Year End Farm Record Keeping Issues

By: Chris Bruynis, Assistant Professor & Extension Educator, OSU Extension.

With the size and scope of many farm businesses today keeping accurate farm records are more critical than ever. The first reason to prepare accurate farm records is to allow management to make critical management decisions. Farm records are needed to determine resource use efficiency, which in turn indicates whether or not the farm business is profitable. Farm records, including enterprise analysis, are also essential for planning and decision making for the business.

A second reason for keeping farm records is for income tax management. Good records are needed to accurately determine potential tax liability and allows for tax planning before the end of the fiscal or calendar year. Poor farm records will typically result in increased tax liability of the farm owner. Obtaining credit is the third reason for keeping farm records. Good financial information provides lenders the necessary information needed to make lending decisions. In addition to determine the amount of the loan, this information is helpful in determining the interest rate a farm business owner may pay.

Characteristics of a Good Record Keeping System

The characteristics of a good record keeping system include easy to use and records the necessary information detail. Depending on the complexity of the business, the amount of detail will vary. Some businesses will want to keep detailed records down to the enterprise or location level. Recommended documents for a good record keeping system include:

• Business accounts for checking, savings, investing and credit cards. It is recommended not to inter-mingle business funds with personal funds. 

• An income and expense ledger or appropriate software program to record all cash business transactions by date and category.

• An inventory that involves both the physical counting and valuation assignment completed at least annually at the end of the business fiscal or calendar year.

• A depreciation schedule for all business assets showing asset basis, cost valuation and market valuation.

• A cost and market valuation balance sheet summarizing assets and liabilities of the farm.

• An income statement listing receipts, expenses, accounts receivable and accounts payable.

• A statement of cash flows showing the source of cash inflows into the business and where business cash outflows went.

• Enterprise records showing receipts and expenses by enterprises with some level of profitability analysis.

Year End Record Adjustment Considerations

Farm businesses typically use the calendar year for their business year and for tax return purposes. Additionally, farmers normally use a cash accounting method for filing their income taxes making it important to make the accrual adjustments in the income statement and balance sheet. Cash accounting can also mask financial issues for several years of low profitability. Farmers can generate cash for family living expenses through a variety of activities such as selling down inventory, not replacing equipment or other capital assets, selling capital assets, increasing accounts payable, or refinancing operating losses. 

The accrual income statement measures the profitability of the business for the year. An accrual adjusted income statement combines the cash basis farm records with the inventories from the balance sheets (the beginning and end of the year) to give a true measure of profitability. 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 January 1 through December 31 time period while the balance sheet should usually be prepared as of December 31.

Farm managers need to make several accrual adjustments to properly capture the true profitability of the business providing a more accurate measure of profitability then the income tax schedule F. Income tax returns are not a good measure of farm profitability because the goal in income tax management is to minimize taxes paid (or at least level them off so we can consistently stay in a lower tax bracket). The main accrual adjustments on financial statements include prepaid expenses (including inputs used in the current year that is used to produce product in a subsequent year such as fall fertilizer applications), accounts payable, accounts receivable, changes in grain and livestock inventories, and investment in growing crops.  A final item that should be included is the tax liability due next year. 

Some farmers are also calculating the total deferred tax liability if the farm business were liquidated. This allows for better decision making in tax planning. Using the tax management tools available to farmer businesses such as Section 179, can significantly increase future taxes. Farm managers may want consider paying some additional tax now instead of in future year when the tax rates are unknown. Talk to your accountant and/or tax professional for a more detailed discussion of this issue.

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