OLAM: accounting for biological assets Harvard Case Solution & Analysis

OLAM: Accounting For Biological Assets  Case Solution

Case Overview:

This case is regarding accounting standards which provide good understanding about IAS 16 and IAS 41. Olam International Limited operates in the agriculture industry. The company performed successfully during the last 20 years, and it became a global organization with market capitalization of $3.5 billion. In 2012, Muddy Water Research, an equity-based firm in the United States argued that Olam was mis leading the public and did not report its financials by the standards of International Financial Reporting. Immediately after the report of Muddy Water, it made it publicly available due to which the share price of Olam decreased from $1.74 to $1.4 which indicates that there was a$0.7 billion loss in terms of market capitalization.

Issues raised by Muddy Waters on Olam

There are numerous issues raised by Muddy Waters on Olam, and in one of them was regarding the Olam’s use of non cash accounting gains especially negative goodwill and biological assets to increase its profits. From the financial year 2008 to 2012, the profits increased by $263 million because of fair value gains from the biological assets.

Muddy Waters mainly criticized the Accounting treatment of Olam Biological assets, which increased the profits based on three key areas. The first area is when Olam booked the farmer's future crops as the gain, which was against the principle of accounting concept "Prudence”which indicates not to the increase the income until it is certain. Secondly, Olam used the mark to market valuation model to book gains for the increases in fair value, which is again not in line with the IAS 41 asit indicates that there are two models to value the biological assets, cost model, and fair value model. Lastly,Olam’s biological assets comprised of commodities, which were not grown yet. This is a wrong treatment according to IAS 41 as it states that the agriculture products (e.g. fruits) which are going to be harvested within the time of 12 months should be categorized in short term consumable biological assets.

Analyze and summarize the key developments in these standards

IAS 41 relates to the recognition and the valuation of the biological assets. Biological assets are very famous in the agriculture industry. Biological assets are those that grow with time biologically such as Cows, Fruit trees, vegetables, and etc.Nowadays, most of the agriculture companies have shown interest in Initial Public Offering and Listing on Stock Exchanges, which is why the reporting of the assets of agriculture companies has now become a challenge. Various developments are being done in Reporting Standards in order to face the new issue. The main development in agriculture-related standards is splitting Biological assets into Bearer assets and Consumable assets. The recording of the bearer assets and consumable assets are different. Bearer asset and longer consumable assets (more than 12 months) involve those assets, which generate agricultural products such as fruit trees,after which it passes the fixed asset rule, which is the future economic benefit will flow to the company. Currently, bearer plants and agricultural product are considered as a single asset, but now it has been amended that the plant and the produced product will be considered differently. The plant which produces, for example, tree is accounted for in IAS 16 and the fruit on the tree is accounted in IAS 41 as well.(Rendra Kurniawan, August 2014)

Discuss how Olamhad accounted for its biological assets previously and how this is setto change.

Olam accounted for the biological asset through the mark to the market position, which is not acceptable by the standard of IAS 41 as it indicates that there are two models to record biological assets in the books of accounts; first is the cost model, and another is the fair value model. Olam valued the biological asset through the present value of future cash flows from the asset, which is not in accordance with IAS 41. On the other hand,IAS 41 indicates that if the company wants to value with fair value model, then the value would be driven by the market value less cost to sell. In order to value the biological assets through mark to market, then as a result, it will create uncertainty for the shareholders because sudden changes in values of the biological asset will be shown in theProfit and Loss Statement........................

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