01 Agricultural Producers.pdf

INTRODUCTION Organizations ranging from small proprietorships to large public companies engage in a variety of farming and ranching activities, including the following: Growing wheat, milo, corn, and other grains Growing soybeans, vegetables, sugar beets, and sug...

INTRODUCTION Organizations ranging from small proprietorships to large public companies engage in a variety of farming and ranching activities, including the following: Growing wheat, milo, corn, and other grains Growing soybeans, vegetables, sugar beets, and sugarcane Growing citrus fruits, other fruits, grapes, berries, and nuts Growing cotton and other vegetable fibers Operating nurseries Breeding and feeding cattle, hogs, and sheep, including wool production Operating dairies Raising fish and shellfish Operating poultry and egg-production facilities Breeding horses Raising mink, chinchilla, and similar small animals Agricultural producers may be involved in one or more activities, and their practices and products may vary because of differences in temperature, soil, rainfall, and regional economics. Agricultural producers primarily market their products directly to existing commercial enterprises, consume them in a related activity, such as the feeding of raised hay and grains to livestock, or market them through agricultural cooperatives. Agricultural cooperatives may act as agents and account for the separate products of each producer, or they may commingle the patrons' products and either market them in the form in which the products were received or process them before sale. Producers also sell some products through governmental programs. Prices of most agricultural products are determined by economic forces, but some product prices are established by federal and state regulatory agencies. Agricultural producers may use forward sales contracts or commodity futures contracts to reduce the risks associated with fluctuating commodity prices. Agricultural producers conduct their operations in various manners. Some agricultural producers manage the entire productive activities of their farms and ranches. Others conduct agricultural operations as tenants under cash or crop-sharing rental agreements. Terms of crop-sharing agreements usually provide for a portion of the crop to be sold for the account of or delivered to the landowner. The extent of the landowner's participation in costs, profits, and management depends on the terms of each agreement. The daily activities of farmers and ranchers who produce market crops may also create additions to fixed assets. Examples include the addition of raised animals to a breeding herd and the construction of buildings, fences, and various types of land improvements by using the producer's equipment and employees. Federal and state income tax laws have significantly affected the operations and accounting practices of agricultural producers. Some accounting practices have been partially justified based on their acceptance for income tax purposes, but these practices may not be in accordance with generally accepted accounting principles. Economic decisions and productive activities of many agricultural producers have also been influenced by government subsidy and credit programs.  UNDERSTANDING THE ENVIRNMENT Accounting Systems More attention has been given to accounting systems and practices in the agricultural industry in recent years because of the increased size and complexity of operating units as well as the greater number of formally educated and trained agricultural producers and managers. Many large private entities and publicly held corporations engaging in agricultural production have sophisticated accounting systems. However, many producers maintain elementary accounting records that are used for both tax and financial accounting. There are numerous sources of accounting forms and systems designed for agricultural producers, including computer processing offered by computer service bureaus and many universities. Internal Accounting Controls As in other small businesses, the internal accounting controls of many small agricultural operations are weak because they typically have small or part- time accounting staffs and little or no segregation of duties. However, involvement of the owner/manager in the operations frequently provides some control, particularly over access to assets and authorization of transactions. Large agricultural operators are likely to have adequate accounting controls over critical functions, such as sales, costs of production, inventories of products and supplies, purchases and disbursements, equipment use, and personnel utilization. Cost Accounting and Cost Allocations Accounting for the cost of agricultural products is similar to accounting for the cost of manufactured products. However, agricultural producers are faced with significant problems of cost identification and determination because the same personnel and equipment are often used in the production and sale of products, administration, and construction and production of assets. In addition, producers may raise diverse crops and animals, which further complicates the process of cost allocation. Certain production costs, such as those for seed, planting, feed, and fertilizer, may be allocated directly to a particular product. Other production costs may be accumulated by department or function and allocated on systematic and rational bases to various products through cost or support centers. For example, costs may be accumulated for machinery and equipment used for more than one agricultural activity and allocated to the activities based on usage records. Departments providing goods or services for more than one product are often called cost centers or support centers and may be established for the purpose of accumulating indirect costs and direct costs for activities such as irrigation and pest and disease control. Production overhead includes all production costs that are common to various products, support centers, and other cost objectives. These costs should be accumulated for each period and allocated to products based on direct labor hours, machinery and equipment use, or another basis that correlates with the use of resources. If overhead and support center costs are estimated in advance and allocated on an interim basis, under- or overapplied costs may result. Under- or overapplied costs should be allocated to cost of goods sold, inventories, and growing crops. Costs should be allocated when one raised product is used in the development of another. For example, grain or hay raised by the producer may be used to feed livestock. The costs of producing the grain or hay should be accumulated and allocated to the cost of producing the livestock. The accounting system of the agricultural producer should be designed to match costs and expenses with related revenues. Costs of resources that are expected to provide future benefits should be deferred as assets on the balance sheet. Costs without expected future benefits should be charged to expense as incurred. Questions frequently arise about the accounting treatment of costs incurred for replanting, costs attributable to prior crops, double-cropping costs, and costs of crops that take over one year to mature. These items, which do not apply to orchards, vineyards, and groves, are discussed below. Partial Replanting Partial replanting occurs for a variety of reasons, including damage from insects, crop disease, and drought. Costs of replanting may include land preparation, irrigation, seed, and labor. If those costs are considered normal costs and, when combined with other capitalized costs, do not exceed estimated net realizable value, they should be included as part of the growing or harvested crop's cost. If the costs are abnormal or excessive, they should be charged to operations. Complete Replanting Complete replanting of a field may occur at some point during the crop year for various reasons, including economic considerations. Generally, the costs incurred with respect to the crop removed should be charged to expense, and the cost of the new planting should be capitalized as the cost of the new crop. However, some costs incurred for an earlier planting may benefit a replanted crop and be appropriately considered costs of the new crop. Examples of such items include deep plowing, estimated residual value of earlier fertilizing, and seedbed preparation. Double-Cropping A parcel of land may be used for more than one crop in the same growing season. For example, winter wheat might be planted in the fall and harvested in early summer of the following year. Immediately following the wheat harvest, soybeans may be planted and harvested that fall. As a result, certain costs may be allocated to more than one crop. For example, the same land preparation or fertilizer costs may benefit both crops and should be allocated to each crop, either on the basis of the relative values of the two crops or on another logical basis. Extended-Period Crops and Methods Some crop costs, such as soil preparation, are incurred prior to planting and should be deferred and allocated to the growing crop. Other cultural practices, such as clearing the residue of harvested crops, cannot be performed or completed until after harvest, which may be in a succeeding year; those costs should be estimated, accrued, and allocated to the harvested crop. Some crops require more than one year to mature, and the costs should be deferred until harvest. It is not uncommon for assets to be constructed by using labor and materials from the farm or ranch rather than by employing an outside contractor. When this occurs, the costs of materials, labor, machinery and equipment, and related overhead applicable to such assets should be capitalized. Ordinarily, the costs of constructed assets includes only the direct construction costs and allocated overhead costs. The overhead rate used in capitalization should generally not be higher than the rate used for product costing. Other general and administrative expenses should not be capitalized. The amount of costs capitalized for internally constructed assets generally should not be more than the estimated external purchase price of such assets. Normal Costs Versus Abnormal or Excessive Costs In order to record assets at amounts that do not defer losses to future periods, the producer should distinguish normal costs from abnormal costs. (Accounting Research Study No. 1, The Accounting Basis of Inventories, contains discussions of "abnormal costs" and "normalizing direct costs" that may be useful in distinguishing normal costs from abnormal costs.) Identification of abnormal costs involves consideration of the producer's performance, which can be measured by various statistics, such as utilization rates, per-acre crop yields, and insecticide application rates. Regional averages, the experience of others producing the same or similar products in a comparable area, and the opinions of specialists may be used to determine the level of performance that represents an acceptable standard of achievement under ordinary operating conditions. Identification of abnormal costs of agricultural assets may require a general knowledge of the normal loss rate of animals, trees, or vines. No separate accounting is necessary for normal losses. When abnormal losses occur in a particular year, the undepreciated costs of lost animals, trees, or vines should be charged to current operations. In some cases the auditor may need to consider the use of specialists in determining normal loss rates.  ENGAGEMENT PLANNING To assist in planning the audit of an agricultural producer, numerous publications are available that contain detailed descriptions of most production operations. Such publications are available from U.S. government agencies, state agricultural universities, agricultural extension services, and commodity and trade organizations. Several unique planning considerations in the audit of an agricultural producer include— 1. The relationship of the producer's fiscal year-end to the harvest cycle of the producer's major crops. (For example, a producer with a fiscal year ending on June 30 whose major crop is rice will have a growing crop for the auditor to consider at year-end; however, the auditor for a similar producer with a fiscal year ending on December 31 would not have that same concern.) 2. The existence of share-crop arrangements. (For example, the auditor should consider terms of the share-crop agreement, title to the growing or harvested crops, possibility of inventory and accounting distortions because of planting schedules and different fiscal years, and the landowner's right to participate in management decisions, including the planting and sale of crops.) 3. Special conditions affecting the producer's crops, plants, and animals, such as diseases and unfavorable weather conditions. (For example, yields expected for a tree-fruit crop may be adversely affected to such a degree by weather conditions that accumulated costs may exceed inventory values. When these costs are increased by growing and harvest costs yet to be incurred, they may exceed anticipated crop revenues.) 4. Government regulations affecting the producer. (For example, the producer may be adversely affected by changes in the farm program or by local restrictions on the use of herbicides, pesticides, or fungicides.) 5. The need for the services of a specialist to evaluate the quality of the producer's crops, plants, or animals. (For example, in some instances the auditors may not possess the knowledge or experience to evaluate the health of plants and animals, estimate crop quality and expected yields,  or recognize the existence of disease, infestations, etc.) (See SAS No. 11, Using the Work of a Specialist.) 6. Availability of specialized information. Information regarding subsidy programs, historical crop yields, and general information regarding local area conditions is available from the Department of Agriculture's Agricultural Stabilization and Conservation Service (ASCS), university extension services, and other sources. The Auditor's Study and Evaluation of Internal Accounting Controls The internal accounting controls that are appropriate for agricultural producers are similar to those appropriate for entities engaged in manufacturing. Controls normally exist over the producer's major transaction cycles, such as purchasing, sales, and payroll. In addition, the producer normally maintains controls over production activities that provide reasonable assurance that costs are appropriately allocated to inventories and self-constructed assets. The AICPA's Professional Standards, vol. 1, AU sec. 320, as amended by SAS No. 48, The Effects of Computer Processing on the Examination of Financial Statements, describes the auditor's study and evaluation of internal accounting controls as a basis for reliance thereon in determining the nature, extent, and timing of audit tests to be applied in the examination. At a minimum, the auditor should obtain an understanding of the producer's control environment and the flow of transactions through the accounting system. If, after this preliminary review, the auditor plans to rely on the system of internal accounting control, the review should be completed, and compliance tests should be performed to determine whether control procedures are suitably designed to provide reasonable assurance that they will prevent or detect errors or irregularities. Accounting for Inventories Inventories of agricultural producers include growing crops, developing animals to be held for sale, harvested crops, livestock held for sale, and secondary products, such as calves from dairy herds and wool from sheep. Growing crops and developing animals to be held for sale should be valued at the lower of cost or market. Inventories of harvested crops and livestock held for sale may be valued at the lower of cost or market or, in accordance with established industry practice, at sales price less estimated costs of disposal, when all the following conditions exist: 1. The product has a reliable, readily determinable, and realizable market price. 2. The product has relatively insignificant and predictable costs of disposal. 3. The product is available for immediate delivery. For the purpose of this section, market means net realizable value as defined in statement 6 of chapter 4 in Accounting Research Bulletin No. 43 and discussed later in this section of the guide. A reliable market price should be found in an established market for products that are comparable to the product being valued and that do not vary significantly because of differences in grade or variety. The product should be located sufficiently close to the marketplace to make delivery practical without significant costs or time delays. These circumstances affect the amount and predictability of market prices. In addition, the marketing procedures should be well established so that transportation and other disposal costs, which should be relatively small, can be estimated with reasonable accuracy. Net Realizable Value Inventories of harvested crops and livestock held for sale and commonly referred to as valued at market are actually valued at net realizable value. Thus, whether harvested crops and livestock held for sale are valued at market or at the lower of cost or market, it is necessary to determine the net realizable value of those inventories. At times, net-realizable-value calculations are required for growing crops and developing animals. For these categories, costs to complete, including direct costs, production overhead, and costs of disposal should be estimated and deducted from the anticipated sales prices to determine the net realizable value for the growing crops and developing animals and to compare it to costs incurred. Determining net realizable value requires estimating selling prices and related costs of disposal in the ordinary course of business. Realized and unrealized gains and losses from hedging transactions and the provisions of forward sales contracts, both of which are discussed in other sections of this guide, should be considered in estimating net sales proceeds. Disposal costs include handling, packing, transportation costs identified with sale of the specific product, and selling expenses such as commissions and other types of direct sales expense. Sources of market information for agricultural commodities are numerous. They include quoted daily prices for traded commodities such as grains and livestock. For other commodities, information may be available from local dealers, crop-reporting services, commercial lending institutions, county extension services, and trade publications. The reputation and credibility of the information source should be considered. The market data should be adjusted to the local price because there are usually significant variations between the local and central market prices, reflecting, at the least, the freight differential. In addition, prices of most agricultural products will depend on their grade classifications, which should be considered in determining net realizable value. Any estimate of net realizable value by the producer should be based on the most reliable evidence available at the balance sheet date. If a material variation from that amount exists at the date the financial statements are issued, the auditor should refer to SAS No. 1, sec. 560, for guidance regarding consideration of subsequent events. An Overview of the Audit of Inventories Audit objectives include (a) obtaining reasonable assurance that inventory quantities represent all agricultural products and animals belonging to the producer and (b) determining that an acceptable valuation method has been properly and consistently applied.1 If a cost method is used to value inventories, cost should not exceed net realizable value. Adequate disclosure related to inventories should be made. Audit procedures for inventories generally are similar to those performed in the audit of manufacturing entities. Unique audit risks may require modification of those procedures, as described here. 1. When no documents exist to evidence title to raised products, reviews of cost records, yield statistics, and supporting documents should indicate the nature and extent of the farming activity and thus provide that evidence. 2. When there is a lack of documentary evidence to support the ownership of raised livestock, the number of animals represented as produced for a period may be tested for reasonableness by applying normal productivity rates to the productive animals in the breeding herd. Inspection of records evidencing real estate ownership may provide additional support for ownership of crops and livestock on the land. Tenant lease agreements should also be considered. 3. Inventories of agricultural products are often stored in public warehouses. The auditor should perform those procedures considered necessary (a) to obtain reasonable assurance that the inventories exist, are owned by the entity, and are in a marketable condition and (b) to determine whether they are pledged as collateral for loans. (See SAS No. 1, sec. 331.14, as amended by SAS No. 43.) SPECIFIC ACCOUNTING PRINCIPLES AND PROCEDURES Field and Row Crops Background and Unique Characteristics Field and row crops with cycles of less than one year are generally classed as annuals. These crops include wheat, barley, milo, corn, soybeans, sugar beets, tobacco, cotton, crops raised for seed, tomatoes, lettuce, beans, cabbages, and melons. Field and row crops are usually planted from seeds or are transplanted from beds and develop to the point of harvest within several months. In certain areas, when weather conditions permit, two and sometimes three different crops can be raised and harvested sequentially from the same field during one year. These practices are referred to as double- and triple-cropping. Good management of field and row crops demands careful protection from spoilage. The delicate nature of some crops requires quick handling from harvest to storage because the product may become worthless in a short period of time. Current methods of harvesting and handling usually prevent spoilage from becoming a significant problem. In recent years hybridization has resulted in plant varieties that carry substantially improved growth, maturation, and yield characteristics compared with older varieties. The development of improved varieties has occurred simultaneously with improvements in both cultural techniques and harvesting equipment. These innovations have increased yields per acre, reduced per-unit costs, and enhanced the general economic value of those plantings. Accounting Principles Costs of growing crops should be accumulated until the time of harvest, subject to lower of cost or market adjustments. Harvested crops held for sale should be reported at the lower of cost or market or in accordance with established industry practice at market if certain conditions described in paragraph 39 of Statement of Position (SOP) 85-3, Accounting by Agricultural Producers and Agricultural Cooperatives, exist. (See appendix C for SOP 85-3.) Cost centers may be established by field, crop, ranch, or other geographic area. To adequately allocate costs to inventories, each cost center should be charged with direct material and labor and an allocation of indirect costs. Where there are multiple crops, records should be maintained to provide a basis for allocation of total costs to the separate crops. Most costs related to producing field and row crops benefit only the current- year crop (for example, furrows and beds constructed for annual plantings). However, certain costs may be expended for resources benefiting more than one crop year and should be allocated to the appropriate years. For instance, in the production of rice crops the engineering and grading costs for borders (ridges used to retain water) may benefit several years. Such costs are properly included in property and equipment and amortized over their useful lives. Generally, farming procedures undertaken after the current year harvest benefit the crop of the succeeding year. There may be instances, however, where additional costs such as costs of special tillage, chopping, or burning are required after harvest of a particular crop to overcome a physical or noxious condition. Those costs should be estimated and accrued as costs of the harvested crop. In some agricultural operations a field or row crop is raised for use in the development of another product, such as grain or hay used by the producer to feed livestock. The costs involved in the production of the field or row crops for the producer's own use should be identified as part of the maintenance costs of the livestock and accounted for in the same manner as other maintenance costs, as described in "Accounting Principles for Breeding Animals," to follow. Auditing Considerations When planning the engagement, the auditor should inquire about the farming procedures and become familiar with the overall operation and any unusual events and practices. The auditor should consider performing the following audit procedures for harvested and growing field and row crops: 1. Physically observing and reviewing crop maturity and quality 2. Confirming the existence of harvested crops stored in outside warehouses (see SAS No. 1, sec 331.14, as amended by SAS No. 43) 3. Reviewing and testing the capitalized costs of growing and harvested crops for reasonableness 4. Determining that capitalized costs of crops do not exceed market When records of ownership are inadequate or non-existent, determining the ownership of harvested crops can present special audit risks. In those situations, evidence of crop ownership may be provided by a review of direct crop costs, harvesting and handling expenses, and applicable leases and tenant agreements. Unique audit risks also may be encountered in reviewing the quality of harvested crops. When inventories include harvested crops, the auditor should seek reasonable assurance that the stored commodity is of acceptable variety and quality. Assessing the value of a commodity can be a demanding procedure. In addition to market conditions, the value will be influenced by physical condition, variety, and quality. The physical state of the product may be affected by obvious conditions, such as mold, decay, or other evidence of physical spoilage, or by deterioration discernible only to those experienced and technically qualified. For instance, seed held in storage for long periods may suffer loss of germination potential that can only be detected by laboratory tests. Other damage may include insect infestations that require microscopic examination to determine the type and extent of deterioration. The variety of a stored commodity may have a material influence on value. For instance, recent technical advances in hybridization have resulted in the development of varieties and strains of agricultural products far superior to the varieties they replaced. As a consequence, stored seeds of an old variety may have only a fraction of their former value. There have even been instances where inventories of plants and trees growing in nursery farms were obsolete before they were ready for market. Quality, though similar to condition, is distinguishable from it. For instance, two groups of seeds may be in good condition and of the same variety but may have distinctive quality differences. One group may pass germination tests with high percentages, whereas the second group may have low percentages or undesirable germination qualities. In reviewing the quantity, condition, quality, and relative value of agricultural products, the auditor should consider using specialists whose credentials demonstrate their ability to evaluate farm products. (See SAS No. 11.) Special attention should be given to inventories of crops grown for seed. Although the commodity may be corn or some other grain, seed crops are significantly different from crops of the same product sold in the general market. Consequently, the auditor should refer to markets applicable to seed crops because general market prices may not be appropriate. Orchards and Vineyards Background and Unique Characteristics Orchards and groves produce such commodities as citrus, walnuts, almonds, pecans, peaches, pears, apples, apricots, cherries, and avocados. There are many varieties and sub-varieties of each. The term vines, for purposes of this section, refers primarily to grape vines, of which there are several hundred varieties. Each variety and type of tree or vine requires a period of development to reach a stage of maturity at which it produces in commercial quantities. During this development period there are substantial expenditures for labor and material to shape and train the tree or vine into an efficient form. For instance, the lower limbs of fruit or nut trees are held apart to spread the tree and develop a wider and more open crown to improve productivity. In addition, trees are pruned and shaped in the early growth stages to encourage a lower profile. Such practices can limit the height of the tree and alter its shape to accommodate mechanical picking or more rapid picking from vehicles. During the development period, trees and vines require grafting, pruning, spraying, cultivation, and similar care. Occasionally, row crops are grown between the rows of developing trees or vines to provide a supplemental source of revenue until the trees or vines reach maturity. Although fruits, nuts, and grapes can be grown in most parts of the nation, different varieties may produce more effectively in particular geographic areas. As a result, the crop development periods and cultural cycles vary significantly in different geographic areas. Trees and vines require several years of development before production occurs in commercial quantities. The costs of labor and materials to shape and train trees and vines constitute a significant portion of the costs incurred during the development years. During the last two or three years of the development period, it is not unusual for trees and vines to produce fruit or nuts in less than commerical quantities. Once the trees and vines have matured adequately, production generally continues for a number of years, depending upon the plant, soil, climate, and other influences. The productive lives of trees and vines with the same general classification may vary, depending on the particular variety. The products of trees and vines require careful handling after harvest. They must be skillfully graded due to wide variations in quality. Then, because of the perishable nature of the products they can be downgraded or become worthless if not stored so that they are protected against temperature variations and insects. Accounting Principles Trees and vines may be planted and brought to production by the producer or on a contract basis. The young trees and vines are usually purchased as nursery stock and transplanted into the orchard or vineyard in the desired pattern. Cultural costs during the development period, including stakes and wires, grafting, and labor for pruning and forming, should be capitalized. Net proceeds from sales of products before commercial production begins should be applied to the capitalized cost of the plants, trees, or vines. The productive lives of the trees or vines can usually be estimated by considering such factors as the geographical area (influence of water, humidity, and temperature), variety or classification of the plant, type of rootstock used, grafting and pruning practices, plant-spacing intervals, and picking or harvesting methods. The best sources of data regarding these factors are grower and commodity associations and the local agricultural extension service. Not all plants in a developing orchard, vineyard, or grove will survive to a productive stage. Normal losses do not generally require an adjustment to reduce the capitalized cost of an orchard or grove. However, the capitalized cost of trees or vines lost through abnormal events, such as unusual disease, frost, or flood, should be written off in the year of the loss and the costs to replant should be capitalized. (The distinction between normal and abnormal is determined on the basis of the procedures discussed in "Normal Costs Versus Abnormal or Excessive Costs" in chapter 3 of this guide.) Each orchard, vineyard, or grove may be considered a cost center, and all costs incurred prior to the time of commercial production should be accumulated in the property accounts. When production in commercial quantities begins, the accumulated costs should be depreciated over the estimated useful life of the particular orchard, vineyard, or grove. Operators of orchards and vineyards should account for costs of growing and harvested crops in the same manner as other agricultural producers, as discussed in "Field and Row Crops," this chapter. Growing costs include annual maintenance cost of the orchard or vineyard, such as cultivation, spraying, fertilizing and pruning; annual depreciation of the orchard or vineyard; and normal tree and vine replacement. Auditing Considerations Audit procedures for orchards and vineyards are similar to those performed for other types of property, plant, and equipment and may include— 1. Considering the relative health and conditions of the trees or vines. 2. Reviewing the estimated remaining productive lives of the trees or vines. This may require an annual inspection of the orchard or vineyard, and, when questions arise, the auditor may need to consult a specialist. 3. Testing total capitalized costs of orchards and vineyards to determine whether such costs are recoverable. In performing such tests, comparisons should be made with prevailing costs for similar orchards and vineyards and with data obtainable from state agricultural universities, agricultural extension services, and commodity and trade organizations. In testing the recoverability of accumulated costs of growing crops, the auditor should consider prospective yield, weather conditions, expected market price, and ability to economically harvest and transport the crop to the marketplace. It is not uncommon for the net realizable value of a growing crop to be less than the accumulated costs. The auditor may perform the following audit procedures: 1. Testing the accumulation of costs of growing crops for accuracy of classification. 2. Comparing accumulated costs with market prices and estimated disposition costs. 3. Considering the physical condition of the inventory in reviewing its net realizable value. The use of a specialist may be advisable. (See SAS No. 11.) Intermediate-Life Plants Background and Unique Characteristics Intermediate-life plants include perennial plants and vines that have growth cycles of more than one year. Such plants include artichokes, asparagus, various types of bush berries, kiwifruit, alfalfa, and grazing grasses. Those plants produce for more than one year, depending on the type of plant and the geographic area, but not as long as trees and vines. Accounting Principles Accounting principles for intermediate-life plants are similar to the principles applicable to orchards and vineyards. Intermediate-life plants may be developed by the agricultural producer or developed by others on a contract basis. Costs of intermediate-life plants developed by the producer include costs of land preparation, plants, preparation of planting beds, stakes and wires, cultural care during the development period, and overhead. Accumulated costs for these plants and vines, whether acquired on a contract basis or self-developed, should be capitalized. When production in commercial quantities begins, the capitalized costs should be depreciated over the estimated productive life of the plantings. Regional differences, climate and soil conditions, and cultural practices may affect the productive capacity and life of intermediate-life plants and should be considered when establishing depreciable lives. The capitalized costs should be classified with property, plant, and equipment; financial statement disclosure of the costs and estimated useful lives should be made. After the development period, annual maintenance costs become a portion of the cost of the current-year crop, along with harvesting costs, depreciation of the plants, and allocated overhead costs. Annual maintenance costs include cultivation, spraying, pruning, and fertilizing. The harvested crop held for sale should be reported at the lower of cost or market or in accordance with established industry practice at market if certain conditions described in paragraph 39 of SOP 85-3, Accounting by Agricultural Producers and Agricultural Cooperatives, exist. Auditing Considerations Audit procedures for intermediate-life plants are similar to those performed for other types of property, plant, and equipment, and may include— 1. Physically observing the condition of the plants. 2. Testing accumulated costs for properly capitalized amounts. 3. Comparing accumulated costs to prevailing costs for similar plants. 4. Testing accumulated costs for recoverability. If there is a question about future productive capability of the plants, it may be necessary to consult a specialist. (For example, unusually heavy rainfall or inadequate drainage may have "drowned" all or a substantial portion of an alfalfa planting [an intermediate-life plant]; in this case, the auditor should consider whether the remaining deferred costs of that crop are recoverable and may need to consult a specialist.) 5. Testing the useful lives or depreciation rates used in accounting for the plants. Actual or anticipated production declines may lead to a revision of useful lives or depreciation rates. Breeding and Production Animals Background and Unique Characteristics Breeding herds consist of mature and immature male and female animals, either of registered or commercial grade, that are maintained for their progeny. Registered herds are used to preserve or improve the desirable characteristics of the animals, and commercial herds provide animals for consumption. Registered animals are bred and retained on the basis of the demand for particular characteristics and their ability to reproduce animals with the same desirable attributes. The values of registered animals may be comparatively higher and significantly greater than those of commercial grade animals. Production animals provide a service or primary product other than their progeny. Examples are dairy cows (milk), poultry (meat and eggs), and sheep (meat and wool). In many areas of the country, commercial-grade cattle are maintained on large grazing areas or on open ranges, such as land rented from the Bureau of Land Management, the U.S. Forest Service, or various state agencies. Range conditions and infrequent observation may result in a higher percentage of un-bred females and lower calf-survival rates than those for animals confined in smaller areas and more closely observed. Horses are still used by agricultural producers, particularly by those who raise cattle and sheep. Some have extensive programs for breeding, raising, and training the saddle horses used in their operations. Dairy herds are used primarily for the production of milk that is often unprocessed when sold to a cooperative or other buyer. Calves are a secondary product of dairy operations and may be retained as replacement animals. Animals not selected as herd replacements, along with those later culled from the productive dairy herd, are usually sold for slaughter. The marketing of milk is controlled in most states. In some jurisdictions the producer owns rights called milk quotas or can contracts that entitle the producer to sell the processor a stated quantity of milk per period. Those rights are separate from the milk-producing herd in some states, and in others they remain with the herd. If the rights are separate, they have a market value and may be purchased and sold. Poultry operations may include the raising of birds for meat, the production of eggs for human consumption, and the raising of breeder pullets. Chicken and turkey operations are similar. There are usually three separate phases of poultry operations: brooder, meat, and eggs. All phases might be found in one integrated operation, or an operation might be limited to one phase. Examples are turkey operations that raise meat birds or chicken operations that raise broilers as the principal source of revenue. In either operation, hatchlings may be purchased from other producers. Other examples of single-phase operations are brooder-chicken farms that produce layer pullets (young hens) and egg-laying units where the sale of eggs is the principal source of income. Income from the sale of older or "spent" hens for meat is nominal and incidental to an egg-laying operation. Poultry operations can utilize the following: complex and costly brooder facilities; large flocks of breeder chickens and laying hens; extensive specialized buildings; feed mills and storage facilities; rooms for washing, candling, and packaging eggs; cold storage; transportation equipment; and manure-handling and manure processing equipment. Around-the-clock intensive care of the flocks requires employees to be on duty or nearby at all times. Therefore, it is common for employee housing to be a significant part of the overall operating facilities. Accounting Principles for Breeding Animals Whether breeding animals are of registered or commercial grade, their purpose is to produce young animals. Thus, accounting for livestock operations usually requires accumulation of the annual maintenance costs of the breeding herd as a means of establishing the cost of young animals. Included in the total to be allocated to the animals produced are costs of feed, veterinary care, medicines, labor, land and pasture rent, and depreciation of the herd and facilities. Costs of maintaining raised animals prior to maturity or disposition are capitalized as an additional cost of the animals. Costs of raising the young animals should be accumulated and allocated on a rational basis. Not all young animals survive to maturity or disposition; normal losses of young animals are usually not expensed directly because total annual maintenance costs are assigned to the survivors. The accumulated costs of animals lost through causes considered abnormal should be written off in the period in which the abnormal losses occur. (See "Normal Costs Versus Abnormal or Excessive Costs" in chapter 3.) Regardless of the size or quality of the herd, the accounting principles applicable to accumulating costs remain the same. The accounting system should provide accumulated costs of replacement animals as well as costs of animals culled. When males are maintained for the breeding herd, the ownership and maintenance costs usually constitute a separate cost center. When artificial insemination is used, the costs of the semen and insemination process are direct costs. Practices of the producer will usually dictate the accounting methods to be used. As the animals mature and costs are accumulated, the accounting considerations may vary depending on the future use of each animal. The usual alternatives include the following:  Transfer to the breeding herd, in which case the costs would be accumulated until the animal is mature and the breeding process is begun. The costs then become part of the depreciable cost of the breeding herd. Sale of young animals to another breeder or feeder, in which case the costs would be accumulated until the animal is sold. A gain or loss equal to the sale proceeds, less the accumulated costs and the expenses of sale, would then be recognized. Retention until fattened and sold, in which case the costs of production, care, and feeding to date of sale are accumulated and charged to cost of sales. Some producers raise feed for their animals. Costs of producing the feed should be considered a cost of the animals and capitalized or accounted for as a production cost based on classification of the animals. The total capitalized costs of raised breeding animals, including interest required to be treated as a cost under FASB Statement No. 34, should generally not exceed the estimated external purchase price of such animals. Generally, breeding animals are fixed assets and their costs should be depreciated over their useful lives. Immature animals are not considered to be in service until they reach maturity, at which time their accumulated costs become subject to depreciation. The same general accounting principles apply to all livestock, which includes cattle, hogs, sheep, and goats. Animals with short productive lives, such as poultry, may be classified as inventory. Auditing Considerations for Breeding Animals Major audit objectives for breeding animals include establishing the existence and proper valuation of the animals. The auditor may choose to perform audit procedures such as— 1. Physically observing the animals. 2. Reviewing and testing the applicable acquisition and accounting records. 3. Reviewing the reasonableness of the useful lives of the animals, the depreciation rates, and salvage values. The reasonableness of useful lives  should be reviewed in light of the experience of similar operations in the same geographical area. 4. Observing and performing counts of animals. Special audit risks exist where animals are left on grazing areas or open ranges. In those situations, the auditor may need to perform or observe counts at interim periods or may decide to use the services of a specialist. (See SAS No. 11.) Test counts should be used only in those circumstances where internal controls and periodic independent observations have conclusively proven the integrity of the accounting system and related internal controls. 5. Considering the use of a specialist where it is necessary (a) to identify breeds; (b) to read brands, tattoos, ear tags, earmarks, and other special identification marks; or (c) to evaluate the quality of the animals. Additional procedures are described in the section of this guide dealing with auditing considerations applicable to animals held for sale. (See the Auditing Considerations subsection of the following section: "Animals Held for Sale.") Accounting Principles for Production Animals Production animals generally are fixed assets subject to depreciation procedures described for breeding animals. The principles are similar to group depreciation methods applicable to other fixed assets. When milk-marketing rights remain with the producing herd, it may be necessary to allocate acquisition costs between the animals and the rights. The costs allocated to the animals should be depreciated over their estimated useful lives. Costs allocated to the marketing rights should be accounted for in accordance with Accounting Principles Board (APB) Opinion No. 17. The accounting principles for poultry operations are much the same as those for livestock, although the operating cycles are much shorter. The production costs of chickens raised for an egg-laying unit should include the initial cost of the birds (or, if hatched, the costs of eggs and hatching expenses), the costs of materials and labor, and allocated indirect costs during the prematurity period. These costs, less estimated salvage value of the chickens, should be amortized over the egg-laying period. Due to the short productive life of poultry, the cost of flocks may be classified as inventory. Costs attributed to eggs produced for human consumption consist of the costs for maintaining the production flock, applicable overhead, and depreciation of the production flock and the facilities. Some production animals produce more than one product. For example, sheep produce lambs, wool, and meat; dairy cattle produce milk, calves, and meat. The primary products are lambs and milk, whereas the secondary products are usually wool and calves. Costs may be allocated as either joint products or by-products depending on the estimated relative values of each. In most instances the meat, or slaughter value, of the production animal is considered salvage. The method of accounting should be determined by the amounts anticipated to be received for each product. Those amounts are affected by the breeding, production, and marketing practices of the producer. Auditing Considerations for Production Animals Audit procedures for production animals with extended productive lives are similar to those for breeding animals and other fixed assets. They include— 1. Testing capitalized costs. 2. Reviewing the reasonableness of depreciation policies, including lives, depreciation rates, and salvage values. 3. Testing depreciation calculations. 4. Applying other procedures described in the sections of this guide dealing with auditing considerations applicable to breeding animals and animals held for sale. Animals Held for Sale Background and Unique Characteristics Animals held for sale include all the progeny of the breeding herds except those retained for the expansion or replacement of existing herds. In some operations, young animals are purchased and maintained until they develop further and are sold. Animals held for sale are usually not retained beyond the time they reach optimal size or weight because their value usually does not increase thereafter and may even decrease. In this section, cattle operations are described in more detail than other animal-feeding operations because they have the longest operating cycle; however, the same principles apply to operations with shorter operating cycles. A calf will usually be kept with its mother from birth until the time it is weaned. These young animals, referred to as weaners, will then be placed on pasture for a period of months or sent to a feedlot. Young feeder animals bought by producers in the spring of the year are often kept on large grazing areas or open ranges, where they are subject to the same physical conditions described for breeding herds, until the fall, when they are transferred to feedlots. Cattle feeders may transfer raised cattle to feedlots or purchase young cattle to be placed in feedlots. Some feed producers and breeders supply young animals and chicks to other producers who raise the animals to maturity, and they provide breeding animals and dairy cows on a rental basis. Terms of the agreements under which these arrangements are made generally provide for sharing the income from the use and sale of the animals. These arrangements provide a source of capital for the producers and reduce their risk of loss; consequently, they are used extensively in cattle, hog, poultry, and dairy operations. Agricultural producers also engage in farming for oysters, abalone, and catfish. The major differences between these operations and the ones already described usually relate to the length of the operating cycles, ease of identification of the operating cycles, ease of identification of the productive group (breeding versus held for sale) for costing purposes, the nature of certain costs, and the environment in which they live. Accounting Principles Animals held for sale are inventories of the producer and should be accounted for at the lower of cost or market, or under certain circumstances at sales price less estimated cost of disposal as explained in paragraph 62 of SOP 85-3. The costs of raised or purchased animals kept in grazing areas or open ranges are determined in the manner discussed in the section of this guide dealing with breeding animals. Costs during the period the cattle are held in feeding pens should be readily determinable. The cattle are in a controlled environment for a relatively short period of time, usually not over six months, and are typically segregated into pens by expected date of slaughter. Accordingly, costs can frequently be aggregated by pens. The purchase price (or transferred cost, if applicable), labor and yard expenses (including depreciation of equipment and pens), veterinary supplies, and feed represent the total costs of the animals at the time of slaughter. Auditing Considerations The audit procedures applied in animal-feeding operations should be designed to deal with the special audit risks resulting from the lack of documents to evidence the ownership of raised animals. Possession of the animals does not necessarily establish ownership. Evidence of ownership of raised animals may be obtained by performing tests that apply the usual productivity rates to the number of breeding animals. The presence of animals without indication of ownership or purchase records should alert the auditor to the possible existence of a leasing or profit-sharing arrangement. Records of feed consumption may provide an indication of the total number of animals in the possession of the producer. Moreover, the client representation letter should contain an affirmation of ownership for the recorded number of animals. In addition, the auditor should review the adequacy of the accounting system and related internal controls, and consider performing the following audit procedures: 1. Observing test counts or total counts of animals held for sale, depending on the adequacy of controls. 2. Testing the costs capitalized for the animals. 3. Obtaining reliable estimates of the weight and quantity of the animals for valuation purposes. 4. Testing the net realizable value of the animals by reference to quoted market prices. Consideration should be given to local market prices that may differ from regional prices.