- - AGRICULTURE CORE CURRICULUM - - (CLF1000) Advanced Core Cluster: AGRICULTURAL BUSINESS MANAGEMENT (CLF1300) Unit Title: AGRIBUSINESS ACCOUNTING ______________________________________________________________________________ (CLF1302) Topic: PRINCIPLES OF AGRIBUSINESS Time Year(s) ACCOUNTING 4 hours 3 / 4 ______________________________________________________________________________ Topic Objectives: Upon completion of this lesson the student will be able to: Learning Outcome #: (G-1) - Distinguish between the two methods of accounting. (G-2) - Describe the two basic bookkeeping systems. Special Materials and Equipment: References: Luening, R. A., Klemme, R. M. & Mortenson, W. P. (1991). THE FARM MANAGEMENT HANDBOOK (7th ed.). Danville, IL: Interstate Publishers. Resources: Deere & Company. (1987). FARM AND RANCH BUSINESS MANAGEMENT (2nd ed.). Available from: John Deere Technical Services, Department F, John Deere Rd., Moline, IL 61265. Evaluation: Completion of activity assignments ============================================================================ *** INSTRUCTORS PLEASE NOTE *** This topic assumes that students are familiar with the material covered in the core curriculum unit on recordkeeping (CLF410). ============================================================================ TOPIC PRESENTATION: PRICIPLES OF AGRIBUSINESS ACCOUNTING A. Methods of Accounting 1. Two different methods of recording income and expenses are used in agricultural businesses: a. The cash method b. The accrual method B. Cash Accounting 1. The cash method of accounting is the type most commonly used by small- and medium-sized farm operators. a. The cash method is easy to use and understand. b. For tax reasons, cash accounting is not allowed for most non-service industries except farming. 2. For income tax purposes, there are certain rules which must be obeyed when using the cash accounting method. a. Deductions for expenses must be made in the year in which the cash is paid out. b. Income must be reported in the year in which it is received. c. The cost of items purchased for resale are not deductible until the year in which the item is sold. d. The profit from the sale of items purchased for resale is figured by deducting the cost from the sale price in the year in which the sale occurs. 3. Advantages of the Cash Method: a. Records are easy to understand and interpret. b. Because net income for taxation is based on cash actually paid out or received, money is generally available to pay taxes. c. Inventories are not considered in determining income. d. Income and expenses can be manipulated at year's end to level income from year to year. 4. Disadvantages of the Cash Method: a. The financial position of the business is not easily determined from cash accounts. b. The use of cash records for business analysis is limited and must be supplemented with additional information. C. The Accrual Method of Accounting 1. The accrual method is used by most non-farm businesses and large farms. 2. The accrual method is not based on the movement of cash. a. Expenses are matched with the related income to determine net income over a specified period of time. b. Income is counted as income when it is earned by (accrues to) the business, i.e., when it is billed rather than when it is actually paid. c. Expenses are counted as expenses when they are incurred (charged) regardless of when they are actually paid. 3. Advantages of the Accrual Method: a. The accrual method of accounting more accurately reflects what is going on in the business. b. Comparisons of business performance from quarter to quarter or year to year are easily made. 4. Disadvantages of the Accrual Method: a. Inventory records must be maintained with the inventory valued by IRS approved methods. b. Actual cash position is more difficult to determine and may require separate records. c. Records are more abstract and difficult to understand; it is possible to show a profit, but not have cash on hand to pay taxes. D. Bookkeeping Methods 1. The double entry method of bookkeeping is used by most large businesses. a. Two entries are made to each account for every transaction. Each credit transaction is balanced by a debit transaction. b. The double entry system is constantly self-checking so entry errors and mistakes in calculations are easily caught. c. This method keeps track of the balance between assets and liabilities. d. A separate equity account is maintained in addition to other accounts. 2. The single entry method of bookkeeping used by most farmers and individuals. a. Income and expenses are recorded only once. Income is recorded as a credit, and expenses as a debit. b. The single entry system is less time consuming and easier to understand than the double entry system. c. Errors may go undetected for some time. d. The balance of assets and liabilities is not constantly evaluated. The account is balanced only periodically as a check on accuracy. ____________________________________________________________________ ACTIVITY: 1. Review the Journal page of the California Vocational Agriculture Record Book. Is this a single or double entry method of bookkeeping? Where are credits recorded? Where are debits recorded? When is the account balanced? ____________________________________________________________________ E. General Accounting Principles 1. Account for each business or enterprise separately. 2. Keep accounts for a definite time period, usually for a quarter or a year. 3. The accounting system should be consistent from one time period to another. 4. The accounting system should give conservative estimates of the value of assets. Overstating the value of assets can lead to bankruptcy. 5. Receipts should be matched with expenses for determining income for a specified time period (cash method excepted). 6. Receipts should be posted during the accounting period in which the sale occurred (cash method excepted). 7. Always record all of the steps of each transaction. 8. Keep personal income and expenses separate from business income and expenses. Maintain separate checking accounts. 9. Document all income and expenses by using a checking account for all financial transactions. F. Equity or Net Worth 1. The primary purpose of accounting is to keep track of the value of a business and the claims against that value. 2. Equity is the claim (in dollars) which the owner(s) of the business have on the firm's assets. Equity is often termed net worth. a. In a sole proprietorship, all of the equity belongs to the owner of the business. b. In a partnership, the equity is divided among the partners. c. In a corporation, the equity is divided among the shareholders. 3. Equity (or net worth) is defined by the general accounting equation: Equity = Assets minus Liabilities G. The Balance Sheet or Net Worth Statement 1. The net worth of a business is reported on the balance sheet, also called the financial statement (in the California Vo. Ag. Record Book), or net worth statement (in Deere's FARM AND RANCH BUSINESS MANAGEMENT). The balance sheet: a. Is a complete listing of assets and liabilities. b. Is a snapshot of the financial condition of the firm at a particular time. c. Is completed at the end of each accounting period (quarterly or annually). d. Is generally necessary when applying for a loan. 2. The balance sheet is used to determine the current financial status of a business. By comparing any change in net worth from the beginning to the end of an accounting period, one can determine whether the value of the business has increased, decreased, or remained the same. 3. The method by which the value of assets is determined is critical to the accuracy of the balance sheet. Two methods of asset valuation are: a. The current value or fair market value. b. The book value or adjusted tax basis. ============================================================================= *** INSTRUCTORS PLEASE NOTE *** Additional methods of valuation will be discussed in CLF 1305, Inventory and Depreciation. ============================================================================= H. Assets 1. Assets are the resources of a business which can be expressed in terms of money. Assets are categorized in terms of the length of time they will tie up capital. Three categories are generally used: a. Short-term (current) assets b. Intermediate-term assets c. Long-term assets 2. Short-term assets include: a. Cash in accounts belonging to the business b. Money owed to the business (accounts and notes receivable) c. Livestock held for sale d. Feed or crops held for sale e. Crops in the field f. Supplies in inventory 3. Intermediate-term assets are assets with a useful life of 1 to 10 years; they are generally depreciable. Examples are: a. Machinery and equipment b. Breeding livestock c. Dairy livestock d. Vehicles 4. Long-term or fixed assets consist of: a. Land owned by the business b. Buildings owned by the business I. Liabilities 1. Liabilities are claims other persons or businesses have against the assets of a firm. These include: a. Outstanding loans b. Money owed to individuals or businesses (accounts payable) c. Services or goods which the business has contracts to deliver to individuals or businesses 2. Current liabilities are debts due within one year. Examples are: a. Accounts payable b. Operating loans c. Rent d. Taxes e. Insurance payments f. Principal due on intermediate- or long-term loans during the next twelve months. __________________________________________________________________ ACTIVITY: 1. Review the Financial Statement (page 11) of the California Vocational Agriculture Record Book. How is the basic accounting equation reflected in this financial statement? Where is the student's equity reflected in the financial statement? 2. Refer to the Net Worth Statement (Figure 9) on pages 3-4 and 3-5 of Deere's FARM AND RANCH BUSINESS MANAGEMENT. This statement compares the balance sheets from two consecutive years. Answer the following questions: What is the current net worth of Young Farms? What is the length of the accounting period? What are the assests and liabilities of the firm? (Categorize them as current, intermediate- or long-term.) Has the business grown in value? If so, by how much? An additional exercise using the data in this statement would be to create a computer spreaedsheet which would automatically calculate changes in the value of assets and liabilities. 3. Obtain the annual report of a large agribusiness corporation and review it with the class. __________________________________________________________________ J. The Earnings Statement 1. The earnings statement is a summary of income, expenses, and adjustments to inventory for a specific period of time. The earnings statement: a. Bridges the gap between the beginning and ending balance sheets. b. Converts cash accounting records to accrual records for analysis. c. Determines net income for the period of analysis. 2. The earnings statement is also called: a. The profit and loss statement b. The operating statement c. The income statement (Deere) d. The income summary (California Vocational Agricultural Education Record Book). 3. The general accounting equation for the earnings statement is: Receipts minus Expenses = Net Income 4. The earnings statement has three major parts: a. The cash operating statement b. Inventory adjustments c. Capital adjustments 5. Net earnings are defined by the equation: Net Cash Earnings +/- Net Inventory Adjustment +/- Net Capital Adjustment = Net Earnings 6. The cash operating statement reports: a. Operating receipts from product sales b. Other income c. Cash expenses 7. Net cash income is defined by the equation: Net cash income = Cash Receipts minus Cash Expenses 8. Inventory adjustments account for money tied up in inventories. This is necessary where cash accounting methods are used because inventories are not considered in determining income and expenses. Inventory adjustments increase the accuracy of the earnings statement and make it useful for a variety of analyses. a. The basic equation for the inventory adjustment is: Beginning Inventory minus Ending Inventory = Net Inventory Adjustment b. Accounts payable, accounts receivable, and prepaid expenses are considered inventory for this purpose. c. Other examples of items included in inventory are stored feed and grain and livestock held for sale. 9. Capital adjustments account for the purchase or sale of equipment, buildings, improvements to buildings, and land. a. The basic equation for capital adjustment is: (Ending Inventory + Sales) minus (Beginning Inventory + Purchases) = Net Capital Adjustment ___________________________________________________________ ACTIVITY: 1. Review the Income Summary on page 12 of the California Vocational Agriculture Record Book. Does this statement include adjustments for inventory and capital? What does this statement tell you that cannot be found on the balance sheet? Compare the Income Summary with the Income Statement (Figure 20) on pages 3-10 and 3-11 of Deere. How do they differ? Which gives a more accurate picture of net income? 2. Refer to the income statement (Figure 20) on pages 3-10 and 3-11 of Deere's FARM AND RANCH BUSINESS MANAGEMENT. This statement compares the balance sheets from two consecutive years. Answer the following questions: What was the net income of Young Farms? Where did this money probably go? What were the total cash expenses? Total cash receipts? Net cash income? Net inventory adjustment? And net capital adjustment? 3. Using the data in this statement, create a computer spreadsheet which would automatically calculate total cash receipts, total cash expenses, net cash income, net inventory adjustment, net capital adjustment, and net income. ___________________________________________________________ 12/16/91 EEZ/JA/sg #%&C