fm6e chapter03
TRANSCRIPT
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Farm Management
Chapter 3Acquiring and Organizing
Management Resources
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Chapter Outline• Purpose and Use of Records• Farm Business Activities• Basic Accounting Terms• Options in Choosing an Accounting System• Basics of Cash Accounting• Basics of Accrual Accounting• A Cash Versus Accrual Example• Farm Financial Standards Council
Recommendations• Chart of Accounts• Output from an Accounting System
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Chapter Objectives
1. Appreciate the value of establishing a good accounting system
2. Discuss some choices for the accounting system
3. Outline the concepts of cash accounting
4. Present concepts of accrual accounting
5. Review some recommendations of the Farm Financial Standards Council
6. Introduce some financial records
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Purpose and Use of Records
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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Measure Profit and Assess Financial Condition
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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Provide Data for Business Analysis
Use the information from the balance sheet and income statement to perform an in-depth analysis.
Analysis of past decisions is useful formaking current and future decisions.
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Assist in Obtaining Loans
Lenders require financial information aboutthe farm business to assist them in theirlending 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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Prepare Income Tax Returns
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 reduceincome tax obligations.
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Farm Business Activities
• Production Activities
• Investment Activities
• Financing Activities
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Figure 3-1Farm business activities to be included
in an accounting system
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Production Activities
These accounting transactions involve activities related to the production ofcrops and livestock. Revenue from productsales or other farm revenue is included here, as are production expenses.
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Investment Activities
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 marketvalue, sale date and price, and gain or loss when sold.
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Financing Activities
These transactions relate to borrowing money,and paying the interest and principal on loans.
Financing activities include money borrowed tofinance new investments and money borrowedto finance production activities.
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Basic Accounting Terms
• 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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Account Payable
An expense that has been incurred butnot yet paid. Typical accounts payableare for items charged at farm supply storeswhere the purchaser is given 30 to 90days to pay the amount due.
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Account Receivable
Revenue for a product that has been soldor a service provided but for which nopayment has yet been received. Anexample would be custom work for a neighbor who has agreed to make paymentat a future time.
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Accrued Expense
An expense that accrues or accumulatesdaily but which has not yet been paid.Examples are interest on loans andproperty taxes.
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Asset
An item of value, tangible or financial.Examples would include machinery,land, bank accounts, buildings, grain,and livestock.
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Credit
An accounting entry in the right-handside of a double-entry ledger. A creditentry records a decrease in the valueof an asset. It records an increase inliability, owner equity, or an income account.
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Debit
An accounting entry in the left-handside of a double-entry ledger. A debitentry records an increase in an asset or expense account. It records a decrease in liability or owner equity.
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Expense
A cost or expenditure incurred in theproduction of revenue.
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Inventory
The physical quantity and financial value of products produced for sale thathave not yet been sold.
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Liability
A debt or other financial obligation thatmust be paid at some point in the future.
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Net Farm Income
Revenue minus expenses. The sameas profit.
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Owner Equity
The difference between business assetsand business liabilities. It represents thenet value of the business to the owner(s)of the business.
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Prepaid Expense
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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Profit
Revenue minus expenses. The same as net farm income.
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Revenue
The value of products and services produced by a business during anaccounting period. Revenue maybe either cash or noncash.
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Options in Choosing an Accounting System
• 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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Accounting Period
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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Single vs. Double Entry
With single-entry, only one entry is made foreach transaction. A double-entry systemrecords changes in values of assets and liabilities as well as revenue and expenses. In double-entry, there are equal and off-settingentries for every transaction. Double-entryaccounting requires more effort, but it is also more accurate.
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Basic vs. Complete
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 performenterprise analysis. Between these extremes are many possibilities.
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How Complete?
• 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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Basics of Cash Accounting
• 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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Basics of Accrual Accounting
• 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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A Cash Versus Accrual Example• November 2009: Purchased, paid for and
applied fertilizer for the 2010 grain crop. $8,000.• May 2010: Purchased and paid for seed,
chemicals, fuel, etc. $25,000.• October 2010: Purchased and charged to
account fuel for drying. $3,000.• November 2010: One half of grain sold for
$50,000. The rest placed in storage and valued at $50,000.
• January 2011: Paid bill for fuel used to dry grain. $3,000.
• May 2011: Remaining 2010 grain sold. $60,000.
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2010 Profit
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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Farm Financial Standards Council Recommendations
• 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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Chart of Accounts
• Lists and organizes all accounts used by the accounting system
• Includes broad categories and sub-accounts
• Each account assigned a number
• Can coordinate account names to match Schedule F for tax purposes
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Table 3-1 Example Chart of AccountsAccount Description Type1010 Cash on Hand Cash1020 Checking Account Cash1100 Accounts Receivable Accounts Receivable1200 Inventory-Crops Inventory1205 Inventory-Livestock Inventory1400 Prepaid Expense Other Current Assets1470 Other Current Assets Other Current Assets1500 Equipment Fixed Assets1510 Building Fixed Assets1690 Land Fixed Assets1710 Accumulated Depreciation Accumulated Depreciation2000 Accounts Payable Accounts Payable2420 Current Portion Long-Term Debt Other Current Liabilities2480 Other Current Liabilities Other Current Liabilities2600 Non-current Liabilities -- Land Non-current Liabilities2740 Other Non-current Liabilities Non-current Liabilities4020 Sales Crops Income4080 Sales Livestock Income4100 Government Payments Income4200 Other Income Income5000 Gain/Loss on Sale of Assets Income6400 Crop Expense Expenses6600 Depreciation Expense Expenses6750 Feed and Grain Expense Expenses6760 Repairs Expenses7010 Property Taxes Expenses7050 Insurance Expense Expenses7100 Interest Expense Expenses8900 Other Expense Expenses
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Output from an Accounting System
• 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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Figure 3-2Twelve possible reports from an accounting
system
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SummaryThis 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 provideinformation 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.