KUALA LUMPUR: Public-listed plantation companies have the option of deferring the adoption of International Accounting Standard (IAS) 41 Agriculture for another year, according to the Malaysian Accounting Standard Board (MASB).
The accounting body said this last month when it announced a new MASB approved accounting framework, the Malaysian Financial Reporting Standards (MFRS Framework).
The issuance was made in conjunction with MASB’s plan to converge with International Financial Reporting Standards (IFRSs) in 2012.
The MASB said the MFRS Framework is to be applied by all other than private entities starting Jan 1, with the exception of entities that are within the scope of MFRS 141 Agriculture and IC Interpretation 15 Agreements for Construction of Real Estate (IC 15). MFRS 141 is the equivalent of IAS 41.
This is to accommodate potential changes as the International Accounting Standards Board is planning to issue a new standard that would subsume IC 15 and is like to amend IAS 41.
“If you want to adopt it, you can. But if you choose not to, that gives you a respite of one year. By the time the revised standard is out, you can adopt the new standard, but if not, you won’t be in compliance with IFRS even though you are in compliance with Malaysian standards,” Lee Kok Wai, partner at Crowe Horwath, explained.
“Companies may choose to go ahead or defer one year. MASB gave its views at the National Standard Setters meeting in New York in March with the hope that the standard would be amended. MASB achieved its objective by putting a review of this standard,” said James Chan, a partner at Crowe Horwath.
Loh Kam Hian, audit partner at KPMG, explained that IAS 41 came about from the need to have a standard for each line of asset and liability reported in the statement of financial position.
“Where do biological assets come in? You have IAS 2 on inventories which cover fruit but exclude the producers — the trees. You will find IAS 16 for fixed assets but again this excludes forest assets.”
“So there’s a gap, there was no standard governing the bearer, the biological assets. Hence IAS 41 to bridge the gap,” said Loh.
Malaysian plantation companies, which have been using the historical cost method in valuing their biological assets, had previously voiced concern about the implementation of IAS 41. IAS 41 requires companies involved in agriculture activities, for example livestock farming, oil palm planting and even timber harvesting, to fair value their biological assets at each balance sheet date.
While the cost method is simple, fair valuation requires judgement in the assumptions applied in the financial model, for example the discount rate, the growth rate, the life expectancy of the assets, among others, to arrive at the assets’ fair value.
To account for the fair value of oil palm trees for example, one would need to determine their market value.
“Is there an active market available, if not, you try to find approximates from similar recent market transactions. When you do not have approximates, you need judgement when you prepare the present value of expected cash flow of the asset,” Loh added.
This requires expertise and additional costs for the preparers of financial statements as independent external valuers are often engaged for this exercise.
Sime Darby Bhd, which owns more than 500,000ha of oil palm estates in Malaysia, Indonesia and Africa, has commenced an assessment of the implication of IAS 41 on financial statements. The valuation methodology was determined and enhanced in consultation with a professional firm of valuers.
As assumptions change with market conditions, the bottom lines of companies will also be affected.
“Results will be quite volatile because values go up an down due to the various variables. The cost method as currently used is much more predictable in that way,” Loh said.
Aside from the element of subjectivity and risk of volatility in companies’ bottom lines, Chan said the judgement calls made by the preparer may also lead to open disagreements with the auditor.
“Auditors are required to challenge and question the preparer and conduct a stress test. If the basis used is not reasonable then there is bound to be disagreement which may lead to qualified accounts,” he explained.
From a practical standpoint, TH Plantations Bhd CFO Mohamed Azman Shah Ishak said for a company with vast oil palm estates in different locations, with differing age profiles and soil conditions, arriving at the fair value may require pages of assumptions, which may only confuse users.
A Sime Darby spokesperson said that given its large planted area, the biggest challenge in implementing IAS 41 is gathering and managing source data relevant for the purpose of valuation of biological assets and the preparation of discounted cash flows to the lowest cash generating unit which is on a field-by-field basis. Source data refers to past historical financial and operational records, projected selling prices, field maps, soil classification, projected financial and operational performance, rainfall statistics, the spokesperson added.
“Furthermore in the event that an external professional valuer is required to determine the fair value of the biological assets periodically, this is likely to be an additional recurring cost,” she said.
Azman questioned whether knowledge of the market value of the biological assets of a company would serve the needs of a long-term investor.
“Because you’re not going to realise it, the company is a going concern which will continue to operate. If you have an intention to sell it, then I want to know the value but otherwise, I just want to know the value it can give me as a going concern not if it’s realised,” he said.
Financial practitioners added that dividends paid by companies are not based on their intrinsic value but on value realised year by year. When the bottom lines reflected in financial statements under fair valuation predominantly comprise unrealised profit, it should be noted that they may not necessarily have the cash flow to pay dividends.
Despite the concerns, Sime Darby said IAS 41 will introduce a new concept of recognising profit upfront in the plantation industry.
“Plantation companies are likely to show a windfall profit in the initial year of planting when biological assets are fair valued. However, the profit would be on a decreasing trend in subsequent years if operations remain static,” the Sime Darby spokesperson said.
Loh said that through education and adequate disclosures in the financial statements, stakeholders would be able to benefit from IAS 41.
“In a world where people are informed, the information will unlock a lot of value. In the cost method, values are generally lower. There’s talk about plantation companies being undervalued so showing fair value, especially in this market when values are high, may unlock some of these values. So, it’s not all bad for the plantation companies. Shareholders may benefit from it,” he added.
This article appeared in The Edge Financial Daily, December 5, 2011.
The accounting body said this last month when it announced a new MASB approved accounting framework, the Malaysian Financial Reporting Standards (MFRS Framework).
The issuance was made in conjunction with MASB’s plan to converge with International Financial Reporting Standards (IFRSs) in 2012.
The MASB said the MFRS Framework is to be applied by all other than private entities starting Jan 1, with the exception of entities that are within the scope of MFRS 141 Agriculture and IC Interpretation 15 Agreements for Construction of Real Estate (IC 15). MFRS 141 is the equivalent of IAS 41.
This is to accommodate potential changes as the International Accounting Standards Board is planning to issue a new standard that would subsume IC 15 and is like to amend IAS 41.
“If you want to adopt it, you can. But if you choose not to, that gives you a respite of one year. By the time the revised standard is out, you can adopt the new standard, but if not, you won’t be in compliance with IFRS even though you are in compliance with Malaysian standards,” Lee Kok Wai, partner at Crowe Horwath, explained.
“Companies may choose to go ahead or defer one year. MASB gave its views at the National Standard Setters meeting in New York in March with the hope that the standard would be amended. MASB achieved its objective by putting a review of this standard,” said James Chan, a partner at Crowe Horwath.
Lee: By the time the revised standard is out, you can adopt the new standard.
Chan: MASB achieved its objective by putting a review of this standard.
Loh: You have IAS 2 on inventories which cover fruit but exclude the producers - the trees.
Loh Kam Hian, audit partner at KPMG, explained that IAS 41 came about from the need to have a standard for each line of asset and liability reported in the statement of financial position.
“Where do biological assets come in? You have IAS 2 on inventories which cover fruit but exclude the producers — the trees. You will find IAS 16 for fixed assets but again this excludes forest assets.”
“So there’s a gap, there was no standard governing the bearer, the biological assets. Hence IAS 41 to bridge the gap,” said Loh.
Malaysian plantation companies, which have been using the historical cost method in valuing their biological assets, had previously voiced concern about the implementation of IAS 41. IAS 41 requires companies involved in agriculture activities, for example livestock farming, oil palm planting and even timber harvesting, to fair value their biological assets at each balance sheet date.
While the cost method is simple, fair valuation requires judgement in the assumptions applied in the financial model, for example the discount rate, the growth rate, the life expectancy of the assets, among others, to arrive at the assets’ fair value.
To account for the fair value of oil palm trees for example, one would need to determine their market value.
“Is there an active market available, if not, you try to find approximates from similar recent market transactions. When you do not have approximates, you need judgement when you prepare the present value of expected cash flow of the asset,” Loh added.
This requires expertise and additional costs for the preparers of financial statements as independent external valuers are often engaged for this exercise.
Sime Darby Bhd, which owns more than 500,000ha of oil palm estates in Malaysia, Indonesia and Africa, has commenced an assessment of the implication of IAS 41 on financial statements. The valuation methodology was determined and enhanced in consultation with a professional firm of valuers.
As assumptions change with market conditions, the bottom lines of companies will also be affected.
“Results will be quite volatile because values go up an down due to the various variables. The cost method as currently used is much more predictable in that way,” Loh said.
Aside from the element of subjectivity and risk of volatility in companies’ bottom lines, Chan said the judgement calls made by the preparer may also lead to open disagreements with the auditor.
“Auditors are required to challenge and question the preparer and conduct a stress test. If the basis used is not reasonable then there is bound to be disagreement which may lead to qualified accounts,” he explained.
From a practical standpoint, TH Plantations Bhd CFO Mohamed Azman Shah Ishak said for a company with vast oil palm estates in different locations, with differing age profiles and soil conditions, arriving at the fair value may require pages of assumptions, which may only confuse users.
A Sime Darby spokesperson said that given its large planted area, the biggest challenge in implementing IAS 41 is gathering and managing source data relevant for the purpose of valuation of biological assets and the preparation of discounted cash flows to the lowest cash generating unit which is on a field-by-field basis. Source data refers to past historical financial and operational records, projected selling prices, field maps, soil classification, projected financial and operational performance, rainfall statistics, the spokesperson added.
“Furthermore in the event that an external professional valuer is required to determine the fair value of the biological assets periodically, this is likely to be an additional recurring cost,” she said.
Azman questioned whether knowledge of the market value of the biological assets of a company would serve the needs of a long-term investor.
“Because you’re not going to realise it, the company is a going concern which will continue to operate. If you have an intention to sell it, then I want to know the value but otherwise, I just want to know the value it can give me as a going concern not if it’s realised,” he said.
Financial practitioners added that dividends paid by companies are not based on their intrinsic value but on value realised year by year. When the bottom lines reflected in financial statements under fair valuation predominantly comprise unrealised profit, it should be noted that they may not necessarily have the cash flow to pay dividends.
Despite the concerns, Sime Darby said IAS 41 will introduce a new concept of recognising profit upfront in the plantation industry.
“Plantation companies are likely to show a windfall profit in the initial year of planting when biological assets are fair valued. However, the profit would be on a decreasing trend in subsequent years if operations remain static,” the Sime Darby spokesperson said.
Loh said that through education and adequate disclosures in the financial statements, stakeholders would be able to benefit from IAS 41.
“In a world where people are informed, the information will unlock a lot of value. In the cost method, values are generally lower. There’s talk about plantation companies being undervalued so showing fair value, especially in this market when values are high, may unlock some of these values. So, it’s not all bad for the plantation companies. Shareholders may benefit from it,” he added.
This article appeared in The Edge Financial Daily, December 5, 2011.
