Hedging crop prices

Are forward sales of a crop derivatives?

A contract to sell a non-financial item such as grain is within IFRS 9 if it can be settled net in cash. If the contract was entered into, and continues to be held, for the delivery of the farmer's own produce in line with its expected sales, it falls under the own use exemption and is accounted for as an ordinary sale contract: nothing is recognised until delivery, when revenue is recognised at the contract price. If the farmer has a practice of settling similar contracts net or buying them back before delivery, the exemption is lost and the contracts are derivatives at fair value. See commodity hedging and own use.

Hedging crop prices with futures

Six months before harvest, a grain producer expects to harvest 1,000 tonnes of wheat and sells 600 tonnes of futures at US$ 220 a tonne, covering the part of the crop it is confident of harvesting. It designates the futures as a cash flow hedge of the highly probable forecast sale of 600 tonnes.

Either way the hedged tonnes earn 132 thousand, the futures price. Until the sale, the effective part of the futures' gain or loss is held in the cash flow hedge reserve; when the wheat is sold, it is reclassified to profit or loss, usually presented with revenue or in a separate line next to it. The other 400 tonnes are unhedged and sold at the market price. See IFRS 9 hedge accounting.

Do growing crops need hedge accounting?

Growing crops are biological assets measured at fair value less costs to sell, with changes in profit or loss. If prices fall, the crop's value falls and the futures gain, and both are recognised in profit or loss, so the hedge partly works without hedge accounting. The offset is imperfect: the crop's fair value reflects the expected harvest, remaining costs and risk, and the farm-gate price rather than the exchange price, so the two do not move one for one. Many farmers therefore hedge the forecast sale of the harvested crop instead, which matches the timing of the cash flows.

How are basis and yield risk handled?

Exchange futures track a benchmark price at a delivery point, while the farmer sells at a local price that differs by the basis, reflecting transport and local supply. IFRS 9 allows the benchmark component of the local price to be designated as the hedged risk if it is separately identifiable and reliably measurable, so movements in the basis do not cause ineffectiveness. Yield risk is the danger that a drought or flood leaves the farmer with less crop than it hedged; hedging only the volume that is highly probable avoids over-hedging, and if the forecast sale is no longer expected, the amount in the reserve is reclassified to profit or loss.

How do feed buyers hedge?

Livestock and poultry producers, millers and food companies buy grain and hedge the forecast purchase with long futures or fixed-price forward purchases. Fixed-price purchase contracts for their own use are not derivatives. Futures designated as cash flow hedges of forecast purchases have their effective gains and losses included in the cost of the grain inventory when it is bought, a basis adjustment, so they reach profit or loss as the feed is used. See poultry farming.

How does US GAAP differ?

ASC 815 has a similar exception, but it is an election: a company chooses to apply the normal purchases and normal sales scope exception to qualifying contracts and documents it, while under IFRS 9 the own use exemption applies automatically when the conditions are met, with an option to designate such contracts at fair value through profit or loss to avoid an accounting mismatch. Grain merchandisers under US GAAP commonly carry grain inventories and forward contracts at fair value. See agriculture accounting.

This guide is general information. It is not tax or legal advice for your situation.