Theoretical Failure of IAS 41: Agriculture

Yohanes Handoko Aryanto, SE Associate Researcher The Indonesian Institute of Accountants handoko@iaiglobal.or.id

Abstract
The purpose of this study is to analyze the theoretical aspects of IAS 41: Agriculture. Based on the results of several other empirical studies, it turns out that the adoption impact of IAS 41 is not as good as expected. In addition, rejection on IAS 41 are appear as it causes volatility of income and misleading on taxation-related decisions. Also, other research states that IAS 41 has failed in achieving its objectives, which is to increase financial statement comparability in agricultural sector. These findings lead to a variety of questions, whether the principle of arrangement in IAS 41: Agriculture is theoretically correct?

Introduction

Accounting is a technology used to engineer financial data so that it becomes useful informat ion for decision making. Same with another technologies, accounting is based on principles. One of the accounting principle is the generally accepted accounting principles (GAAP) that used in a jurisdiction, such as US GAAP and the Indonesian Financial Accounting Standards (Indonesian GAAP). Nowadays, the economic globalization is on progress. This can be seen from the many companies that perform economic activity in various jurisdictions. Because of the economic activ ity is no longer limited by jurisdiction, therefore the financial reports should be based on accounting principles that are not limited by jurisdiction. So that all of the stakeholders residing in different jurisdictions can have the same understanding of the financial information presented. This is one reason for the creation of a set of internationally accepted accounting principles, called the International Financial Reporting Standards (IFRS). As a set of internationally accepted accounting principles, IFRS is not limited by jurisdiction and created as a principle for engineering financial informat ion that is intended for large-scale users.

This is explained in the IFRS conceptual framework that, the objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decision. In order to internationally accepted, IFRS must be able to used for a variety of economic practices that apply in various jurisdictions. Therefore, the prescription in IFRS are mo re princip le (princip le based) rather than rule (rule based). The principle based prescription of IFRS made this standard may be used for a variety of business practices in various jurisdictions. However, th is princip le based regulation improve management judgement in the determination of accounting policies used to engineer the financial info rmation. The use of IFRS make a financial report can be compared with other financial reports across jurisdiction. This is very useful in increasing the global investment, as users of financial reports (investors) will have the same understanding of the financial informat ion presented.

Qualitative Characte ristics

A financial statement must meet certain quality in order to fulfill its purpose. Therefore, the IFRS conceptual framework described the qualitative characteristics that must be achieved in a financial statement, which are understandability, relevance, reliability, and comparability. Characteristic of reliability consists of the representational faithfulness, substance over form, comp leteness, neutrality, and prudence. In addition, in the process of preparing the financial statements there is a cost benefit constraint. This means, the benefits of presenting the informat ion must be greater than it costs. IFRS is also mentioned a true and fair presentation presentation concept. The true presentation means present the truth of all transactions and other events that could have been presented fairly. The fair presentation means present

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all t ransactions and events that illustrate what is generally understood as reasonable. The qualitative characteristics comparab ility is quite important in the use of IFRS. In general, IFRS is expected to improve the comparab ility of financial statements internationally. The implications expected fro m the co mparability is the decrease in cost of capital and the increasing flo w of global investment.

IAS 41: Agriculture

IAS 41 is one of the IFRS accounting principles. IAS 41 applies to agricultural act ivities, such as accounting treatment for biological assets, agricultural produce at the time of harvest, the government grants; financial statement presentation and disclosure of agricu ltural act ivity. IAS 41 issued by the International Accounting Standards Board (IASB) with the main objective to improve the comparability of financial statements in the agricultural sector, because there is no uniformity in the accounting method applied in this sector.

3.1 Biological Asset

Biological assets described in this accounting standard represents living creatures such as animals and plants. In this standard, biological assets are distinguished into biological assets that are harvested and sold (consumable bio logical assets), and biological assets other than biological assets that are harvested and sold (bearer biolog ical assets). Entit ies encouraged in IAS 41 paragraph 43 to present quantitative description of consumable biological assets and bearer biological assets, distinguishing between consumable bio logical assets and bearer biological assets or immature and mature biological assets. Although IAS 41 d istinguishes biological assets, but the measurement of biological assets are the same. IAS 41 mentioned that biological assets are measured on initial recognition at fair value less costs to sell, except for the case when the fair value cannot be measured reliably. In addition to regulating the biological assets, IAS 41 also regulates agricultural products. Agricultural products as defined in this standard are harvested produced of biological assets. Measurements for agricultural products is at its fair value less costs to sell at point of harvest.

its significant attributes. Entities select attributes corresponding to the attributes used in the market as the basis of pricing. In determining fair value, the entity using a value based on the following levels. If the value in a level is not available, the entity shall use the value in the levels below it. Modified fro m IAS 41 paragraphs 1718, 1. The fair value that reflects the current quotation price in active markets. If there are several active market, entities select the most relevant. 2. The most recent market transaction price, provided that there has not been a significant change in economic circu mstances between the date of the transaction and the end of the reporting period. 3. Market prices for similar assets with adjustment to reflect differences. 4. Sector benchmark such as the value of cattle expressed per kilogram of meat. This standard clearly stated that the fair value used should be the most reliable fair value. If the entity have to use estimates, it must be the most reliable estimate. In addition, paragraph 24 exp lains that under certain conditions, sometimes cost can approximate fair value. IAS 41 requires in itial recognition of gain or loss of a bio logical asset at fair value less costs to sell, and changes in fair value less costs to sell of a b iological asset, shall be included in proft or loss as for the period in which it rises . This also applies for agricultural products, A gain or loss arising on initial recognition of agricultural p roduce at fair value less costs to sell shall be included in profit or loss for the period in which it arises. When fair value cannot be measured reliably, an entity may use cost less any accumulated depreciation and any accumulated impairment loss as a basis for measurement.

3.3 Accretion Concept

Accounting concepts used in IAS 41 is the concept of accretion. In this concept, revenues are recognized along with the growth of assets. The reasoning of this concept are (Su wardjono, 2003), 1. Usually, b iological assets may be sold any time at the various levels of growth in a certain market price. For examp le, goats can be sold any time at any age in quite certain market prices. 2. The older the age of biological assets, the higher the price. For examp le, the older teak trees the higher its price.

3.2 Fair Value

Paragraph 15 of IAS 41 exp lained that the measurement of fair value for biological assets and agricultural products can be facilitated by grouping biological assets and agricultural products based on

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Based on this concept, revenues are earned along with the growth of assets, it just have not yet realized. Accretion is an income (inco me consist of revenue and gain) and meet the definit ion of inco me described in the IFRS conceptual framework, Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. [F 4.25(a)] In the definition of income above, stated that income is an increases in economic benefits during the accounting period in the form of enhancements of assets. This is consistent with the concept of accretion which is used as the basis of IAS 41. Biological assets are measured at fair value less costs to sell at the initial recognition, then the differences of fair value less costs to sell is recognized in profit or loss. Measurement at fair value less costs to sell was aimed to reflect the value of assets during the growth period. Then, the differences in fair value less costs to sell is recognized in profit or loss because it reflect the increase in the value of assets that meet the definit ion of inco me. Conceptually, Patton & Littleton (1970) mentioned that revenue is the company's product because it formed simultaneously during the production activities without having to wait the time when the product delivered to customer. However, to be recognized in profit or loss, a revenue should be realized, or the event of exchange has occurred. In the concept of accretion, revenue may be recognized without having to be realized, but in a condition that the realization is certain and only a matter o f period.

Analysis on IAS 41

IAS 41 has been applied for more than 7 years in several countries and will be adopted in countries that now in the process of convergence with IFRS. However, a recent study published by The Institute of Chartered Accountants of Scotland shows that the implementation of IAS 41 seems to meet a lot of problems. In addition, there are also countries that have not yet adopted IAS 41 in the process of its convergence with IFRS such as India, Malaysia, and Indonesia. These are an indication that there are something wrong with IAS 41.

IAS 41 in France, UK and Australia, 1. Qualitative characteristics of comparab ility is not achieved. The most common measurement model used is the cost model (historical cost). As for the fair value model, there are various models that are used such as NPV, independent/external valuation, NRV, and the market price. The use of different measurement model resulted in the differences of earnings quality in agricultural sector internationally. In addition, almost no entity that can meet all disclosure requirements in IAS 41. 2. Cost benefit constraint is not met. The respondents agreed that the costs incurred to measure and report the biological assets at fair value is outweigh the benefit. In some jurisdictions, the rejection of IAS 41 is quite strong because of taxation matters . 3. Earnings volatility. The respondents strongly agreed that the measurement at fair value as required by IAS 41 increase the volatility of earn ings. In France, at some cases, the auditor gave the label 'health warn ing' to attract the attention of readers of the report on the uncertainty associated with the assessment of biological assets. 4. The role of auditors in policing the application of the standard varies across countries. In some cases, disagreement occurred between auditors and managements 5. Unreliable data. In some tropical countries, the fair value determined by the authorities of the market does not reflect the fair value of commodit ies such as coffee, tea, bananas, and cocoa. Not all stakeholders accept that the fair value (or world market price) of these plantation crops is a fair price that fully reflects their value.

4.2 Overgeneralization of the Accretion Concept in IAS 41

The concept of accretion is used as the basic reasoning in the IAS 41. All bio logical assets measured at fair value less costs to sell, and the differences in the changes of fair value less costs to sell are realized in profit or loss to reflect the revenue that earned simu ltaneously with asset growth. But the problem is, IAS 41 overgeneralized this treatment for

4.1 Research Findings by Charles Elad & Kathleen Herbohn (2011)

Elad & Herbohn (2011) describes some interesting findings in their research on the implementation of

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all of the biological assets, whereas not all of the biological assets that owned by entity are designated for capital appreciation or sold. Therefore, for this kind of biological assets (bearer biological assets), measured at fair value less costs to sell and recognized the differences in the changes of fair value less costs to sell in profit or loss would lead to a misleading info rmation. Th is is due to the revenue associated with these assets will never earned and realized. Examp les of biological assets that are not held for capital appreciation or sale is a stud cows and laying hens. Both animals in this example is the biological assets that are used only to produce other biological assets. In the case of laying hens, when the hens are still laying eggs, the increase in fair value does not reflect the unrealized inco me, because it will never be realized. Also, after these hens no longer lay eggs, usually they are disposed because its have no more value. In addition, the recognition of differences in the changes of fair value less costs to sell at profit or loss also based on the assumption that the revenue (or decrease in revenue) will surely be realized. In cases of teak trees, such treatment is not appropriate. In general, teak tree takes about 25 years since planted to be ready for harvest. Thus, the realization of revenues that relflected the increase in the value of teak trees will occur after 25 years. In fact, according to IAS 41, the entity that own teak trees should recognize an unrealized increase or decrease of revenue in the profit and loss for 25 years, and this sort of information would be misleading. Malaysian Accounting Standards Board (2010), explains that the treatment prescribed in IAS 41 is not appropriate for biological assets in the form of palm plantation. For palm, measurement under IAS 41 will result in a very high revenue to be recognized in profit or loss on initial recognition. Then, after the initial recognition, the revenue recognized fro m the differences in the changes of fair value less costs to sell will be reduced very drastically and then became stable. These kind of condition can be utilized by agricultural entities engaged in palm plantation to declare div idends. The overgeneralization of the accretion concept also incurred in b iological assets held less than one year. In some cases, there are biological assets held less than one year, such as certain types of fish and sugarcane. Measurements under the fair value less costs to sell at the initial recognition of these kind of biological assets is simply irrelevant. The main drawback of the recognition of the differences in the changes of fair value less costs to sell in the profit and loss is the increasing volatility of earnings. This is proven by Elad & Herbohn (2011)

on their research. In addition, the recognition of unrealized revenue in the profit and loss are very prone to be used for dividend distribution. This was implicitly described by Lefter and Ro man (2007) in their research.

4.3 Analysis on the Biological Assets

Treatment

of

Based on the analysis that the concept of accretion is not exactly applicable to all types of biological assets, the treatment of biological assets need to be differentiated based on the nature and usefulness of informat ion that is expected to be obtained from the presentation of such biological assets. In principle, the presentation of informat ion in financial reports should meet the qualitative characteristics described in the conceptual framework. IAS 41 has distinguished biological assets that are harvested and sold (consumable b iological assets), and biological assets other than biological assets that are harvested and sold (bearer bio logical assets). Further distinction of biological assets needed for the biological assets which are held by less than one year and more than one year. Based on these distinction, the treatment of biological assets can be formulated more precisely. For biological assets in the form of bearer biological assets and held more than one year, the accounting treatment would be more appropriate if based on the treatment of fixed assets (plant, property, and equipment). This is because of the nature and characteristics of informat ion that needs to be presented in the financial statements of such biological assets are similar to the nature and characteristics of fixed assets, which are used to support business acvtivities and not used for capital appreciation or sale. In IFRS, the treat ment for biological assets are excluded fro m the scope of regulation in IAS 16, accounting standards for plant property, and equipment. This is due to biological assets have the characteristics of accretion, therefore regulated separately in IAS 41. In fact, as noted earlier, there are overgeneralization concept of accretion in the IAS 41. During the bio logical transformation, treat ment for bearer bio logical asset that held more than one year will be similar to the treatment of fixed assets under development, which is recognized at cost. The treatment for biological assets in the form o f bearer biolog ical assets and held less than one year will follow the treat ment of consumable b iological assets held less than one year. The treatment is based on the similarity of nature and characteristics of informat ion.

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The treatment for biological assets in the form o f consumable bio logical assets and held less than one year will similar to the treatment of inventories. This is because the similarity of the nature and characteristics of informat ion with inventories, which is controlled less than one year (current). IFRS does not include these treatment in the accounting for invetory because of the accretion characteristics in the biological assets and agricultural products (same reason with the fixed assets exclusion). During the bio logical transformation, treat ment for consumable biological assets held less than one year will be similar to the treatment of inventories in process, which is recognized at cost. The treatment for biological assets in the form o f consumable biological assets and held for more than one year will follow the treat ment in IAS 41, wh ich is measured at fair value less costs to sell. The accretion concept in this measurement is quite appropriate because the concept of earned revenue along with the growth of assets is in accordance with the nature of consumable biological assets held for more than one year. Ho wever, given the existence of a biological asset that needs a very long time to realized the revenue (such as teak), the differences in changes of fair value less costs to sale should not be directly recognized in p rofit or loss. Other co mprehensive income is appropriate enough as a place to recognize these differences. Here is a diagram illustrating the appropriate treatment for biological assets,

treatment of certain types of biological assets against all types of biological assets, which consequently significant to the quality of financial report and distortion of informat ion.

Acknowledgement
Author acknowledge all of the contribution from the technical division of The Indonesian Institute of Accountants.

References
Delloite IAS Plus. (2011). Conceptual Framework For Financial Reporting 2010. Online. Available: http://www.iasplus.com/standard/framewk.ht m Eland, Charles. & Kathleen Herbohn. 2011. Implementing Fair Value in the Agricultural Sector. Scotland: SATER. Ermayanti, Dwi. (2009, 21 Maret). Pengungkapan dan Saran Interpretatif. Online. Available: http://dwiermayanti.wordpress.com/2009/03/21/p engungkapan-dan-sarana-interpretif/ IASB. (2009, 16 September) IAS 41: Agriculture. Online. Available: http://ec.europa.eu/ internal_ market/accounting/docs/consolidated/ias 41_en.pdf Lefter, Viorel. & Aureliana Geta Ro man. 2007. IAS 41 Agriculture: Fair Value Accounting . Bucharest: Academy of Econo mic Studies. Leng, Tan Bee. (2010, 12 Oktober). IAS 41: Agriculture. Online. Availab le: http://www. iaig lobal.or.id/prinsip_akuntansi/seminar_ ias41/ 8IAS%2041%20Agriculture.pdf Mirza, Abbas Ali.; Magnum Orrell. & Graham J.Ho lt. 2005. IFRS Practical Implementation and Workbook Second Edition. New Jersey: John Wiley & Sons, Inc. Philips, G. Edward. 1963. The Accretion Concept of Income. The Accounting Review Vo l. 38, No. 1 (Jan., 1963), pp. 14-25. Suwardjono. 2005. Teori Akuntansi: Perekayasaan Pelaporan Keuangan Edisi 3 . Jogjakarta: BPFE.

Conclusion

The purpose of IFRS is to be an internationally accepted accounting principles. Therefore, the principles prescribed in the IFRS should be able to accommodate various issues arising in international practice. In the case of IAS 41, it should be accommodate biological assets (in every nature and characteristics) that exist in all parts of the world. Not only the biological assets that exist in countries that are members of the IASB. IASB should review the IAS 41. Various studies have shown various results in the implementation of IAS 41 in practice. In addit ion, a theoretical study shows a defect in the IAS 41. These standards are a clear examp le overgeneralizat ion reasoning for the

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