In the U.S. Timber Industry

INTRODUCTION

In this memorandum, I will discuss the financial reporting implications under U.S. GAAP and IFRS for a timber company that has significant standing timber and determine the senior manager’s decision of different accounting treatments. In addition, I will elaborate on Plum Creek’s arguments against fair value accounting. Finally, I will choose the accounting method that is preferred for different roles.

REPORTING STANDARDS UNDER U.S. GAAP AND IFRS

Under U.S. GAAP, standing timber is treated as inventory, valued at historical cost. Timber firms do not recognize a gain in inventory under U.S. GAAP if the fair value is greater than the net book value. Therefore, there is no effect on the income statement or the balance sheet. However, if the fair value is less than its net book value, the timber firm can recognize an impairment loss. Therefore, its net income on the income statement will decrease as well as its inventory and retained earnings on the balance sheet will decrease.

Under IFRS, standing timber is treated as biological assets such as living animals and plants. Under IAS 41, the valuation of biological assets is similar to those of agricultural crops, which are harvested product of the entity’s biological asset. It is recorded at fair market value less estimated cost to sell at the end of each quarter. Timber firms should record a gain if the fair value increases and vice versa under IFRS. If there were a gain, its net income on the income statement would increase and vice versa. Its inventory and retained earnings on the balance sheet will also increase.

SENIOR MANAGER

A senior manager at a timber company should act in the best interest of investors. Under U.S. GAAP, forestland is treated as property plant and equipment and is depreciated over its estimated useful life. The depreciation expense will decrease the company’s net income. No adjustments will be made if the fair value is greater than its net book value. There would be a decrease in accounts on the income statement and balance sheet with only losses recorded. Therefore, there are fewer incentives to invest in additional forestland.

In contrast, investors would prefer adopting IFRS for the purpose of investing and selling forestland so a senior manager should implement IFRS. Under IFRS, forestland is treated as biological assets, which are recorded at fair value. The market value of forestland fluctuates so reporting under IFRS would give companies more incentives to invest. Fair value is a more relevant measurement because the value of the inventory based on fair market value, which reflects a timber company’s true financial position. Increases of forestland value in a company from fair value will give timber companies a bigger incentive to invest in forestland. This is an indication to investors