AGRI 4411 Farm Management Chapter 03

Chapter 3Acquiring and OrganizingManagement Resources

Purpose and Use of Records

Farm Business Activities

Basic Accounting Terms

Options in Choosing an Accounting System

Basics of Cash Accounting

A Cash Versus Accrual Example

Farm Financial Standards Council Recommendations

Chart of Accounts Output from an

Accounting System

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1. To appreciate the value of establishing and selecting a good accounting system

2. To outline the concepts of cash and accrual accounting

3. To review some recommendations of the Farm Financial Standards Council

4. To introduce some financial records

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1. Measure profit and assess financial condition

2. Provide data for business analysis3. Assist in obtaining loans4. Measure the profitability of

individual enterprises5. Assist in the analysis of new

investments6. Prepare income tax returns

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• These are among the most important reasons for keeping records.

• Profit is estimated by developing an income statement, the topic of chapter 6.

• The financial condition is shown on the balance sheet, the topic of chapter 5.

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• Use the information from the balance sheet and income statement to perform an in-depth analysis.

• Analysis of past decisions is useful for making current and future decisions.

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• Lenders require financial information about the farm business to assist them in their lending decisions.

• Following the farm financial difficulties during the 1980s, many agricultural lenders are requiring more and better records.

• Good records increase the odds of getting a loan.

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• Internal Revenue Service (IRS) regulations require keeping records for tax purposes.

• Tax records are often inadequate for management purposes.

• Sound record-keeping can also help reduce income tax obligations.

Production Activities Investment Activities Financing Activities

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These accounting transactions involve activities related to the production of:

•crops and livestock•revenue from product sales or •other farm revenue is included •as are production expenses.

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These activities relate to the purchase,depreciation, and sale of long-lived assets,such as land, equipment, or breeding livestock.

Records should include:•purchase date and price,•annual depreciation, •book value, •current market value, •sale date and price, and •gain or loss when sold.

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• These transactions relate to borrowing money, and paying the interest and principal on loans.

• Financing activities include money borrowed to finance new investments and money borrowed to finance production activities.

Account payable Account

receivable Accrued expense Asset Credit Debt Expense

Inventory Liability Net Farm Income Owner Equity Prepaid Expense Profit Revenue

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An expense that has been incurred butnot yet paid.

Typical accounts payable are for items charged at farm supply storeswhere the purchaser is given 30 to 90days to pay the amount due.

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Revenue for a product that has been soldor a service provided but for which nopayment has yet been received.

An example would be custom work for a neighbor who has agreed to make paymentat a future time.

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An expense that accrues or accumulatesdaily but which has not yet been paid.

Examples are interest on loans andproperty taxes.

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An item of value, tangible or financial.

Examples would include machinery,land, bank accounts, buildings, grain,and livestock.

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• An accounting entry in the right-hand side of a double-entry ledger.

• A credit entry records a decrease in the value of an asset.

• It records an increase in liability, owner equity, or an income account.

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• An accounting entry in the left-hand side of a double-entry ledger.

• A debit entry records an increase in an asset or expense account.

• It records a decrease in liability or owner equity.

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A cost or expenditure incurred in theproduction of revenue.

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The physical quantity and financial value of products produced for sale thathave not yet been sold.

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A debt or other financial obligation thatmust be paid at some point in the future.

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Revenue minus expenses. The sameas profit.

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• The difference between business assets and business liabilities.

• It represents the net value of the business to the owner(s) of the business.

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A payment made for a product or servicein an accounting period before the onein which it will be used to produce revenue.

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Revenue minus expenses. The same as net farm income.

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• The value of products and services produced by a business during an accounting period.

• Revenue may be either cash or noncash.

What accounting period should be used?

Should it be cash or accrual? Should it be single or double entry? Should it be basic or complete?

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A period of time used to summarize revenueand expenses and estimate profit. It can beeither a calendar year or a fiscal year.

It is generally recommended that a firm’saccounting period follow the production cycle of the major enterprises.

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• With single-entry, only one entry is made for each transaction.

• A double-entry system records changes in values of assets and liabilities as well as revenue and expenses.

• In double-entry, there are equal and off-setting entries for every transaction.

• Double-entry accounting requires more effort, but it is also more accurate.

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• The most basic accounting system is one that is very simple and uses cash accounting.

• A complete system would be computerized with capabilities for both cash and accrual accounting, and with

the ability to track inventories, loans, and depreciation, and to handle payroll accounting and perform enterprise analysis.

• Between these extremes are many possibilities.

How much accounting knowledge does the user have?

How large and complex is the farm? How much and what kind of

information is needed or desired for management decision making?

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Revenue: recorded when and only when cash is received for sale of product or service

Expenses: recorded when they are paid, even if that is not when the item is bought or used to produce a product

Advantages: simple and easy-to-use Disadvantages: recorded revenues

and expenses may not be accurate reflections of activities during the accounting period

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Revenue: recorded when the item is produced, regardless of when sold

Expenses: “matched” to revenue; recorded when used to produce

Advantage: accurate Disadvantage: requires more time and

knowledge than cash system

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November 2003: Purchased, paid for and applied fertilizer for the 2004 grain crop. $8,000.

May 2004: Purchased and paid for seed, chemicals, fuel, etc. $25,000.

October 2004: Purchased and charged to account fuel for drying. $3,000.

November 2004: One half of grain sold for $50,000. The rest placed in storage and valued at $50,000.

January 2005: Paid bill for fuel used to dry grain. $3,000.

May 2005: Remaining 2004 grain sold. $60,000.

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Cash grain sales 50,000 50,000Grain inventory increase N/A 50,000 Total Revenue $50,000 $100,000

Fertilizer 0 8,000Seed, chemicals, fuel 25,000 25,000Drying fuel 0 3,000 Total Expenses 25,000 36,000

Net Farm Profit $25,000 $64,000

Cash Accounting Accrual Accounting

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Accrual-based system recommended, but cash system accepted, with end-of-year adjustments

A full discussion of the adjustments will be provided in chapter 6

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Balance Sheet: report that shows the financial condition of the farm at a point in time

Income Statement: report of revenue and expenses over the accounting period

Other reports, depending on complexity of system

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• This chapter discussed the importance, purpose, and use of records as a management tool.

• Records provide the information needed to measure how well a business is performing.

• They also provide information needed to make sound decisions in the future.

• Any accounting system must be able to handle production, investment, and financing activities.

• The output desired from the accounting system must be considered when choosing one.