acquiring and organizing management resources

1. © Mcgraw-Hill Companies, 2008
Farm Management
Chapter 3
Acquiring and Organizing
Management Resources

2. © Mcgraw-Hill Companies, 2008
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 analysis
3. Assist in obtaining loans
4. Measure the profitability of individual
enterprises
5. Assist in the analysis of new investments
6. 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 for
making current and future decisions.

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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.

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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 reduce
income tax obligations.

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Farm Business Activities
• Production Activities
• Investment Activities
• Financing Activities

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Figure 3-1
Farm business activities to be included
in an accounting system

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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.

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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 market
value, 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 to
finance new investments and money borrowed
to 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 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.

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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.

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

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Expense
A cost or expenditure incurred in the
production of revenue.

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

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

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Net Farm Income
Revenue minus expenses. The same
as profit.

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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.

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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.

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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 an
accounting period. Revenue may
be 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 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.

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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.

32. © Mcgraw-Hill Companies, 2008
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.

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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.

37. © Mcgraw-Hill Companies, 2008
2010 Profit
Cash grain sales 50,000 50,000
Grain inventory increase N/A 50,000
Total Revenue $50,000 $100,000
Fertilizer 0 8,000
Seed, chemicals, fuel 25,000 25,000
Drying fuel 0 3,000
Total Expenses 25,000 36,000
Net Farm Profit $25,000 $64,000
Cash Accounting Accrual Accounting

38. © Mcgraw-Hill Companies, 2008
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 Accounts
Account Description Type
1010 Cash on Hand Cash
1020 Checking Account Cash
1100 Accounts Receivable Accounts Receivable
1200 Inventory-Crops Inventory
1205 Inventory-Livestock Inventory
1400 Prepaid Expense Other Current Assets
1470 Other Current Assets Other Current Assets
1500 Equipment Fixed Assets
1510 Building Fixed Assets
1690 Land Fixed Assets
1710 Accumulated Depreciation Accumulated Depreciation
2000 Accounts Payable Accounts Payable
2420 Current Portion Long-Term Debt Other Current Liabilities
2480 Other Current Liabilities Other Current Liabilities
2600 Non-current Liabilities -- Land Non-current Liabilities
2740 Other Non-current Liabilities Non-current Liabilities
4020 Sales Crops Income
4080 Sales Livestock Income
4100 Government Payments Income
4200 Other Income Income
5000 Gain/Loss on Sale of Assets Income
6400 Crop Expense Expenses
6600 Depreciation Expense Expenses
6750 Feed and Grain Expense Expenses
6760 Repairs Expenses
7010 Property Taxes Expenses
7050 Insurance Expense Expenses
7100 Interest Expense Expenses
8900 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 3-2
Twelve possible reports from an accounting
system

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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.