The Three Levels of Farm Accounting
I am going to hazard a guess that at least 90% of our farmers are in what I call the first level of farm accounting. This is the old tried and true favorite – Cash basis of accounting. Most farmers report farm net income on their tax return using this method of accounting. Income is recorded as cash is received and expenses are recorded as they are paid. Most of these farmers use this method for their management of the farm business which does not accurately reflect the net income of the business.
The second level of farm accounting builds on cash accounting by at least recording the fair market value of crop inventory (crop harvested, but not yet sold) and possibly the value of the cost of growing crop. This amount is usually booked at year-end and is used for the financial statements presented to the bank. If the farmer is not doing these statements, we know that the banker is for sure is doing it and you should get a copy from them. This method of accounting gives a better picture of your overall farm profitability, but only when you book the fair market value adjustments (which is usually at year-end).
The third and highest level of farm accounting is using accrual accounting on a real-time basis. This means that as you purchase input costs for the farm, they are booked to a cost of growing crop inventory account and once the harvest is completed, these accumulated costs are then transferred over to a harvested crop inventory account and deducted as the crop is sold. This gives you the truest picture of what your actual profit is at any point in time.
The most successful farmers are at least in level two and most are making the changeover to level three.
What level are you at and what steps are you doing to get to the third level.