Auditors and investors in Southeast Asia are pushing back against an accounting standard used to value farm animals, crops and other agricultural produce that they fear will make profits more volatile and raise the risk of corporate skulduggery.
The standard is used in many developed markets, but attracted controversy in Asia last year when Singapore-listed Olam International was accused by short-seller Muddy Waters of aggressively booking fair value gains from its array of so-called “biological assets”.
How Malaysia, Indonesia and Thailand - all of which have large palm oil, rubber and other agricultural industries - account for such assets is proving to be the biggest sticking point as they move to international accounting standards.
The standard means companies must regularly value how much their palm fruit or cow herds are worth before they have been harvested or slaughtered. That means estimating what the crop or livestock will ultimately sell for.
If the market price of palm oil were to rise, they would then boost their bottom line with a “fair value” gain in the palm fruit on their trees - or similarly book a fair value loss if prices fall.
Investors are concerned this leaves accounts of agricultural companies at the mercy of sudden swings in commodity prices and that unscrupulous executives could use dubious pricing models to exploit the rule to pad their earnings.
“We would look through this noise and just look at the underlying earnings, that is, strip out the fair value gains and losses and look at the underlying revenue and expenses and profits,” said Andrew San, an assistant investment manager at Aberdeen Asset Management in Kuala Lumpur.
Aberdeen, which oversaw US$322.4 billion (HK$2.5 trillion) as of March, holds stakes in Malaysian plantation companies including United Plantations, United Malacca and Oriental Holdings.
Commodities firm Olam was targeted in November by Muddy Waters, which questioned the company’s debt level and asset quality, sending its stock and bond prices tumbling.
Olam said it adheres to Singapore Financial Reporting Standards, which are based on international accounting rules.
Weeks after Muddy Waters’ attack on Olam, Hong Kong Exchanges and Clearing said companies wanting to list have to exclude unrealised fair value gains from biological assets in trying to meet the bourse’s requirements.
“We consider that the risks in biological assets are higher as they are perishable and their valuation is usually subject to higher uncertainty due to the complex and not easily verifiable assumptions adopted,” the exchange said at the time.
Malaysia is due to adopt the standard, known as IAS 41, from next year, while Indonesia has not yet fixed a timeline for implementing it. Thailand’s Federation of Accounting Professions says it is discussing the issue with companies and will decide whether or not to adopt it by the end of this year, with implementation tentatively scheduled for 2015 or 2016.
I Gede Nyoman Yetna, a senior official in the Indonesian stock exchange’s listing division, told Reuters that the model “is not considered to be compatible with the agricultural environment in Indonesia”.
Accountants say they are also worried that companies, particularly those cultivating crops or livestock that have relatively illiquid markets, will use dubious assumptions on what constitutes fair value to suit their bottom lines.
“The big challenge is the pricing: Will people aggressively use this standard to achieve certain gains?” said one accountant in Malaysia, who declined to be named as he has been in involved in discussions with the Malaysian accounting standards board on their proposed adoption of the rule.
Agriculture companies listed in countries that already use this accounting method have seen big swings in their profit as a result of fair value gains.
Revaluation gains from biological assets delivered more than a third of Singapore-listed Wilmar International’s US$733.8 million pretax profit from its plantations and palm oil mills in 2011 during the commodity’s bull run, but just 7 per cent of US$410.8 million last year.
Thailand’s largest meat and animal feed producer, Charoen Pokphand Foods, adopted the standard early last year after acquiring a stake in a Hong Kong-listed company that already uses it.
The company’s chief executive, Adirek Sripratak, said the standard had proved “quite a headache” to apply.
“Under this standard, when market prices are up, it will push up inventory gain, which will make profit look irregular. If prices go down, there will be inventory loss,” he said.
Adding to the difficulty in using the standard is that the audit industry in some emerging markets does not have enough professionals conversant with the rules to check that they are used properly.
“Our accounting profession is not as strong as Singapore and Malaysia,” said Ersa Tri Wahyuni, a technical advisor to the Indonesian Institute of Accountants. “We only have 1,000 public accountants, so the profession itself is not very strong.”
The International Accounting Standards Board, which sets the rules, is not deaf to these concerns.
Last month it announced proposed changes on how companies should account for “bearer plants” - mature palm trees, grape vines and other plants that yield produce over a certain period of time, but are not the produce themselves.
It is proposing that those plants should not be accounted for at fair value, but instead treated like manufacturing equipment. However, the fruit hanging from their branches should still be measured at fair value as it grows.
Some accountants are still not happy, arguing that it is very difficult to split a tree into parts and account for it in different ways and that instead the fruit should not be valued until it is harvested.
“The tree should be accounted at cost whereas the fruit bunches are at fair value? It creates havoc for us,” said the Malaysia-based accountant.
Others acknowledge that, if used properly, fair value accounting can provide investors with useful information.
“The pros are that some companies incur costs to develop plantations and so on, so biological gains reflect future profitability,” said James Koh, an analyst at Maybank Kim Eng.
The lingering worry, though, is that in some Southeast Asian markets, where corporate governance problems are already high on investors’ red flag list, this presents one more risk factor.
“Some companies in Indonesia, usually big and multinational ones, are actually looking forward to the standard-setter adopting the rule,” said the Indonesian Institute of Accountant’s Wahyuni. “But we need to be careful whether this eagerness is genuine or if they want to put the fair value into their profit and loss account.”