Year-end and farm business considerations


The end of the year is not only a time for holidays but also the close of the business year for most farmers. The majority of farm operators use a calendar year (Jan. 1-Dec. 31) as their business year for income tax purposes and also to prepare financial statements about their operation.

Even if a business is on a different fiscal year for tax reporting purposes, they may still want to prepare financial statements based on a calendar year. Since most farmers also use a cash basis method for filing their income taxes, it is important to realize some of the additional information that is needed in preparing two of the basic financial statements for the farm business.

These two statements are an accrual income statement and a balance sheet. The accrual income statement measures the profitability of the business for the year. It provides a more accurate measure of profitability then the income tax schedule F.

The balance sheet measures the operator’s level of ownership or equity in the business. These statements should be prepared using the same time period or point in time from year to year. The income statement typically covers the Jan. 1 through Dec. 31 period while the balance sheet should usually be prepared as of Dec. 31.

Accrual adjustments

An accrual income statement matches revenues with costs for a given time period, regardless of when revenue was actually received or when expenses were actually paid.

For example, fertilizer applied and paid for in the fall of 2014 is considered a 2015 expense for business analysis purposes even though it will be taken as an expense on the 2014 income tax return for a cash basis tax payer.

To arrive at an accrual income statement, adjustments are made to cash income and expenses for changes in values between the beginning and end of the year for grain and livestock inventories, accounts receivable, accounts payable and prepaid expenses.

The exact dollar amounts for these items are also used in preparing a balance sheet.

Grain and livestock. Grain and livestock inventories are generally the most significant item to consider when making these adjustments.

Therefore it is very important to estimate the quantity and value of these items as accurately as possible. Grain should be valued based on the local cash market as of the end of the year. Determining the proper value for livestock can be more difficult.

Again, it is important to get an accurate estimate of the number and weight of the animals. The current cash price can be used for estimating values for market livestock. A conservative “base value” should be used for breeding livestock.

A conservative base value would reflect the value for slaughter purposes rather than for breeding stock purposes. However, judgment should be used in how these values reflect on individual circumstances.

This base value can utilize local cash prices but should not fluctuate significantly from year to year.

This prevents net farm income and net worth changes simply due to valuation changes in breeding livestock, an asset that normally wouldn’t be liquidated for an on-going business.

Accounts receivable

Other accounts receivable might include custom work which has been performed but payment not received, outstanding settlements with landlords for seed and pesticides for the crop or crop insurance proceeds that are due.

Prepaid expenses as of Dec. 31 would include inputs and supplies that have been purchased and paid for in the present year, but are for the following year’s crop.

The most common items are seed, chemicals, fertilizer, fuel and feed. Fertilizer and nitrogen that have been applied in the fall for next year’s crop are considered prepaid expenses.

Accounts payable are expenses that have been incurred for the business year but have not been paid for as of Dec. 31.

This could include a variety of items. Examples of accounts payable include outstanding drying and storage charges, accrued interest on operating and term loans, payroll taxes, cash rent, repairs and real estate taxes.

Real estate taxes are considered an account payable because they are always due one year in arrears.

Balance sheet considerations

Other items that shouldn’t be overlooked when preparing a balance sheet include an estimated current liability for the income and social security tax that will be due. This may be a significant amount, depending on the situation.

Principal due on intermediate and long-term notes should be divided into what is due within and beyond 12 months.

This is important in accurately assessing the liquidity of the operation and determining the short-term cash flow needs for the upcoming year. Many producers are now leasing machinery and other assets.

While lenders may not require that the total outstanding lease be included as a liability, it would helpful to provide a footnote on the balance sheet describing the terms of the lease.

The lease payment for the upcoming year should be listed as a current liability. If significant equity is being built up in the leased item, one alternative to reflect this equity on the balance sheet is to list the value of the leased item as an asset and the remaining balance on the lease as a liability.

This should be discussed with your lender to adequately disclose the financial obligation.

Since machinery is usually a significant asset for most producers, it would be prudent to attach a detailed machinery listing with individual valuations rather than just one total value. Machinery dealers can assist in estimating values for individual machinery items.

Extension can help

Many OSU Extension educators and specialists are trained to use the FINPACK computerized software program to help you analyze your farm records. If you are interested in a comprehensive review of your present financial standing, contact your local Extension professional.

The FINPACK program is also an excellent tool for evaluating changes you may be considering to your business.

Examples might include: adding or reducing cow numbers, adding or reducing crop acres, adding a new enterprise, purchasing equipment, or constructing a new building.

(Adapted from an article written by Dale Latz, Department of Agricultural and Consumer Economics, University of Illinois, 2001.)

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