- - AGRICULTURAL CORE CURRICULUM - - (CLF1000) Advanced Core Cluster: AGRICULTURAL BUSINESS MANAGEMENT (CLF1300) Unit Title: Agribusiness accounting ____________________________________________________________________________ (CLF1305) Topic: INVENTORY AND DEPRECIATION Time Years 4 Hours 3 / 4 ____________________________________________________________________________ Topic Objectives: Upon completion of this lesson, the student will be able to: Learning Outcome #: (G-3) - Describe, complete, and use inventory and depreciation schedules. (G-4) - Distinguish between the MACRS and alternate MACRS methods of calculating depreciation. (G-5) - Become familiar with government regulations that control the use of the above methods of calculating depreciation. (G-6) - List the purposes of an inventory. 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 supplemental worksheets TOPIC PRESENTATION: INVENTORY AND DEPRECIATION A Definition: An inventory is a listing of items that are owned (generally organized in some logical fashion) and then valued. B. Why are inventories maintained? 1. They are a required part of reporting income to the Internal Revenue Service. 2. They are part of the accrual accounting system (which is a method of figuring net income that uses inventories and apportions or assigns parts of interest of the year it was actually charged, rather than when payment was made or received). 3. They provide managerial information regarding the current value of assets. 4. Depreciation is a form of expense used to offset income, which thus reduces taxes by lowering income (depreciation is subtracted from income BEFORE figuring taxes). 5. They provide documentation regarding tangible property for insurance purposes. C. Inventory Valuation Methods 1. Cost method - Items are valued at the cost of production or purchase. 2. Market Price Method - Items are valued at the market price minus the cost of marketing. 3. Unit Livestock Method - Livestock are grouped according to age and kind; value for each group is calculated by averaging price for the last three to five years. 4. Depreciated Cost Method - The value of an asset is reduced as it is used up in a predetermined time period. (NOTE: Once the time period of useful life has been determined, it CANNOT BE CHANGED.) 5. Replacement Cost Method - The cost of replacing a structure with one of equal utility is calculated. D. Be conservative in valuing inventory. 1. Do not overstate the value of assets to a banker; insolvency or bankruptcy could be the result. 2. Use the actual cost of purchased feed and supplies. 3. Use current net farm price for produced feed and supplies. 4. Use a simple per unit livestock price based on the market value for raised livestock. E. Depreciation 1. Depreciation is a method of prorating the cost of a working asset over its useful life. Depreciation may be defined as any decrease in value which occurs, regardless of repair and maintenance. 2. Types of Depreciation a. MACRS (Modified Accelerated Cost Recovery System) - This is a method of determining depreciation which allows faster recovery of the cost of the item than the straight line method does. It replaces the former Accelerated Cost Recovery System, ACRS, which must be used for assets placed in service after 1980 and before 1987. MACRS applies to all property placed in service after 1986. b. Alternate MACRS Method - This is the straight line method of depreciation. Property is depreciated the same amount every year of its useful life. This method evenly distributes cost recovery. Note that the recovery period of an item under the alternate MACRS method may differ from that for MACRS. 3. MACRS - The following tables are for instructional purposes only, consult the IRS publication, FARMER'S TAX GUIDE, for current year information. a. MACRS table for items placed in service in 1987 or 1988 (200% Table). Year 3-Year 5-Year 7-Year 1 33.33% 20% 14.29% 2 44.45% 32% 24.49% 3 14.81% 19.2 % 17.49 4 7.41% 11.52% 12.49% 5 11.52% 8.93% 6 5.76% 8.92% 7 8.93% 8. 4.46% b. MACRS table for items placed in service in 1989 or 1990 (150% Table). Year 3-Year 5-Year 7-Year 20-Year 1 25% 15% 10.71 3.75% 2 37.5% 25.5% 19.3% 7.219% 3 25% 17.85% 15.03% 6.677% 4 12.5% 16.66% 12.25% 6.177% 5 16.67% 12.25% 5.713% 6 8.33% 12.25% 5.285% 7 6.13% 4.888% 8 4.522% c. No matter when an item is purchased, MACRS is taken for the full year. d. Always round off to the nearest whole dollar. 4. Useful Life of Items under MACRS a. Three-year Property: 1) Pickups 2) Breeding hogs 3) Race horses over two years of age when placed in service or any other horse over twelve when placed in service b. Five-year Property: 1) Breeding sheep and goats 2) Breeding beef and dairy cattle 3) Trucks 4) Computers and peripheral equipment 5) Automobiles c. Seven-Year Property: 1) Farm machinery, equipment, and fences 2) Breeding and work horses (12 years or less) 3) Single purpose agriculture or horticultural structure placed in service before 1989. d. Ten-year Property: 1) Single purpose livestock and horticultural structures placed in service after 1988. e. Twenty-year Property: 1) Farm buildings ============================================================================== *** INSTRUCTORS PLEASE NOTE *** Check the current IRS Farmer's Tax Guide, Publication 225, for any changes that may have occurred. ============================================================================== 5. Alternate MACRS - Straight Line a. Straight Line Table Year 3-Year 5-Year 7-Year 20-Year 1 16.67% 10% 7.14% 2.5% 2 33.33% 20% 14.29% 5% 3 33.33% 20% 14.29% 5% 4 16.67% 20% 14.29% 5% 5 20% 14.29% 5% 6 10% 14.29% 5% 7 14.29% 5% 8 7.14% 5% b. Take half a year of depreciation in the year the item is put into service and half a year of depreciation in the year the item is disposed of. c. Always round off to the nearest whole dollar. d. Useful Life of Items Under the Alternate MACRS Method: Property Recovery years Automobiles 5 Computers and peripheral equipment 5 Farm machinery and equipment 10 Single-purpose structures 15 Trees and vines 20 Grain bins 10 Fences 10 Dairy and beef cattle 7 Horses 10 Breeding swine 3 Breeding sheep and goats 5 Farm buildings (other than single-purpose) 25 ________________________________________________________________ ACTIVITY: 1. Provide copies of the useful life of an item and the IRS depreciation schedule. Spend 2 days with practice problems (see following supplemental worksheets) in class helping students to do depreciation correctly. Do not send these exercises home as homework; students will need your help. 2. Have a speaker from the IRS or a CPA talk about tax laws affecting depreciation. 3. Give an exam on depreciation using the Depreciable Property Test from one of the Junior College or University field days. Contact agriculture instructors in your section or region who might have copies of past tests. ________________________________________________________________ Supplemental Worksheet #1 Depreciable Property Use the following information for a depreciable property inventory: On January 2, 1989, Jo bought a computer to be used in the farm business. On April 1, Jo bought a riding mower for her lawn maintenance project. On April 4, 1989, Jo bought a pickup truck for farm use. On January 2, 1990, Jo purchased a light tractor, also for farm use. On March 17, 1990, she sold the riding mower for $1,800. All are in the same enterprise category. a. Set up a depreciation schedule for 1990 for those purchases. b. Cost or basis of items: Computer $ 4,010 Pickup 10,000 Tractor 23,000 Power Mower 2,000 Jo decided to use the following methods: 1) The straight line method for the pickup 2) MACRS for everything else She calculated depreciation for 1989 on the 1989 depreciation forms. Calculate the depreciation expense for 1990. Supplemental Worksheet #2 Depreciable Property A. The Setting Bob Buttermaker lives on a dairy farm. When he entered high school, in 1987, he purchased a small herd of 8 Holstein cows. Additionally, he built a barn to house his cows and store his feed and equipment. Bob has made agreements with his father to use some land for pasture in exchange for labor. Since that time, Bob has increased his herd and purchased additional assets. In 1989, he purchased a pickup truck which he uses 50% for personal use and the rest for his enterprise. Last year, Bob purchased 6 more cows and a tractor and equipment. B. Farm Inventory The following is a listing of the assets that Bob owns on January 1, 1990. Some assets may not be depreciable. Decide which items are depreciable and make the appropriate calculation. Property Original Cost Estimated Life Method 1987 cows $12,000 5 Alt MACRS Barn (March 1987) 8,000 20 MACRS Supplies 365 1 Pickup truck 3,500 5 MACRS Raised heifers 1,480 7 Feed on hand 985 1 Tractor 6,000 7 Alt MACRS Equipment 1,800 7 Alt MACRS 1989 Cows 4,500 5 MACRS 11/11/91 EEZ/JA/ch #%&C