EPPA4713 INTEGRATED CASE STUDY

Case 2
OLAM : Accounting for Biological Assets

Prepared by,

Sri Nur Izzati Binti Amdan A143314

Noraini Binti Mohd Yusuf A143342
Yap Lee See A143364
Muhammad Mukhazzam Bin Mansor A143403
Nur Husna Binti Mohd Dahan A143408
Jennifer Chan Mei Yung A143430
Prepared for,

Dr Radziah Abd Latiff

TABLE OF CONTENT

Item Page

Question 1 : Facts and issue of OLAM 1

Question 2 : Do fair value gains in biological assets qualify as income

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under the Conceptual Framework

Question 3 : Is it the fair value gain is income? 4

Question 4 : MFRS 13 and MFRS 14 5

Question 5 : Performance on related issue,relevance and reliability 6

References 11

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Question 1: Facts and Issue in Olam : Accounting for Biological Assets

Olam was founded in Nigeria in 1989 by the Kewalram Chanrai Group and known as
Chanrai International Limited (Chanrai). The successful company of Chanrai then move their
headquarters from Nigeria to London, England and explore new opportunities. I n 1995 it change
it names from Chanrai International Limited to Olam International Limited (Olam) and in 1996 it
shifted its corporate headquarters from London to Singapore. Olam expanded its operation to
Southest and Central Asia, Europe, North and South America, Russia and Australia. In 2005,
Olam was listed on the Singapore Exchange (SGX) as it is the largest producer in agriculture
business on the SGX and the growth in the market capitalization of Olam has been phenomenal
since listing.

In 2012, Muddy Waters research, an equity research firm based in the United States
accused Olam was engaging in potentially misleading and dangerous accounting practices and
claimed that it was on the verge of bankruptcy. Muddy Waters release 133 pages of report on the
issue of Olam. Muddy Waters alleged that Olams aggressively use non cash accounting gains
especially from negative goodwill and biological assets and the impact is on exhibit 5 Olam Case
Study on Net Income from 2008 to 2012 which they recognize the fair value. Based on the net
income statement there was a drastic increasing of fair value gains every year from 0 in 2008 and
110,874 in 2012 which is more than 100%. Next, Muddy Waters criticisms of accounting for
biological assets resulting in increased profit in three key areas which is Olam books the farmer
future crops as gains, Olam used mark-to-market valuation model to book gains for increase in
fair value and Olams biological assets consist of commodities which are not yet grown and we
can see the impact on exhibit 6, Olams cash flow , exhibit 7, net gain from changes in fair value
of biological assets contribute more than one quarter of the profit before tax in 2012. Next, the
increasing of the fair value also can be seen in exhibit 7 and 8 then on exhibit 9 about the net
gain reduced net cash flow from operating activities.

On 28th November 2012 Olam was release a public rebuttal against Muddy Waters
accusations with a 45 page public rebuttal. Olam stated that they applied IAS 41 appropriately by
doing professional valuation and prepared the financial statement based on IAS 41 and the non
cash gains prescribed by IAS 41. Olam also applied Singaporean Financial Reporting Standard
FRS 41 on Agriculture stated that the fair value gains of the biological assets were justifiably

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derived. On The 45 page of defense Olam state they already disclose in its annual reports some
of the key of parameters us for valuation. However the inclusion of gains in fair value of the
biological assets may inflate or introduce volatility to net profit and the gains are unrealized.
There have some challenges of IAS 41 which are the recognition and measurement requirements
were not sound, generate much scrutiny of accounting practices for unrealized gains, auditor
reliance on estimate and professional judgment of independent valuators and there is argument
between Hong Kong Stock Exchange and IAS 41.

Question 2: Do fair value gains in biological assets qualify as income under the Conceptual
Framework for Financial Reporting?

FY 2008 FY 2009 FY 2010 FY 2011 FY 2012

Fair value gains from biological
0 18,952 53,989 80,365 110,874
assets (SGD 000)
Percentage of increase compared
N/A 100 184.87 48.85 37.96
to prior year (%)
Table 1

Fair value gains from biological assets that were reported in Olam International Limited
has increased continuously from 2008 to 2012. These reflected in the income statement of the
company as non-cash item.

MFRS 13 para.9 defines fair value as the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market participants at the
measurement date and MFRS 141 para. 5 define a biological asset as a living animal or plant.
The Conceptual Framework of Financial Reporting para. 4.25(b) stated that income is an
increase 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.

The income definition provided by the framework can be divided into four segments
which is the income are obtained during the accounting period, in form of inflows or
enhancements of asset that result in increases in equity and does not relate to contributions from
equity participants. Extract of the analysis is as follows:

Plantations consist of almonds and coffee that are grown in order to sell to various domestic
and international markets as part of normal business operations. The almond orchards and coffee

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 plantations presently consist of trees aged between 1 to 24 years and 1 to 3 years respectively (2011: 3 to
20 years and 1 to 2 years respectively).
During the year ended 30 June 2012, the Group harvested approximately 33,252 metric tonnes
(2011: 18,839 metric tonnes) of almonds, which had a fair value less estimated point-of-sale costs of
approximately $212,700,000 (2011: $122,587,000). The fair value of almonds was determined with
reference to the market prices at the date of harvest.
Annual crops consist of seeds for various commodities (cotton, onions, tomatoes and other
vegetables) that are given to farmers to sow and grow. Farmers take all the harvest risks and bear all the
farming costs. On harvesting of the commodities, the Group has the first right to buy the produce from
these farms.
At the end of the year, the Groups total planted area of plantations and annual crops that is
yielding is approximately 15,374 (2011: 14,710) hectares and 2,522 (2011: 4,504) hectares respectively
excluding hectares for those commodities whose plantations are not managed by the Group.
Livestock relates mainly to dairy cattle in Uruguay and Russia. At the end of the year, the
Group held 44,931 (2011: 43,640) cows, which are able to produce milk (mature assets) and 31,920 (2011:
14,862) heifers and calves, being raised to produce milk in the future (immature assets). The Group
produced 160.0 million litres (2011: 105.0 million litres) of milk with a fair value less estimated point-of-
sale costs of $78,701,000 (2011: $50,408,000) in the year ended 30 June 2012.

The third and fourth elements of income definition which are income is in form of
inflows or enhancements of asset that result in increases in equity and does not relate to
contributions from equity participants are also met by Olam International. The form of inflows is
by the gain obtained by the changes in fair value of the biological asset that are disclosed in Note
12 of the financial statement.

Figure 1

Olam International disclosed their financial statement under Note to Financial Statement,
page 142. The extract of the disclosure is as follows:

Fair value determination

The fair value of biological assets (other than annual crops and livestock) is estimated with
reference to a professional valuation using the present value of expected net cash flows from the biological
assets. The valuations are based on following significant assumptions:
(i) The average life of trees for plantations has been taken up to 15 to 25 years;
(ii) Rates considered for discounting future cash flows range between 12% and 13% per annum;
(iii) Annual rate of inflation ranging from 0% to 4% per annum;
(iv) Location, soil type and infrastructure for determining estimated yield; and
(v) Market price of the biological assets dependent on the prevailing market price of the products
after harvest.
The annual crops have been valued using adjusted cost, which is the estimate of the yield and
cost of the crop at harvest discounted for the remaining time to harvest, which approximates fair value.

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 The fair value of livestock is determined based on valuations by an independent professional
valuer using market prices of livestock of similar age, breed and generic merit.

Financial risk management strategies related to agricultural activities

The Group is exposed to financial risk in respect of agricultural activity. The agricultural
activity of the Group consists of the management of biological assets to produce marketable output. The
primary financial risk associated with this activity occurs due to the length of time between expending cash
on the purchase or planting and maintenance of biological assets and on harvesting and ultimately
receiving cash from the sale of the marketable output. The Group plans for cash flow requirements for such
activities and manages its debt and equity portfolio actively.

In conclusion, the fair value gains in biological assets reported by Olam International are
qualified as income under The Conceptual Framework for Financial Reporting as it meet the
definition provided by the framework and had disclose all information that are related to the
gain.

Question 3 : Is it the fair value gain is income?

Definition of fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction that is not for sale between market participants based
on market-based view at the measurement date such as current market price. Fair value will be
measure based on market-based measurement not based on entity specific assumption. It will not
relevant for the entity that has intention to hold an asset or to settle or otherwise fulfill a liability
for measuring based on fair value. As we know that Olams biological asset is include of not yet
grow plant and the lifespan of the assets is long so it is not relevant for Olam that hold the asset
for a long time to use fair value. Based on Olam profit and loss statement, the profit before tax
and profit after tax for the financial years 2008 to 2012 are affected by recognition of fair value
gains from biological assets and gains from negative goodwill since these two gains made up
high percentage of profit figures for some years. The recognition of negative goodwill will not
show an accurate performance of Olam. Other than that there is also issue about mark to market.
Mark to market is when a company updates the value of an asset to its current market price. This
method is used to establish value for these securities when preparing financial statement that can
affect shareholders equity. The hierarchy of mark to market in level 1 is markets prices for the
asset are available and can be used in the mark to market calculation. In level 2, asset do not
have market price. They are marked at fair value based on model. The model is fed with inputs
for which there are market prices such as prices of similar securities and interest rate. Lastly in
level 3, asset do not have available market prices for the modal inputs, forcing the people

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preparing the financial statements to make assumption about those inputs values. Olam used
level 3 approach and the valuation was conducted professionally. Unobservable inputs shall be
used to measure fair value to extent that the relevant observable inputs are not available, thereby
allowing for situations in which there is little, if any, market activity for the assets or liability at
the measurement date. But the inclusion of the gains in the fair value of the biological assets in
the profit and loss statement may inflate or introduce volatility to the net profit. The gains are
unrealized or in some understanding are considered book gains or non-cash accounting gains.
Transactions in the non-cash accounting do not involve payment or receipt or cash. It can be
either non-cash accounting gain or expenses. It is crucial to separate non-cash items from cash
items in financial analysis. The presence of non-cash items are precisely why cash flow is not the
same as net income. The aggressive use of non cash accounting will boost Olam net profit so it
will not show the real profit that Olam made and can effect shareholder in making decision.

Questions 4 : MFRS 13 and MFRS 14 on Olam International Limited

MFRS 141 Agriculture sets out the accounting for agriculture activities and emphasis that
biological assets should be measured at fair value less costs to sell. Meanwhile, MFRS 13 Fair
Value Measurement defines that fair value is a market-based measurement, not an entity-specific
measurement and it explains more about the fair value measurements and disclosures.
In this case, Olam should recognize the biological assets since Olam controls the assets as
the result of past event. It is probable that future economic benefits associated with the asset will
flow to the entity and the fair value or cost of the asset can be measured reliably. Therefore, the
biological assets shall be measured at initial recognition and at the end of each reporting period
at fair value less costs to sell. So, MFRS 13 should be applied in order to get the fair value
accurately and reliably. The valuation techniques used to measure the biological assets should be
appropriate in the circumstances and the sufficient data are available for valuation. This is
because the availability of data will helps to develop the inputs to establish the sound
assumptions that could be used by market participants when pricing the biological assets and
biological products. The level of the fair value hierarchy could be considered to determine how
the inputs could be categorized. Other than that, the relevant observable inputs should be
maximized and the unobservable inputs should be minimized in the valuation process of the
biological assets.

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 Olam asserted that the fair value of biological assets (other than annual crops and
livestock) is estimated with reference to a professional valuation using the present value of
expected net cash flows from the biological assets. Olam defence that it had applied IAS 41
(MFRS 141) appropriately and the fair value gains of the biological assets were justifiably
derived. In the case of biological assets with a long production cycle like Olam, there is often
little or no active market exist. Therefore, there is no quoted market price in an active market
(Level 1) and no inputs that are derived principally from or corroborated by observable market
data by correlation or other means (Level 2). Hence, Olam used unobservable inputs to measure
fair value which was allowed by MFRS 13 if there is little or no market activity for the asset at
the measurement date (Level 3).
An entity will develops unobservable inputs using the best information available in the
circumstances which might include the entity's own data, taking into account all information
about market participant assumptions that is reasonably available. It is based on assumptions and
estimation with reference to professional valuation. Present value measurement used by Olam is
one of the techniques to measure fair value for assets classified under Level 3 of fair value
hierarchy. In conclusion, we do agree that Olam implement MFRS 141 together with MFRS 13
as guidance to measure fair value of its biological assets appropriately.

Question 5 : Performance on Related Issue, Relevance and Reliability on Olam

International Limited

5.1 : Performance analysis

Olam Wilmar Golden Agri

SGD '000 USD '000 USD '000
2012 2011 2012 2011 2012 2011
Sales/Revenue 17,093,751 15,803,387 45,463,414 44,710,034 6,051,748 5,952,924
Cost of Sales 13,866,578 13,126,857 41,572,433 40,839,399 4,440,953 4,116,237
Operating & Other Expenses (2,878,202) (2,319,184) (2,881,390) (3,047,467) (1,070,109) (1,105,437)
Operating Expenses 2,443,998 1,991,837 2,457,266 2,622,891 982,326 1,039,512

Table 2

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1. Sales of growth

Sales of growth is the amount by which the average sales volume of a company products or
service has grown, typically year to year.

Figure 2

Based on the calculation, its shown that Olam International have the higher ratio sales of
growth compare to the other two big companies. It is quite satisfy for sales performance.

2. Operating self-sufficient

Operating self-sufficient is a situation in which an organization generates sufficient revenues

from clients to cover all of their operational costs.

Figure 3

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 The good performance ratio of operating self sufficient will be more than 1. A ratio of 1
means they do not depend on grant revenue or other funding. But yet these three companies
does not show the most efficient operating system, because all of them are showing negative
figure. But Olam International has the almost self sufficient compare the other companies.

3. Gross profit margin

A profitability ratio to calculate the percentage of sales that exceed the cost of goods sold, be
known as operating income margin.

Figure 4

Once again based on the analysis, Olam International has the higher ratio of gross profit
margin compare Wilmar and Golden-Agri companies. This shown Olam International has a
good strategic for their production line.

5.2 Relevance and Reliability

Relevance is a qualitative characteristic in accounting associated with information that is timely,

useful, has predictive value, and is going to make a difference to a decision maker for an instance
is fair value. Reliable is a qualitative characteristic in accounting achieved when information is
verifiable, objective and you can depend on it for example, historical cost which the transaction
is really happen.
In the article, Olam asserted that the fair value of biological assets (other than annual
crops and livestock) is estimated with reference to a professional valuation using the present
value of expected net cash flows from the biological assets. This measurement will yield
inherently subjective valuations. Unlike an objective value from an external market, present

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value is highly dependent on the discount rate and growth projections (future cash flows) used in
the calculation. Both components are hard to estimate with 100% accuracy and entity will make
various assumptions using incomplete information. Therefore, I can conclude that the issues in
using of present value are (1) growth projection (expected cash flow) and (2) discount rate.

Since present value based upon the expected cash flow which was forecasted,
consequently, the actual result in future may deviate substantially from the predicted values.
Firstly, cash flow tomorrow is not worth as much as it is today. The main reason is because of
inflation. As prices rise over time, a dollar cannot buy as much stuff in the future compared to
what it can buy today. Second, there will always have uncertainty in any projection for the
future. We will not know what will happen including an unforeseen decrease in profitability of
the company. Since cash flow in the future carries a risk that cash today does not, we must
discount future cash flow to compensate us for the risk we take in waiting to receive it. The
greater the uncertainty of future cash flow, the higher the discount rate, thus the lower the present
value of the future cash flow.

Next, another issue to the calculation of present value is its sensitivity to discount rates.
The method requires you to estimate a discount rate (rate used to convert its cash flows into
todays dollar). It is a critical component in the discounted cash flow calculation that determines
how much a series of future cash flows worth as a single lump sum value today. A small change
(increase or decrease) in the discount rate will have a considerable effect on the final output. If
Olam used an inaccurate discount rate in their analysis, they might already over or under
estimate their profit which will create more issue in the future. In conclusion, present value is not
a very reliable measurement. It is not flexible and only uses information available at the time of
the decision. It does not account for changes in the future. It also requires that user know the
exact discount rate, the size of each cash flow and when each cash flow will occur which very
hard and impossible to determine accurately.

In the article stated that Olam booked the farmers future crops as gains. Crop production
is depends on climatic condition. There are so many natural disasters that occur nowadays.
Unexpected natural disaster such as earthquake, flood and tornado will effect and destroyed the
crops. A gradually increase in overall temperature at earth atmosphere will attribute to the
greenhouse effect and the temperature could increase up by to 10 degrees over next century.

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Relevant fair value that achieved today could not be the same on the day after. Olam have
biological assets at many countries. As example, Olam has almond orchards in California and
peanut farms in Argentina. Based on US News there are out of control earthquakes, wildfires,
mudslides, and heat waves have ravaged California since 1989. In July 2006, The Central Valley
and Los Angeles regions suffered through a severe heat wave for nearly two weeks. Fresno had
six days with a high temperature above 110 degrees, a new record. There also also floods occur
in Argentina in 2003,2005, 2007 and 2015. All of the natural disaster that already stated above is
unexpected and can affect all the biological assets that Olam have.
In this case, Olam adopted fair value model to evaluate the biological asset. The
advantage Olam obtains from using fair value modal to evaluate the biological assets is the
revenues generated from biological assets can be identified and reported on each accounting
period, but not only at the harvest point and sale .

The evaluation of biological assets by fair value for each period ensuring the balance
sheet value is close to the market price. Base on MFRS 141, Para 26, the gain or loss arising on
initial recognition of a biological asset at fair value less costs to sell and from a change in fair
value less costs to sell of biological asset shall be included in profit or loss for period in which it
arises (MFRS 141, Para 26). Hence, the changes of value due to the biological transformation of
biological asset could be recognized once it happens but not only at harvest point and sale.
Furthermore, the recognition of gain arising from the increased fair value of biological asset can
be considered as relevance information which can be used by investors or financial statement
users in decision making.

On the other hand, the recognition of the revenue arising from evaluation of biological
asset by fair value approach could cause the unfeasible gain or loss due to overestimation.

As we know that the fair value is provide the current information (market price) which is
determined by market forces outside the firms. So, it is unstable and fluctuates all the times.
Thus, the fluctuation will create the unreliability issue in Olams reporting for biological asset
fair value. For example, the overestimation of fair value could happen in the next period which
fair value are drop compared with last reporting period and cause the unfeasible gain or loss.
Lastly, the investors will fell unsatisfied because of the income loss due to the decreasing of
company net income from unfeasible loss.

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 References

1.
Malaysian Accounting Standard Board, 2011. The Conceptual Framework for Financial
Reporting.1
2.
Malaysian Accounting Standard Board, 2011. MFRS 13: Fair Value Measurement.1
3. Malaysian Accounting Standard Board, 2011. MFRS 141: Agriculture.1
4. Cheong Mun Hong CFA, 2014. How Fair Are Fair Value Gains.
http://www.valueinvestasia.com/2014/05/09/how-fair-are-fair-value-gains/
5. Definion of relevance and reliability, http://www.accountingtools.com/questions-and-
answers/what-is-relevance-in-accounting.html

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