With the introduction of new UK Generally Accepted Accounting Principles (UK GAAP) over the past couple of years, stud owners should take note of how their accounting records disclose the value of their stock at the business year end.
Changes to accounting standards
Financial Reporting Standard (FRS)102 was introduced for medium-sized companies with effect for accounting periods commencing on or after 1 January 2015 and for small companies and LLPs (in the form of FRS102.1A) with effect from 1 January 2016.
Under previous accounting standards a bloodstock breeding business could account for its stock in one of two ways. The first was the most common way showing it as closing stock and valuing the stock at the lower of its cost or net realisable value (net realisable value being the expected selling price less anticipated costs of sale). The second option, which was much less common, was to account for bloodstock under the Herd Basis and stock was shown as a fixed asset within the accounts. The Herd Basis is an irrevocable election and can be used for any kind of livestock of the same species used “wholly or mainly for the products obtainable from the living animal which the animals produce for the farmer to sell”. In the case of bloodstock breeders the keep of mares and sale of progeny could satisfy this condition.
Under FRS102, and as detailed in HMRC’s Business Income Manual at BIM55710, both stallions and mares (as well as foals) should be dealt with as stock in trade and valued individually at the end of each year. We are aware of cases where the mares are accounted for as fixed assets but this does not align to HMRC’s Business Income Manual.
FRS102, section 34, introduced the concept of biological assets (any living animal or plant) and stated that any business that is engaged in agricultural activity (the management of the biological transformation of biological assets for sale into agricultural produce ‘harvested product’ or into additional biological assets) shall determine an accounting policy for each class of biological asset.
Stud owners carrying out breeding activities therefore have the option under FRS102 to value their closing stock under either the cost model (lower of cost and net realisable value) or the fair value model (fair value less costs to sell where fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction).
However, in any case under FRS102 any biological assets will need to be shown as stock rather than a fixed asset, even where a Herd Basis election is in force.
Determining the cost of mares, stallions and foals
Mares will usually either have been purchased or transferred from training. If purchased the acquisition price will form the ‘cost’ for the purposes of valuing the stock at each year end. If the mare is transferred from training then the market value of the mare on the date it is introduced to the stud will form the ‘cost’ for the purposes of the stock valuation. Where a mare has been bred and reared by the breeder from foal then the ‘cost’ will be the costs of rearing and keeping the horse incurred to date.
When a nomination fee is paid for a mare to be covered it is often agreed that this will form the ‘cost’ of the foal for the purposes of valuing the stock. Sometimes the nomination fee is left as part of the ‘cost’ of the broodmare until such time as the foal is born, however it can be shown as a separate asset on the bloodstock valuation if preferred.
When the foal is born the cost is increased by its cost of keep from the date of weaning until sale or transfer into training (if applicable). There is a current rule of thumb agreed between The Thoroughbred Breeders’ Association (TBA) and HM Revenue & Customs (HMRC) that estimates the cost of keep for a foal at £75 per week. This amount is added to the nomination fee to form the ‘cost’ of the foal for valuation purposes. It is worth noting that an alternative basis can be used for keep costs provided they can be supported by evidence i.e. specific keep invoices. This keep rule of thumb also applies to Yearlings if they have not yet been sold or put into training.
As mentioned above, horses treated as stock are usually included at lower of cost and net realisable value (if the cost model is chosen for biological assets) and so the value of each horse has to be considered at each year end. However, as far as stallions are concerned HMRC generally accepts a rule of thumb method of valuation where they allow the cost of a stallion (cost being the same as for mares mentioned previously i.e. acquisition price, market value when transferred from training or rearing costs if reared from a foal) to be written off in equal instalments until the stallion reaches the age of 10.
The aim of the write down is to give an acceptable approximation to the net realisable value of the stallion, although the method should not be used where the actual value of the horse is known at the year end or it would give an obviously unreasonable result e.g. where the value of the stallion has decreased/increased dramatically in comparison to the rule of thumb method.
It should be noted that there is no automatic right down of mares in the same way as there is for stallions.
It is therefore important for stud owners to take an interest in the value of their horses at each year end to ensure that where they will be relying on their financial accounts for external investment or bank funding that the stock is valued appropriately and disclosed accordingly on the business balance sheet. Should HMRC choose to open an enquiry, one of the primary areas of interest is valuation, so evidence of realistic valuations is important both in avoiding an enquiry and in settling an enquiry.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.
The tax treatment depends on the individual circumstances of each client and may be subject to change in future.