CHAPTER 15FARM RECORD SYSTEM

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

Objectives1. To appreciate the value of establishing a

good accounting system2. To discuss some choices for the accounting

system3. To outline the concepts of cash accounting4. To present concepts of accrual accounting5. To review some recommendations of the

Farm Financial Standards Council6. To introduce some financial records

Purpose and Use of Records1. Measure profit and assess financial

condition2. 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

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 financial condition is shown on the balance sheet.

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.

Assist in Obtaining LoansLenders require financial information aboutthe farm business to assist them in theirlending decisions. Many agricultural lendersare requiring more and better records.

Good records increase the odds of getting a loan.

Prepare Income Tax ReturnsInternal Revenue Service (IRS) / LHDNregulations require keeping records for taxpurposes.

Tax records are often inadequate for management purposes.

Sound record-keeping can also help reduceincome tax obligations.

Farm Business Activities Production Activities Investment Activities Financing Activities

Farm business activities included in an accounting system

Production ActivitiesThese accounting transactions involve activities related to the production ofcrops and livestock. Revenue fromproduct sales or other farm revenue is included here, as are production expenses.

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

Records should include purchase date andprice, annual depreciation, book value, currentmarket value, sale date and price, and gain or loss when sold.

Financing ActivitiesThese 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.

Basic Accounting Terms Account payable Account receivable Accrued expense Asset Credit Debt Expense

Inventory Liability Net Farm Income Owner Equity Prepaid Expense Profit Revenue

Account PayableAn expense that has been incurred butnot yet paid. Typical accounts payableare for items charged at farm supplystores where the purchaser is given 30 to 90 days to pay the amount due.

Account ReceivableRevenue 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 payment at a future time.

Accrued ExpenseAn expense that accrues or accumulatesdaily but which has not yet been paid.Examples are interest on loans andproperty taxes.

AssetAn tangible item, financial item, or item of value.

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

CreditAn 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.

DebitAn 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.

ExpenseA cost or expenditure incurred in theproduction of revenue.

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

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

Net Farm Income

Revenue minus expenses or sameas profit.

Owner EquityThe difference between business assetsand business liabilities. It represents thenet value of the business belongs to the owner or owners of the business.

Prepaid ExpenseA payment made for a product / service or input in an accounting period before it is received or will be used to produce revenue, respectively.

ProfitProfit or net farm income is revenue minus expenses.

RevenueThe value of products and services produced by a business during anaccounting period. Revenue maybe either cash or non-cash.

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?

Accounting PeriodA 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’saccounting period follow the production cycle of the major enterprises.

Basics of Cash Accounting Revenue: recorded when and only when cash

is received from the sale of product or service

Expenses: When the item is bought or used to produce a product. It will be recorded when paid.

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

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

Basics of Accrual Accounting Revenue: recorded when the item is

produced regardless of when sold Expenses: “matched” revenue -

recorded when used to produce Advantage: accurate Disadvantage: requires more time and

knowledge than cash system

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

Possible reports

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 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.