Bookwork, The Missing Management Component: Part 1 - Farm Income Determination

By Heather Gessner

It is fair to say that many ag producers do not like bookwork. Many times this job gets pushed to the side, until a bill is due or taxes need to be filed. It is also fair to say it is a missing component to the management of most operations. A missing component that could lead to the collapse of the operation.

Cash Accounting Systems

The goal of most producers’ book keeping system are to:

Pay the bills and reduce income tax payments. While paying bills is good, and there may be nothing wrong with limiting the amount of income tax paid, there are many challenges caused by this approach.

Schedule F Income

Taxes are based on a cash basis, i.e. what was spent the current year. However, cash accounting does not provide information on what the true expenses on an enterprise production level were.

The Schedule F is also filled out in an effort to keep the producer in the lowest tax bracket possible, so some crops may be held for sale in the following year, inputs may be bought under “Pre-pay” situations and depreciation through the use of section 179 or other bonus depreciation sections are used. These efforts all increase the expenses, compared to income received for that year. The problem with using only cash accounting is that it masks financial issues during low profitability years. During low profitability situations, family living expenses will be paid with cash by:

• Selling down inventory
• Selling capital assets
• Increasing accounts payable
• Refinancing operating losses
• Living off depreciation

The Schedule F cannot provide insight into the financial situation of the operation. It does not provide information regarding changes to inventory, true depreciation, deferred sales, prepaid expenses and other information that can be found on an income statement and through accrual accounting.

Accrual Accounting

Through accrual based accounting methods, producers can determine the “True Profitability” of their operation. Accrual accounting matches the expenses for inputs with the income from the product grown through their use. Agriculture accrual accounting adjusts revenue by first subtracting revenue from prior year production and then adding revenue earned, but not yet received from the current year’s production. Similarly, expenses are adjusted by subtracting the expenses from prior year production paid this year and adding expenses that have been incurred but not paid yet. To summarize, the agriculture accrual accounting method includes all income actually produced during the accounting period, whether sold or not. In addition, it includes all expenses incurred during the accounting period, whether they have been paid or not.