From Crops to Credits: Accounting and Tax in the Agriculture Sector
Farming plays a vital role in our economy, sustaining livelihoods and providing essential resources. However, farming is far from simple. Beyond planting crops and raising livestock, farmers face unique financial, tax, and compliance challenges. At the recent CIBA Practice Management Conference, experts shared how accountants can help farmers tackle these issues, from valuing livestock under International Accounting Standards IAS 41 to managing unpredictable income and navigating complex tax rules. Let’s explore how accountants can make a real difference in the farming sector.
Farming Risks and Their Financial Impact
Farming is a high-risk industry, with challenges that can disrupt operations and complicate financial management. Accountants need to understand these risks to provide meaningful support.
Natural Risks
Farmers are exposed to unpredictable events like droughts, floods, and pests. These events can destroy crops and livestock, impacting the fair value of biological assets. For example, a sudden drought may lower livestock prices, resulting in significant losses on the income statement. Accountants must account for these fluctuations accurately to help farmers maintain financial stability.
Operational Challenges
Modern farming often involves high-tech machinery, and allocating costs like depreciation, fuel, and repairs can be tricky. Many farmers also diversify into other ventures, like running guest houses or selling processed products, which complicates financial reporting. For example, a farmer operating both a vineyard and a wine-tasting business must separate income streams for tax purposes, creating additional administrative work.
Financial Risks
Farming income is highly volatile due to market price changes and fair value adjustments. These shifts can affect creditworthiness and investor confidence. For instance, a rise in livestock values may improve a farm’s financial ratios, but a sudden price drop could make the farm appear unstable. Reliable financial planning and fair value estimation are crucial for managing these risks.
Applying IAS 41: Agriculture
IAS 41 sets accounting standards for biological assets and agricultural produce. It requires assets like crops, livestock, and harvested produce to be valued at fair value, providing a realistic view of a farm’s financial position.
Biological assets are measured at fair value minus selling costs. For example, cattle are valued based on current market prices, less transport and sale costs. Once crops are harvested, they are reclassified as inventory under IAS 2 and valued at the lower of cost or net realisable value.
Fair value adjustments can create income volatility in the financial statements. For example, a drop in livestock prices due to a disease outbreak would result in unrealised losses, even if the farm remains profitable operationally.
Applying IAS 41 can be challenging, mainly due to the following:
Fair Value Estimation: Reliable market data can be hard to find, especially for niche products. For instance, valuing non-GM maize requires significant effort to find accurate benchmarks.
Income Volatility: Fair value adjustments can cause large swings in reported income, making it harder to assess true operational performance.
Cash Flow Mismatches: A harvested crop’s value may reflect market prices, but the sale might not occur for months, straining cash flow.
By understanding these complexities, accountants can help farmers ensure compliance and maintain financial stability. It is also clear that although there are challenges, applying IAS 41 correctly brings more benefits for farmers.
Taxation for Farmers
Tax laws for farming are intricate and require careful navigation to ensure compliance while maximising benefits.
Trading Stock Rules
Farmers must include the value of livestock and produce as trading stock in tax returns. This includes natural increases, like calves born during the year. For example, livestock lost to disease must be excluded from closing stock, which can complicate calculations.
Capital Development Deductions
Farmers can claim deductions for expenses like soil erosion prevention or irrigation systems. However, these deductions are only allowed if sufficient taxable income exists. For instance, a farmer who builds a dam during a low-income year may not be able to claim the full deduction.
Adverse Event Provisions
Tax laws allow farmers to deduct the cost of replacing livestock sold due to disasters like droughts or disease. However, proving these circumstances and maintaining proper records can be difficult, especially for small-scale farmers.
Equalised Tax Rates
Farmers can opt for equalised tax rates to smooth out the impact of volatile income. This system calculates taxes based on average income over several years, reducing the burden in high-income years. However, applying for this requires detailed historical records, which not all farmers maintain.
Game Farming Income
Income from game farming, like selling live game or hunting fees, is taxable. However, related activities like accommodation are not considered farming income, requiring separate accounting. This distinction often complicates compliance and reporting.
Deferred Tax in Faming
Deferred tax is an accounting concept explained in IAS 12, which deals with the differences between how income or expenses are reported in the financial statements and how they are taxed. In farming, this often happens because IAS 41 requires biological assets to be measured at fair value, while tax authorities might only tax these gains when the assets are actually sold. For example, if a farmer's livestock increases in value due to market conditions, this increase will show as income in the financial statements but won’t be taxed until the livestock is sold.
This timing difference creates deferred tax—a way to account for taxes that will be paid (or saved) in the future. If the fair value adjustment increases income now but taxes are payable later, a deferred tax liability is recorded. On the other hand, if tax rules allow deductions before they appear in the financial statements, a deferred tax asset is created. Understanding and managing deferred tax is essential for farmers to plan ahead and avoid surprises when it’s time to settle taxes. Accountants play a key role in ensuring these figures are accurately calculated and included in the financial statements.
The Role of Business Accountants
As a business accountant, you are essential in helping farmers with financial and tax complexities. From ensuring compliance with IAS 41 to leveraging tax benefits, accountants can provide tailored solutions that help farmers manage risks, optimise cash flow, and grow their businesses.
By proactively addressing these challenges, accountants not only support their farming clients but also strengthen South Africa’s agricultural sector.
For more on Farm accounting read our previous article From Seeds to Sale: Accounting for Farming Operations.