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Accrual accounting can help farmers determine success of their farm operation

Accrual accounting can help farmers determine success of their farm operation

Accrual accounting can help farmers determine success of their farm operation

With all the talk about a crisis in some sectors of the farm industry, many producers are probably looking hard to find out what their real bottom line was for 1998.

Traditionally the Schedule F tax form has been the primary determining factor in deciding whether the farm operation is profitable, but an accrual accounting system may be a much more reliable measuring stick.

"In general, cash accounting or 'tax accounting' does not give the farmer a true picture of net income," said Rick Costin, area farm management specialist in the University of Kentucky College of Agriculture based in Elizabethtown.

For a given year, cash basis net income may vary dramatically from the true income. A University of Illinois study analyzed the income information of 151 farmers over a six-year period. Results showed an annual average difference of 85 percent between net income when measured on an accrual basis versus a cash basis.

Cash accounting does not handle such things as fertilizer or feed used in 1998 but paid for in early 1999, or the profit from grain produced in 1998 but held for a better price and sold in 1999.

"Accrual accounting is the ideal method for proving net farm income, but it is used on a very limited basis in agriculture," said Costin. "Those that have been using this method to get reliable net farm income information have a solid base on which to determine the profitability of their farm operation."

The accrual approach says that income and expense truly exist whenever they are earned or incurred, regardless of when the cash transaction occurs.

"I explain to farmers that the accrual-adjusted method is trying to apply all expenses whether paid for last year, this year or next year to the crop or livestock produced during the current year," said Costin.

Accrual accounting is based on knowing beginning and ending inventories, accounts payable and receivable, as well as prepaid accounts.

"As long as an accurate balance sheet is done at the beginning of each year, a farmer will have all the pertinent information needed to create an accurate net farm income statement based on an accrual accounting system," added Costin.

Additional information on how to set up net farm income statements and how to use the information effectively is available from Cooperative Extension area management specialists based in regional offices throughout Kentucky. Check with your local UK Cooperative Extension Service office to help find the farm management specialist nearest you.

Contact Information

Scovell Hall Lexington, KY 40546-0064