Chapter 3 Acquiring and Organizing Management Resources Farm Management Chapter 3 Acquiring and Organizing Management Resources

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 farm management chapter 3

Chapter Objectives To appreciate the value of establishing a good accounting system To discuss some choices for the accounting system To outline the concepts of cash accounting To present concepts of accrual accounting To review some recommendations of the Farm Financial Standards Council To introduce some financial records farm management chapter 3

Purpose and Use of Records Measure profit and assess financial condition Provide data for business analysis Assist in obtaining loans Measure the profitability of individual enterprises Assist in the analysis of new investments Prepare income tax returns farm management chapter 3

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. farm management chapter 3

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 for making current and future decisions. farm management chapter 3

Assist in Obtaining Loans 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. farm management chapter 3

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 reduce income tax obligations. farm management chapter 3

Farm Business Activities Production Activities Investment Activities Financing Activities farm management chapter 3

Figure 3-1 Farm business activities included in an accounting system farm management chapter 3

Production Activities These accounting transactions involve activities related to the production of crops and livestock. Revenue from product sales or other farm revenue is included here, as are production expenses. farm management chapter 3

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 market value, sale date and price, and gain or loss when sold. farm management chapter 3

Financing Activities 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. farm management chapter 3

Basic Accounting Terms Account payable Account receivable Accrued expense Asset Credit Debt Expense Inventory Liability Net Farm Income Owner Equity Prepaid Expense Profit Revenue farm management chapter 3

Account Payable An expense that has been incurred but not yet paid. Typical accounts payable are for items charged at farm supply stores where the purchaser is given 30 to 90 days to pay the amount due. farm management chapter 3

Account Receivable Revenue for a product that has been sold or a service provided but for which no payment has yet been received. An example would be custom work for a neighbor who has agreed to make payment at a future time. farm management chapter 3

Accrued Expense An expense that accrues or accumulates daily but which has not yet been paid. Examples are interest on loans and property taxes. farm management chapter 3

Asset An item of value, tangible or financial. Examples would include machinery, land, bank accounts, buildings, grain, and livestock. farm management chapter 3

Credit 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. farm management chapter 3

Debit 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. farm management chapter 3

Expense A cost or expenditure incurred in the production of revenue. farm management chapter 3

Inventory The physical quantity and financial value of products produced for sale that have not yet been sold. farm management chapter 3

Liability A debt or other financial obligation that must be paid at some point in the future. farm management chapter 3

Net Farm Income Revenue minus expenses. The same as profit. farm management chapter 3

Owner Equity The difference between business assets and business liabilities. It represents the net value of the business to the owner(s) of the business. farm management chapter 3

Prepaid Expense A payment made for a product or service in an accounting period before the one in which it will be used to produce revenue. farm management chapter 3

Profit Revenue minus expenses. The same as net farm income. farm management chapter 3

Revenue The value of products and services produced by a business during an accounting period. Revenue may be either cash or noncash. farm management chapter 3

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? farm management chapter 3

Accounting Period A period of time used to summarize revenue and expenses and estimate profit. It can be either a calendar year or a fiscal year. It is generally recommended that a firm’s accounting period follow the production cycle of the major enterprises. farm management chapter 3

Single vs. Double Entry 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. farm management chapter 3

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 perform enterprise analysis. Between these extremes are many possibilities. farm management chapter 3

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? farm management chapter 3

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 farm management chapter 3

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 farm management chapter 3

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. farm management chapter 3

2004 Profit farm management chapter 3

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 farm management chapter 3

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 farm management chapter 3

Figure 3-2 Twelve possible reports farm management chapter 3

Summary 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. farm management chapter 3