Farm Management Chapter 3 Acquiring and Organizing Management Resources.

Farm Management

Chapter 3Acquiring and Organizing

Management Resources

farm management chapter 3

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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• Output from an Accounting System


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Chapter Objectives

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

2. To discuss some choices for the accounting system

3. To outline the concepts of cash accounting

4. To present concepts of accrual accounting

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

6. To 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 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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Cash vs. Accrual Example• 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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2004 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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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


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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.

Farm Management Chapter 3 Acquiring and Organizing Management Resources.

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