FAIR VALUE AND HISTORIC COST ACCOUNTING OF BIOLOGICAL ASSETS
VALOR RAZONABLE VERSUS COSTE HISTÓRICO DE ACTIVOS BIOLÓGICOS
Josep Mª. Argilés
University of Barcelona (Department of Accounting)
Josep Garcia Blandón
IQS, (Faculty of Economics)
Teresa Monllau
Universitat Pompeu Fabra (Department of Economics and Business)
Address for correspondence:
Josep Mª. Argilés. Department of Accounting. Facultat d’Econòmiques. Universitat de
Barcelona. Av. Diagonal, 690. 08034 Barcelona. Spain.
Phone:
00 34 93 4021956
00 34 93 4021957
Fax.
00 34 93 4029099
e-mail:
josep.argiles@ub.edu
Acknowledgements: The authors would like to thank the firm CABSA for providing the
data that made this paper possible, and the Spanish Ministerio de
Educación y Ciencia for granting this research (SEJ2005-04037/ECON).
FAIR VALUE AND HISTORIC COST ACCOUNTING OF BIOLOGICAL ASSETS
VALOR RAZONABLE VERSUS COSTE HISTÓRICO DE ACTIVOS BIOLÓGICOS
ABSTRACT
This paper starts out to analyse the recent debate about the convenience of the move of
accounting from historical cost toward the fair-value principle. In spite that there is no
unanimous opinion on the advantages and drawbacks of its implementation with respect
to historic cost, in the existing previous literature. on agricultural accounting prevails a
claim against the requirement of IAS 41 of fair valuation for biological assets.
This research provided empirical evidence that the use of fair value principle for
biological assets provides significant different valuations of assets and revenues with
respect to historic cost, but does neither disclose significant differences in profits, nor
increase volatility, nor bring about different profitability and accounting manipulation.
Provided that historic cost is a complex valuation method for biological assets, it seems
that fair value is an interesting tool for the predominant small holdings in the
agricultural sector in the European Union.
Keywords: agricultural accounting, fair value, historic cost, biological assets.
RESUMEN
Este trabajo comienza analizando el debate existente sobre la conveniencia de la
transición que la contabilidad está experimentando desde el coste histórico hacia el
valor razonable. A pesar de que en no hay acuerdo unánime respecto a las ventajas e
inconvenientes de la implementación del valor razonable, en contabilidad agrícola
prevalece la opinión en contra de la utilización del valor razonable para los activos
biológicos.
En este estudio se aporta evidencia empírica de que las empresas que aplican el valor
razonable en la valoración de los activos biológicos presentan diferencias significativas,
respecto a las que valoran al coste histórico, en sus activos e ingresos, pero no ofrecen
valores significativamente diferentes en beneficios, ni presentan mayor volatilidad en
ninguna de estas magnitudes. Tampoco muestran cifras significativamente diferentes de
rentabilidad ni siquiera de manipulación contable. No se encuentra que el criterio de
valoración de los activos biológicos influencie significativamente la dispersión de los
resultados.
Palabras clave: contabilidad agrícola, valor razonable, coste histórico, activos
biológicos.
1. Introduction
An important public debate in recent years has been the reform of the accounting
standards toward “fair value” accounting. Most worldwide important accounting groups
and institutions, such as The International Accounting Standards Board (IASB), the
U.S.A. Financial Accounting Standards Board (FASB), and the Accounting Regulatory
Committee (ARC) and the European Financial Reporting Advisory Group (EFRAG) in
the European Union (EU) have encouraged the convergence of international accounting
toward standard based on market prices, opposite to traditional accounting measurement
based on historical cost.
The FASB early issued several standards requiring recognition or disclosure of fair
values estimates for assets and liabilities, mainly for financial instruments. For example,
Statements of Financial Accounting Standards (SFAS) number 87 in 1985 on
employer’s accounting for pensions, number 105 in 1990 on disclosure of information
about financial instruments, number 107 in 1991 on disclosures about fair value of
financial instruments, etc. The International Accounting Standards Committee (IASC)
issued International Accounting Standard (IAS) requiring measurement at fair value and
value changes to be recognised in profit or loss. The most important were the IAS 32 on
disclosure and presentation of financial instruments, issued in 1995 and revised in 1998
by IAS 39, and the IAS 41 on Agriculture, issued in 2000. The EU adopted the whole
existing IAS by the Commission Regulation (EC)1725/2003, with the exception of IAS
32 and 39, that were adopted in 2004 by Commission Regulations (EC)2086/2004 and
(EC)2237/2004.
Fair value is defined as the amount for which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arm's length transaction (e.g., IAS
39, IAS 41, SFAS 107). In 2006 SFAS 157 redefined fair value as the price that would
be received to sell the asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date1.
In spite of this persistent trend toward fair value, the reform has aroused controversial
stances, usually debating around financial instruments, in the practitioner ground (e.g.,
Day, 2000; Economist, 2007; Joint Working Group of Banking Associations on
Financial Instruments, 1999). A rapport of the European Central Bank (2004)
summarizes the potential drawbacks and advantages of a fair value accounting
1
framework from the point of view of financial institutions. There is also an unsolved
debate in the academic ground.
Academics’ debate is usually referred to financial instruments and framed within the
agency theory, supposing information asymmetry between market participants and the
existence of perfect versus imperfect market conditions. Barth and Landsman (1995)
concluded that in perfect and complete markets a fair value accounting-based balance
sheet reflects all value-relevant information. However, in more realistic market settings
management discretion applied to fair valuation can detract from balance sheet and
income statement relevance. Watts (2003) argues that fair valuation is subject to more
manipulation and, accordingly, is a poorer measure of worth and performance. Rayman
(2007) concludes that fair value accounting is liable to produce absurdities and
misleading information, if it is based on expectations that turn out to be false. In the
same vein, Liang and Wen (2007) are critical with the beneficial effects of moving to
fair valuation because it inherits more managerial manipulation and induce less efficient
investment decisions than cost valuations. Plantin and Sapra (forthcoming) conclude
that, when there are imperfections in the market, there is the danger of the emergence of
an additional source of volatility as a consequence of fair valuation, and thus a rapid
shift to full mark-to-market regime may be detrimental to financial intermediation and
therefore to economic growth. On the contrary, Bleck and Liu (2007) found that historic
cost accounting makes easier to hinder bad investment projects, prevents from
liquidating them, therefore accumulating volatility to hit the market at a later date and
produce crash prices, increasing overall volatility and reducing efficiency (i.e. reducing
profitability) with respect to market valuation. Gigler et al. (2006) concluded that even
in the case of mixed attribute report (i.e., some items are valued at market while others
are carried at historical cost), fair value performs better: it provides stronger signals of
financial distress. All these previous mentioned studies are analytical and mainly use
mathematical models. However, to our knowledge, there are few empirical studies
contrasting hypotheses on these issues. Hann et al. (2007) found empirical evidence of
fair-value pension accounting not improving the informativeness of the financial
statements and even impairing it. Slightly related to these issues, Beaver et al. (2005)
found a small decline in the ability of financial ratios to predict bankruptcy from 1962
to 2002, and an incremental explanatory power of market-related variables over this
period. They explain the deterioration of predictive ability of financial ratios in terms of
an insufficient improvement of FASB standards.
2
The IAS 41 brought the debate into the agricultural accounting domain. Most authors
were critical with the requirement of fair valuation for biological assets and value
changes to be recognised in profit and loss statement. Penttinen et al. (2004) claimed
that fair valuation would cause unrealistic fluctuations in net profit of forest enterprises.
Herbohn and Herbohn (2006) and Dowling and Godfrey (2001) stressed on the
increased volatility, manipulation and subjectivity of reported earnings under this
standard. Both studies were performed in the context of the Australian of Accounting
Standards Board 1037 (requiring similarly to IAS 41) and provided empirical evidence
of Australian entities preference for cost valuation or delaying the adoption of fair
valuation. Specifically, Herbohn and Herbohn (2006) calculated coefficients of
variation of profits, and gains and losses from timber assets as a percent of net profits,
of eight public companies and five state and territory government departments with
material holdings of timber assets for four years. The authors argued that figures
provided an insight into the volatility caused by the fair value measurement. Elad
(2004) complained that the IAS 41 is a major departure from historic cost accounting,
could signal the demise of the French Plan Comptable Général Agricole (PGCA)
model, entails the recognition of unrealized gains and increases profit volatility.
However, Argilés and Slof (2001) welcomed fair value measurement for biological
assets because it avoids the complexity of calculating their costs, given the
predominance of small family farms in Western countries, and specifically in the
European Union (EU), with no resources and skills to perform accounting procedures
and valuations. The nature of farming makes an historical-based valuation of biological
assets inherently difficult because they are affected by procreation, growth, death, as
well as typical problems, usually exceeded in agriculture, of joint-cost situations. This
complexity is a specially acute problem for small family households. Kroll (1987) and
Lewis and Jones (1980) concluded that historical costs are not very informative to users,
and allocations to assets are arbitrary in most cases. The American Institute of Certified
Public Accountants (1996) and the Canadian Institute of Chartered Accountants (1986)
recommended the historic cost, considering also the possibility of realizable value as an
alternative. The French PGCA adhered also to the historic cost principle. However,
Kroll (1987) regretted that the complexity in asset valuation and accounts was an
important barrier to its use in practice. Elad (2004) points out that simplicity is not a
merit of fair value where does not exist an active market for a biological asset. Argilés
and Slof (2001) stated that IAS 41 conceptual’s framework has already been in fact
3
widely and successfully implemented in the EU through the Farm Accountancy Data
Network (FADN), which has been fulfilling the role of a quasi-standard-setting body in
the absence of previous pronouncements on agricultural standards from other authorities
(Poppe and Beers, 1996).
Therefore, an assessment of the convenience of fair valuation for agriculture should
balance its advantages and drawbacks. Simplicity is the main advantage of fair
valuation of biological assets with respect to historic cost. But there is no unanimous
pronouncement in previous literature with respect to whether volatility in income and
profits, relevance, manipulation and profitability are improved or worsened with fair
value. The present paper contributes providing empirical evidence about it in
agriculture.
The remainder of this paper is organized as follows. Section 2 explains the research
design used in this study. We provide results in the third section and present conclusions
in the fourth section.
2. Research design
2.1. Empirical design
The purpose of the study is to empirically test the effects of the valuation method used
for biological assets, in revenues, profits, volatility and accounting manipulation.
We performed mean comparison tests between samples of farms that used fair value and
historic cost for biological assets valuation. The tests were performed for revenues,
profits and assets.
We tested the contradictory hypotheses of increase-decrease in volatility with fair
valuation through mean and median comparisons for standard deviation of revenues,
profits, assets and return on assets. In order to control for relative variations we also
compared coefficient of variations.
In order to test whether it is fair valuation or historic cost that entails less efficient
investment decisions, we performed mean comparisons for return on assets between
both samples.
We tested the hypothesis that fair value increases manipulation through the traditional
ratio of standard deviation of profit to standard deviation of cash flow.
4
In order to avoid the incidence of influential cases, we also performed Pearson chisquare tests of median association for all previous mentioned variables.
We reinforced tests on the influence of the valuation method with regression models.
We considered profits as a dependent variable of the valuation method employed and
controlling for the cash flow generated by the farm, that is supposed to be a reliable data
and independent on accruals and accounting manipulation. On the other hand, we
considered profits depending on the valuation method, but controlling for sales
performed by the farm. We thus defined the following regression models to reinforce
tests on volatility:
profitstdv i = β 0 + β1 ⋅ cashflowstdvi + β 2 ⋅ historiccost i + ε i
(1)
profit ij = β 0 + β 1 ⋅ cashflowij + β 2 ⋅ historicco st i + ε ij
( 2)
profit ij = β 0 + β 1 ⋅ sales ij + β 2 ⋅ historicco st i + ε ij
(3)
where profitstdvi is the standard deviation of annual profits of farm i, cashflowst dvi is
the standard deviation of annual cash flow generated by farm i, historiccosti is a
dummy variable, which value is 1 when the farm applies historic cost valuation to
biological assets and 0 otherwise, profit ij is the annual variation of profit of farm i in
year j with respect to previous year, cashflowij is the annual variation of cash flow
generated by farm i in year j with respect to previous year and sales ij is the annual
variation of sales of farm i in year j with respect to previous year.
We performed an ordinary least squares regression for equation (1) and panel data with
random effects regressions for equations (2) and (3), thus correcting for autocorrelation
disturbances. As we did not find data of whole years for all farms, and the panel data
was unbalanced, we performed panel data regressions with random effects.
2.2. Sample
5
The Spanish firm CABSA provided us with notes to financial statements of 117 listed
Spanish farms. CABSA is a firm that provides analysis and financial data of about
300,000 Spanish firms. We classified the sample in two groups: those disclosing fair
valuation for biological assets in their notes and those disclosing historical cost
valuation. We then selected financial data from those farms available in SABI and
CABSA. SABI is a data base of financial statements of about 1,000,000 Spanish and
150,000 Portuguese firms. It covers a larger number of firms than CABSA, but they do
not provide notes to financial statements. Through these data bases we collected twelve
years-data for these firms. Our review yielded 11 farms valuing biological assets at fair
value and 101 at historical cost and 5 were discarded because they did not provide
information about their valuation method, or it was not clear the applied method, and/or
there was no available financial data for them.
CABSA and SABI databases collect information of financial statements of companies
obliged to file in the Spanish Registro Mercantil. Most farms have no legal obligation to
disclose financial information because of their small size and legal form, and usually do
not write up accounting. Only the small proportion of farms that by their legal form are
trading companies must file financial statements in the mentioned Registro Mercantil.
However, there is no other public file for financial statements from Spanish farms.
The small proportion of farms from our sample using fair value can be explained in
terms of the Spanish obligation to use the historic cost, stated in the accounting
standards number 3 and 13 of the Spanish Plan General Contable. Market value is only
allowed when cost price is higher. The 8th rapport of accounting principles of the
Asociación Española de Contabilidad (AECA) recognising the possibility to use market
prices in agricultural and mining companies under certain conditions, is a mere
recommendation of a professional association. Some of the few firms using fair value
allege difficulties in calculating historic cost and/or the recommendation of AECA.
3. Results
Table 1 display results about the incidence of the valuation method applied to biological
assets in profits, assets, revenues, volatility and profitability.
As the distribution of our samples did not fit normality, we applied the Mann-Whitney
test.
6
Tests performed did not find significant differences in mean values of profits, assets and
revenues between samples. However, we found significant differences in median values
of assets with p<0.01 and revenues with p<0.1, that is consistent with the application of
different valuation methods. Results suggest that the use of fair value for biological
assets significantly changed the value of farm assets and revenues, with respect to
historical cost valuation, but did not significantly affect the amount of profits.
The absence of significant differences in standard deviation of profits, assets and
liabilities does neither provide empirical evidence, for the agricultural sector, to the
commonly accepted hypothesis (e.g. Plantin and Sapra, forthcoming; Dowling, 2001;
Pentinen et al., 2004) of greater volatility with fair valuation, nor to Bleck and Liu’s
(2007) hypothesis of greater volatility with historic cost. No significant differences in
coefficients of variation of these variables confirm this result.
The fact that mean and median values of return on asset are not significantly different
between groups neither confirm, in the specific circumstances of agricultural sector,
Liang and Weng’s (2007) hypothesis of less efficient decisions under fair valuation, nor
Black and Liu’s (2007) argument that under historic cost bad investment projects would
be pooled with good projects and prevented from liquidation. In a similar way, no
significant differences in standard deviation of return on assets confirms the absence of
greater volatility under fair value and suggests that there is no significant transfers of
gains and loses between periods.
No significant differences in standard deviation of profits to standard deviation of cash
flows between groups suggests that fair value did not provide greater discretionarily to
manipulate earnings, as is usually assumed (e.g. Watts, 2003; Liang and Wen, 2007).
Regressions performed for equations (1), (2) and (3) are displayed in table 2. Column
(A) displays estimations when the independent variable is standard deviation of profits,
Values of variance inflation factors, condition indexes and variance proportion of
variables suggest that collinearity and multicollinearity do not likely disturb regression
estimations. The model presents a significant goodness-of-fit and explains about 98% of
the total variability. The insignificant sign for the coefficient of the dummy variable
suggests no influence of the valuation method in profit volatility. The control variable
presents the expected significant positive sign.
The Durbin-Watson statistics for regression estimations of equations (2) and (3)
determine the typical autocorrelation pattern for independent variables in panel data.
Given that we have unbalanced panel data, we performed panel data regressions with
7
random effects. Results displayed in columns (B) and (C) of table 2 reinforce the
absence of influence of fair valuation in volatility of profits. Both models present a
significant goodness-of-fit and the expected significant positive sign for the control
variables. In none of the columns the dummy variable for valuation method presents a
significant sign.
Therefore, estimations from table 2 reinforce our finding that fair valuation of biological
assets is not associated with higher volatility.
4. Conclusions
These paper reviews recent literature on the debate about the convenience of the move
of accounting from historical cost toward the fair-value principle. There is a lack of
agreement about the advantages and drawbacks. No unanimous pronouncement can be
ascertained in previous literature with respect to whether volatility in income and
profits, relevance, manipulation and profitability are improved or worsened with the use
of fair value principle. However, in the existing literature on agricultural accounting
prevails a claim against the requirement of IAS 41 of fair valuation for biological assets.
Most authors complain that it is a major departure from the convenient valuation
method applied in agriculture and will entail serious drawbacks for the agricultural
sector.
Tests performed with the data sample used in this study provided empirical evidence
that fair value of biological assets does neither disclose significant differences in profits,
nor increase volatility, nor bring about lower profitability and accounting manipulation.
However, significant differences were found in median values of assets and revenues.
None of the alleged drawbacks for the agricultural sector were empirically confirmed by
this research. On the other hand, fair valuation avoids the unaffordable complexities of
cost calculation for biological assets for the predominant small holdings in the
agricultural sector. Therefore, fair value for biological assets seems to be a useful
simple valuation method that will help to get a more widespread use of accounting in
the agricultural sector.
8
Notes:
1. The IASB started a project on fair value measurement and issued a discussion
paper (IASB, 2006) aiming at a providing a single source of guidance on fair
valuation, adopting the same definition as in SFAS 157, but stating that “it will
neither introduce nor require any new fair value measurements” (IASB, 2008).
References
American Institute of Certified Public Accountants (1996) Audits of Agricultural
Producers and Agricultural Cooperatives. New York: AICPA.
Argilés, J.M. and Slof, J. (2001) “New opportunities for farm accounting”. European
Accounting Review, 10(2), p.361-383.
Barth, M.E. and Landsman, W.R. (1995) “Fundamental issues related to using fair value
accounting for financial reporting”. Accounting Horizons, 9(4), p. 97-107.
Beaver, W.H., MchNichols, M. and Rhie, J.-W. (2005) “Have financial statements
become less informative? Evidence from the ability of financial ratios to predict
bankruptcy”. Review of Accounting Studies, 10, p. 93-122.
Bleck, A. and Liu, X. (2007) “Market transparency and the accounting regime”. Journal
of Accounting Research, 45(2), p. 229-256.
Canadian Institute of Chartered Accountants (1986) Comptabilité et Information
Financière des Producteurs Agricoles. Toronto: CICA.
Day, J.M. (2000) Speech by SEC staff: fair value accounting-let’s work together and get
it done. http://www.sec.gov/news/speech/spch436.htm
Dowling, C. and Godfrey, J. (2001) “AASB 1037 sows the seeds of change: a survey of
SGARA measurement methods”. Australian Accounting Review, 11(1), p. 45-51.
Economist (2007) “A book-keeping error”. Economist, 384(8544), p. 69.
Elad, Ch. (2004) “Fair value accounting in the agricultural sector: some implications fro
the international accounting harmonization”. European Accounting Review,
13(4), p. 621-641.
European Central Bank (2004) “Fair value accounting and financial stability”.
Occasional Paper Series, 13.
9
Gigler, F. Kanodia, Ch. And Venugopalan, R. (2007) “Assessing the information
content of market-to-market accounting with mixed attributes: the case of cash
flow hedges”. Journal of Accounting Research, 45(2), p. 257-276.
Hann, R.N., Heflin, F. and Subramanayam, K.R. (2007) “Fair-value pension
accounting”. Journal of Accounting and Economics, 44, p. 328-358.
Herbohn, K. and Herbohn, J. (2006) “International Accounting Standard (IAS) 41: what
are the implications for reporting forest asstes?”. Small-scale Forest Economics,
Management and Policy, 5(2), p. 175-189.
IASB (2006) “Fair value measurements. Part 2: SFAS 157 fair value measurement”.
Discussion paper. http://www.iasb.org/NR/rdonlyres/5D20E453-26D3-4E0AAB08-FC391917FD89/0/DDFairValue2.pdf
IASB (2008) “Fair value measurement, where are we in the project?”.
http://www.iasb.org/Current+Projects/IASB+Projects/Fair+Value+Measurement
/Fair+Value+Measurement.htm.
Joint Working Group of Banking Associations on Financial Instruments (1999)
Accounting
for
financial
instruments
for
banks.
http://www.aba.com/aba/pdf/GR_tax_va4.PDF
Kroll, J.C. (1987) “Le nouveau plan comptable: les occasions perdues”, Économie
Rurale, 180: 20-25.
Lewis, A.E. and Jones, W.D. (1980) “Current cost accounting and farming businesses”,
Journal of Agricultural Economics, 31: 45-53.
Liang, P.J. and Wen, X. (2007) “Accounting measurement basis, market mispricing,
and firm investment efficiency”. Journal of Accounting Research, 45(1), p. 155197.
Penttinen, M., Latukka, A. Meriläinen, H., Salminen, O. and Uotila, E. (2004) “IAS fair
value and forest evaluation on farm forestry”. Proceedings of Human dimension
of family, farm and community forestry international symposium. March 29April 1.
Poppe, K.J. and Beers, G. (1996) “On innovation management in Farm Accountancy
Data Networks”, Agricultural Economics Research Institute LEI, 535: 1-37.
Plantin, G. and Sapra, H. (forthcoming) “Marking-to-market: panacea or Pandora’s
box?”. Journal of Accounting Research.
10
Rayman, R.A. (2007) “Fair value accounting and the present value fallacy: the need fro
an alternative conceptual framework”. British Accounting Review, 39, p. 211225.
Watts, R.L. (2003) “Conservatism in accounting. Part I: explanations and implications”,
Accounting Horizons, 17(3), p. 207-221.
11
Table 1. Mean and median comparisons between samples of farms using fair value and historic cost
Number of observations
Fair value
Historic cost
Fair value
Mean
Historic cost
Profits (in €)
128
1092
Assets (in €)
128
1095
319563.3
7401826.0
Revenues (in €)
Std. dev. of profits
Std. dev. of assets
Std. dev. of revenues
Coefficient of variation of profits
Coefficient of variation of assets
Coefficient of variation of revenues
Return on assets (in percent)
Std. dev. of return on assets
Std. dev. of profits to std. dev. of cash flow
128
11
11
11
11
11
11
128
11
11
1094
101
101
101
99
99
99
1092
101
99
6866245.0
132724.8
484998.5
454484.3
18,92257.0
0.2574009
0.2595552
0.0334731
0.016708
0.8954057
370621.7
11000000.0
11800000.0
Notes:
Mann-Witney test for means
Pearson chi-square tests of association for medians, and tests corrected for continuity.
Significance levels: * p<0.1, ** p<0.05 and *** p<0.01
12
262950.5
1043571.0
993581.2
-2.206374
0.2842284
0.3065067
0.0269575
0.0213837
0.9338611
Median
Fair value
Historic cost
68288.0
61345.0
6116298.0
2951522.0 ***
3437802.0
84387.1
401498.3
211038.4
1.912104
0.2584495
0.2374224
0.0186692
0.141564
0.9434019
4259313.0 *
69361.4
260525.0
354348.1
0.8591279
0.259699
0.246293
0.0236735
0.014827
0.9815769
Table 2. Estimations relating profits to cash flow and sales (t-statistics in parenthesis)
Variable
Constant
historiccost
Control variables:
cashflowstdv
(A)
Eq. (1)
profitstdv
(B)
Eq. (2)
│profit │
(C)
Eq. (3)
│profit │
-6984.62
(-1.05)
2965.405
(0.41)
16865.23
(0.61)
-11239.84
(-0.39)
158214.5
(1.17)
332716.9
(0.53)
0.9702714
(32.14)
***
│cashflow │
0.9562842
(201.05)
***
│sales │
0.0852866
(8.86)
Fitness of the model:
R-square
R-square (overall)
0.9835
***
***
0.9801
2
Wald (chi-sq. )
40446.31
Significance levels: * p<0.1, ** p<0.05 and *** p<0.01
13
0.2263
***
79.08
***