The double earning risk of commodity base company

Agriculture business's principal asset is biological asset. Mining business's principal asset is the reserve of mining asset.

The recent implementation of fair value valuation has double the earning volatility of those 2 type of businesses. Those businesses are commodity base business. Their revenue depend on commodity price. The fair value accounting require them to value their asset in current market value. And the valuation method used is often present value of future benefit, which depend on the prediction of future commodity price.

As there is no possibility to predict the volatility, or the high and low of the commodity price, valuation often base on the historical trend of the commodity price. If, when the valuation is made, the trend is on the up trend and has been on the up trend for 10 years, the valuation will be excessive. If, when the valuation is made, just after the commodity price crash, everybody has been so pessimistic, although past few years the trend has been consistently on the uptrend, you can imagine the valuation will be very low. Everybody will accept the fact that commodity price trend will be on the down trend going forward or stagnant at low level at best.

When commodity price keep going up, the revenue will go up, causing the earning to go up. Besides, the management will revalue their asset following the new prediction of future price trend. The higher asset value will show higher earning in that particular year. So overall, the revenue and revaluing of asset will drive up earning in twin booster. Vice versa, the reversing of commodity price will cause earning drop in twin booster too.

When to revalue the asset require judgement from the management. If the management want the earning to look good, they will try to time the market and revalue the asset at the highest price of commodity, avoid revalue asset at the bottom price of commodity. If the management is responsible, they will have to always think of revalue the asset according to the long term trend of the commodity price.

In this sense, I think this fair value accounting opened a room for earning manipulation for irresponsible management.