1. Fair Valuation in Agricultural Sector

2. Agenda
Introduction
Ind-AS 113 Framework
Challenges for Fair Valuation in Agricultural Sector
Questions & Answers

3. Equal to historical cost?
Introduction
What is Fair Value?
Market price?
Arm’s Length Price?
Transaction Price?
Equal to historical cost?

4. Ind-AS 113 – Framework for Fair Valuation
Ind-AS 41 – Agriculture
Biological Assets
Agricultural Produce
Shall be measured on initial recognition and at the end of each reporting period at its fair value less costs to sell
Agricultural produce harvested from an entity’s biological assets shall be measured at its fair value less costs to sell at the point of harvest.
Ind-AS 113 – Framework for Fair Valuation

5. Ind-AS 41 – Examples of items to be fair valued
Biological assets
Agricultural produce
Products resulted through processing after the harvest
Sheep
Wool
Threads, carpets, yarn
Fruit trees
Reaped fruits
Processed fruits
Cotton Plants
Harvested Cotton
Threads, clothes
Sugar Cane
Harvested Cane
Sugar
Dairy Cattle
Milk
Cheese
Tea bushes
Leaves
Tea
Grape Vine
Grapes
Wine
Oil Palms
Picked Fruits
Palm Oil
Rubber Trees
Harvested Latex
Rubber Products
Timber Tree Plantation
Felled Trees
Logs, Lumber

6. IND-AS 113 – Fair Value

7. Objectives Provide single source of guidance
Clarify definition of fair value
Provide clear framework for measuring fair value
Enhance fair value disclosures
Does not deal with when is fair value required

8. Definition
“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.”
Exit price concept
Consider characteristics of asset/liability:
Condition
Location
Restrictions on sale/use
Excludes transaction costs
Includes transport costs
Example: The fair value of cattle at a farm is the price for the cattle in the principal market less the transport and other costs of getting the cattle from the farm to that market.

9. Steps to measure Fair Value
Step 1 – Determine asset/liability to be fair valued [unit of account]
Step 2 – Determine Principal or Most Advantageous Market [market participants’ perspective]
Step 3 – For non-financial assets, determine what is Highest and Best Use
Step 4 – Evaluate valuation techniques to determine fair value (Market Approach, Cost Approach, Income Approach)
Step 5 – Disclosures (Fair Value Hierarchy)

10. Example: Identification and Grouping of Biological Assets
Based on significant attributes of Biological Asset such as age, consumable character, reproduction capacity or quality.
Example: For measurement purposes, a wood producer divides his tree plantations depending on their growth and, more precisely, depending on the volume per tree so that the value of the trees is calculated in correspondence with the grouping.
Dividing the biological assets can also be carried out from a regional point of view.
Example: A wood producer with activity worldwide divides his tree plantations in the regions Brazil and Central America, because there are strong differences between the different regions concerning the thickness of the trunk and this characteristic has a decisive influence upon the fair value

11. Step 2: Identify the market
Use principal market if available
“The market with the greatest volume and level of activity for the asset or liability.”
Otherwise, use most advantageous market
“The market that maximises the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability, after taking into account transaction costs and transport costs.”
Most advantageous market should be used only in the absence of principal market

12. Step 2: Identify the market - Example
Asset can be sold in 2 markets with same levels of activity.
What is the fair value?
Fair value: 23
Most advantageous
market: 22

13. Step 2: Identify the market – Market Participants’ Perspective
Use assumptions & characteristics that market participants consider
Market-based measurement, not entity-specific
Market participants:
Independent
Knowledgeable
Able to transact
Willing to transact

14. Step 3: Determination of Highest and Best Use
Non-financial asset fair values based on Highest and Best Use
Highest and Best Use
stand-alone basis or combined with other assets and/or liabilities
based on market participants’ perspective; intentions irrelevant
physically possible; legally permissible; financially feasible
usually, but not always, current use

15. Step 3: Determination of Highest and Best Use - Impact
Land This will be particularly significant for an entity with land used for farming. If the highest and best use of the land is, for example, with a factory built on the land, the fair value of land has two components: the value of land assuming its current use (farming) and the incremental value to fair value (i.e. amount by which the fair value of land differs from the value in its current use) Biological Asset The highest and best use of sheep for a buyer may be to obtain wool, however the current use by the entity might be production of mutton or lamb.

16. Step 3: Determination of Highest and Best Use - Challenges
Significant for entity with land used for farming.
Example: With a factory built on the land, the fair value of land has two components: the value of land assuming its current use (farming) and the incremental value to fair value (i.e. amount by which the fair value of land differs from the value in its current use).
Significant impact on the value of biological assets
Example: The highest and best use of sheep for a buyer may be to obtain wool, however the current use by the entity might be production of mutton or lamb. The extent of the impact will vary for different types of biological assets such as consumable biological assets and bearer biological assets. Therefore, the range of values will be based on the different uses of the asset coupled with the impact of pricing trends for given commodities at a point in time.

17. Step 4: Valuation Techniques
Market Approach
Income Approach
Cost Approach
Assess appropriateness based on circumstances
Maximize observable inputs
Change in technique acceptable if equally or more representative of fair value

18. Step 4: Valuation Techniques - Application
Market Approach :
Many biological assets have relevant market-determined prices or values available, as they are often basic commodities that are traded actively.
For example, calves and piglets
If an active market does not exist:
The most recent market transaction price, provided that there has not been a significant change in economic circumstances between the date of that transaction and the balance sheet date.
Market prices for similar assets with adjustment to reflect differences.
Sector benchmarks, such as the value of an orchard expressed per export tray, bushel, or hectare and the value of cattle expressed per kilogram of meat.

19. Step 4: Valuation Techniques - Application
Income Approach
Present value of the future cash flows expected to be generated from the asset.
Reason: Lack of active markets and lack of reliable quoted market prices.
Includes directly attributable cash inflows and outflows.
Inflows: Price in the market of the harvested crop for each harvest over the asset’s life
Outflows: Incurred to raise or grow the asset and get it to market, for example, direct labour, feed, fertilizer, and transport costs
Market: Where the asset will be sold
Discount Rate: Pre-tax discount rate
Instances in which this approach is relevant include long-term biological assets, such as plantation forests, tea plantations, and vineyards, but this is also appropriate for some short-term assets.

20. Step 4: Valuation Techniques - Application
Cost Approach
Best indicator when limited biological transformation takes place, for instance , in case of the fruit trees planted right after the closing date;
Applies where price is barely influenced by the biological transformation process, for instance for the initial growth in a pine plantation that has a production cycle of 30 years;
Applies when no known reliable parameters are available, e.g. prices or growth rates or physical volumes.

21. Step 5: Fair Value Hierarchy
Level
Characteristics
Example
Level 1
Observable
Quoted prices for identical assets or liabilities in active markets (unadjusted
Quoted Equity Shares on a Stock Exchange
London Metal Exchange (LME) futures contract prices
Level 2
Quoted; similar items in active markets
Quoted; identical/similar items, no active market
Foreign Currency Forward Contract where inputs for measurement such as discount rate curves and interest rate curves are based on the observable market data
Level 3
Unobservable inputs (e.g., a company’s own data)
Market perspective is still required
Models that incorporate management assumptions that cannot be corroborated with observable market data.

22. Accounting for Fair Value Changes
All the biological assets and agricultural produce have to be valued at Fair Value less costs to sell at each reporting date.
The difference between the fair value as on the two reporting dates has to be accounted for in the Profit and Loss Account.
This can result in significant volatility in profits year-on-year.
Initial losses on biological assets typically arise when a biological asset is purchased. The cost of the biological asset is often higher than the fair value less costs to sell, as the latter represents an exit price, and transaction expenses therefore create a loss.
Initial gains on biological assets arise when new biological assets are generated – for example, when a calf or a piglet is born

23. Examples

24. Example 1: Biological Assets attached to land
In some cases there isn’t an isolated market for biological asset, but only for combined asset.
Enterprise can use the value as starting point for determining the fair value of biological asset by deducting the fair value of land.
Example: An enterprise buys a vineyard. Details are as under:
Therefore fair value of the Grape vine is 3.5 Million INR
Particulars
Total Price
Price of Land
Land Improvement
Grapevine
Beginning of the year
12 Million INR
8 Million INR
1 Million INR
3 Million INR
Closing Date
12.8 Million INR
8.2 Million INR
1.1 Million INR
3.5 Million INR

25. Example 2: Value of Partly Grown Salmon
While there is a market for fully grown salmon, there is no market for a partly grown salmon. In such case, how do you fair value partly grown salmon? Answer: The fair value of a partly grown salmon is measured by projecting the cash inflows from the sale of the salmon fully grown, less the cash outflows needed to grow the salmon to its marketable weight and discounting them to a present day value.

26. Example 3: Poultry Farming
How do you fair value the chickens in a Poultry Farming? Answer: Fair value can be different at various stages and various techniques will be used at different stages. Breeding – 1 to 8 weeks Growing – 9 to 28 weeks Laying – 29 to 68 weeks There are market for hens under breeding and growing stage as there are ready breeders and growers. For hens under laying stage, this can be valued based on the present value techniques (Various estimates will have to be applied such as production yield, market prices for eggs, rearing and other direct costs, discount rate etc.)

27. Example 4: Fair Value of Tea Plantations
Tea Plantations have an estimated 60 year economic life after initial harvesting of tea bushes. There is generally no active market for tea plantations in India. How will tea plantations be fair valued?
Answer:
The most appropriate approach will be calculation of net present value of future cash flows associated with tea plantations. This will include estimating
Future yield rates;
Selling prices are based on expected future costs;
Growing, processing and selling costs which could be based on long term average levels;
Cash flows are to be discounted at a pre tax rate, that takes into account the cost of capital plus a suitable risk factor; and
An appropriate rental charge is included to represent the use of the developed land on which the trees are planted.

28. Example 5: Fair Value of Timber Forest
Income Approach - Discounted Cash Flow Method: The most acceptable and widely used – mainly due to lack of active markets for large plots of forest land, implies a lack of reliable quoted market prices for standing timber. Key assumptions include – harvesting plans, timber prices, forestry costs, growth rates, and the discount rate Market Approach: Can be used if there is a market for certain species and quality of standing timber mostly plantations with relatively short rotation cycle typically between 5-20 years Historical Cost: Newly planted trees – Cost is the most appropriate approximate of the fair value. Additionally, cost is applied where there are no known reliable parameters, e.g. prices or growth rates or physical volumes

29. Example 6: Fair Value of Growing Almond Crop
While Almond Tree Plantation can be valued using Discounted Cash Flow Technique, how do you measure the fair value of a growing almond crop? Answer: Valuation: Current almond selling prices and current growing, processing and selling costs. The calculated crop value is then discounted to take into account that it is only partly developed, and then further discounted by a suitable factor to take into account the agricultural risk until crop maturity

30. CHALLENGES

31. Challenges
Ind-AS 41 and 113 will bring in a lot of changes and will have wider impact including recognition, measurement and disclosures. Few of the challenges that could come up are as follows :
What should be considered as a unit of account? Should it be an individual assets or a group of assets? How should the assets be grouped together to be measured for fair value?
How the markets should be determined? Which markets should be considered? In the absence of any market, how should an entity develop a hypothetical market?
Incorporating and estimating market participants’ characteristics in the absence of a principal market could be a real challenge
What if there are rate regulations e.g. sugar industry?

32. Challenges (contd..)
Estimating fair value technique through income approach involves significant judgement and estimations e.g. how do you factor in climate changes for a tea plantation where the estimated yields span up to 60 years
Establishing models for fair valuation could become very complex
Ind-AS 101 – Deemed Cost Exemption – Bearer Plants
Under market approach, using prices for recent transactions could be faulty or may not be fruitful for instance, in a rubber plantation, there may not exist an active market for the rubber plantation. Even if a market exists, no two plots will be the same. Where markets exist, often they are restricted to smaller plots, not on a scale that is of interest to strategic or financial investors. Further, significant volatility in market prices can distort the valuations
For certain items, historical cost may be appropriate but may not be relevant

33. Benefits of Fair Value Measurement
Reflect current market conditions
Financial statements reflect the impact of current market conditions on financial instruments
More transparency
Investors and other users have greater insight into management’s views as to ultimate settlement amounts
Benefits
Communication and Knowledge Sharing
Lack of market prices requires the use of models to determine fair value

34. Conclusion
While there are significant challenges, this is going to be the future and hence a detailed understanding is required
Significant changes to the organizational framework, including developing, attracting and retaining competent staff will be crucial
Previous experience in other parts of the world is available and will help in reducing the implementation challenges
Once models are developed, they can be used for years.
Role of auditors

35. Questions?

36. Thank You