Classification as assets

The IASB (2013a:A41) states that a transaction or other event must be recognised as an asset when it is probable that any future economic benefit associated with the item will flow to the entity and the item has a cost or value that can be measured with reliability. It is necessary to agree on the asset in question before it can be measured and the nature and use of a transaction or another event determines its classification as an asset. Different assets exhibit different characteristics and can be held for a variety of uses in order to generate future economic benefits. For some assets significant judgement is therefore required to determine their classification.

In some cases, the process of aggregation of individual assets and liabilities converts them into a new asset or liability and the individual items lose their separate identity. Self-constructed assets and the installation of specialised equipment are examples of this type of aggregation. In such cases, the unit of account is, for measurement purposes, the lowest level of aggregation at which an identifiable asset is ready to contribute to the generation of future cash flows. Additionally, the IASB (2013a:A532) requires separate line items to be disclosed on the face of the financial statements. In view of the IASB requirements, this study considers the following sub-classification of assets to be necessary for reporting for

cap-and-trade schemes in the agricultural sector, as summarised in sections 3.4.1.1 to 3.4.1.5 below.

3.4.1.1 Intangible assets

Intangible assets are identifiable non-monetary assets, without physical substance, held for use, for the production of goods or services, to be rented to third parties or to be used for administrative purposes, for example franchises, copyright, knowledge about the market and contracts with distributors. In the original consensus, the IASB (2005:2079) considered carbon emissions allowances, whether allocated for free or purchased, to be intangible assets. This consensus was based on carbon emissions allowances that are not produced in the course of making inventories or other assets (IASB 2005:2081). The VCUs are generated or produced through a series of adaptation activities over an extended period of time (Forest Trends 2011:25).

Adaptation activities in the agricultural sector will involve certain adaptation costs that may merit recognition as intangible assets. Such costs will include soil testing, detoxication, soil cover management and new crop species technology development. These costs are incurred to increase soil organic matter and nutrients and enhance carbon absorption capacity. According to Forest Trends (2011:13), the time required to navigate a cap-and-trade project cycle in the agricultural sector, and the adaptation of third-party standard requirements that occur along the way, remain the most significant and unpredictable contributors to project cost.

The adaptation costs will certainly be recouped through increased productivity and the generation of VCUs and are therefore essentially internally generated intangible assets (Siegel & Borgia 2007). The IASB (2013a:A1045) requires an intangible asset arising from the development phase of an internal project to be recognised if, and only if, an entity can demonstrate all of the following:

 the technical feasibility of completing the intangible asset so that it will be available for use or sale,

 its intention to complete the intangible asset and use or sell it,

 its ability to use or sell the intangible asset,

 how the intangible asset will generate probable future economic benefits.

Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset,

 the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset, and

 its ability to measure reliably the expenditure attributable to the intangible asset during its development (IASB 2013a:A1045).

One precondition for an asset to be recognised as an intangible asset is that it must be separately identifiable. The adaptation cost must have an additionality attribute if the project is to meet the CDM requirements under the UNFCCC (2008). Additionality means that emissions reduction or sequestration would not have occurred without the project activities.

The additionality attribute therefore means that the effects of the adaptation cost can be monitored and tracked separately, and thus meet the criteria for recognition.

3.4.1.2 Biological assets

Agricultural activities involve managing the biological transformation process and harvesting the biological assets for sale or for conversion into agricultural produce or into additional biological assets (IASB 2013a:A1131). Biological assets are living animals or plants capable of biological transformation, which comprises the processes of growth, degeneration, production and procreation that bring about either qualitative or quantitative changes or both.

In the case of SALM, biological assets are targeted for the production of harvested agricultural produce and also VCUs. This requires some changes and adaptation to ensure

that the biological assets help in carbon sequestration or avoid carbon emissions.

Additionally, SALM practices increase productivity and enhance harvested produce resilience which leads to reduced post-harvest losses. The IASB (2013a) requires that when biological assets are used for productive purposes, they must be classified under IAS 41, Agricultural activities.

As pointed out by Maina and Wingard (2013), the initial recognition criterion for a biological asset or for any agricultural product is basically a single accounting unit, but emerging discussions are calling for more than one unit of accounting on initial recognition (IASB 2014:2). Under IAS 41, the IASB (2013a:A1131) requires entities to treat a bearer plant and its agricultural produce as a single accounting unit until the point of harvest. The recent amendments will require an entity to recognise a bearer plant separately from its agricultural produce prior to harvest with effect from 1 January 2016, and to include the bearer biological assets under property, plant and equipment (IASB 2014:2). This begs the question of whether there is also a need to recognise the carbon capture potential of the biological assets as a separate unit of accounting.

According to Manor House Agricultural Centre (2015), practices such as companion planting take advantage of natural synergies that increase yields. Companion planting refers to practices where, for example, some plants attract helpful insects while others repel pests, for instance green beans and strawberries while others like borage help control tomato worms, while its blue flowers also attract bees. The question that arises is how the supportive attribute of one crop to the other should be accounted for. In the process of embracing cap-and-trade scheme activities farmers may have to buy seeds and seedlings at higher prices.

Such seeds or seedlings are more adaptable to weather changes, more resilient to pests and have higher productivity. These are the additional factors that an entity that has adopted SALM activities in the agricultural sector must consider, with the implication that the value of biological assets on initial recognition will be equally higher.

3.4.1.3 Inventories

As highlighted in table 3.1, composting and residual management create manure which is a substitute for inorganic fertiliser. According to the IASB (2013a:A558), inventories comprise goods held for sale in the ordinary course of business activity, or for production for the purpose of such sales, or for daily consumption in the rendering of services. The composted organic matter, before application, forms part of the inventories of any entity that has adopted SALM practices.

Additionally, in the agricultural sector inventories will also include the agricultural produce which is initially recognised at the point of harvest, that might be amended by some recent proposal to have two units of accounting for bearer crops where the crop and produce are recognised separately before harvest (IASB 2014:5). Agricultural produce that is to be reclassified from biological assets to inventories should be initially recognised at fair value.

SALM activities are synonymous with organic farming, and some entities promote their produce as organically farmed. Organic agricultural produce attracts a premium price and are readily acceptable, depending on grading which is influenced by various factors (Manor House Agricultural Centre 2015). Such produce usually attracts better grades and thus higher market prices. Moreover, since organic agricultural products are readily acceptable by consumers there is a reduced cost to sell. Considering the requirement for valuing agricultural produce at fair value less cost to sell at the point of harvest (IASB 2013a), it is obvious that SALM activities significantly influence the fair value on initial recognition.

Organic agricultural produces has a longer shelf life and is more resilient and this results in reduced post-harvest losses, which in turn influences the fair value at the point of harvest.

Where an entity is involved in processing agricultural produce or any other artificial processing after harvesting, these are not considered SALM activities. However, if the presumption that every agricultural product has a fair value that can readily be determined

(IASB 2013a:A1134) is relaxed, such processing may influence the fair value on initial recognition at the point of harvest.

3.4.1.4 Property, plant and equipment

According to the IASB (2013a), property, plant and equipment are tangible non-current assets held for use in the production or supply of goods or services, for rental to others, or for administrative purposes. Some property, plant and equipment are very unique in the agricultural sector such as the development of structures for handling compost, hedges for preventing soil erosion and bearer crops (IASB 2014:5). In addition, adaptation to SALM practices may lead to the development of special green houses that can trap carbon (CO2) from the atmosphere, the use of organic growing media such as coconut coir, and the use of carbon supplementation equipment (Government of Canada 2015).

The principles under IAS 16, require that property, plant and equipment should be recognised initially at cost and that, in the case of bearer crops, the fair value at the point of transition be the deemed cost (IASB 2013a:A676; IASB 2014:5).

3.4.1.5 Financial instrument

According to the World Bank (2009), the overall objective of the KACP is to enable farmers to generate VCUs. The VCUs are marketable instruments issued upon validation and verification of the SALM activities. The IASB (2013a:A245) states that it is imperative to highlight to the users of financial statements the range of financial instruments used by an enterprise and how they affect the financial position, performance and cash flows.

Additionally, the IASB (2013:A315) requires that an entity recognise and classify financial assets on the basis of the entity’s business model for managing such financial assets.

Although the original argument on the classification of allocated allowances as financial assets (IASB 2005:2090) was decided in favour of intangible assets, the existence of markets and exchanges for the trading of emissions allowances provided evidence that they qualified as financial assets, as the allowances would be readily convertible to cash.

The issue of VCUs, which creates a marketable financial instrument, under the KACP is dealt with at intervals of three to five years in order to facilitate aggregation. The contracted farmers have to surrender the VCUs through the World Bank’s (2014) bio-carbon fund.

However, there is also an independent market on which VCUs can be sold.