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					Farm Management

      Chapter 3
Acquiring and Organizing
 Management Resources
                      Chapter Outline
• Purpose and Use of Records
• Farm Business Activities
• Basic Accounting Terms
• Options in Choosing an Accounting System
• Basics of Cash Accounting
• Basics of Accrual Accounting
• A Cash Versus Accrual Example
• Farm Financial Standards Council
  Recommendations
• Output from an Accounting System
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                  Chapter Objectives
1. To appreciate the value of establishing a
   good accounting system
2. To discuss some choices for the
   accounting system
3. To outline the concepts of cash accounting
4. To present concepts of accrual accounting
5. To review some recommendations of the
   Farm Financial Standards Council
6. To introduce some financial records
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    Purpose and Use of Records

1. Measure profit and assess financial
   condition
2. Provide data for business analysis
3. Assist in obtaining loans
4. Measure the profitability of individual
   enterprises
5. Assist in the analysis of new investments
6. Prepare income tax returns

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                     Measure Profit and
                  Assess Financial Condition

  These are among the most important reasons
  for keeping records.

  Profit is estimated by developing an income
  statement, the topic of chapter 6.

  The financial condition is shown on the
  balance sheet, the topic of chapter 5.


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Provide Data for Business Analysis

Use the information from the balance sheet
and income statement to perform an
in-depth analysis.

Analysis of past decisions is useful for
making current and future decisions.




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         Assist in Obtaining Loans
Lenders require financial information about
the farm business to assist them in their
lending decisions.

Following the farm financial difficulties during
the 1980s, many agricultural lenders are
requiring more and better records.

Good records increase the odds of getting
a loan.
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    Prepare Income Tax Returns

    Internal Revenue Service (IRS) regulations
    require keeping records for tax purposes.

    Tax records are often inadequate for
    management purposes.

    Sound record-keeping can also help reduce
    income tax obligations.


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          Farm Business Activities
• Production Activities
• Investment Activities
• Financing Activities




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                        Figure 3-1
            Farm business activities included
                in an accounting system




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                  Production Activities
 These accounting transactions involve
 activities related to the production of
 crops and livestock. Revenue from product
 sales or other farm revenue is included
 here, as are production expenses.




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                  Investment Activities
These activities relate to the purchase,
depreciation, and sale of long-lived assets,
such as land, equipment, or breeding livestock.

Records should include purchase date and price,
annual depreciation, book value, current market
value, sale date and price, and gain or loss
when sold.


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                  Financing Activities

These transactions relate to borrowing money,
and paying the interest and principal on loans.

Financing activities include money borrowed to
finance new investments and money borrowed
to finance production activities.




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          Basic Accounting Terms
•   Account payable      •   Inventory
•   Account receivable   •   Liability
•   Accrued expense      •   Net Farm Income
•   Asset                •   Owner Equity
•   Credit               •   Prepaid Expense
•   Debt                 •   Profit
•   Expense              •   Revenue


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                  Account Payable

  An expense that has been incurred but
  not yet paid. Typical accounts payable
  are for items charged at farm supply stores
  where the purchaser is given 30 to 90
  days to pay the amount due.




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                  Account Receivable

    Revenue for a product that has been sold
    or a service provided but for which no
    payment has yet been received. An
    example would be custom work for a
    neighbor who has agreed to make payment
    at a future time.




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                  Accrued Expense

        An expense that accrues or accumulates
        daily but which has not yet been paid.
        Examples are interest on loans and
        property taxes.




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                       Asset

       An item of value, tangible or financial.
       Examples would include machinery,
       land, bank accounts, buildings, grain,
       and livestock.




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                      Credit

      An accounting entry in the right-hand
      side of a double-entry ledger. A credit
      entry records a decrease in the value
      of an asset. It records an increase in
      liability, owner equity, or an income
      account.




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                     Debit

    An accounting entry in the left-hand
    side of a double-entry ledger. A debit
    entry records an increase in an asset
    or expense account. It records a
    decrease in liability or owner equity.




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                     Expense

          A cost or expenditure incurred in the
          production of revenue.




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                  Inventory

    The physical quantity and financial
    value of products produced for sale that
    have not yet been sold.




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                    Liability

     A debt or other financial obligation that
     must be paid at some point in the future.




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                  Net Farm Income

          Revenue minus expenses. The same
          as profit.




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                  Owner Equity

   The difference between business assets
   and business liabilities. It represents the
   net value of the business to the owner(s)
   of the business.




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                  Prepaid Expense

       A payment made for a product or service
       in an accounting period before the one
       in which it will be used to produce
       revenue.




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                  Profit
  Revenue minus expenses. The same as net
  farm income.




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                    Revenue

          The value of products and services
          produced by a business during an
          accounting period. Revenue may
          be either cash or noncash.




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                   Options in Choosing
                  an Accounting System

•   What accounting period should be used?
•   Should it be cash or accrual?
•   Should it be single or double entry?
•   Should it be basic or complete?




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                  Accounting Period

  A period of time used to summarize revenue
  and expenses and estimate profit. It can be
  either a calendar year or a fiscal year.

  It is generally recommended that a firm’s
  accounting period follow the production
  cycle of the major enterprises.



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           Single vs. Double Entry

   With single-entry, only one entry is made for
   each transaction. A double-entry system
   records changes in values of assets and
   liabilities as well as revenue and expenses.
   In double-entry, there are equal and off-setting
   entries for every transaction. Double-entry
   accounting requires more effort, but it is
   also more accurate.


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                  Basic vs. Complete
The most basic accounting system is one
that is very simple and uses cash accounting.
A complete system would be computerized
with capabilities for both cash and accrual
accounting,and with the ability to track
inventories, loans, and depreciation, and to
handle payroll accounting and perform
enterprise analysis. Between these extremes
are many possibilities.

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                  How Complete?
• How much accounting knowledge does
  the user have?
• How large and complex is the farm?
• How much and what kind of information is
  needed or desired for management
  decision making?



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       Basics of Cash Accounting
• Revenue: recorded when and only when
  cash is received for sale of product or
  service
• Expenses: recorded when they are paid,
  even if that is not when the item is bought or
  used to produce a product
• Advantages: simple and easy-to-use
• Disadvantages: recorded revenues and
  expenses may not be accurate reflections of
  activities during the accounting period

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    Basics of Accrual Accounting
• Revenue: recorded when the item is
  produced, regardless of when sold
• Expenses: “matched” to revenue;
  recorded when used to produce
• Advantage: accurate
• Disadvantage: requires more time and
  knowledge than cash system

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       Cash vs. Accrual Example
• November 2003: Purchased, paid for and
  applied fertilizer for the 2004 grain crop. $8,000.
• May 2004: Purchased and paid for seed,
  chemicals, fuel, etc. $25,000.
• October 2004: Purchased and charged to
  account fuel for drying. $3,000.
• November 2004: One half of grain sold for
  $50,000. The rest placed in storage and valued
  at $50,000.
• January 2005: Paid bill for fuel used to dry
  grain. $3,000.
• May 2005: Remaining 2004 grain sold. $60,000.
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                            2004 Profit

                             Cash Accounting     Accrual Accounting


 Cash grain sales             50,000             50,000
 Grain inventory increase        N/A             50,000
  Total Revenue                        $50,000             $100,000

 Fertilizer                        0              8,000
 Seed, chemicals, fuel        25,000             25,000
 Drying fuel                       0              3,000
  Total Expenses                        25,000               36,000
   Net Farm Profit                     $25,000              $64,000




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  Farm Financial Standards Council
         Recommendations

• Accrual-based system recommended, but
  cash system accepted, with end-of-year
  adjustments
• A full discussion of the adjustments will be
  provided in chapter 6



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Output from an Accounting System
• Balance Sheet: report that shows the
  financial condition of the farm at a point in
  time
• Income Statement: report of revenue and
  expenses over the accounting period
• Other reports, depending on complexity of
  system


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                        Figure 3-2
                  Twelve possible reports




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                  Summary
This chapter discussed the importance,
purpose, and use of records as a
management tool. Records provide the
information needed to measure how well a
business is performing. They also provide
information needed to make sound decisions
in the future. Any accounting system must be
able to handle production, investment, and
financing activities. The output desired from
the accounting system must be considered
when choosing one.
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