation models and assessment of t&e financial #osition of an enter#rise* iven t&e measurement #roblems in accrual accounting, more and more investors and ot&er users of financial statements are beginning to focus on com#an" cas& flo+s instead of earnings of a firm Subatnie's, 56680* /uture cas& flo+ of biological assets ma" be mat&ematicall" de#icted in t&e follo+ing +a" see %able 80: .as& flo+ stream from investment is indicated as F t   in time t N 6, 7, 5*** ( , +&ere t&e e)#enses at t&e beginning are: F 6 V 6* %able 8  Future as# Flow of Biological Assets Biological asset t"#e 6 7 5 ************ ( .attle &erd F 6 F 7 F 5 *************** F(  Note. Source: %&e aut&ors3 o+n stud"*

 4e+ Wealand and Australian accounting bodies +ere unified in t&eir belief t&at certain agricultural assets e*g*, livestoc'0 s&ould be valued at t&eir net current value* !nder#inning t&e c&oice of net current value is a vie+ t&at it  #rovides more relevant information to t&e #roducers, farm advisers, and ot&er relevant users /is&er et al*, 56760* %&e 1AS F7 re2uirements allo+ using -./ met&od for biological assets assessment in some situations, and annual accounts la+ allo+s using t&is met&od for assessment of financial instruments 1nternational Accounting Standards .ommittee, 5666H Su#reme .ouncil of Re#ublic of $atvia, 75a0* Broad a##lication of cas& flo+ is #ossible in ascertaining t&e sources and uses of cas&, e)#laining t&e difference  bet+een earnings and cas& c&anges, evaluating a com#an"3s abilit" to settle debts and #a" dividends, and #redicting a com#an"3s future cas& flo+ Subatnie's, 56680* %&e abovementioned investment evaluation met&ods re2uire c&oosing a relevant discount rate, +&ic& ma" be inter#reted as sun' ca#ital cost #ossibilities* -iscount rate ma" be based u#on government bond "ields in t&e investment #eriod as +ell as on t&e #ro;ect ris' degree* %&e c&ief ris's for biological assets in t&e dair" farming sector, for instance, a cattle &erd, are diseases, insects, etc** %&e main disadvantages of t&e abovementioned met&ods are uncertaint" of cas& flo+ #ro;ections and isolation of t&e model variables* 1t ma" &a##en to be im#ossible to affect t&e most sensitive variables against 4P* %&ese met&ods do not anal"se t&e interactions among elements of a s"stem +it&in time* %&e economic crisis and its conse2uences do not allo+ using t&e traditional statistical and economic forecasting met&ods +&ic& cannot #rovide ade2uate evaluation of t&e future #rocesses*

Ambiguous circumstances re2uire finding #rinci#all" ne+ met&ods ⎯ a##roac&es +&ere statisticall" uncertain relations&i#s &ave a minor role* 1n suc& conditions, t&e role of e)#ert met&ods increases, +&ile for totall" obscure circumstances, one of t&e actual +or'ing met&ods is s"stem d"namics S'ribans, 56760* %&e s"stem d"namics met&od &as become a modern ever"da" a##roac& to find business #roblem solutions* S"stem d"namics is one of researc& directions of s"stems +&ic& anal"ze a s"stem3s be&aviour +it&in time de#ending on t&e structure of t&e s"stem3s elements and t&eir interactions, including cause and effect relations&i#s, reci#rocal lin's, reaction time to e)#osure, etc** Economic s"stem d"namics e)#lores t&e aggregate of economic relations&i#s affecting t&e ob;ect b" a##l"ing relations&i#s3 mat&ematical e2uations, calculation algorit&ms, and s#ecial com#uter #rograms for simulation modelling* %&e main tas' of t&e s"stem d"namics met&od is to reflect t&e real relations&i#s in t&e model b" imitating be&aviours of t&e economic ob;ect* %&e ne)t ste# after creating t&e model is an e)#eriment +it& t&e &el# of t&e model and anal"sis of t&e results S'ribans, 566J0* %&e s"stem d"namics met&od +as created and develo#ed b"