Learning objectives:

The main objectives of the chapter are:

Recognize the different accounting principles
Cite the line items and classifications used
within the financial statements
Specify the differences between financial and
managerial accounting
What is agriculture accounting?
Agriculture accounting can be explained as
a specialty accounting which primarily records
financial and monetary transactions throughout
agriculture activities, classifies financial
transactions in respect of type, estimates
production costs incurred during the cultivation of
agriculture goods and then reports those financial
according to their purpose.
Introduction
One of the most crucial aspects of farm management is to
understand revenues, expenses and cash flows. A proper system
of accounting is needed to accumulate this information over
time, so that each transaction is recorded correctly. Once
the accounting information has been recorded, it is
summarized into a set of financial statements that can be
used to determine the financial results, financial position
and cash flows of a farm.
A good accounting system should provide a vehicle for
gathering information, from which decisions can be made to
properly manage the finances of a farm.
 A note on terminology
There are many types of operations in the field of agriculture
Breeding and feeding cattle, sheep, horses and so forth
Growing fruits, nuts, wheat and corn, vegetable fibers (as
cotton).
Growing vegetables, soybeans, sugarcane and so forth
Operating dairies
Operating plant nurseries
Operating poultry and egg production
Raising fish and shellfish
Raising small animals such as mink and chinchilla
The economic entity concept
An economic entity is a business, so a farm is an
economic entity. In accounting, an economic entity is kept
separate from the personal transactions of the owner, so
that the financial condition of the owner and the business
are not intermixed. This means the accounting records for a
farm must exclude any activities related to the owner.
 If the owner goes on a private trip, the cost of that trip is
personal – its cost is not to be included in the financial
statements of the farm. The owner pays for the trip out of
his own pocket. It never appears in the financial records
of the farm.
If the owner buys a truck for the personal use and pays
for it through the farm entity, the farm is suffering a loss
of cash while not gaining from the use of the truck. The
owner should first records a distribution of money from
the farm to his private bank account and then purchase
the truck with these funds.
Financial Statements
Income statement: This report shows the revenues
generated, expenses incurred that offset the revenues All the mentioned
and the resulting profit or loss for the farm. statements report
on the activity over
Balance sheet: This report shows the assets, liabilities
a period of time
and equity of a farm as of a specific point in time.
except the balance
Statement of cash flows: This report shows the cash sheet only reports
inflows generated by a farm for a period of time as well on the financial
as its cash outflows. condition of a farm
as of a specific
Statement of owner’s equity: This report shows any
date.
changes in the owner’s interest in the business during
the reporting period.
 The financial statements are not just used internally to
manage the farm but they are also required by lenders and
creditors.
What is the difference between lenders and creditors?
A Lender is an entity that lends money in exchange for the
payment of interest, such as a bank.
A creditor is a business that allows a farm to pay bills on a
later date but without paying interest.
Lenders and creditors want to know if a farm
operation is a good credit risk and so will demand a
complete set of the financial statements before agreeing to
extend credit.
Format of the financial statements
Each of the financial statements is prepared in a certain format,
which differs depending on the industry in which the business operates.
For example, the income statement format for a farm differs from the
one used by mining operation, a bank and a manufacturing firm.
Each of these organizations conduct business in a different way,
and so needs to tailor its financial statements to reflect those
differences.
Now let us start to focus on the different financial statements
used by farms and understand the format of each one. These financial
statements are the income statement, statement of owner’s equity,
balance sheet and last but not least, the statement of cash flows.
 Income Statement
The income statement presents a summarization of four types of
activities in which a farm may engage. They are:
 Revenues. This is sales generated from the sale of farm products.
 Expenses. This is the cost to produce and sell farm products, as
well as other administrative costs of the farm.
 Gains. This is any gains generated from the sale of farm assets
such as from the sale of a tractor.
 Losses. This is any losses generated from the sale of farm assets.
The equation for the income statement is as follows:

Revenues - Expenses + Gains – Losses = Net profits or losses

 A problem with the income statement is that
it includes both operating and financing
Sample Income Statement activities. Operating activities are associated
with the operations of the farm while
Farm Revenues
financing activities are the cost of loans and
Operating expenses the income from the investment. The two
- activities need to be split apart to be able to
Operating income evaluate how the farm is performing.
=
+ Other revenues and gains An additional problem is that the income
statement can include the results of investing
- Other expenses and losses activities.

= Net income or loss

The main point is to be consistent in using the
same categories over time, so that the results
reported in a number of successive income
statements can be compared
 Statement of Owner’s Equity
The statement of owner’s equity shows any changes in the owner’s interest
in the business during the reporting period. The statement presentation
states the assets that the owner invested in the farm minus any assets
withdrawn plus any profits earned minus any losses incurred.
Sample statement of owner’s equity
Previous year
Beginning equity balance sheet
+/- Net income or losses From the income
statement
+ Additional investment in the farm
For the personal use of
- Withdrawals from the farm the owner
= Ending equity
 Balance Sheet
The balance sheet is sometimes called the statement of the financial
position, since it refers to the status (position) of the organization as of a
particular point in time. The balance sheet is laid out based on the following
equation, which is as follows:
Assets = Liabilities + Equity
 The assets classification in the balance sheet can include such as cash, receivables,
and fixed assets. Assets are listed by the amount of time it would take to convert into
cash (order of liquidity)
 The liabilities classification includes the obligations of the farm such as payables and
mortgage debt. Liabilities are ordered by the time of payment, which means accounts
payable are reported before long term debt.
 The equity section contains the ending equity figure that was just described for the
statement of owner’s equity.
 Sample Balance Sheet
Assets Liabilities
Cash Flow
Current assets Statement Current liabilities
Cash Accounts payable
Converted To be paid
into cash Receivables Interest payable in a
within one Prepaid expenses Taxes payable period
year less than
Inventory Accrued expenses
a year
Total current assets Current portion of long term debt
Fixed (non current) assets Total current liabilities
To be paid
Breeding stock Non current liabilities
in a
Not Buildings Mortgage payable period
converted
Farm machinery Deferred taxes more
into cash
than a
within Perennial crops Total non current liabilities
year
one year Less: Accumulated depreciation Contributed capital
Total fixed (non current) assets Retained capital Statement
of owner’s
Total assets Total liabilities and equity equity
 Statement of Cash Flows
The statement of cash flows reveals the inflows and outflows of cash
that a farm has experienced during the reporting period. The general format of
the statement is to group cash inflows and outflows into three general
categories and trace the total amount back to the cash on hand at the end of
the period as stated in the balance sheet.
The statement of cash flows segregates cash flows into three categories:
Cash receipt or payment associated with the daily
operations of the farm. Most cash flows should appear within this
category.
Involves the purchase or sale of fixed assets, the
purchase and sale of securities for the investment purpose and other
similar activities.
. Involves either the receipt of long term funds or the
repayment of these funds to the other party, as the receipt of a loan and
its repayment.
 Cash flow from operating activities
Net income $3,000,000
Adjustments:
Depreciation and amortization $125,000
Provisions for losses on accounts receivable 20,000
Gain on sale of facility (65,000) 80,000
Increase in trade receivables (250,000)
Decrease in inventories 325,000
Decrease in trade payables (50,000) 25,000
Cash flow from operating activities 3, 105,000
Cash flow from investing activities
Purchase of fixed assets (500,000)
Proceeds from the sale of breeding livestock 35,000
Net cash flow from investing activities (465,000)
Cash flow from financing activities
Owner withdrawals (80,000)
Proceeds from real state loans 360,000
Net cash flow from financing activities 280,000
Net increase in cash and cash equivalents 2,920,000
 Financial statement disclosures
A complete set of financial statements also includes a
number of disclosures, which may be referred to as
footnotes. These disclosures clarify and expand upon
certain line items noted in the financial statements, and
supply other information.
Disclosures are usually added to the annual financial
statements that are issued to outsiders, and not to the
more abbreviated monthly financial statements.
 Profits vs. Cash Flows
The income statement reports on profitability, while the statement of
cash flows reports on cash flows. What is the difference?
Profitability occurs when total revenues exceed total expenses.
Positive cash flows occur when total cash inflows exceed total cash outflows.
These two amounts can vary substantially, to the point where a farm may
report profits and yet experience negative cash flows (and vice versa). Here
are several issues that can cause disparities between the two figures:
An expense may be recognized in the income statement, even though the supplier or
employee has not yet been paid. This happens under the accrual basis of accounting.
Revenue may be recognized in the income statement, even though the customer has
not yet paid. Again, this happens under the accrual basis of accounting.
A farm may pay a substantial amount for a new asset, such as a tractor, which causes
a large cash outflow. However, the related expense is spread out in the income
statement over a number of years.
 Which of the two measures is more important?

Definitely cash flow

The primary focus is always on having sufficient cash to pay the bills,
so the farm accountant should always know exactly how much cash is
available, when more cash is coming in, and when cash is expected to be
paid out. That being said, a farm must consistently report profits over the
long term. When this is the case, lenders are more willing to provide loans,
and buyers are more willing to offer a reasonable price to buy a farm.
 Accounting Principles

Accounting principles serve as a guideline for how to record information and

prepare financial statements. The accounting principles include:
 The economic entity concept, where the accounting for a business is kept separate
from the accounting for its owners.
 Conservatism principle. This principle states that expenses and liabilities should be
recorded as soon as possible, but that revenues and assets are to be recorded only
when there is a high degree of certainty that they will occur.
 Consistency principle. This principle states that, once an accounting method is
adopted, it should continue to be used until a demonstrably better method comes
along.
 Cost principle. This principle states that a business should only record its assets and
liabilities at their original purchase prices.
 Full disclosure principle. This principle states that one should include in an entity’s
financial statements all of the information that would affect a reader’s understanding
of those statements.
 Going concern principle. This principle states that the financial statements are
constructed on the assumption that an organization will remain in operation for the
foreseeable future.
 Matching principle. This principle states that, when a business records revenue, it
should also record all related expenses at the same time.
 Materiality principle. This principle states that a transaction should be recorded in the
accounting records if not doing so might alter the decision-making process of someone
reading the firm’s financial statements.
 Reliability principle. This principle states that only those transactions that can be
proven should be recorded.
 Revenue recognition principle. This principle states that a business should only
recognize revenue when it has substantially completed the earnings process.
Otherwise, revenue is reported too soon, which overstates the amount of profits that
were actually earned.
 Financial Accounting and Managerial Accounting
The agricultural accounting is dealing with both the financial and managerial accounting
Financial Accounting Managerial Accounting
Main purpose Focuses on the process used to record business Involves collecting, analyzing, and reporting
transactions and convert this information into information about the operations and finances of a
financial statements. business.
Users Outside parties such as lenders or creditors. Reports are directed to the managers of the business.
Aggregation Financial accounting reports on the results of an Managerial accounting frequently reports at a more
entire business. detailed level, such as the profits earned from a
particular crop.
Efficiency Reports on the profitability (and therefore the Reports on specifically what is causing problems and
efficiency) of a business how to fix these issues.
Standards Comply with the various accounting standards Does not have to comply with any standards when it
compiles information for internal consumption.
Time period Financial accounting is concerned with the financial Managerial accounting may address budgets and
results that a business has already achieved, so it forecasts, and so can have a future orientation
has a historical orientation
Timing Requires that financial statements be issued Issue reports much more frequently, since the
following the end of an accounting period information it provides is of most relevance if
managers can see it right away.