Tarheel Farm Inc. Inventory Background

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Tarheel Farm Inc. (TFI) is a private corporation involved in agricultural production, with a fiscal year ending June 30. Although not publicly traded, TFI is required to prepare annual financial statements primarily for its bank, which historically mandated compliance with US GAAP rules. Currently, TFI has the option to report under IFRS, a flexibility that may influence accounting treatments for its inventories. The company’s primary activities include the production of beef cattle, corn, winter wheat, and recently, hibiscus plants. All of these commodities have a short life cycle of less than one year, which raises pertinent considerations regarding their valuation and treatment according to accounting standards.

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The valuation of inventories is a crucial aspect of financial reporting, especially within the agricultural sector where assets comprise biological goods and harvested products. Under both US GAAP and IFRS, the treatment of inventories aligns with the recognition, measurement, and disclosure principles embedded within each framework, although there are notable differences in their application. Analyzing TFI’s inventory as of June 30 necessitates a detailed assessment of its various products—corn, wheat, cattle, and hibiscus plants—taking into account their unique characteristics and stage of development.

Inventory Valuation under US GAAP

Under US GAAP, inventories are generally valued at the lower of cost or net realizable value (NRV). Cost includes all costs of purchase, conversion, and other costs incurred to bring the inventories to their present location and condition. Specifically, for agricultural products, US GAAP emphasizes the use of the cost method, which in this case involves applying the standard cost of production or acquisition, and adjusting for impairment if necessary.

For the corn and wheat, the cost includes accumulated costs associated with planting, cultivating, harvesting, and transportation. The corn has an accumulated cost of $95,000 with an estimated selling costs of $4,500, and the land costs are $5,000 per acre, totaling $2,000,000 for 400 acres. Since the land is not yet harvested or sold, its valuation is typically not included in inventory but might be disclosed as part of land holdings unless the land is held for sale, which does not seem to be the case here.

The harvested wheat inventory is valued at the lower of its historical cost ($27,000) and its NRV. NRV is calculated as the current market price ($6.10 per bushel + $0.10 increase = $6.20 per bushel) minus estimated selling costs ($0.05 per bushel), totaling $6.15 per bushel. The market value per bushel exceeds the cost, so the wheat inventory remains at its historical cost of $27,000 under US GAAP.

The cattle inventory, including heifers and steers, is valued at the lower of cost ($50,000) and NRV, which in this case is their market value of $70,000 less selling costs of $2,000, resulting in a net realizable value of approximately $68,000. Since the market value ($70,000) exceeds the cost, the inventory is maintained at the cost basis of $50,000, unless an impairment is identified.

Hibiscus plants are a novel product for TFI, with history of sales at $25 per plant. Given the absence of a local market and the product’s uniqueness, IFRS allows inventory valuation at the lower of cost or net realizable value, which is likely close to historical cost ($10 per plant) or possibly the previous sale price, considering the plant’s rarity and sales history. Since no significant selling costs are expected, and there is no market for this product, the inventory is valued at cost, i.e., $10 per plant, totaling $5,000 for 500 plants.

Inventory Valuation under IFRS

Under IFRS, the principles for inventory valuation are similar, emphasizing the lower of cost and net realizable value. However, IFRS distinguishes biological assets (such as crops) from inventories, requiring biological assets to be measured at fair value less costs to sell at the point of harvest, with subsequent measurement of harvested products at the same fair value. As such, the valuation of corn and wheat involves fair value measurement upon harvesting.

The corn, being unharvested as of June 30, may be accounted for at cost or fair value less costs to sell, but since the crop has not been harvested, its valuation may follow US GAAP conventions unless the company chooses to measure agricultural biological assets at fair value. Therefore, the corn remains at its cost basis of $95,000 until harvest, at which point it transitions to inventory at fair value less costs to sell.

The wheat, harvested and stored, would be measured at its fair value less costs to sell at harvest, which aligns with the current market price of $6.20 per bushel less $0.05 per bushel transportation costs, totaling $6.15 per bushel. The total fair value is therefore 6.15 * 6,000 bushels = $36,900, replacing the historical cost of $27,000. This adjustment reflects the higher market value and aligns with IFRS’s emphasis on fair value measurement at the point of harvest.

The cattle inventory is valued similarly in IFRS, with a focus on transfer at fair value less costs to sell. Since the market value ($70,000) exceeds the cost ($50,000), the inventory remains valued at cost unless impairment thresholds are surpassed.

Hibiscus plants, as biological assets, should be measured at their fair value less costs to sell at the recognition date. Given the previous sale at $25 per plant and the current selling price, it’s reasonable to assume a fair value similar to this previous sale price, especially in the absence of a market. Thus, the inventory of hibiscus plants should be valued at $25 per plant, totaling $12,500 (500 * $25).

Comparison and Analysis of Included and Excluded Costs

Under both US GAAP and IFRS, inventory costs include expenditures directly attributable to bringing the inventory to its present condition and location. This includes purchase costs, conversion costs, and related costs such as transportation and handling. For harvested crops like wheat, costs also encompass harvesting and storage. In the case of biological assets like livestock and plants, initial costs include purchase price and direct costs of growth or cultivation.

US GAAP generally excludes land costs from inventory valuation unless the land itself is held for sale, where it would then be classified as a tangible asset held for sale according to ASC 360. Any land costs associated with the crop are usually disclosed separately, not capitalized into inventory. Similarly, under IFRS, land costs are not included in inventory unless the land itself is being held for sale.

Costs excluded from inventory typically include administrative expenses, research costs, and costs incurred after harvesting or planting unless they are part of the process of bringing the inventory to saleable condition. Both standards ensure that inventory valuation reflects only those costs directly related to current assets, minimizing the risk of overstatement.

Conclusion

In conclusion, the valuation of TFI’s inventories as of June 30 varies between US GAAP and IFRS, primarily due to differences in treatment of biological assets and fair value measurement. Under US GAAP, inventories are reported at the lower of cost or NRV, with land costs excluded unless inventory held for sale. Under IFRS, biological assets are measured initially at fair value less costs to sell at harvest, subsequently transitioning to inventories at that fair value. The quantitative valuation underscores the importance of accurate cost allocation and the recognition of market value to provide a transparent picture of the company’s assets.

References

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