Class Notes: Accounting for Farming Enterprises

Accounting for farming enterprises under the International Financial Reporting

Standards (IFRS) provides a framework for recognizing, measuring, and reporting
transactions unique to agricultural activities.

It addresses the dynamic nature of biological transformation, uncertain market

conditions, and seasonal operations.

Key Concepts

1. Nature of Farming Activities

o Farming involves managing biological assets like plants and animals for
production.

o Activities include planting, breeding, harvesting, and selling agricultural

produce.

2. Types of Farming Enterprises

o Crop Farming: Producing grains, vegetables, or fruits.

o Livestock Farming: Rearing animals for meat, milk, or wool.

o Mixed Farming: Combining crop and livestock production.

3. Unique Characteristics

o Biological assets undergo natural transformation (growth, reproduction,

or degradation).

o Fluctuating values due to market prices, weather, and demand.

o Long production cycles that can span multiple reporting periods.

Key IFRS Standards for Farming Enterprises

1. IFRS 13 - Fair Value Measurement

o Provides guidance on measuring biological assets and agricultural

produce at fair value.

o Fair value is based on market conditions, adjusted for costs to sell.

2. IFRS 41 - Agriculture

o Applies to biological assets (e.g., crops and livestock) and agricultural

produce.
 o Biological assets are measured at fair value less costs to sell, except
when fair value is not reliably measurable.

o Agricultural produce is measured at fair value at the point of harvest.

3. IFRS 16 - Leases

o Governs leases of agricultural equipment or land.

o Recognizes lease liabilities and right-of-use assets for long-term

agreements.

4. IFRS 15 - Revenue from Contracts with Customers

o Regulates revenue recognition from sales of agricultural products.

5. IFRS 9 - Financial Instruments

o Covers agricultural loans, derivative contracts, and hedging activities.

Financial Statements for Farming Enterprises

1. Statement of Profit or Loss

o Revenue from the sale of agricultural produce.

o Expenses such as labor, feed, seeds, fertilizers, and maintenance.

o Fair value gains or losses from biological assets.

2. Statement of Financial Position (Balance Sheet)

o Assets: Biological assets, inventories, equipment, and land.

o Liabilities: Loans, payables, and accrued expenses.

o Equity: Owner’s capital and retained earnings.

3. Statement of Cash Flows

o Operating Activities: Cash inflows from produce sales and outflows for
operational costs.

o Investing Activities: Purchase or sale of machinery, equipment, or land.

o Financing Activities: Loans taken or repaid, owner contributions, or

dividends paid.

Key Accounts in Farming

Biological Assets
 ✓ Includes animals and crops.
✓ Measured at fair value less costs to sell.

Agricultural Produce

✓ Recognized as inventory at fair value at harvest.

Farm Expenses

✓ Direct costs like seeds, feed, fertilizer, and pesticides.

✓ Indirect costs like labor and utility expenses.

Depreciation

✓ Allocated for farming equipment, vehicles, and buildings.

Grants and Subsidies

✓ Government grants recorded in accordance with IAS 20 - Accounting for

Government Grants.

Special Considerations

✓ Biological Transformation
✓ Growth, reproduction, and quality changes are reflected in the fair value
measurements.
✓ Seasonality
✓ Revenue and costs can fluctuate due to seasonal cycles.

Risk Management

✓ Consider crop insurance and financial hedging against price or yield volatility.

Fair Value Challenges

✓ Assessing fair value requires market data and professional judgment, especially
in cases of illiquid markets.

Challenges in Accounting for Farming Enterprises

✓ Fair Value Measurement

✓ Market prices may not always be available, leading to reliance on estimates.

Biological Asset Complexity

✓ Tracking changes due to growth or reproduction requires detailed monitoring.

Revenue Recognition

✓ Determining when control over agricultural produce is transferred to the

customer.
Best Practices

✓ Detailed Record-Keeping
✓ Track biological assets, production processes, and financial transactions
systematically.
✓ Regular Fair Value Assessments
✓ Conduct frequent market evaluations to ensure accurate valuations.
✓ Use of Technology
✓ Employ farm management and accounting software to streamline operations
and reporting.
✓ Professional Advice
✓ Consult with auditors or accountants specializing in agriculture to ensure
compliance with IFRS.

Question

Farm Fresh Limited is a farming enterprise engaged in both crop farming (maize and
wheat) and livestock farming (dairy cows). As of 31st December 2023, the company
provided the following information:

1. Biological Assets:

o 200 dairy cows, purchased at the beginning of the year for $1,000 each.

o 1,000 hectares of maize and wheat crops in various stages of growth.

2. Agricultural Produce:

o The dairy cows produced 100,000 liters of milk during the year.

o At harvest, the crops yielded 500 tons of maize and 300 tons of wheat,
measured at $200 and $250 per ton, respectively, as their fair value at the
point of harvest.

3. Fair Value Adjustments:

o The dairy cows were revalued at $1,200 each as of the reporting date.

o The maize and wheat crops, still in growth, were valued at $100,000 in
total.

4. Expenses Incurred:

o Feed and maintenance for livestock: $50,000.

o Fertilizer, seeds, and pesticides for crops: $30,000.

o Labor costs: $20,000 for livestock and $15,000 for crops.

o Other overheads: $10,000.

 5. Revenue:

o Milk sales: $120,000.

o Maize and wheat sales: $160,000 and $75,000, respectively.

6. Grants Received:

o A government subsidy of $20,000 for adopting sustainable farming

practices.

Requirements:

1. Prepare the journal entries to record:

a. The fair value changes of the biological assets (dairy cows and crops).
b. The revenue from the sale of agricultural produce (milk, maize, and wheat).
c. The government subsidy.

1. Journal Entries

a. Fair Value Adjustments

1. Dairy cows revaluation:

o Initial value = 200 cows × $1,000 = $200,000.

o Revalued value = 200 cows × $1,200 = $240,000.

o Fair value gain = $240,000 - $200,000 = $40,000.

Dr. Biological Assets (Dairy Cows) $40,000

Cr. Fair Value Gain on Biological Assets $40,000

2. Crops under growth revaluation:

o Fair value at reporting date = $100,000.

o Dr. Biological Assets (Crops) $100,000

o Cr. Fair Value Gain on Biological Assets $100,000

b. Revenue from Agricultural Produce

1. Milk sales: $120,000.

Journal Entry:

Dr. Cash/Receivables $120,000

Cr. Revenue from Milk $120,000

 2. Maize sales: $160,000.

Journal Entry:

Dr. Cash/Receivables $160,000

Cr. Revenue from Maize $160,000

3. Wheat sales: $75,000.

Journal Entry:

Dr. Cash/Receivables $75,000

Cr. Revenue from Wheat $75,000

4. Government Subsidy

Grant received = $20,000.

Journal Entry:

Dr. Cash $20,000

Cr. Grant Income $20,000

2. Prepare the Statement of Profit or Loss for the year ended 31st December 2023,
considering:

o Fair value adjustments.

o Costs incurred during the year.

o Revenue and subsidies.

3. For the Year Ended 31st December 2023

Particulars Amount
($)
Revenue
Milk Sales 120,000
Maize Sales 160,000
Wheat Sales 75,000
Total Revenue 355,000
Fair Value Gains
Dairy Cows Revaluation 40,000
Crops Under Growth Revaluation 100,000
Total Fair Value Gains 140,000
Subsidy Income 20,000
Total Income 515,000
Expenses
Feed and Maintenance for Livestock (50,000)
Fertilizers, Seeds, and Pesticides for Crops (30,000)
Labor Costs (Livestock) (20,000)
Labor Costs (Crops) (15,000)
Overheads (10,000)
Total Expenses (125,000)
Net Profit 390,000

4. Prepare the Statement of Financial Position as of 31st December 2023, showing:

o Biological assets.

o Agricultural produce.

o Other key financial elements.

5. Statement of Financial Position

6. As of 31st December 2023

Particulars Amount ($)

Assets
Biological Assets (Dairy Cows) 240,000
Biological Assets (Crops) 100,000
Cash/Receivables 375,000
Total Assets 715,000
Liabilities
Payables/Accrued Expenses 0
Total Liabilities 0
Equity 325,000
Retained Earnings 390,000
Total Equity 715,000

7. Discuss the challenges that Farm Fresh Limited may face when applying IFRS 41
(Agriculture) for the valuation of biological assets and agricultural produce.

Fair Value Measurement:

✓ Determining the fair value of biological assets and crops in growth can be subjective,
especially if active markets are unavailable.
✓ Volatility:

✓ Frequent changes in fair value introduce income statement volatility, making it harder
to predict financial performance.
✓ Complexity:
 ✓ Estimating fair value requires specialized knowledge, market data, and professional
judgment, which may not always be readily available.
✓ Seasonal Variations:

✓ Income and expenses do not match neatly within reporting periods due to the seasonal
nature of farming activities.
✓ Cost and Time:

✓ Regular fair value assessments can be expensive and time-consuming, especially for
smaller enterprises.
✓ Regulatory Compliance:

✓ Ensuring consistent application of IFRS 41 and other relevant standards requires

robust systems and training.

Background to the Expected Credit Loss (ECL) Model

The Expected Credit Loss (ECL) model was introduced under IFRS 9: Financial
Instruments, which became effective on January 1, 2018, replacing the earlier standard,
IAS 39: Financial Instruments – Recognition and Measurement.

It represents a significant shift in accounting for credit impairments, aimed at addressing

shortcomings in the previous model and enhancing the timeliness and accuracy of financial
reporting.

Motivation for the ECL Model

1. Shortcomings of the Incurred Loss Model (IAS 39):
o Under IAS 39, credit losses were recognized only when objective evidence of
impairment was present (e.g., default or significant financial difficulty).
o This "incurred loss" approach often delayed the recognition of credit losses
until they were already apparent, leading to sudden, large write-offs during
economic downturns.
o During the 2008 Global Financial Crisis, delayed loss recognition was
criticized for exacerbating the crisis by overstating asset values in the lead-up
to the crash.
2. Global Financial Crisis Impact:
o The financial crisis highlighted the need for a more forward-looking approach
that could anticipate and prepare for credit risk.
o Stakeholders, including regulators and investors, demanded greater
transparency and earlier recognition of potential credit losses to improve
financial stability.
3. Development of IFRS 9:
 o In response, the International Accounting Standards Board (IASB)
developed IFRS 9, focusing on a proactive method of recognizing credit
impairments.
o The ECL model was introduced as part of IFRS 9 to address these concerns,
requiring entities to account for credit losses based on future expectations
rather than past events.
o Key Principles of the ECL Model
Forward-Looking Impairment Approach:
o The ECL model requires entities to estimate credit losses using forward-
looking information, including macroeconomic forecasts, to reflect potential
future defaults.
Staged Impairment Framework:
o IFRS 9 classifies financial assets into three stages based on changes in credit
risk, with different impairment measurement requirements:
o Stage 1: Assets with no significant increase in credit risk (12-month ECL).
o Stage 2: Assets with significant increases in credit risk (lifetime ECL).
o Stage 3: Credit-impaired assets (lifetime ECL).
Comprehensive Credit Risk Assessment:
o Entities must consider the Probability of Default (PD), Loss Given Default
(LGD), and Exposure at Default (EAD) to estimate expected losses.
o Incorporating these components ensures a granular and realistic evaluation of
credit risks.

o Key Objectives of the ECL Model

o Timeliness of Loss Recognition:
o Encourage earlier recognition of potential credit losses to reduce the risk of
sudden financial shocks.
o Transparency and Comparability:
o Improve the quality of financial reporting by providing more detailed and
timely insights into an entity’s credit risk exposure.
o Alignment with Risk Management Practices:
o Integrate accounting practices with sound risk management strategies,
ensuring that financial statements align with actual business operations.

Blue Horizon Farm is a diversified farming operation engaged in both livestock and
crop production. Below is a summary of their financial data for the year ended
December 31, 2023:
Item Amount (Kes)
Opening inventory of feed 50,000
Feed purchased during the year 85,000
Closing inventory of feed 40,000
Direct labor costs 150,000
Machinery depreciation 40,000
Livestock sales 300,000
Crop sales 200,000
Veterinary expenses 30,000
Seeds and fertilizers 50,000
Farm insurance 20,000
Required:
1. Calculate the total feed expense for the year. Show your workings. (2 marks)
2. Prepare an enterprise contribution statement showing the gross profit from both
livestock and crop operations. Clearly allocate shared costs based on
reasonable assumptions. (5 marks)
3. Calculate the operating profit margin ratio for the farm. Explain what this ratio
indicates about the farm's operational efficiency. (3 marks)