The Balance Sheet

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					                                            The Income Statement

An income statement is one of four financial statements that a producer needs to complete and
analyze each year. The income statement (or profit and loss statement) is a summary of revenue
received and business expenses incurred during a defined period, usually twelve months. Groups
of income and expenses are called “accounts.” Accounts are simply descriptions indicating what
type of income or expense is represented such as crop sales (income) or seed (expense). The
income statement, once completed, provides the producer with a statement of profit (or loss)
derived from the business.

Why do you need an income statement?
The income statement provides the producer with a measure of success of the business in terms
of net income or loss for a particular period of time. Comparing income statements over time
gives the producer an indication whether the business is profiting over time and moving towards
the fulfillment of the business goals. Much of the information on the income statement,
particularly the net income figure, can be used to calculate valuable financial ratios. These ratios
can point out strengths and weaknesses quickly. Most lenders will want to see a previous years’
income statement to determine credit worthiness for a loan.

How is it constructed?
Income accounts are presented first on the income statement. Revenue can be from the sale of
crops or livestock, agricultural program payments, custom work, dividends, etc. Expense
accounts are presented below the income accounts. These could include labor, seed, fertilizer,
etc. The income statement also includes expenses that are not paid in cash, such as depreciation.

Once all income and expenses have been identified, the producer can determine true profitability
by subtracting the total expenses for the production cycle from the total revenue. Net income for
the farming business is the result which can be either positive or negative.

Steps to constructing the income statement:

     1. Transfer totals from Income Statement Transaction Log forms to the Income Statement
        Worksheet by enterprise/center.
     2. Make sure any non-cash transactions are accounted for properly, especially depreciation.
     3. Make year-end allocations so that all support and cost centers have transferred costs to a
        profit center. See the Allocations section of this curriculum.
     4. Total each profit center and record results to the final income statement by enterprise.
           ** Note that the “Total” column on this final income statement represents to whole-
           farm income statement.

Duckworth, Brenda, Stan Bevers, Rob Borchardt, and Blake Bennett. Department of Ag Economics, Texas Cooperative Extension, Texas A&M
University. May 2003.
What are accrual adjustments, and how do they relate to the Income
Accrual adjustments are necessary temporary adjustments made so that income and expenses
presented are “matched.” In order to evaluate a specific enterprise, the production cycle must be
complete (wheat is harvested, calves are weaned and ready for sale, vegetables are picked, etc.)
and the income and expenses presented represent that particular enterprise. Income and expenses
are “matched” to the represented production cycle and enterprise.

An example of a necessary accrual adjustment is feed that has been fed to calves but has not been
paid for. The amount owed, prorated for amount fed, should be included in current year
expenses. When the feed debt is paid the following year, the accrual will be “reversed” by
subtracting the accrued amount (previous year) from the cash transactions (following year). If
the accrual is not reversed, the expense will be double-counted.

Other examples of accrual adjustments are:

       Income earned, but not yet received (deferred)
       Income received, but not earned
       Prepaid expenses
       Accounts payable/ accounts receivable
       Inventory Changes
       Management labor

In short, if the input has been used it should be expensed, regardless of whether or not the
payment has been made. If the income has been earned (resource given up) it should be included
in the current year, regardless of whether or not the payment has been received.

It should be pointed out that the IRS does not require accrual adjustments (or changes in
inventory value) for tax purposes. In fact, the producer’s tax accountant should be aware of any
accrual adjustments because they should not be included for tax purposes if the producer pays
taxes on a cash basis. However, until the manager produces an accrual- adjusted income
statement, he does not know true profitability.

How do producers figure accrual adjustments for prepaid expenses?
Changes in prepaid inventory, like feed or supplies are the first indication of resources used. The
basic formula for determining usage is:

                                             Beginning inventory
                                      +      Purchases
                                      -      Ending inventory
                                             Amount used

For example, a producer has $500 of feed in inventory at the beginning of the period and at the
end of the period only has $300 of feed- his inventory has changed. He may have purchased
feed during the year, but in effect, he utilized more than he purchased. From a tax standpoint, all
purchases are included as feed expense, even though the producer fed some inventory he had on
hand at the beginning of the year. Likewise, some of the feed actually purchased in the tax year
may be held in inventory and used the following year. For tax purposes, the amount paid for in
the tax year is expensed.

From a management standpoint, the focus of bookkeeping is the measure the amount fed (used)
in the given production cycle, even if the production cycle spans past the end of the taxable year.
If the stocker calves are ready to sell in the spring, a producer should accumulate all costs
associated with getting those calves all the way to the sale barn, including feed fed the previous
year. This process “matches” the income produced with the actual expenses incurred; only then
is true profitability measured.

       In the first year of accrual adjustments:
       The producer would simply estimate the amount of feed fed to the calves from the prior
       year, and make an accrual adjustment (add that amount to the feed expense.) The
       purchases (that have actually been paid for) should be recorded on the transaction log-
       subtract the amount remaining in ending inventory to arrive at the additional amount to
       be expensed. Be sure to keep a journal to show the tax accountant what adjustments
       have been made.

       In subsequent years of making accrual adjustments:
       Assume feed in inventory at the beginning of the year was fed first. The producer will
       not have a cash payment for this expense, so an adjustment should be made. To do this
       adjustment, the producer should reduce the previous year’s ending inventory by the
       amount the inventory decreased, and record that amount to the income statement
       worksheet as a non-cash transaction. (Add expense to the income statement, subtract the
       same amount from the balance sheet.) For purchases, subtract ending inventory from
       total purchases (from the transactions log) and the remaining amount is added to the
       accrual (from previous year) to arrive at the total expense for the production cycle.
       Again, be sure to keep a journal to show the tax accountant what adjustments have
       been made.

What about determining whether one enterprise is profitable?
As discussed throughout this curriculum, most agricultural producers produce more than one
commodity. Good management practices, such as evaluating each enterprise individually, are
very important in today’s agricultural industry. Good producers want to know which crop or
livestock is making money and which is not. Unless producers know which crop or livestock is
making money, they cannot eliminate the poor performing ones.

The first step in creating an income statement by enterprise is to keep cash transactions on the
transaction log. The log is arranged by enterprise and specifies which report (income statement
or balance sheet) the transaction should flow to. Note that all transactions recorded to this log
reflect a cash transaction and will flow to the cash flow report. See sections on transaction log,
cash flow report, and balance sheet for further explanations.

An agricultural business should identify each enterprise of the business. What will I have to sell
at the end of the production cycle? The production cycle may be different for each commodity
and may span across years. For example, wheat is planted in the fall (in southern regions), but it
is not harvested until early summer.

       Each enterprise, like corn, tomatoes, onions, wheat, weaned calves, stocker calves, etc.,
       should be named as Profit Centers.

           For guidance on daily cash transactions, see the Transaction Log section of this
           For non-cash transactions affecting the income statement, use the Income
           Statement Worksheet.

What do I do with it once I have it?
The income statement is a progress report of the business. The net income or loss for the
farming or ranching business tells the operator whether or not the business is moving toward
fulfilling the goals of the manager. By comparing the income statement over a number of years,
profitability can be seen moving up or down. In addition, the manager will want to use the net
income figure to calculate ratios to show the strengths and weaknesses of the business. Income
statements by enterprise can help the producer determine which of his enterprises are
contributing to the profits or which is taking profit away. Most importantly, the income
statement is one tool in a toolbox of financial reports that helps a manager evaluate his business
so that decisions are made based on a strong foundation of information.

                   Building the Income Statement
                                 Lesson Plan

I.    Goals

      A. Define an income statement.

      B. Teach methods of compiling the income statement.

      C. Explain uses of the income statement.

II.   Lesson Highlights and Descriptions

      A. What is an income statement? An income statement, also known as a
         Profit & Loss, is a report telling the story of Profit (result of
         operations), set within a specified timeframe (Jan-Dec). It tells the
         reader that from January to December how much money was earned
         and how much money was spent to earn it. Income statements also
         break the information down into “accounts”. Accounts are simply
         descriptions indicating what type of income or expense is represented.
         Keep in mind that all cash received is not necessarily income (sale of
         a tractor) and that all cash spent is not necessarily an expense
         (purchase of tractor.) As stated above, the income statement tells the
         story of how much Net Income a business makes from selling a
         product. Assets (equipment, buildings, breeding livestock) are inputs
         to producing a product, however, the input is not entirely used up
         within one production cycle. The inputs from these assets are added
         little by little to the products sold; the resulting expense is recorded in
         the form of depreciation (non-cash expense). Depreciation expense
         (percentage of purchase price) is recorded yearly to the income
         statement, but the purchase price of the asset at the time of purchase is
         recorded on the Balance Sheet in the fixed assets section.

      B. The transaction log design provides for even further income statement
         analysis. Agriculture producers typically produce multiple
         enterprises. Sometimes two crops are planted on the same acreage
         within the same year (double-cropping.) Profit margins (income less
         expenses) are extremely small in agriculture and can change
         dramatically from year to year. For this and many other reasons, a

           high-yielding crop can actually be costing an operation more money
           than it is providing. It is a “dog”. Unless producers are aware of the
           enterprises that are making money and which are costing money, they
           cannot eliminate the bad ones. Likewise, if a particularly strong
           enterprise is not identified, a producer may not utilize it fully. The
           transaction log design provides for analysis of enterprises
           individually, including overhead costs. Income Statements by
           Enterprise are an integral component of a successful accounting

        C. Income Statements by Enterprise are compiled by recording totals
           from the Transaction Log to the income statement worksheets by
           enterprise. Non-cash transactions per enterprise can be recorded
           directly to the income statement worksheets. The worksheets allow
           spaces for both cash and non-cash transactions. An example of a non-
           cash transaction would be depreciation, management labor, or
           bartering. There are spaces on the transaction log for both
           management labor and depreciation; however, these amounts are
           recorded in the Labor Support Center and Machinery & Equipment
           Support Center, respectively. At the end of the year, they are
           allocated back to the responsible enterprises. Products sold absorb all

        D. Once all cash and non-cash transactions are recorded on the
           worksheets, those totals (again, by enterprise) are taken to the final
           Income Statement by Enterprise.

        E. Income statements provide one more piece of the financial puzzle of a
           business. As mentioned above, they are important in planning. An
           income statement is one of the most demanded reports of all financial
           statements. Tax information is determined from income statements,
           lenders make decisions, in part, from income statements, and it is the
           one report in which producers are most interested.

III. Potential Speakers

        A. Extension Agents

        B. Extension Specialists

IV. Review Questions

     A. The income statement reflects a “running balance” of items owned or
        owed as of a certain date. (True or False)

        False. The income statement tells about the net income resulting from
           operations within a specified range of time. The balance sheet tells
           about what a business owns vs. what is owes (% ownership) as of a
           certain date (running balance.)

     B. Should the income statement reflect all cash purchases during the year?

        No. The expense portion of the income statement should reflect the
          inputs actually used in producing the income reflected. The unused
          portion of inputs purchased (extra fertilizer, feed, etc.) should be held
          in inventory on the balance sheet. Likewise, purchases of assets, like
          machinery, should not be included as an expense; rather, the purchase
          amount should increase the balance of the non-current asset section of
          the balance sheet and the related current depreciation should be
          included as an expense for the year.

     C. Note payments are considered an expense. (True or False)

        False. The principle portion of the payment reduces the balance of the
           corresponding liability (debt) on the balance sheet, and the interest
           portion only is included on the income statement as an expense.

                           Income Statement


     √ The income statement (profit & loss) tells the reader the “result
     of operations”, or net income from operations within a specified
     range of time.

     √ Income Statements by Enterprise break the income and expenses
     down by responsible enterprise so that each commodity can be
     individually evaluated. The “profit centers” must eventually
     absorb, on a pro rata basis, all costs of the business, including
     management labor, depreciation, taxes, utilities, labor, etc.

     √ Internally used income statements include both cash and non-
     cash transactions. Tax-based income statements include only cash
     transactions (if the producer reports on a cash basis.) The tax
     accountant would be most interested in the Transaction Log so
     that he/she can readily determine the cash transactions.

     √ Steps to compiling an income statement:

          1. Transfer cash totals by “account” from the transaction log
             to the income statement worksheets.
                * Non-cash transactions, like depreciation expense, should be
                recorded directly to the income statement worksheets.
          2. Allocate support centers to responsible profit centers, and
             record the allocations as a non-cash transaction on the
             income statement worksheets. (The support centers
             should now have a zero balance.)
          3. Transfer center totals by account, including profit and
             support centers, to the final Income Statement by
             Enterprise report.

                                  Income Statement
                                     Case Application

The Doe’s income statement is shown below. The income statement details the income and
expenses associated with the farming business, including the family living withdrawals
(personal), depreciation (a real business expense), and interest costs associated with the land
purchase. It does not include Mrs. Doe’s salary

As shown, the farming operation generated $18,569 in revenue. This includes revenue from the
sale of calves, cull cows and vegetables.

Total cash expenses for the operation were $30,250. However, depreciation added $3,629 to this
figure. Total cash and non-cash expenses were $33,879. Major expense items include personal
withdrawals, hired labor (the son’s wages), depreciation, and feed for the cattle. These four
expenses account for 75% of the operations total expenses.

Given these incomes and expenses, the net farm income from operations was a loss of $15,310.
The operation needs to either increase the income generated, reduce expenses, or allocate some
of the personal expenses away from the farming business.