Agriculture, a fundamental element of our economy presents unique challenges when it comes to financial reporting, particularly due to the nature of biological assets. These assets including living plants and animals, are central to farming operations and introduce complexities due to their biological transformation and the inherent variability in their valuation.

Accountants offering or expanding their services into agricultural accounting must be familiar with these unique financial requirements.

The accounting standards for farming

The International Accounting Standard 41 (IAS 41) Agriculture prescribes the appropriate accounting treatment and disclosures for agricultural activities. Specifically, it deals with the accounting of biological assets, agricultural produce at the point of harvest and related government grants. It aims to ensure that the financial statements of entities engaged in agriculture reflect the unique characteristics of biological assets and the transformations these assets undergo through growth, degeneration, and production. IAS 41 mandates that:

• Biological assets and agricultural produce at the point of harvest be recorded at their fair value minus any selling costs. This approach captures the actual market conditions at the time of harvest, rather than just the cost of production, leading to financial statements that better reflect the market-based realities of farming operations.

• Government grants are accounted for in a way that aligns with the conditions under which they are received, ensuring that the financial impact of these grants is transparently and accurately reflected in the entity’s financial statements. This methodological approach facilitates clearer, more actionable financial insights for stakeholders involved in or with the agricultural sector.

Recording of Biological Assets

Biological assets are living plants or animals fundamental components of farming and other agricultural operations, held by an entity for agricultural production or breeding. Examples of biological assets include livestock, crops, vineyards, and orchards.

The valuation and management of these assets are critical as they undergo biological transformation—growth, degeneration, reproduction—which significantly affects their quality, quantity, and ultimately, their economic value. Accounting standards such as IAS 41 Agriculture provide specific guidance on how to recognise, measure, and disclose the value of biological assets in financial statements, ensuring that their fluctuating value is accurately reflected in line with current market conditions.

Recognition

Farming operations should recognise biological assets and agricultural produce in their financial statements when normal asset recognition rules are met. This is when they gain control over the assets, there is expected future economic benefits to be derived, and the value or cost can be reliably measured.

Measurement

At each reporting period, biological assets must be measured at their fair value minus any selling costs, except when fair value cannot be reliably measured. Similarly, agricultural produce harvested from the entity’s biological assets should also be measured at fair value less costs to sell at the point of harvest or full maturity. This approach ensures that the financial statements accurately and consistently reflect the value of the assets based on current market conditions.

Accounting for biological assets involves determining their fair value, a task that can be complex due to market fluctuations and the nature of the assets themselves. Consider the valuation of livestock, which must factor in market prices, expected yield, and other relevant elements. The challenges here include dealing with variable market conditions and assessing the physical condition of the assets.

Determining Fair Value

Fair value measurement, guided by IFRS 13, is critical in agricultural accounting. It requires assets to be valued based on what they would fetch in a current transaction between willing parties. For instance, when valuing bearer plants like fruit trees, accountants must consider the cost and any amendments from IAS 41 and IAS 16. Clear disclosures about valuation methods and inputs are essential for transparency.

Example 1: Valuation of Livestock

Consider a livestock farm that raises cattle. Under IAS 41, the livestock must be measured at fair value minus any selling costs. Let's say at the start of the year, the farm has 50 head of cattle valued at a fair market price of R15,000 each. If market conditions improve, raising the average price to R16,000 per head by year-end, the increase in value (R1,000 per head) is recognised as a gain/profit in the financial statements. This gain reflects the biological transformation and market conditions, offering a true picture of the farm's economic activities.

Journal entries

Initial recognition of 50 cattle @R15,000 each (R750,000):

Dr. Biological assets (Livestock) R750,000

Cr. Equity (Revaluation surplus) R750,000

Description: To record the initial recognition of 50 head of cattle at R15,000 each

Year-end fair value adjustment for 50 cattle @R1,000 (R50,000)

Dr. Biological assets (Livestock) R50,000

Cr. Gain on revaluation of biological assets R50,000

Description: To record the increase in fair value of livestock at R1,000 each for 50 cattle

Example 2: Harvesting of Crops

A vineyard grows grapes that are harvested annually to produce wine. At the time of harvest, the grapes are measured at their fair value less costs to sell. For instance, if the fair value of the harvested grapes is R250,000 and the costs to sell (harvesting, packaging, etc.) are R25,000, the grapes are recorded in the financial statements at R225,000. This valuation captures the actual market value at the point of harvest, ensuring the financial statements reflect the real income potential from the crops.

The crops are subsequently sold for R300,000.

Journal entries

At the point of harvest:

When the grapes are harvested, they are valued at fair value less costs to sell (R250,000-R25,000). The journal entries would be:

Dr. Agricultural produce (Inventory) R225,000

Cr. Change in value of crop inventory (revenue account) R225,000

Description: To record the harvested grapes at fair value less costs to sell of R225,000

At the point of sale:

Dr. Cash/Bank R320,000

Cr. Sales Revenue R320,000

Dr. Change in value of crop inventory (revenue account) R225,000

Cr. Inventory – Harvested Crops R225,000

Description: Recognition of revenue from the sale of crops and matching cost of goods sold.

Example 3: Fair Value Challenges

Consider a farm specialising in exotic ornamental plants. Valuing these plants can be challenging due to unique characteristics and a small market. If fair value cannot be reliably measured due to these complexities, IAS 41 allows for these biological assets to be valued at cost less any accumulated depreciation or impairment. This exception applies until a reliable fair value can be determined, ensuring that the financial records remain pragmatic and grounded in verifiable data.

Journal Entries

If fair value cannot be reliably measured and the assets are carried at cost:

Dr. Biological assets (Ornamental plants) - Cost amount

Cr. Cash/Bank - Cost amount

Description: To record the acquisition of ornamental plants at cost

Accumulated depreciation or impairment (if applicable):

Dr. Depreciation/Impairment expense - Estimated amount

Cr. Accumulated Depreciation/Impairment - Estimated amount

Description: To record depreciation or impairment of ornamental plants

Meticulous record keeping

Farmers generally have a good grasp of the quantity and specifics of their livestock, including the type, breed, and age, with only minor discrepancies. However, the nature of animal husbandry means that the number of animals is never fixed; livestock populations fluctuate as animals reproduce and inevitably, some die. This reality is captured in the adage, "Where there is livestock, there is deadstock," which holds particularly true in challenging conditions such as harsh winters or birthing seasons.

Consequently, farmers must keep their stock records up to date by meticulously tracking these changes in their accounting systems. Every animal holds economic value, which needs to be accurately documented to maintain precise financial records.

Handling Government Grants and Support

Government grants can affect the financial statements of farms significantly. It’s important for accountants to accurately reflect these grants, according to the conditions attached, either as income or as reductions in asset costs. For example, a dairy farm receiving subsidies for adopting sustainable practices would recognise this support as income, helping offset some costs.

Example 4: Receiving A Government Grant

Assuming the farm receives a government grant of R50,000 as a subsidy for using sustainable farming methods, which is intended to offset the costs of biological assets:

Journal entries

At initial recognition of the grant:

Dr. Cash/Bank R50,000

Cr. Deferred Income – Government Grants R50,000

Description: Initial recognition of government grant as deferred income.

When the grant conditions are met (e.g., completion of sustainable practices):

Dr. Deferred Income – Government Grants R50,000
Cr. Other Income – Government Grants R50,000

Description: Recognition of government grant as income upon meeting the conditions of the grant.

Tax Implications of Farming Operations

The taxation of income generated from pastoral, agricultural, or other farming operations is governed by Section 26(1) of the Income Tax Act, which stipulates that such income should be calculated according to the Act’s provisions, but it must also align with the stipulations outlined in the First Schedule. This schedule specifically addresses how to compute taxable income that arises from farming activities.

To determine a farmer’s annual taxable income, the income from their farming operations is aggregated with any other sources of income they may have. This comprehensive income total forms the basis for the tax assessment for that year.

Importantly, the applicability of the First Schedule is not affected by whether the farming operations produce a taxable profit or a loss, and it continues to apply even if the farming activities have been discontinued, as specified in Section 26(2). This includes scenarios where the taxpayer may still possess livestock or produce or is engaged in agreements like “sheep leases” that involve livestock or produce previously considered in tax calculations. These provisions guarantee that the tax implications for farming operations are uniformly enforced until the farmer sells off the final piece of livestock or produce, regardless of whether they have stopped farming activities.

This framework also extends to game farming, which is classified under farming operations for tax purposes, and thus subject to the same taxation rules. The robust structure provided by Section 26 and the First Schedule ensures that all income derived from farming is accurately and fairly assessed, reflecting the unique aspects of agricultural production and its financial implications.

Learn more about accounting for farming operations with CIBA’s Accounting For Farming 2024 CPD course

What you will learn

By attending this webinar you will gain the following competencies: 

• Comprehensive understanding of the requirements outlined in IFRS and IFRS for SMEs concerning accounting for biological assets.

• Insight into the practical considerations and challenges involved in preparing informative financial information for farmers, including additional disclosures and annexures such as a farming statement.

• Understanding of the disparities between the accounting and taxation ramifications associated with farming.

• Proficiency in producing financial statements that adhere to both IFRS and IFRS for SME standards.

• Awareness of the VAT implications pertinent to farming practices.