Understanding the Real Value of Your Farm
Understanding the Real Value of Your Farm
In this blog, we explore the application of the Adjusted Book Value Approach to the valuation of farms and the special considerations that arise.
When it comes to farming in southwestern Ontario, the value of land has seen double digit increases over the past three years, with a 22% increase in 2022 alone.
For farmers considering selling or planning for retirement, now is the time to learn the true value of their land and business.
In this blog, we will provide you with an overview on farm valuations.
According to the 2021 Census of Agriculture, there were 48,346 farms reported in Ontario. Of those farms, the number of farmers younger than 35 years old dropped by 15% while the number of middle-aged farmers declined by 20%, compared to the previous census.
Perhaps, the most telling difference is the 8% increase in the number of farmers 55 years and older in 2021, compared to 2016. Thus, indicating that younger farmers are either not interested in the farming business, can’t afford it, or both.
As the market becomes increasingly more competitive, understanding your farm’s value is more important than ever.
The Valuation Approach – Adjusted Book Value
The value of a farm is driven by the value of its underlying assets, such as land and/or quota. Farms typically do not have commercially transferrable goodwill, as the cash flows generated do not provide a sufficient return on the net assets of the farm corporation. Therefore, an Adjusted Net Book Value approach is typically used in the valuation of farms.
Our blog Valuation Approaches: The Adjusted Book Value Approach, discusses this approach in more detail, but to summarize: shareholders’ equity, or net assets of a corporation, are adjusted to reflect the market value of assets and other adjustments.
We discuss some specific adjustments and considerations for farmers below:
Cash-Based Reporting Adjustment
Under Canadian tax law, farms have the option to prepare their taxes on either an accrual or cash basis, with most electing to file on a cash basis. Conversely, most externally prepared financial statements are reported on an accrual basis. Since taxes are typically filed on a cash basis, this may result in either a prepayment or deferral of taxes when compared to an accrual basis.
For example, say a farmer prepays for $100,000 of feed at a fiscal year end. Under the cash basis for tax purposes, the $100,000 payment would be deductible in that fiscal year. However, under accrual accounting, the $100,000 payment would be included in inventory at the year end and recognized as an expense in a later period.
A valuation of a farm corporation should consider the future tax receivable or liability resulting for this prepayment or deferral of taxes under the cash basis.
Adjustments of Assets and Liabilities to Market Value
Land and Buildings
Capital assets included on a company’s financial statements are amortized to allow for the cost of the asset to be expensed over time, resulting in the assets being reported at net book value. For farms, capital assets usually include the land and buildings, such as the barn or home, as well as farming equipment and vehicles.
From a valuation perspective, a farm’s capital assets need to be adjusted to fair market value to account for the difference between net book value and fair market value. For assets like the farmland and buildings, their value may need to be adjusted upwards as these typically, in practice, appreciate over time. For assets such as equipment and vehicles, farm machinery tends to maintain its value for a longer period than manufacturing equipment. As a result, a valuation of a farm’s equipment, such as tractors or combines, may be required, and adjusted upwards as well.
When capital assets appreciate in value over their original cost, there are taxes related to capital gains that would be paid on the eventual sale of the assets of the farm. Further, there are tax implications related to recapture and/or terminal loss that would also be realized at the time of an eventual sale. When valuing a farm in a notional context, we consider the contingent taxes that would be paid on the eventual sale of the assets, which are discounted to reflect the future timing of the disposition.
Another consideration unique to farm valuations is the existence of quota. In Canada, producers of milk, chicken, and eggs are required to hold quotas which then allow them to distribute their products. For accounting purposes, quota is classified as an intangible asset and is amortized over time in the same way as other capital assets. This means that the value of the quota will need to be adjusted to reflect fair market value, which may fluctuate depending on the type of quota. It is important to note that while the price of certain types of quotas may be regulated by governing bodies, this may not necessarily represent the price that the quota is transacted at when sold in combination with a farm.
If you’re planning on selling your farm, or if you need to know its value for planning purposes, a business valuation is the first step to gaining a better understanding of its value. The valuation experts at Davis Martindale bring a wealth of experience in preparing farm valuations and tackling issues unique to farmers.
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