Finanzbuchhaltung und Naturkapital: Palmöl
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Executive Summary
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Ensuring global food system stability requires companies use consistent, transparent and accurate approaches to their financial accounting of agriculture, so that reported values are reliable.
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Yet frequently market participants receive inaccurate, and potentially misleading information about the economic benefits and consequences of using natural capital.
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As an example, we conducted a review of the financial disclosures of selected palm oil companies.
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Our analysis indicates that companies operating in the palm oil sector may be disclosing potentially false and misleading accounting information to market participants. These firms likely require additional analytical scrutiny to understand the robustness of their accounting disclosures and their uses of natural capital.
Introduction
Ensuring global food system stability requires companies use consistent and accurate approaches to their financial accounting of agriculture, so that reported values are reliable. Firms are subject to various accounting regulations under International Financial Reporting Standards (IFRS), or their local accounting standards.
Naturally, markets, analysts, and portfolio managers rely on audited financial information to better understand the financial valuation and overall investment thesis in the palm oil sector. Crucial then to this understanding is accurate information. Yet, market participants may receive inaccurate, and potentially misleading information about the economic benefits and consequences of palm oil production.
Questions financial accountants and analysts ask frequently:
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Are biological assets – the oil palm tree – and agricultural produce – the fresh fruit bunch (palm oil fruit) – consistently and accurately reported on, and in compliance to accounting standards, so that natural capital is valued accurately?
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Are companies consistently and accurately valuing their agriculture businesses based on a transparent and accurate analysis of their value underpinning their businesses, and their related assets and liabilities?
Note: International Accounting Standard 41: Agriculture. Paragraph 3. IAS 41 is “applied to agricultural produce, which is the harvested produce of the entity’s biological assets, at the point of harvest. Harvest means is the detachment of produce from a biological asset or the cessation of a biological asset’s life processes. Thereafter, IAS 2 Inventories or another applicable Standard is applied. Accordingly, this Standard does not deal with the processing of agricultural produce after harvest; for example, the processing of grapes into wine by a vintner who has grown the grapes. While such processing may be a logical and natural extension of agricultural activity, and the events taking place may bear some similarity to biological transformation, such processing is not included within the definition of agricultural activity in this Standard.” (IFRS Foundation. International Accounting Standard 41: Agriculture). IAS 2: Inventories covers inventories, the movement and storage of agriculture assets, is not addressed here. Accordingly, IAS 41 does not deal with the processing of agricultural produce after harvest; for example, the processing of grapes into wine by a vintner who has grown the grapes. While such processing may be a logical and natural extension of agricultural activity, and the events taking place may bear some similarity to biological transformation, such processing is not included within the definition of agricultural activity in this Standard. Products that are the result of processing after harvest that are excluded from IAS 41, and instead, are included in IAS 2 Inventories, include: yarn, carpet, logs, lumber, cheese, sausages, cured hams, thread, clothing, sugar, cured tobacco, tea, wine, processed fruit, palm oil (crude palm oil; refined, bleached, deodorized palm oil; etc.), rubber products, etc.
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In answer to these questions, our examination focused on firms operating in the global palm oil industry. We checked to ensure that their implementation of key accounting regulations relating to their production of palm oil is compliant with these standards.
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Details
To aid in understanding the accounting issues discussed in this report, some background on palm oil firms is useful. Each company is responsible for transforming living plants or animals – biological assets, a form of natural capital – into agricultural produce - either harvested plants or meat. Together these constitute biological assets. Natural capital: The stock of renewable and non-renewable assets from which humans derive benefits through ecosystem services.
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Natural capital serves as a critical input to agricultural companies’ production and supply chain. Companies in the agriculture sector rely upon natural capital to maintain their growth and yield production curves.
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For example, agricultural producers rely on functioning soils and hydrological systems, healthy biotic environments and pollinators, and many other natural capital factors to increase the value of their assets, to improve their cash flows, to grow their businesses, and finally to compete against their peers in the marketplace. As such, how a company manages the natural capital risk of its biological assets affects both the profitability and value of these assets.
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By examining agricultural production through a financial accounting lens, it is possible to understand more clearly how companies use their biological assets. The audited and unaudited financial information provided by agricultural firms yield a variety of useful information relating to biological assets that helps analysts and portfolio managers better understand the benefits and costs of production and how they are addressing natural capital constraints.
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In 2004, the Government of Indonesia updated the 1987 Plantation Law (further updated in 2014) and established the Plasma Scheme to empower its smallholder farmers. Divided into two models, The Plasma Scheme aimed to promote cooperation among multiple stakeholders:
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The smallholder farmers (plasma farmers)
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The plantation companies (nucleus or inti)
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Financial institutions (banks)
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Regional and national governments in Indonesia.
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Model One
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In the first model, when entering a formal arrangement with smallholders, companies (the nucleus) must assist in the development and cultivation of smallholder lands by facilitating or guaranteeing loans, through profit sharing or other agreed-upon arrangements. Under the 2004 law, the Indonesian government facilitates the establishment of public private partnerships, with private financial institutions to provide credit facilities and loan guarantees to smallholders to grow agriculture products to be inventoried by the companies.
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In some cases, these companies provide direct loans to the farmers to help grow crops. In exchange, companies take possession of the smallholders’ land title and become the sole party to which smallholders must sell their product. The companies, essentially, outsource the production of their inventory but typically supply fertilizers, training, and other forms of support. After harvest, land title reverts to smallholders once they fulfil their credit obligations and provide their harvests over the terms of the arrangement.
Model Two
The second model is like the first but has a notable exception. The second model allows companies to take legal possession of and manage the farmers’ land. We have concluded that this arrangement is a long-term lease of the land until harvest. The smallholders are treated as shareholders of the companies and receive dividends from profits periodically instead of lease payments on their land.
Last of the important background details is that the palm oil sector usually finances itself through two cash flow sources, investing and financing activities. Consequently, mergers and acquisitions (M&A), and other highly leveraged buyouts, are common in the sector.
Methodology
The research methodology was to carefully select the following parameters, in sequence.
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Geographies
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We limited the investigation to firms headquartered in Indonesia, Malaysia, and Singapore. These countries account for 85% of palm oil production and trade worldwide. Thus, they are responsible for a significant portion of regionally harmful greenhouse gas (GhG) emissions and cause related deforestation, biodiversity loss, air pollution and water quality risks. That is, their use of natural capital is important to evaluate and to understand.
Companies
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We identified palm oil companies to study: Astra Agro Lestari, Eagle High Plantations, Noble Group, London Sumatra, and Indofood Agri Resources.
Disclosures
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· We analyzed the specific disclosures of selected palm oil producers and traders.
Time Frame
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The period examined is 2013-2018.
Why It Matters
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Identified here are the key accounting standards and principles that may be material to market participants’ understanding of the economics underlying palm oil production with following impacts on financial rations, as shown in Table 1.
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Despite certain inconsistencies and lack of comparability among the standards, we assumed for the purpose of this analysis that the IFRS is universally accepted and that the PSAK and SFRS standards considered have IFRS equivalents. We also point out differences where applicable.
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Table 1: Categories of Financial Ratios and Natural Capital.​
The below specific standards were reviewed during the analysis.
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IAS 1: Presentation of Financial Statements (section 1.69: Liability Prescription)
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It prescribes conditions under which liabilities are to be classified as current; that is, owed in the near-term.
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Companies affected:
IAS 17: Leases
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It prescribes the accounting policies and disclosures applicable to leases, both for lessees and lessors. Leases are required to be classified as either finance/capital leases or operating leases. Finance leases transfer substantially all the risks and rewards of ownership and give rise to asset and liability recognition by the lessee and a receivable by the lessor. Whereas operating leases result in expense recognition by the lessee, with the asset remaining recognized by the lessor.
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Companies affected:
IAS 39: Financial Instruments: Recognition and Measurement
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This section provides that guarantors of liabilities shall report the portion of the liabilities secured as their own liabilities even though affiliates will make repayments – similar to IFRS 4 for insurance contracts.
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Companies affected:
IAS 41: Agriculture
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It details the conditions to be present for assets to be classified as agricultural or biological and how to measure.
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Companies affected:
IFRS 4: Insurance Contracts
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This section applies, with limited exceptions, to all insurance contracts that an entity issues and even to reinsurance contracts that it holds.
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Companies affected:
IFRS 7: Financial Instruments
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It requires disclosure of information about the significance of financial instruments to an entity, and the nature and extent of risk arising from those financial instruments, both in qualitative and quantitative terms.
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Companies affected:
IFRS 9: Financial Instruments
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This is IASB's replacement of IAS 39 Financial Instruments: Recognition and Measurement. The Standard includes requirements for the recognition of and measurement of impairment, derecognition and general hedge accounting for financial instruments.
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Companies affected:
IFRS 13: Fair Value Measurement
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It covers biological assets (including agricultural assets and livestock). Both standards require that Fair Value Measurement be the result of an exit price, make use of a fair value hierarchy (level 1,2 and 3 inputs), resulting in a market-based value, rather than entity-specific.
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Companies affected:
IFRS 16: Lease Disclosures
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It specifies how leases will be recognized, measured, presented, and disclosed.
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Companies affected:
PSAK 30: Leases
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Has been superseded by PSAK 73 as of 1 January 2020.
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Companies affected:
PSAK 60: Financial Instruments: Disclosures
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Similar in all respects to IFRS 7.
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Companies affected:
PSAK 71: Financial Instruments
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Similar in all respects to IFRS 9. Became effective 1 January 2018.
PSAK 73: Leases
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Similar in all respects to IFRS 16. Became effective 1 January 2020.
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Companies affected:
SFRS 16: Lease Disclosures
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Similar in all respects to IFRS 16.
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Companies affected:
SFRS 39: Financial Instruments: Recognition and Measurement
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Similar in all respects to IFRS 39.
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Companies affected:
SFRS 41: Agriculture
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Similar in all respects to IFRS 41.
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Companies affected:
Case Studies
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Below are details of our accounting analyses conducted on each of the chosen firms. After each firm in parentheses are the accounting standards examined in our analyses.
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