Record Keeping PDF

Record Keeping DXP02702 —UN—23FEB11 INTRODUCTION DXP01877 —19—18NOV10 Without record keeping, the chances of ma...

Record Keeping DXP02702 —UN—23FEB11 INTRODUCTION DXP01877 —19—18NOV10 Without record keeping, the chances of managing a business that succeeds are poor. The many facts and Why records are needed figures involved in conducting a business demand a good The kinds of records needed record keeping system. Most business managers will tell The information needed you that records are a very precious asset. Without good What to do with the information records, managers can't make good business decisions. Here is some of the information you need to know about record keeping: Continued on next page SP63763,3BAA1B9 -19-23JUL14-1/5 2-1 090117 PN=17  Record Keeping WHY KEEP RECORDS Two good reasons to keep records are to: Comply with income tax reporting requirements (Fig. 1). Assist in planning and management, such as obtaining credit, participating in government programs, and deciding what to produce (Fig. 2). KINDS OF RECORDS Record summaries that may be used in farm and ranch business management are: DXP01871 —19—18NOV10 CHART OF ACCOUNTS — The chart of accounts is a set of records that provide an inventory of the information needed to construct the financial statement necessary to analyze the health and profitability of the farm business. The chart of accounts normally includes an income and expense ledger, an inventory of current assets, a machinery account with depreciation schedules, loan amortizations, a land account, and any others that might Fig. 1 — Income tax reporting is a good reason to keep records be necessary to create the kind of records needed for good management. NET WORTH STATEMENT — A net worth statement shows the financial condition of a business at a particular point in time. It lists all assets, values of assets, and liabilities of the business. It also is known as a balance sheet, financial statement, or statement of financial condition. INCOME STATEMENT — An income statement is the financial record that reflects the profitability of the business over an accounting period, usually one year. It is also known as a profit and loss statement or an operating statement. DXP01872 —UN—18NOV10 USEFULNESS OF RECORDS There are several uses for a good set of farm and ranch records. A good set of records will provide the information to: Measure the financial health of the farm/ranch business Evaluate the profitability of the business Fig. 2 — Good records help in planning and management decisions Make business decisions Obtain farm/ranch loans that they get the accountant's information only once a Use for investment analysis year. Many of their decisions during the year are guesses Assist in the preparation of tax returns and in tax that are not based on sound facts. Alex and Mindy need management records that can give them a current picture of their THE RECORD SYSTEM financial and production situation. Alex and Mindy Kendalls and their two children own a STEPS TO SET UP A RECORD SYSTEM farm and ranch business that includes corn, soybeans, What the Kendalls’ need to do can be done in four steps: and cattle. 1. Select a record keeping system suited to their The Kendalls’ use file folders to store their cancelled particular needs. checks and receipts. Each year Alex and Mindy take their file folders to their tax accountant for preparation of their 2. Select an accounting system suited to their business income tax return. They are beginning to find that this situation. method may not be the best for their farm. 3. Select a method of reporting farm income and They don't really know how the farm is doing until the expenses. accountant has completed his analysis. The problem is Continued on next page SP63763,3BAA1B9 -19-23JUL14-2/5 2-2 090117 PN=18  Record Keeping 4. Develop a procedure to get exactly the information needed from the records. SP63763,3BAA1B9 -19-23JUL14-3/5 KINDS OF RECORDS The Kendalls’ will need to have two kinds of records in their record system: Financial records Physical records DXP01873 —19—18NOV10 The financial records include receipts and expenses, assets, and liabilities. That information will allow construction of the financial statements used for business analysis (Fig. 3). The physical records (Fig. 4) show the production of crops and livestock and the usage of inputs. Physical records Fig. 3 — Financial records show money received and spent include such things as crop yields, calving percentages, weaning weights, unpaid family labor, acres planted, and machinery use. The scope of this book is to concentrate on the following. FACTORS FOR SELECTION As the Kendalls’ consider the level of farm record keeping DXP01874 —19—18NOV10 for their operation, they must consider three factors: The amount of information desired from the records The amount of time they can devote to record keeping Their record keeping abilities LEVELS OF RECORD KEEPING SYSTEMS Alex and Mindy can select from three levels of record Fig. 4 — Physical records show production achieved keeping systems. The three levels are: Income tax purposes only Complete farm or ranch business analysis Income taxes plus some business analysis Continued on next page SP63763,3BAA1B9 -19-23JUL14-4/5 2-3 090117 PN=19  Record Keeping A record keeping system for income tax purposes meets the requirements for taxpayers who use the cash method for reporting income and expenses. This includes a record of cash receipts, cash expenditures, and depreciation on farm machinery, equipment, purchased breeding livestock, and buildings (Fig. 5). The cancelled check and DXP01875 —19—18NOV10 receipt file folder method the Kendalls’ use is mainly for income tax purposes. The second level of farm and ranch record keeping (Fig. 6) is for income taxes plus some business analysis. Records are organized for taking a complete inventory and for recording labor and production information. This system can provide a set of financial statements, and a Fig. 5 — The minimum records required for income tax purposes procedure for conducting a financial analysis. are receipts, expenses, and depreciation Complete business analysis records (Fig. 7) provide a record of cash transactions, physical quantities, inventory, depreciation, and all the information necessary to complete all tax and financial statements. It can also provide a whole farm or ranch detailed enterprise analysis. DXP01876 —19—18NOV10 Level three provides the most information and requires the most work. Many computer programs are available to provide record keeping systems for all three levels. Fig. 6 — The second level of record keeping DXP01877 —19—18NOV10 Fig. 7 — The third level of record keeping SP63763,3BAA1B9 -19-23JUL14-5/5 2-4 090117 PN=20  Record Keeping ACCOUNTING SYSTEMS The major disadvantage is that revenue is often recorded In choosing an accounting system, Alex and Mindy should in a year the production did not actually occur. Similarly, consider these questions. expenses may be recorded in a year the item was not actually used in production. In either case, the calculated What will be their accounting period? profitability for the year may not be accurate. Will they use cash or accrual accounting? Will they use a single entry or double entry system? The accrual method reports income and expenses in the time period they occur. Income is reported when produced ACCOUNTING PERIOD and expenses when used in the production process. The accrual method uses an inventory to match income and Most farmers and ranchers use a calendar year expenses to the appropriate time period. accounting period which means they summarize their revenue and expenses between January 1 and The major advantage of accrual accounting is that it December 31st. However, in some instances, a fiscal provides a more accurate calculation of profit for the year accounting period could be used if it better fits relevant accounting period. A primary disadvantage of the production characteristics of the farm. Some farm the accrual method is the detailed and complex records businesses have intensive production activities during that are required. All items must be recorded and valued December and it might be more logical to close the year in the inventory. Another disadvantage is you work with when activities are slower. Alex and Mindy have opted for estimated values. However, with careful market research a calendar year accounting period. the potential error associated with estimated values can be minimized. CASH OR ACCRUAL ACCOUNTING If a cash accounting method is chosen, the manager can Now that the Kendalls’ have selected an accounting period, use an inventory system to make accrual adjustments they must decide between cash or accrual accounting. based on beginning and ending inventory values. The ease of keeping cash method records is a definite The cash method records income and expenses based plus though they do not have the accuracy of accrual on the actual cash transactions. In order to use the cash accounting. However, if records of inventories are kept method, income must be reported in the year the cash, or its equivalent, is received. Deductions for farm expenses with a cash method, they can be used to adjust the cash method to approximate accrual accounting and overcome are made in the year the cash is paid for the expenses. some of the shortcomings. This is the approach that is The cash method does not use an inventory to keep track illustrated in this text. of unsold products or unused supplies. In the cash method, the cost of items purchased for resale SINGLE ENTRY OF DOUBLE ENTRY ACCOUNTING is not deductible until the year the item is sold. The profit A single entry system makes one entry into the record from the sale of items purchased for resale is determined books for each transaction. For example, if Alex and by deducting the cost from the sale price in the year of Mindy sold a steer, the dollar amount of the sale would be the sale. entered in a revenue ledger under steer sales. Similarly, The major advantage of the cash method is simplicity in for the purchase of fertilizer, the dollar amount of the recording transactions and ease in determining taxable purchase would be entered into an expense ledger under income for income tax purposes. fertilizer purchases. Continued on next page SP63763,3BAA1C0 -19-23JUL14-1/3 2-5 090117 PN=21  Record Keeping Single entry accounting (Fig. 8) lists the receipts and expenses without any effort to maintain a current balance between them on paper. The current balance is mainly kept as a check when accounts are complex. The single entry system still keeps track of asset accounts such as capital purchases and sales, depreciation, and liability accounts or credit. The double entry accounting system (Fig. 9) keeps balance in financial transactions. The double entry DXP01878 —19—18NOV10 system helps to keep track of current changes each time a transaction is made. In double entry accounting, each credit transaction must be in balance or offset by a debit transaction. A single entry accounting system plus inventory adjustments is presented in this text. SUMMARY OF ACCOUNTING Fig. 8 — Single entry accounting requires only one en- The Kendalls’ study their farming operation, review their try for each transaction past experiences with record keeping, and estimate the amount of time they can devote to record keeping. The Kendalls’ select a level two record system. This level will provide the information lenders require including a net worth statement, income statement, and projected cash flow. Alex and Mindy want a current and accurate picture of their financial and production situation for each accounting period. As Alex and Mindy consider their experiences with farm record keeping, they decide to use the single entry accounting system. They choose the cash method for recording income and expenses because of its simplicity and flexibility. However, they plan to use a farm inventory to make accrual adjustments at the end of the year. Other circumstances may require different choices. There is no DXP01879 —19—18NOV10 single best record keeping system for everyone. Alex and Mindy build the foundation for a practical record system they can trust. They chose a record keeping system best for their situation. Now the Kendalls’ must develop the procedures to get exactly the information they need to produce the records they want. Fig. 9 — Double entry accounting requires a credit and debit THE PROCEDURES items on the deposit slip, such as borrowed money, gifts, receipts (not subject to income tax), livestock (by Alex and Mindy consider four concepts to help them set head, type, and weight), crops by units (tons, bushels), up their record keeping system. These ideas for record and wages. Keep all receipts for expenses for which keeping can help everyone: checks were written or cash was paid. It is a good idea Learn about the record keeping system before starting to keep the farm bank account and the personal bank to use it. Read as much about the subject as possible. account separate. If you are going to use a computer, consider running a Each month reconcile the checkbook and record trial farm or at least several trial entries. If you use a keeping system. record book, study the index and practice finding parts RECORD KEEPING PROCEDURE STEPS of the book. Develop a habit of keeping the record system up to The Kendalls’ develop a step-by-step procedure for their date. Make entries regularly and include complete record keeping. They will create a chart of accounts information including date, quantity, weight, description, including: and name of the person or firm you deal with. Do most business through a bank account. Deposit all farm or ranch income in the bank account. Identify all Continued on next page SP63763,3BAA1C0 -19-23JUL14-2/3 2-6 090117 PN=22  Record Keeping 1. Enter a beginning of the year inventory including all Reflect non-cash income and expenses. The income owned assets (including breeding and raised livestock, statement will state differences between cash receipts livestock and crops purchased for resale, livestock and cash expenses, and between beginning and ending and crops held for sale and growing crops), accounts inventories. It also will determine the net farm income payable, accounts receivable, prepaid expenses, and from operations. the beginning cash balance. Provide a management tool. Inventories are important in accrual formulas used to develop a farm or ranch 2. Enter a detailed breakdown of all outstanding loans business analysis. including principal, interest, remaining loan balance, Place values on business assets. These inventory and accrued interest. values may be used as collateral when obtaining credit. They also may be used to estimate insurance needs 3. Set up a depreciation schedule for all capital assets and to complete an estate plan. (machinery, equipment, and breeding livestock). For most farms and ranches, December 31st seems to be 4. Set up an expense ledger or journal to record cash the most popular time for income tax and management expenses by expense category. Continuously enter purposes. That is the date the Kendalls’ pick for their expenses into the appropriate accounts. yearly inventory. 5. Set up an income ledger or journal to record cash The inventory date must be the same time each year income by category of product sold. Continuously so accurate comparisons of financial performance can enter receipts into the appropriate records. be made. Also, the ending inventory of one year is 6. Enter an end of the year inventory for each of the automatically the beginning inventory for the next year. items in the beginning of the year inventory or any The Kendalls’ plan to use their chart of accounts to other items acquired during the year. establish the data required to complete the two major 7. Complete the farm or ranch analysis. The business financial statements needed to conduct business financial analysis includes a set of financial ratios that analyses. The chart of accounts will also provide the are used to measure the health and profitability of the information necessary to make the accrual adjustments. business. Before beginning a discussion of the chart of accounts, it is necessary to understand the structure of the two financial This is a summary of the Kendalls’ record keeping statements that will be developed from the data in the chart procedures. Now, let's look at it in more detail. of accounts. The two financial statements are introduced below, and then the chart of accounts that provide the data BEGINNING INVENTORY VALUES are described. Subsequently, the financial statements will As the Kendalls’ take their beginning of the year inventory, be revisited to review and interpret the entries. more questions are asked. Why should inventory records The net worth and income statement can be used in be kept? When should we inventory? What should be combination with a projected cash flow statement to inventoried? How do we estimate values of the items we conduct further financial analyses. The projected cash inventory? flow is actually a budget and it will be covered in chapter Why inventory? You must inventory in order to: four along with the additional analyses. Create a true picture of the business. This may be done by listing all assets and liabilities on a net worth statement. SP63763,3BAA1C0 -19-23JUL14-3/3 2-7 090117 PN=23  Record Keeping FINANCIAL STATEMENTS NET WORTH STATEMENT The two financial statements are the net worth statement and the income statement. The net worth statement is The net worth statement (Fig. 10) is a financial statement often referred to as a balance sheet and the income showing what is owned and owed at a particular point in statement is often referred to as a profit and loss time. For most farm businesses, the point in time is the statement. Each of these important financial statements end of the calendar year. Assets are anything owned summarizes data from the chart of accounts into a format by the business, and liabilities are anything owed by the that can easily be utilized to monitor the financial health business. Completing the net worth statement at the of the farm business. end of the year also provides for a beginning of the year statement for the following year. 12/31/Year 1 12/31/Year 2 Chart of Accounts ASSETS Current Farm Assets Cash $1,700 $8,500 Cash Accounts Receivable $14,533 $13,510 Accounts Receivable Crop Inventory $172,750 $255,300 Crop Inventory Market Livestock $143,340 $172,097 Market Livestock Inventory Prepaid Expenses $1,319 $2,263 Prepaid Expenses Investment in Growing Crops $13,800 $22,500 Growing Crops Total Current Assets $347,442 $474,170 Non-Current Farm Assets Machinery & Equipment $292,384 $393,390 Depreciation Schedules Raised Breeding Stock $30,950 $42,400 Raised Breeding Livestock Purchased Breeding Stock $41,000 $34,840 Depreciation Schedules Land $1,548,500 $1,588,500 Land Buildings & Improvements $200,000 $180,000 Depreciation Schedules Total Non-Current Assets $2,112,834 $2,239,130 TOTAL FARM ASSETS $2,460,276 $2,713,300 LIABILITIES Current Farm Liabilities Accounts Payable $15,855 $35,657 Accounts Payable Operating Loan Balance $43,382 $51,248 Operating Loan Current Portion Term Debt $66,900 $74,586 Amortization Schedules Accrued Interest $12,546 $15,485 Amortization Schedules Total Current Farm Liabilities $138,683 $176,976 Non-Current Farm Liabilities Machinery & Equipment $106,301 $123,333 Amortization Schedules Land Mortgage $556,000 $525,000 Amortization Schedules Total Non-Current Farm Liabilities $662,301 $648,333 DXP05241 —UN—23JUL14 TOTAL FARM LIABILITIES $800,984 $825,309 FARM NET WORTH (EQUITY) $1,659,292 $1,887,991 LIABILITIES PLUS NET WORTH $2,460,276 $2,713,300 Fig. 10 — Net Worth Statements for the Kendalls' Farm Business for Two Consecutive Years Continued on next page SP63763,3BAA1BE -19-23JUL14-1/4 2-8 090117 PN=24  Record Keeping The net worth statement summarizes assets and liabilities Non-current assets are assets not easily converted to and then reveals net worth (equity) by subtracting liabilities cash or not expected to be converted to cash during the from assets. The net worth or equity represents what next accounting period. This category typically includes the owner has invested in the business. The net worth the long-term investments the farm uses in the production statement is often referred to as a balance sheet with the process. Examples are machinery, equipment, breeding balance coming from the equation: livestock, buildings, and land. Total Assets = Total Liabilities + Net Worth Valuation of assets can be challenging and can be This equation can be algebraically shown as: recorded assuming either a cost basis or a market value basis. The cost basis is the acceptable method for use Equation 2: Net Worth (Equity) = Total Assets – Total in financial management and will be illustrated in the Liabilities discussions that follow. A market value basis would involve trying to estimate the current market value of all assets as The net worth statement is divided into two major parts, if they were to be sold. Whereas the cost basis approach assets and liabilities, with net worth categorized with the is used for financial management of the farm business, the liabilities section. This satisfies the basic balance sheet market value approach is useful when applying for loans. equation, shown above, and is logical, since net worth is the owner’s claim against the business. The assets and The liabilities or debts of the farm business are shown on liabilities are further divided into current and non-current the liabilities side of the net worth statement. Like assets, categories. Fig. 10 shows net worth statements for the the liabilities are categorized as current and non-current. Kendalls’ farm business for two consecutive years. The Since the liabilities are determinable dollar amounts, they last column shows the account that provides the data for reflect a market valuation. Thus, a cost basis and market each entry. basis net worth statement would show the same values. ASSETS LIABILITIES Current assets are items owned by the Kendalls’ farm Current liabilities include all debts that are currently due business that have been produced to be sold or have or will come due during the next year. This could include been purchased for resale. Current assets also includes current debts that are due but have not yet been paid. supplies on hand that will be used on the farm during Thus, when the Kendalls’ prepared their year two net worth the coming year or accounting period. Included in statement, the current liabilities section includes any debts this category are cash, accounts receivable, products that are currently due or will come due between December produced and held for sale, products purchased for 31st of year two and December 31st of year three. resale, prepaid expenses, supplies, and investment in growing crops. Other items could be included if they The non-current liabilities section of the net worth meet the criteria of being for sale or used up during the statement shows the remaining loan balances on all loans coming year. The rule of thumb for a current asset is any after the current portion is subtracted. The loan balances item owned by the farm business that will be sold or used represent the amount due beyond the coming accounting during the upcoming accounting period. period. Continued on next page SP63763,3BAA1BE -19-23JUL14-2/4 2-9 090117 PN=25  Record Keeping INCOME STATEMENT Year 1 Year 2 Chart of Accounts Revenue Cash Revenue Crop sales $405,263 $448,186 Cash Revenue Market livestock Sales $166,235 $210,500 Cash Revenue Government payments $14,022 $17,200 Cash Revenue Gain/loss on sale of culled breeding livestock $14,685 $12,500 Capital Transactions Accrual Adjustments Inventory change - crops $42,154 $82,550 Crop Inventory Inventory change - market livestock $3,421 $28,757 Market Livestock Inventory Change in accounts receivable ($807) ($1,023) Accounts Receivable Change in value of raised breeding livestock $9,450 $11,450 Raised Breeding Livestock Change in value of growing crops $6,803 $8,700 Growing Crops Total Revenues $661,226 $818,820 Expenses Operating Expenses Cash Operating Expenses Livestock purchased for resale $136,780 $142,568 Cash Expenses Seed $35,624 $39,765 Cash Expenses Fertilizer $62,345 $65,317 Cash Expenses Chemicals $14,568 $21,663 Cash Expenses Feed $46,363 $47,799 Cash Expenses Vet/breeding/medicine $4,132 $4,732 Cash Expenses Machinery Hire $4,500 $6,932 Cash Expenses Labor hired $3,256 $4,300 Cash Expenses Fuel and Lubrication $29,777 $52,044 Cash Expenses Repairs & maintenance $22,194 $34,986 Cash Expenses Rent and leases $65,528 $69,854 Cash Expenses Insurance — farm and crop $12,453 $20,516 Cash Expenses Supplies $4,369 $6,570 Cash Expenses Utilities $2,167 $2,543 Cash Expenses Miscellaneous $1,547 $2,856 Cash Expenses Depreciation $46,677 $55,646 Depreciation Schedules Accrual Adjustments Inventory change — accounts payable ($1,923) $19,802 Accounts Payable Inventory change — prepaid expenses ($981) ($944) Prepaid Expenses Total Operating Expenses $489,376 $596,949 Interest expense Cash interest $41,236 $50,149 Loan Amortizations DXP05242 —UN—22JUL14 Change in interest payable ($702) ($1,316) Loan Amortizations Total Interest $40,534 $48,833 Total Expenses $529,910 $645,782 Net Farm Income from Operations $131,316 $173,038 Fig. 11 — Income Statements for Two Years for the Kendalls' Farm Business Continued on next page SP63763,3BAA1BE -19-23JUL14-3/4 2-10 090117 PN=26  Record Keeping The income statement (Fig. 11) is a financial statement that reflects profitability by summarizing revenue and The expenses on the income statement are divided into expenses for the year or accounting period. The income operating expenses and interest. The operating expenses statement shows the revenue and expenses by different are further divided into cash operating expenses, categories and subsequently subtracts expenses from depreciation, and accrual adjustments. The interest revenue to give an indication of profit. A positive expense is divided into cash interest and the change in difference represents a profit, while a negative difference accrued interest. reflects a loss. Whereas the net worth statement shows Operating expenses are the normal day to day expenses the financial position at a specific point in time, the income of running the farm business. They include cash expense statement shows revenue and expenses over a period of items such as feed, seed, fertilizer, chemicals, fuel, labor, time; usually one year in agriculture. Fig. 11 shows the etc. Operating expenses also include depreciation, which Kendalls’ income statements for two consecutive years. is a non-cash expense, and the accrual adjustments. The last column shows the account that provides the data for each entry. Interest is not considered an operating expense and is shown as a separate category under expenses on the INCOME income statement. The revenue section of the income statement is divided NET FARM INCOME FROM OPERATIONS into cash revenue and accrual adjustments. The cash revenue is the actual revenue realized by cash sales. The Net farm income from operations is defined as total farm cash revenue for the Kendalls’ farm includes crop sales, revenue minus total farm expenses. It represents the market livestock sales, government payments, and the profit of the farm from the normal day to day operation. It gain or loss on the sale of breeding livestock. does not include any revenue from non-typical sales of assets such as land, buildings, or machinery. The accrual adjustments section of revenue is where the accrual adjustments are made such that the income SUMMARY statement is a true representation of profit during the Now that the Kendalls’ have a basic understanding of year. For the Kendalls’, adjustments are shown for crops, these two financial statements, the following segments market livestock, accounts receivable, growing crops and will illustrate how to develop a chart of accounts that will the value of raised breeding livestock. provide the data for the net worth statement and the EXPENSES income statement. SP63763,3BAA1BE -19-23JUL14-4/4 2-11 090117 PN=27  Record Keeping CHART OF ACCOUNTS include personal cash; rather, business cash. This is an easy concept, but often difficult to make a judgment of A well designed chart of accounts can provide the data how much is personal versus how much is business. The necessary to develop an income statement and a net available cash could be recorded in a spreadsheet such worth statement. The entries in each of these financial that it could be linked to the current asset segment of the statements can be linked to the chart of accounts. Most net worth statement. computerized farm accounting systems will automatically create the links. In a spreadsheet application, the links REVENUE AND EXPENSES could be created such that no direct entries into the financial statements would be needed; all the data would The Kendalls’ will record cash revenue and expenses automatically move to the appropriate category. during the year. Their account entries record the date, vendor, units purchased or sold, price per unit, and The illustrations below are illustrations of a typical chart total amounts. In addition, the total amounts are then of accounts, but do not imply these are the only accounts categorized by type. required. The actual accounts needed would be dictated by the nature and scope of the business. CASH ACCOUNT A cash account is a simple recording of the amount of cash on hand in the farm business account. It should not Market Govt. Date Vendor Unit Amount Price Total Crops Livestock Payments 01/04/20xx Local Livestock Auction hd. 5 $625 $3,125 $3,125 01/11/20xx Local Livestock Auction hd. 8 $565 $4,520 $4,520 01/15/20xx Local Grain Elevator bu. 1000 $5.25 $5,250 $5,250 DXP05243 —UN—22JUL14 01/15/20xx Local Grain Elevator bu. 300 $9.35 $2,805 $2,805 01/18/20xx Local Livestock Auction hd. 18 $625 $11,250 $11,250 January $26,950 $8,055 $18,895 $0 Totals Yearly $448,186 $210,500 $17,200 Totals Fig. 12 — Revenue Account for the Kendalls' Farm Fig. 12 illustrates the Kendalls’ revenue account where of categories is determined by the scope of the farm cash revenue is recorded during the year. In this business. At the end of the year, the category totals for illustration, cash revenue is recorded for crops, market the revenue account will be linked to the cash revenue livestock, and government payments. The number section of the Kendalls’ income statement. Continued on next page SP63763,3BAA1BF -19-06AUG14-1/14 2-12 090117 PN=28  Record Keeping Date Vendor Unit Amount Price Total Seed Fertilizer Chemicals Feed Fuel 01/04/20xx Feed Store tons 2 $625 $1,250 $1,250 01/11/20xx Diesel gal. 500 $3.90 $1,950 $1,950 01/15/20xx Co-op tons 6 $425.00 $2,550 $2,550 Farm Chemical 01/15/20xx gal. 3 $55.00 $165 $165 DXP05244 —UN—22JUL14 Company 01/18/20xx Feed Store tons 3 $625 $1,875 $1,875 Co-op lbs. 40 $8.25 $330 $330 January Totals $8,120 $330 $4,425 $165 $1,250 $1,950 Yearly Totals $39,765 $65,317 $21,663 $47,799 $52,044 Fig. 13 — Cash Expense Account for the Kendalls' Farm Fig. 13 illustrates the Kendalls’ expense account where expense categories are normally needed for a farm or cash expenses are recorded during the year. In this ranch business. At the end of the year, the category illustration, expenses are recorded by date and vendor totals for the expense account will be linked to the cash for seed, fertilizer, chemicals, feed, and fuel. Many more expenses section of the Kendalls’ income statement. Continued on next page SP63763,3BAA1BF -19-06AUG14-2/14 2-13 090117 PN=29  Record Keeping FARM PRODUCTS HELD FOR SALE Date Commodity Units Quantity Price Total Change 12/31/Year 1 Corn bu. 17159 $5.39 $92,487 12/31/Year 2 Corn bu. 20678 $5.80 $149,930 $57,443 12/31/Year 1 Soybeans bu. 8859 $9.06 $80,263 DXP05264 —UN—22JUL14 12/31/Year 2 Soybeans bu. 10774 $9.78 $105,370 $25,107 Totals for Year 1 $172,750 Totals for Year 2 $255,300 $82,550 Fig. 14 — Crop Inventory Account for the Kendalls' Farm Business In any typical farm or ranch business, not all products for The change in the crop inventory represents the change sale are sold by the end of the year. Some farm products in value of crops stored during the year. For example, produced (for sale) on the farm or purchased for resale the corn in storage was valued at $92,487 in year one are on-hand at the end of the year. and $149,930 in year two. This represents a real value Crop and market livestock held for sale represent increase for the Kendalls’ in a product that is produced products produced on the farm during the normal on the farm, plus the value was created in year two. business operations, but which have not been sold. A Therefore, the change in value for all stored crops crop inventory would include items, such as grain, that ($82,550) is linked to the Kendalls’ income statement as has been harvested and currently in storage, either private an accrual adjustment in income. Although the value will or commercial. A crop inventory for the Kendalls’ is not be realized until the stored crops are actually sold, illustrated in Fig. 14. The Kendalls’ grow corn, soybeans, this accrual adjustment properly assigns the increase in and wheat, and normally store some of their production value to the appropriate year. with the local grain elevator. NOTE: This accrual adjustment assigns the increase in The crop inventory shows 17,159 bushels of corn in corn value to the year it was created rather than storage as of December 31st of year one. The price the year the corn was actually sold. If the corn, is an estimate of the net price, $5.39, that could be from year two, was sold in year three for $160,000, received for the corn on that date. Multiplying the net then cash revenue would show a $160,000 sale. price times the quantity in storage gives an estimated However, the inventory would be reduced by value of corn of $92,487. Similarly, soybeans in storage $149,930 which would leave $10,070 of revenue have an estimated value of $80,263 on December 31st of in year three. It is in this manner that accrual year one. The value of corn and soybeans are added to adjustments match income (and expenses) to the give a crop inventory value of $172,750. This value is actual time period they are created. transferred to the net worth statement as crop inventory under current assets in the appropriate year. The same procedure would apply for year two. Continued on next page SP63763,3BAA1BF -19-06AUG14-3/14 2-14 090117 PN=30  Record Keeping Date Commodity Units Quantity Price Total Change 12/31/Year 1 Steers head 110 $858.00 $94,380 12/31/Year 2 Steers head 128 $889.00 $113,795 $19,415 12/31/Year 1 Heifers head 72 $680.00 $48,960 DXP05265 —UN—22JUL14 12/31/Year 2 Heifers head 82 $711.00 $58,302 $9,342 Totals for Year 1 $143,340 Totals for Year 2 $172,097 $28,757 Fig. 15 — Livestock Inventory Account for the Kendalls' Farm Business A market livestock inventory is shown for the Kendalls’ breeding livestock owned by the business. The same in Fig. 15. Market livestock on hand at the end of the procedure would apply for year two. year can be in several different market classes due to weight class or gender. Different classes do not always The change in value of the steers, from year one to two, is have the same value. Thus, the manager should create $19,415 and the change in the value of heifers is $9,342. an inventory to reflect what is actually on the farm at the Similar to the change in crop values, these changes time of the inventory. Fig. 15 shows a class of heifers and represent value that was created during year two. This steers for each year reflected on the net worth statement. inventory change in value would be linked to the year two At the end of year one, 110 steers with a net value of $858 income statement as an accrual adjustment in market per head are owned by the farm. The total value of these livestock. The change in value of the livestock inventory is steers is $94,380. At the end of year one, 72 heifers with shown on the Kendalls’ income statement. a net value of $680 per head are owned by the farm. The In summary, a year-end inventory of products held for sale total value of these heifers is $48,960. The total value of is an essential component of a chart of accounts. This market livestock, $143,340, is the sum of the values for inventory provides data for the construction of the current both market livestock classes. This value is transferred assets portion of the net worth statement and the accrual to the net worth statement as market livestock inventory adjustments for income on the income statement. under current assets in year one. Remember: this entry is for market livestock held for sale. It does not include SP63763,3BAA1BF -19-06AUG14-4/14 ACCOUNTS RECEIVABLE DXP05266 —UN—22JUL14 Date Identification Amount Change 12/31/ Year One Local Grain Buyer $14,533 12/31/Year Two Local Grain Buyer $13,510 ($1,023) Fig. 16 — Illustration of Account for Accounts Receivable An account receivable is simply an amount owed to the for the grain. This account receivable amount is an asset farm business, but not yet paid. At the end of a year, an and would be linked to current assets on the Kendalls’ account receivable is an asset to the business because net worth statement. Similarly, the $13,510 would be it is something owned. Consider the Kendalls’ accounts entered on the year two net worth statement. However, receivable account illustrated in Fig. 16. the change in accounts receivable would be entered as an accrual adjustment on the Kendalls’ year two income At the end of year one, the Kendalls’ are owed $14,533 for statement under accrual adjustments to revenue. grain sold to the buyer; however, the buyer had not yet paid Continued on next page SP63763,3BAA1BF -19-06AUG14-5/14 2-15 090117 PN=31  Record Keeping INVESTMENT IN GROWING CROPS Amount Invested Total DXP05267 —UN—22JUL14 Date Crop Units Per Unit Invested Change 12/31/Year One Wheat 50 Acres $276 $13,800 12/31/Year Two Wheat 75 Acres $300 $22,500 $8,700 Fig. 17 — An Illustration of An Account for Growing Crops At the end of any fiscal year (December 31st for the This illustration assumes that the farm had 50 acres of Kendalls’), a farm business may have crops growing, wheat on December 31st of year one and the production but not yet at maturity. An example would be wheat costs to date were $276 per acre for a total investment of planted during the fall with the expectation of harvesting $13,800. The $13,800 is a farm business asset and would the following summer. As of the end of the fiscal year, be linked to the net worth statement under current assets. the wheat would not be harvested; rather, still growing. The year two amount of $22,500 would be current assets The growing crop is an asset. However, how should the in the year two net worth statement. asset be valued in the chart of accounts? The growing crop should NOT be valued based on projected yield The change in total investment, $8,700, represents a primarily because, at the date of valuation, there is no greater investment in year two than in year one. This yield or production. Rather, the growing crop should amount should be linked to the revenue section of the be valued based on the production costs invested from income statement as an accrual adjustment for the the beginning of production to the current date. Thus, if change in the value of growing crops. the Kendalls’ had planted wheat in the fall, the value of the growing wheat should be the amount invested up to December 31st. Fig. 17 illustrates an account for the growing wheat for the Kendalls’ farm. Continued on next page SP63763,3BAA1BF -19-06AUG14-6/14 2-16 090117 PN=32  Record Keeping PREPAID EXPENSES Number DXP05268 —UN—22JUL14 Date Item Units of Units Amount Paid Change 12/31/Year One Fuel, Feed, Seed, etc. Gal., lbs., etc. $1,319 12/31/Year Two Fuel, Feed, Seed, etc. Gal., lbs., etc. $2,263 -$944 Fig. 18 — An Illustration of an Account for Prepaid Expenses Prepaid expenses are items used in production that are expense for fuel since they would be using the fuel in on hand at the end of the year but will be used during the storage. In this procedure, the fuel expense is correctly next year. Examples are inventories of fuel, feed, and accounted for in the time period it is used. seed. These items have value but are not held for sale; rather, they are to be used in the coming year’s business RAISED BREEDING LIVESTOCK operations. Typically, these items would be valued at If a farm business has an enterprise based on raising their acquisition cost and shown as a current asset on the market livestock, then the breeding livestock could be net worth statement. Fig. 18 is an illustration of prepaid acquired by purchasing the animals or raising the animals. expenses for the Kendalls’ farm. Only totals are shown If the animals are purchased, they should be depreciated for illustration. However, a complete account should be which will be covered in a later section. However, if created for all categories of prepaid expenses. the animals are raised, a separate account in the chart In this example, suppose in year one the Kendalls’ had of accounts should be constructed. Raised breeding fuel on hand (in storage) which had an original cost of livestock are not depreciated because they do not have $1,319. This fuel on hand is an asset and should be a purchase price as a starting point. Thus, the question linked to the net worth statement as a prepaid expense is: how should they be valued, and how does that value in the current asset category. Similarly, $2,263 would be affect the net worth statement and income statement? shown in the year two net worth statement. These values There are a couple of acceptable methods for valuing are shown on the net worth statement (Fig. 10). raised breed livestock. It is recommended that the The change in prepaid expenses should be recorded in reader research the different methods, if applicable. This the income statement category for operating expenses as example illustrates one of the more common methods of an accrual adjustment. The change is calculated as the valuing these assets. year one total minus the year two total and this change is The Kendalls’ net worth statement shows all raised entered on the income statement as a change in prepaid breeding livestock in one category. However, the chart expenses under accrual adjustments (Fig. 11). This is of accounts would normally have different categories for a different calculation than the other accounts which animals of different ages. To explain, assume a beef subtract year one from year two, and here is why. The cattle enterprise where the owner raises some of the $2,263 year two cost of the fuel has already been recorded breeding livestock by keeping replacement heifers from as a cash expense in the expense ledger. However, the the females born on the farm. Suppose a heifer calf is fuel is in storage and will not be used until year three born on the farm during the spring of year one; and at the (although it has been paid for). By recording the change end of year one that calf is still on the farm and shown in (-$944) as an expense, it is essentially offsetting the cash the market livestock inventory at a value of $700. At this expense of the fuel in year two. Now, just for illustration, time, the owner does not know for certain if the heifer will suppose the Kendalls’ do not prepay any fuel in year be kept for the breeding herd or sold as market livestock. three. Thus, their prepaid expense account would be However, by listing this animal in the market livestock zero. The change would be a positive $2,263 which would inventory, the value is attributed to year one. be entered into the income statement operating expense as an accrual adjustment. There would not be any cash Continued on next page SP63763,3BAA1BF -19-06AUG14-7/14 2-17 090117 PN=33  Record Keeping During year two, the owner decides to retain this heifer for reaches maturity. However, upon reaching maturity, the the breeding herd. Therefore, the animal is transferred value should remain constant until the animal is sold. from the account for market livestock to a new account Maturity age for breeding is different for different animals. for raised breeding livestock at the $700 value. This Thus, the time period to maturity will vary. transaction does not affect income or total assets; NOTE: It is NOT acceptable to increase the value of raised however, it does move the animal from current assets to breeding livestock based on increases in market non-current assets on the net worth statement. Further, value. The animals are not being held for sale. assume during the year the owner invests another $150 Thus, market value does not apply in a cost basis (production cost) in the development of this heifer. As net worth statement. Furthermore, if the value was of December 31st of year two, this heifer could show a increased by market value, it would create a bias on value of $850, which would be a $150 increase in value the income statement. An increase in market value during year two. In year two, the $850 would link to the of non-current assets should NEVER be construed net worth statement as a non-current asset for raised as income unless the asset is sold. The only breeding livestock; and the $150 would be entered on the exception is raised breeding livestock that have not revenue section of the year two income statement. It is reached maturity and the change in income is based acceptable to continue to increase (by production cost) on changes in production costs, not market value. the value of the raised breeding livestock until the animal SP63763,3BAA1BF -19-06AUG14-8/14 DXP05269 —UN—22JUL14 Date Category Value Change 12/31/Year One Beef Cattle Heifers $30,950 12/31/Year Two Beef Cattle Heifers $42,400 $11,450 Fig. 19 — An Illustration of The Account for Raised Breeding Livestock The Kendalls’ have raised breeding livestock on their productive service to the farm for more than one year. farm and all different age categories all shown together. This category also assumes the machinery and equipment A complete account for breeding livestock would have are held for productive services and not for sale. separate sections for the different age groups. When the animals reached maturity, an increase in value would not Machinery and equipment should be depreciated with be shown. Fig. 19 shows the composite account for the a depreciation schedule for each item shown in the Kendalls’ raised breeding livestock. machinery and equipment section of the chart of accounts. There are several different methods of depreciation and The value column, $30,950 for year one and $42,400 it is not the scope of this publication to demonstrate the for year two, would be linked to the net worth statement various methods. The illustrations herein will refer to under non-current assets. The change in year two, straight line depreciation. $11,450, would link to the revenue section of the year two income statement as an accrual adjustment in the NOTE: For management control and decisions, the value of raised livestock. The entries from this account depreciation schedule for the chart of accounts are actually shown on the net worth statement (Fig. 10) should NOT be constructed based on the IRS and the income statement (Fig. 11). methods described in the Farmers Tax Guide. The IRS methods do not necessarily reflect the MACHINERY AND EQUIPMENT, PURCHASED actual life of the item and does not include a BREEDING LIVESTOCK, AND BUILDINGS salvage value. Use of the IRS methods may not accurately reflect profit on the income statement Machinery and equipment on the Kendalls’ farm refers or value on the net worth statement. to any machinery and/or equipment that will provide Continued on next page SP63763,3BAA1BF -19-06AUG14-9/14 2-18 090117 PN=34  Record Keeping Purchase Price $50,000 Projected Economic Life 10 Years Depreciation Method Straight Line Estimated Salvage Value $10,000 Annual Undepreciated Year Depreciation Balance 1 $4,000 $46,000 2 $4,000 $42,000 3 $4,000 $38,000 4 $4,000 $34,000 5 $4,000 $30,000 DXP05270 —UN—22JUL14 6 $4,000 $26,000 7 $4,000 $22,000 8 $4,000 $18,000 9 $4,000 $14,000 10 $4,000 $10,000 Fig. 20 — An Illustration of Depreciation Schedule for the Chart of Accounts Items that are depreciable are any purchased productive they think the machine would have a realistic value assets with an economic life that is greater than one of $10,000. In each year, the annual depreciation of year, but not perpetual. Examples in agriculture include the machine is a business expense, albeit not a cash buildings and improvements, machinery and equipment, expense, and should be linked to the income statement and purchased breeding livestock. It is not within the scope as an operating expense under depreciation. It is not an of this text to define and discuss the various depreciation accrual adjustment; rather, a simple proration of the cost methods; however, a simple illustration is provided in Fig. of the machine over each year of productive service. 20. Fig. 20 shows a straight line depreciation schedule for a $50,000 tractor that is depreciated over ten years and is The undepreciated balance, or book value, of the machine expected to be worth $10,000 at the end of the ten years. each year would be linked to the net worth statement under The depreciation, which is a proration of the original cost non-current assets. Each year, the value of this machine over the economic life, is calculated at $4,000 per year. under non-current assets would decline until it reached the The depreciation formula is: salvage value and then the value would remain constant until the machine is removed from the farm business. Annual Depreciation = (Purchase Price – Salvage Value) / Economic Life Although the economic life would be different, the same accounting procedures used for depreciation apply to or purchased breeding livestock and buildings. Actually, any farm asset that provides productive service more than one Annual Depreciation = ($50,000-$10,000) / 10 = $4,000 year and has a finite life should be depreciated. Other per year assets could include items such as grain storage facilities, The annual depreciation is subtracted from the original fences, corrals, stock ponds, computers in the business, cost to arrive at the depreciable balance at the end of beehives, orchards (not the land portion), and many other each year. The undepreciated balance is often referred items that would fit the criteria. to as the book value of the machine and should not be The values on the net worth statement (Fig. 10) and considered the actual market value if the item was sold. income statement (Fig. 11) do not correspond to Fig. A separate depreciation schedule should be constructed 20 because it is assumed the Kendalls’ have more for all depreciable items in the farm business, which could machinery, buildings, breeding livestock, etc. than just be considerable. this machine illustrated. The depreciable balance of any In this illustration, the Kendalls’ have a machine with item should decrease over time. However, the total of a $50,000 purchase price which they believe will be all items could increase if the Kendalls’ purchase new productive for 10 years. At the end of the 10 years, depreciable items for the farm. Continued on next page SP63763,3BAA1BF -19-06AUG14-10/14 2-19 090117 PN=35  Record Keeping the value of land should be at the original net purchase NOTE: The discussion of depreciation herein is based on price and should not show an increase in value over time. a cost basis net worth statement. The book value of However, in some instances, permanent improvements the asset would decrease each year. If a manager added to the land can be shown either with the land or as constructed a market value net worth statement, improvements. In either case, the land and permanent the assets could conceivably increase in value (especially breeding livestock). For management improvements should remain at their original cost. Land is not depreciated simply because it does not have a purposes, the cost basis should be used for analyses. Under no accounting circumstances determinable life. should increases in perceived market value be An account for land would just show the original cost for used for depreciable assets to create income on an each parcel along with any permanent improvements. income statement. Income from depreciable assets This value would be linked to the net worth statement each can only be recognized if the asset is sold; and, even year as a non-current asset. The land account should then, the income is sales price above book value. not change unless new land is purchased or permanent improvements are made to existing land. There would LAND never be an accrual adjustment on the income statement for changes in land value. Land is a farm business asset that is perpetual, meaning that it lasts forever. On a cost basis net worth statement, Continued on next page SP63763,3BAA1BF -19-06AUG14-11/14 2-20 090117 PN=36  Record Keeping ACCOUNTS PAYABLE Date Vendor Amount Owed Change 12/31/Year One Local Co-op $13,578 12/31/Year One Local Lumber Yard $2,277 Total for Year One $15,855 DXP05271 —UN—22JUL14 12/31/Year Two Local Co-op $21,345 12/31/Year Two Local Fuel Distributor $14,312 Total for Year Two $35,657 $19,802 Fig. 21 — An Illustration of An Account for Accounts Payable Accounts payable refers to open accounts the farm The operating loan is normally for funds used to purchase business may have with vendors such as the local co-op, operating inputs such as feed, seed, fuel, labor, chemicals, feed store, hardware store, lumber yard, etc. These fertilizer, etc. The structure of the operating loan is accounts are not considered term or operating loans. designed for the borrower to repay the funds before the Rather, they are simply open accounts that are normally end of the production period. However, in some instances, paid, in full, periodically (perhaps every month). A chart of the borrower is not able to fully pay the loan by the end accounts should include a section for each of the accounts of the year. In this case, the loan is considered due as of payable for the farm business. Fig. 21 is an illustration December 31st and the outstanding balance would be of how an accounts payable account might appear for shown on the net worth statement as a current liability. A the Kendalls’ farm business. simple account, like the previous illustrations, should be constructed to show the outstanding balance from year In this example, the Kendalls’ owed $15,855 to two to year. Any outstanding balances on the operating loan different vendors as of December 31 of year one, and have no effect on the farm income statement. Any interest $35,657 to two vendors as of December 31st of year due on the operating loan (as of December 31st. would two. Both of these values would be linked to the current be entered as accrued interest under current liabilities liabilities section of the net worth statement of the on the net worth statement. An operating loan balance appropriate year. These values are shown on the net outstanding is shown on the Kendalls’ net worth statement. worth statement (Fig. 10). TERM DEBT The change in accounts payable, $19,802, from year one to year two would be entered as an accrual adjustment Term debt refers to farm business loans where the under operating expenses on the income statement. borrower repays the loan, with interest, over designated Although the items have not yet been paid for, they do time periods such as monthly, quarterly, semi-annually, or represent items purchased by the Kendalls’ for the use on annually. Term loans are usually acquired to purchase the farm. Including the change in accounts payable as machinery and equipment, land, breeding livestock, and an expense appropriately assigns the expenses to the buildings. correct year. When those items are paid for in year three they will be listed as a cash expense. However, they will To illustrate how a term loan would provide information be removed from the accounts payable account, thus to the net worth statement and income statement, the resulting in no financial impact in year three. This change Kendalls’ have a $40,000 term loan that is scheduled to in account payable is shown on the income statement be repaid in equal annual payments over five years. The for year 2 (Fig. 10). loan payment each year will be the same, but the principal amount and interest amount will change. The actual OPERATING LOAN amount owed is a liability to the business and the interest each year is a business expense. For simplicity, the loan An operating loan for a farm business is much like a payment date each year is July 1st which is exactly at the line of credit at a lending institution. The farm business halfway point of the year. Fig. 22 shows the Kendalls’ obtains approval for a given dollar amount for the year loan broken down by year. and then withdraws the funds as needed during the year. Continued on next page SP63763,3BAA1BF -19-06AUG14-12/14 2-21 090117 PN=37  Record Keeping The loan is shown in Fig. 22, which shows a loan amount of $40,000, an interest rate of 7%, and a loan term of An Illustrated Term Loan Amortization Schedule five years with annual payments. The loan payment for the Kendalls’ Farm Business is scheduled for July 1st of each year. A complete Amount $40,0 table showing each year’s payment, principal, interest, Bor- 00 rowed remaining balance, accrued interest, and change in Interest 7% accrued interest is called an amortization schedule. The Rate calculation of the annual payments, principal, and interest Term 5 Years will be covered in a subsequent chapter. Payment July 1st Each Date Year Fig. 22 indicates that if the machine were purchased on Year Pay- Principal Interest Loan Ac- Change July 1st of any year, the first payment of $9,756 would ment (P) (I) Balance crued in Ac- be due on July 1st of the next year. In that first payment, (P+I) Interest crued $6,956 would be principal or that portion of the lender’s Interest funds that are repaid. The interest in payment number 0 $1,400 $1,400 DXP05197 —UN—24JUL14 one, $2,800, represents the interest that would be paid for 1 $9,756 $6,956 $2,800 $33,044 $1,157 -$243 the use of the lender’s funds in year one. In year one, the 2 $9,756 $7,443 $2,313 $25,602 $896 -$260 Kendalls’ have $40,000 of the lender’s funds at an interest 3 $9,756 $7,963 $1,792 $17,638 $617 -$279 rate of 7% (7% times $40,000 equals $2,800). 4 $9,756 $8,521 $1,235 $9,117 $319 -$298 The line labeled zero in Fig. 22 represents the year the 5 $9,756 $9,117 $638 $0 $0 -$319 Kendalls’ purchased the machine. No actual payment is due in year zero; however, an accrued interest of $1,400 Fig. 22 — Depreciation Schedule for the Kendalls' Farm Business would exist on December 31st of that year. To understand this accrued interest, it is important to understand that future interest is not normally due until the time period of that year. What is actually due in the coming year is actually passes. In other words, when the Kendalls’ the principal payment recorded for the coming year. The purchased the machine, they knew that an interest accrued interest and current portion of term debt would be payment of $2,800 would be due in one year. However, if summed over all of the Kendalls’ term loans and recorded they paid off the loan early, the entire $2,800 would not on the net worth statement. A loan amortization schedule be due. The $2,800 actually becomes due one day at a would be necessary for each of the term loans. time as time passes. Thus, on December 31st of year The non-current liabilities section of the net worth zero, only half of the first year has passed, and $1,400 of statement shows the remaining loan balances on all loans the first year’s interest has accrued. If the Kendalls’ were after the current portion is subtracted. Typically, the term to pay off the loan on December 31st, they would actually loans are shown in different categories for machinery and owe $1,400 in interest. Using this logic, on December 31st equipment and land. Referring to the Kendalls’ machinery of any year, the accrued interest on all loans is actually a loan in Fig. 22, column five shows the loan balance after current liability on the net worth statement. each of the annual payments is made. This loan balance The principal portion of the term loan is the amount to includes only the lender’s principal that has not been be repaid of the lender’s funds; this is due regardless of repaid; it does not include interest that has not accrued. the time period. Principal does not accrue like interest. For example, if the Kendalls’ were in year three of the On any net worth statement prepared on December 31st, loan, their loan payment would be $9,756, of which $7,963 the principal portion of the next year’s loan is recorded is principal repaid. After this payment, $17,638 of the as the current portion of term debt. For example, in Fig. original $40,000 has not been repaid. If the Kendalls’ were 22, if the Kendalls’ were preparing a net worth statement preparing a net worth statement at the end of year two, on December 31st of year two, the current portion of the non-current liabilities would include the loan balance term debt would be the principal payment in year three, at the end of year three, $17,638. It would not include which is $7,963. This is confusing to some beginning the loan balance of year two because a part of that loan students of financial statements as they wonder why a balance is in current liabilities ($7,963), because it is due net worth statement for year two would not include the within one year. Once again, the Kendalls’ would sum the principal payment in year two. But remember: the year outstanding loan balances for all loans and record them two payment has already been paid as of December 31st as non-current liabilities. Continued on next page SP63763,3BAA1BF -19-06AUG14-13/14 2-22 090117 PN=38  Record Keeping Procedurally, the interest should be calculated in two Each year’s interest on any loans is recorded on the farm parts: the interest for the first six months of year three, income statement as an expense. The interest is not and the second six months of year three. They will not be classified as an operating expense, rather, it is shown the same because the outstanding principal changes with in a separate expense category. The expense category the July 1st payment. This calculation can be simplified by has two entries—one for cash interest and one for the taking the cash interest and adding the change in accrued change in accrued interest. To understand this rather interest which will give the actual interest for the year. In confusing concept, consider the loan in year three of the year three, the cash interest is $1,792 and the change in illustration. In year three, the cash interest payment is accrued interest is -$279. The $1,792 minus the $279 $1,792 which represents the sum of accrued interest in gives $1,513 which would be the actual interest expense the last six months of year two and the first six months for year three. Each year, the cash interest and change of year three. In other words, the interest paid in year in accrued interest is recorded on the Kendalls’ income three is actual interest from parts of two years. In keeping statement under interest expense. with the accrual principles, the total interest expense should be for just one year (year three in this example). SP63763,3BAA1BF -19-06AUG14-14/14 NET WORTH STATEMENT AND INCOME for one accounting period. Referring back to fig. 11, the STATEMENT REVISITED Kendalls’ have income statements for two consecutive years. All of the data in the income statement are linked The previous sections have illustrated how a chart of to the Kendalls’ chart of accounts. accounts can provide the data necessary for construction of the net worth statement and income statement for the The income statement for year two shows the cash Kendalls’ farm business. The various accounts illustrated revenue during the year and the accrual adjustments are typical of many farms and ranches. However, there the Kendalls’ make at the end of the year. Remember: could be many other accounts needed based on the the accrual adjustments facilitate all revenue to be scope of the farm business. This chapter does not provide appropriated to the year it was created. The Kendalls’ a detailed explanation of farm accounting; rather, strives total revenue for year two is $818,820. to provide some examples that will assist in the logical The expenses on the income statement are divided into construction of the major financial statements. operating expenses and interest. The operating expenses NET WORTH STATEMENT include cash operating expenses, depreciation, and th