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Chapter 2: Accounts.

Key Terms

Accounts

Adjunct account

Automated accounting system

Balance

Chart of Accounts

Contra account

Credit

Current assets

Current liabilities

Debit

Double-entry accounting

Equity

Expense accounts

Financial transaction

Intangible assets

Journal

Journal entry

Ledger

Manual accounting system

Non-current assets

Non-current liabilities

Posting

Revenue accounts

Single-entry accounting

Source documents

Tangible assets

Trial balance

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You learned in Chapter 1 about an overview of accounting for farm businesses and the activities involved in farm businesses; the nature and purpose of the income statement, statement of owner equity, balance sheet and statement of cash flows; the meaning of terms such as financial position, financial performance, financing activities, investing activities, and operating activities, and how to read farm financial statements.

The next step in understanding and using a farm financial reporting system is to understand the types of items found on the financial statements and how accounting systems manage these items. As mentioned in Chapter 1, the title of each item on the financial statements has a meaning. It is necessary that you understand these definitions. That knowledge and the management of these items adds to the reliability of the statements and helps to compare one farm's financial statements to another's.

In this chapter, you will be able to define the terms "account" and "ledger" and to describe their purpose. You will also learn how to construct the "Chart of Accounts" and to describe its purpose and its construction. You will be able to identify and define the accounts found on farm financial statements. Finally, you will be able to identify the types of source documents used in financial transactions and apply transactions analysis and double-entry accounting in recording transactions.

THE CHART OF ACCOUNTS
Learning Objective 1 * To define the terms "account" and "ledger"
and to describe their purpose.


The term "account" identifies the means by which farm financial statement items are managed in the financial records. Accounts are records of the activities involving all financial statement items. You are probably familiar with having a personal "bank account." Each person or organization has a separate account in a bank's accounting system. Similarly, each item on farm financial statements has a separate account. Each item's account is a record of the dollar amounts of all of the activities involving that item. The account lists all of the increases and decreases of that item in terms of dollar amounts and provides a net amount or balance of all of the increases and decreases. Table 2-1 contains an example of Steve and Chris Farmer's account for Cash.

The top of the account displays the name of the account. The account contains information about activities involving cash. It lists dates and descriptions for all activities in the order in which they occurred. The balance is the amount of cash in the account after each transaction occurs. The amount of cash that belonged to the Farmers' farm business was $20,000 on January 1. On May 12, after the Farmers paid for tractor parts, the amount of cash that belonged to the Farmers' farm business was $19,750, and so on. You will probably notice that this account looks a lot like a checkbook register.

The ledger is the collection of all of the accounts for a farm operation. In a manual accounting system, in which all accounting is done by hand without the use of a computer and software, each account is listed on a separate ledger page and all the transactions that affect that account are recorded there. In an automated accounting system, the same is true, except that it is in a computer and not a book.
Exercise 2-1 Review the components of an account. What are they?
Answer: Name of the account, dates, and descriptions of activities,
debits, credits, and balance.

Learning Objective 2 * To record financing activities involving
nonowners.


The Chart of Accounts is the list of all farm financial statement items of significance to a farm operation. Because it is a list of farm financial statement items, it is a list of "accounts." The farm accountant develops the Chart of Accounts when setting up the accounting system for the farm business for the first time, to know what accounts to include in the ledger and what accounts to present on the financial statements. The accountant may modify the chart from time to time as farm activities change.

The Chart of Accounts lists all of the significant farm financial statement items for the farm operation in the order of the five categories discussed in Chapter 1: assets, liabilities, equity, revenues, and expenses. All assets are listed first, then all liabilities, then all equity accounts, and so on. Gains and losses are also listed, usually after expenses. The Chart of Accounts includes the names of each of the accounts, but may also refer to accounts by number. The numbers assigned to accounts usually follow a logical pattern based on the type of account (asset, liability, equity, revenue, expense, gain, or loss). Appendix C presents the FFSC recommendations for a numbering system for a farm Chart of Accounts and an example based on that system.

The accounts listed in a farm's Chart of Accounts will depend upon the products and activities of the farm operation. It also depends upon the level of detail that the farm manager and farm accountant deem necessary. The Chart of Accounts in Appendix C is very detailed. The farm accountant can adapt the Chart of Accounts in Appendix C to fit the particular operation by adding, deleting, or combining accounts. Table 2-2 shows an example of a Chart of Accounts with less detail. The Chart of Accounts in Table 2-2 would be appropriate for a livestock feeding operation.

To help you learn how to construct a Chart of Accounts, you will work with an example of a 4-H project in this chapter. Some of you might have participated in 4-H projects and may have kept financial records of your project, so you may be able to relate to these procedures.
The preparation of farm financial statements begins by knowing the
Chart of Accounts. Steve and Chris Farmer developed a Chart of Accounts
when they first set up their accounting system. From the Farmers'
financial statements in Appendix we can surmise that their Chart of
Accounts would look like the following.

Farmers' Chart of Accounts

Cash
Accounts Receivable
Feeder Livestock Inventory Raised for Sale
Feeder Livestock Purchased for Resale
Feed Inventory Raised for Use
Feed Inventory Purchased for Use
Crop Inventory Raised for Sale
Prepaid Expenses
Cash Investment in Growing Crop
Breeding Livestock
Machinery and Equipment
Office Equipment & Furniture
Perennial Crops
Land, Buildings and Improvements
Leased Assets
Accumulated Depreciation
Accounts Payable
Taxes Payable
Interest Payable
Notes Payable Due within One Year
Current Deferred Taxes
Real Estate Notes Payable
Non-Current Deferred Taxes
Obligations on Leased Assets
Valuation Equity
Retained Capital
Owner Withdrawals
Non-Farm Income
Other Capital Contributions/Gifts/Inheritances
Cash Crop Sales
Cash Sales of Market Livestock
Gains/Losses from Sale of Culled Breeding Livestock
Feeder Livestock
Purchased Feed
Wage Expense
Payroll Tax Expense
Truck and Machinery Hire
Herbicides, Pesticides
Livestock Supplies, Tools, and Equipment
Insurance
Real Estate and Personal Property Taxes
Depreciation Expense
Interest Expense
Gains/Losses on Sales of Farm Capital Assets
Income Tax Expense


DEFINITIONS OF ACCOUNTS

The Chart of Accounts in Appendix C serves as the guide for the definitions and discussion of the accounts below. Many are self-explanatory, but some definitions require discussion.

Assets
Learning Objective 3 * To identify accounts for current and
non-current assets.


In Chapter 1, you read that assets are the items purchased by the farm business and expected to earn money for the farm. Another way to tell whether an item or account is an asset is to think of assets as those items that the farm business owns or is entitled to. Recall that the term current assets designates assets that are either cash, will be sold for cash, or will be used up during the next year. Non-current assets are used for more than one year. Non-current assets are sometimes subdivided into two categories: tangible and intangible assets. Tangible assets are physical in nature, such as land, buildings, and equipment. Intangible assets are nonphysical in nature, such as investments and certain rights, such as a patent. The accounting procedures for tangible and intangible assets are very similar.

Some typical accounts for current assets include the following.

* Cash--record of the amount of cash currently on hand (currency) and in the checking and savings accounts for the farm business.

* Accounts Receivable--record of the amount of money owed to the farm business from the sale of grain, livestock, or other products, which has been finalized but the cash has not been received yet.

* Feeder Livestock Inventory--record of the value of feeder pigs, calves, lambs, poultry, and other meat animals being fed with the intention of selling them. Separate accounts may be set up for feeder livestock that were purchased and feeder livestock that were raised or for each class of meat animal (for example, feeder pigs and feeder calves).

* Breeding Livestock Inventory--record of the value of raised breeding livestock that are for sale, not for use in the herd.

* Feed Inventory--record of the value of the feed currently on hand that will be fed to livestock during the next year. Separate accounts could be set up for purchased feed and grown feed.

* Crop Inventory--record of the value of raised or purchased crops currently on hand that will be sold sometime during the next year.

* Prepaid Expenses--record of costs or expenses paid for in advance and not yet used up. When an expense is "prepaid," another party owes the farm business either goods or services.

* Cash Investment in Growing Crops--record of the annual costs of growing perennial crops (cultivating, pruning, fertilizing, harvesting, and so on) that are in production. (1)

Non-current assets are those assets used in the operation of the farm business that are expected to last more than one year. An account is set up in the Chart of Accounts and in the ledger for each type of non-current asset owned by the farm business. The following are typical accounts for non-current assets.

* Breeding Livestock--record of the value of breeding livestock for use in the herd, not for resale as market animals. Includes beef cattle, dairy cattle, hogs, sheep, poultry, llamas, goats, and horses. Inventory of semen should have a separate account.

* Machinery and Equipment--record of the value of all trucks, tractors, implements, harvesters, and other equipment.

* Office Furniture and Equipment--record of the value of furniture and equipment such as desks, chairs, computers, fax machines, cell phones, and storage cabinets that are used for the farm business.

* Perennial Crops and Natural Resources--record of the costs of planting and developing orchards, groves, vineyards, alfalfa, and bush berries (plants only) during the development period (before production begins). (2) Examples of natural resources would be timberland or gravel pits, revenue from which contributes to farm income. A separate account could be set up for natural resources.

* Land, Buildings and Improvements--record of the value of farmland, farm buildings (including sheds and silos), major improvements to buildings, costs of fences, tiling, ditching, water wells, and other improvements to the land.

* Investments in Cooperatives and Other Investments--record of money invested in farm cooperatives and other investments including certificates of deposit, money market funds, mutual funds, stocks, and bonds. Land purchased for the purpose of speculating on land prices, not for farm production purposes, is also an investment.

* Leased Assets--record of the value of assets that are leased from another party and qualify as a capital lease. In a capital lease, the asset is leased for almost all of the asset's normal life or will be owned by the party using the asset at the end of the lease agreement.

* Accumulated Depreciation-an account that shows the total amount of depreciation recorded since the purchase of the assets.

Accumulated Depreciation is not an asset account but is related to non-current assets. This account is an example of a "contra account." A contra account is a financial statement item that subtracts from another account. Non-current assets are reported at the original amount that was paid for each asset. Accumulated Depreciation subtracts the amount of the cost that has been allocated over the years that the assets have been owned. (You will learn more about depreciation in Chapters 4 and 6.) A contra account subtracts from another account. An adjunct account is a financial statement item that adds to another account. This chapter identifies additional types of contra and adjunct accounts. Chapter 4 provides numerical examples of these accounts.
Exercise 2-2 Now that you can recognize assets, think about a 4-H
project, such as a market steer. If you were developing a Chart of
Accounts and setting up a ledger, what assets would you have for
your market steer project (that is, what asset accounts would you
set up in your 4-H accounting system)? Answer: Assets would
probably include cash, halters, supplies, clippers, clipping chute,
feed, bedding, and market steer. An account would be set up for
each of these assets.


Liabilities
Learning Objective 4 * To record various operating activities
involving revenues.


Liabilities are amounts of money owed to outside parties (for example, lenders) that have not been paid back. From Chapter 1, you know that current liabilities are debts that are due within a year. The following are typical accounts for current liabilities in a farm Chart of Accounts.

* Accounts Payable--record of the amount of bills owed to suppliers for purchased goods and services that have not yet been paid for. Examples of unpaid bills would be a bill for the cost of the fuel delivered to the farm or a utility bill received from the power company.

* Taxes Payable--record of the amount of taxes owed but not yet paid to local, state, and federal agencies for payroll, income, property, and other taxes.

* Interest Payable--record of the amount of interest owed to lenders on real estate, equipment, and operating loans.

* Notes Payable Due within One Year--record of the amount of principal on loans (other than real estate) that is due during the next year.

* Real Estate Notes Payable Due within One Year--record of the amount of principal on real estate loans that is due during the next year.

* Current Deferred Taxes--record of taxes that will be due in the future that arise because of differences between financial accounting income and taxable income relating to current assets and current liabilities.

* Obligations on Leased Assets Due within One Year--record of the amount owed to the owner of leased assets that is due within the next year.

Non-current liabilities are debts that will take longer than one year to pay off. In most cases, payments are made every month or every few months or perhaps once every year, until the principal (the loan amount) is paid off. The following are accounts for typical non-current liabilities of a farm operation.

* Notes Payable--record of the amount of principal on loans (other than real estate) that will be paid off after the next year.

* Real Estate Notes Payable--record of the amount of principal owed to lenders on real estate loans that will be paid off after the next year.

* Non-Current Deferred Taxes--record of taxes that will be due in the future that arise because of differences between financial accounting income and taxable income relating to non-current assets. These differences also arise because of differences between market values and costs of non-current assets. (3)

* Obligations on Leased Assets--record of the amount owed to the owner of leased assets for the remainder of the term of the capital lease agreement.
Exercise 2-3 Think about your 4-H market steer project. Can you
identify any liabilities? Think about something you might have
purchased for the project but might not be able to pay back until
you sell the market steer. Answer: Every 4-H member's situation is
different, just as every farm operation is different, but
liabilities might include accounts payable. Accounts payable would
be a record of the amount of money owed to the feed store for feed,
for example, or for the grooming supplies that you bought. Did you
borrow money from your parents or a bank to buy the steer? If so,
you would also have an account for notes payable for the amount of
the loan. You might also have an account for the interest payable
(for the amount of interest that you owe on the loan). You would
have a balance in these accounts until you paid off the amount that
you owe.


Equity
Learning Objective 5 * To identify accounts for equity items.


Equity represents the value of the farm operation to the owner(s).

* Valuation Equity--record of differences between the market value of non-current assets and the original cost of these assets and also the related non-current deferred taxes. (4) These items can be recorded in the following separate accounts:

* Change in Excess of Market Value over Cost--record of the differences between the original costs of purchased non-current assets and their market values at the end of the year.

* Change in Non-current Portion of Deferred Taxes--record of the difference in non-current deferred taxes from the end of last year to the end of this year.

* Retained Capital--record that summarizes all remaining equity transactions.

It includes Net Income and the following accounts:

* Owner Withdrawals--record of the amount of farm assets (usually cash) used for personal expenses for the year.

* Non-Farm Income--record of the amount of income from sources other than the farm that was used for farm business transactions rather than for personal expenses.

* Gifts and Inheritances--record of transactions involving transfers of assets to or from the farm operation without payment involved.
PRACTICE WHAT YOU HAVE LEARNED After studying the definitions for
asset, liability, and equity accounts, test yourself by completing
Problem 2-1 at the end of this chapter.


Revenues
Learning Objective 6 * To identify accounts for revenues.


Revenue accounts are records of the amount of money earned by the farm operation from the production or sale of farm products. The types of revenue accounts will depend on the types of farm products produced and sold from each farm operation.

Some typical accounts for farm revenues include the following.

* Cash Crop Sales--record of the total amount of cash received during the year from selling crops.

* Changes in Crop Inventories--record of the market value of crops and feedstuffs (grain and hay) that were harvested during the year and are still on hand (not yet sold) at the end of the year. This account is also a record of any difference between the purchase price of any crop or feedstuffs that were purchased during the year and the market value of those crops or feedstuffs still on hand at the end of the year. This account is a contra or adjunct account to Cash Crop Sales.

* Cash Sales of Market Livestock and Poultry--record of the total amount of cash received during the year from selling feeder livestock and poultry.

* Changes in Market Livestock and Poultry Inventories--record of the market value of raised market livestock or poultry at the end of the year.

This account is also a record of any difference between the purchase price of any market livestock or poultry that were purchased during the year and the market value of that market livestock or poultry still on hand at the end of the year. This account is a contra or adjunct account to Cash Sales of Market Livestock and Poultry.

* Livestock Products Sales--record of the total amount of cash received during the year from selling wool, eggs, milk, and any other livestock products.

* Proceeds from Government Programs--record of the total amount of cash received from government programs during the year that is not intended to be paid back.

* Crop Insurance Proceeds--record of the total amount of cash received during the year from insurance companies for crop damage.

* Gains/Losses from the Sale of Culled Breeding Livestock--record of the difference between the cash amount received from selling culled breeding livestock and the balance sheet value of that livestock on the day that it was sold.

* Change in Value Due to Change in Quantity of Raised Breeding Livestock--record of the increase or decrease in the total value of raised breeding stock due to changes in the number of breeding livestock on the farm from the end of last year to the end of this year. This account is also a record of changes in the total value of raised breeding livestock due to increases in age of individual breeding animals from the end of last year to the end of this year. (5)

* Change in Accounts Receivable--record of the difference between the accounts receivable balance at the end of last year and the accounts receivable balance at the end of this year. This account is a contra or adjunct account to all other revenue accounts.
Exercise 2-4 Think again about your 4-H market steer project. What
accounts would you use to record the revenue from the steer? (Hint:
Study the definitions very carefully. Your answer depends on
whether or not you have sold the steer when you record the
revenue). Answer: If you have sold the steer, you would record the
amount of cash received in the account entitled Cash Sales of
Market Livestock and Poultry. If you have not yet sold the steer,
you would record the revenue in the account entitled Changes in
Market Livestock and Poultry Inventories. The amount of revenue
that you would record depends on whether you raised the steer or
whether you bought the steer when you started the project. If you
bought the steer, you would record the difference between the
purchase price and the market value. If you raised the steer, you
would record the market value of the steer.

Expenses

Learning Objective 7 * To identify accounts for expenses.


Expense accounts are records of the costs incurred by the farm for the year. Some expenses involve operating activities and others relate to financing and investing activities. Accounts are set up in the Chart of Accounts and the ledger for each individual expense or group of expenses. The farm accountant decides which accounts to set up depending upon the type of farm operation, the types of costs incurred in the farm business, and the amount of detail that the farm accountant chooses to report. Table 2-3 summarizes the types of expense accounts that can be set up in the Chart of Accounts and the ledger.

The following is an explanation of various types of accounts for production expenses.

* Feeder Livestock--record of the total amount of cash spent during the year for the purchase of feeder calves, feeder pigs, feeder lambs, and poultry. This item includes only the cost of those animals purchased, not raised.

* Purchased Feed--record of the total amount of cash spent for feed during the year.

* Wages Expense--record of the total amount of wages paid for hired help during the year.

* Payroll Tax Expense--record of the total amount of cash paid during the year to the state and federal agencies for the employer's share of Social Security taxes for each of the employees.

* Board for Hired Labor--record of the total amount paid during the year for food, lodging, and any other expenses solely for the benefit of the hired help.

* Insurance for Hired Labor--record of the total amount paid by the farm during the year for any health and accident insurance coverage for the employees.

* Rent--record of the total amount of rent paid during the year to rent land only.

* Truck and Machine Hire--record of the total amount paid during the year for hiring trucks and other machines and equipment, including labor for the operator, if necessary.

Several accounts listed in the Chart of Accounts in Appendix C are self-explanatory, such as Repairs and Maintenance for Farm Vehicles, Machinery, Equipment (parts, labor, tires, and so on), Small Tools and Supplies (hammers, nails, nuts and bolts, welding rods, and so on), and Repairs and Maintenance for Buildings and Improvements (lumber, paint, labor, and so on), as are the accounts for Fuel, Oil, Gas, Grease, Seed, Fertilizers, Herbicides, Pesticides, Twine, Sacks, Poisons, Seed Tests, Veterinarian, Vaccinations, Medications, Breeding Fees, Registrations, Disinfectants, Sprays, Livestock Supplies and Tools and Equipment, Shearing, Wool Twine and Sacks, Livestock Inspections, Office Supplies, Dues, Journal and Papers, and Bank Charges (farm bank account only). Many farm accountants may decide to combine all of these accounts into one account, such as Operating Expenses. Other types of accounts for operating expenses include the following:

* Insurance--record of the total amount paid during the year for all insurance other than health and accident insurance for the employees and personal life insurance.

* Real Estate and Personal Property Taxes--record of the total amount paid during the year for taxes on land and personal property used in the farm business.

* Electricity, Water, and Telephone--record of the total amount paid during the year for utilities that pertain to the farm, not personal use.

Some expense accounts require some calculations and are not necessarily records of cash paid, but are records of some specific production expenses of running the farm operation. Some of these accounts include the following:

* Depreciation Expense--record of the allocation of the cost of purchasing non-current assets. A portion of the original cost of each asset is recorded as depreciation expense each year.

* Change in Accounts Payable--record of the difference between the balance of Accounts Payable at the end of last year and the balance at the end of the current year. This account is a contra or adjunct account of all operating expenses.

* Change in Prepaid Insurance--record of the difference between the balance of Prepaid Insurance at the end of last year and the balance at the end of the current year. This account is a contra or adjunct account of all operating expenses.

* Change in Investment in Growing Crops--record of the difference between the balance of Investment in Growing Crops at the end of last year and the balance at the end of the current year. This account is a contra or adjunct account of all operating expenses.

The preceding list of accounts describes types of operating expenses related to the production of farm products. Other accounts are associated with selling farm products and general expenses. These accounts include:

* Sales Costs--record of expenses related to marketing or selling farm products, such as checkoff fees, transportation, advertising, commissions, storage costs, and financing of storage costs.

* General and Administrative Expenses--record of the cash paid for office labor, office supplies, accounting fees, information systems costs, and so on.

Some accounts report on the expenses associated with financing and investing activities. These accounts include:

* Interest Income--record of the total amount of cash received from interest on investments.

* Interest Expense--record of the cash paid to lenders for the interest portion of loan payments.

* Change in Interest Payable--record of the difference between the balance of Interest Payable at the end of last year and the balance at the end of the current year. This account is a contra or adjunct account to Interest Expense.

* Gain/Losses on Sales of Farm Capital Assets--record of the difference between the cash received for the sale of machinery, equipment, or other non-current asset and the value of that asset on the balance sheet on the day that it was sold.

* Gains/Losses Due to Changes in General Base Values of Breeding Livestock--record of the change in value of breeding livestock due to changes in base values for age categories. (6)

Finally, some revenues and expenses occur that do not readily fall into any specific category. The following accounts are records of these types of items.

* Miscellaneous Revenue--record of the cash received from farm income other than those described above.

* Income Tax Expense--record of the total amount of income tax paid on the farm business income only.

* Change in Taxes Payable--record of the difference in the balance of Taxes Payable at the end of last year and the balance at the end of the current year. This account is a contra or adjunct account to Income Tax Expense.

* Extraordinary Items--record of the total amount of income or expense (or gains or losses) considered highly unusual and occurring infrequently.
Exercise 2-5 Once again, think about the 4-H market steer project.
What expense accounts would you set up in your Chart of Accounts
and ledger for that project? Think about what costs you would have
to pay for to complete the project. Answer: Expense accounts for a
market steer project might include Purchased Feed, Vaccinations (if
the steer gets sick), Medications (if antibiotics or other feed
supplements are added to the feed), Livestock Supplies and Tools
(for the cost of the grooming supplies), Depreciation Expense (for
depreciation of the clipping chute and clippers), perhaps Sales
Costs, Interest Expense (on the loan if you borrowed money to buy
the steer), and Gain or Loss on the Sale of Farm Capital Assets
(determined when the steer is sold).

PRACTICE WHAT YOU HAVE LEARNED Review the definitions of accounts
for revenues, expenses, gains, and losses and complete Problem 2-2
at the end of the chapter.

Certificates of deposit are
considered investments because
they usually result in a penalty
for withdrawal before maturity.

If grain is delivered from the
farm to the local grain elevator
but the check is not received
until some time later, the farmer
would receive a copy of a document
indicating what kind of
grain, the total weight or
bushels of the grain delivered,
the market price on the day of
delivery, and the total dollar
amount of the sale.

Insurance is a good example of
a prepaid expense because it is
usually paid at the beginning of
the coverage period. The farm
business is entitled to coverage
by the insurance company
during that period, so the farm
accountant should record
insurance as an asset until it is
used up over time.

These sales are considered to be
the normal annual culling of
livestock, not the liquidation of
large numbers of livestock that
result in downsizing the herd or
flock. The farm accountant should
record the gains or losses from
downsizing or liquidating the
herd or flock as Gains/Losses on
the Sale of Farm Capital Assets.

The amount that an employee
receives is something less than
the total wage because Social
Security and income taxes are
deducted from the employee's
paycheck. However, the farm
accountant records the total
wage as an expense. The farm
business owes the deductions to
the state and federal governmental
agencies. The farm business
must match the amounts
that have been deducted from
each employee's paycheck for
Social Security taxes and pay
these amounts also.

Examples of miscellaneous
revenue would be tax refunds,
sales of timber or other natural
resources, and the sale of feed, or
breeding livestock (to a neighbor,
for example) when the farm
operation is not ordinarily in
the business of selling feed or
breeding livestock to produce
revenue. These are unusual or
infrequently occurring sources
of revenue for the farm.


RECORDING TRANSACTIONS
Learning Objective 8 * To describe the process of transactions
analysis.


The management of each account involves recording the increases and decreases of the balances in the accounts as activities (transactions) occur. A financial transaction is an activity or event that affects the financial position or financial performance of the company. Every time a financial transaction occurs, it must be analyzed to determine which accounts (from the Chart of Accounts) are affected, and whether there has been an increase or decrease in each account. In every financial transaction, at least two accounts will be affected. For example, when parts for a tractor are purchased for cash, the two accounts that are affected are Repairs and Maintenance Expense and Cash. The Repairs and Maintenance Expense account increases because an additional cost has been incurred in operating the farm, and the Cash account decreases because there is now less cash on hand. Table 2-4 summarizes the steps involved in analyzing financial transactions.

Transactions Analysis
Learning Objective 9 * To identify the types of source documents
used in financial transactions.

Learning Objective 10 * To apply transactions analysis and
double-entry accounting in recording transactions.


Step 1: Transaction occurs

Many transactions occur in a farm business each year. You will recognize transactions as being related to the financing, investing, and operating activities described in Chapter 1. (Table 2-5 reproduces the list of activities/transactions from Table 1-1 in Chapter 1.) Every time that farm products are sold, supplies or inventory are purchased, bills are paid, or payments are made on loans or rental agreements, a financial transaction occurs. Each transaction for accounting purposes involves money. Many activities and events occur that do not involve money. An accounting system records only financial transactions (those measured in terms of dollars).

Usually a document provides written evidence of a financial transaction. Accountants often refer to them as source documents. A source document is the receipt, invoice, bill, contract, or other paper that accompanies the transaction. Table 2-5 lists some common source documents for each of the types of activities.

he source documents provide the details of the transaction for recording. Source documents corroborate the financial statements. If someone wants to check the source of the numbers on the financial statements, these source documents should be organized for easy retrieval if the need arises.

Step 2: Determine which accounts are affected Every time that a transaction occurs, the source documents are filed and held as evidence for referral when preparing financial statements or tax returns. Each transaction must also be recorded.

To record a transaction, first determine the affected accounts. Every transaction involves at least two accounts. For example, suppose that money is borrowed from the bank and deposited in the farm business checking account. The source documents will include the promissory note that indicates how much money (the principal) was borrowed, when it was borrowed, when it has to be paid back, how many payments will be made and the amount of each payment, and the interest rate on the loan. A deposit slip will also be a record that the amount of the loan was deposited in the checking account. The deposit slip is the key document for this transaction.

The preceding transaction is a financing activity. It involves borrowing money, so that means that the farm business now owes money to the bank. When the farm business owes money to an outside party, a liability must be reported on the balance sheet. From the definitions in this chapter, we can identify the accounts that are involved in the transaction. By examining the list of liabilities, we can conclude that the account that most closely describes this liability is Notes Payable. We can be more specific with the account title if we know when it would be paid back (that is, "due within the next year" or non-current). The other account that is involved in the transaction is Cash, because the borrower has deposited money in the farm's checking account.
Exercise 2-6 The following transactions are typical transactions
for the 4-H market steer project. Try to identify the accounts
involved in each transaction.

1. Borrowed $500 to purchase the steer.

2. Used the money to purchase the steer.

3. Bought $100 worth of feed for the steer and charged it.

4. Sold the steer for $1,500.

5. Paid the bill at the feed store.

Answer: 1. Cash and Notes Payable; 2. Cash and Feeder Livestock; 3.
(not recorded); 4. Cash and Cash Sales of Market Livestock and
Poultry; 5. Cash and Purchased Feed.


Step 3: Determine if the account balance increased or decreased Each transaction results in a change (an increase or a decrease) in the balance of the affected accounts. In the example above, Cash and Notes Payable are the identified accounts. In this transaction, Cash increased because the farm business received money. Liabilities also increased because the farm business now owes more money than it did before; therefore, Notes Payable also increased.
Exercise 2-7 For the transactions in Exercise 2-6, some of the
account balances increased and some of the account balances
decreased. Can you tell which ones increased and which ones
decreased? Answer: 1. Both Cash and Notes Payable increased; 2.
Cash decreased and Feeder Livestock increased; 3. (none); 4. Both
Cash and Cash Sales of Market Livestock and Poultry increased; 5.
Cash decreased and Purchased Feed increased.


Recording Transactions

Recording a transaction requires that we remember two characteristics. The first is that every account has two types of events (increases and decreases).We can refer to this characteristic as "two sides to every account." The second is that every transaction has at least two components. We can refer to this characteristic as "two sides to every transaction." Both characteristics are distinct from each other, but work together to form the procedures for recording transactions.

Two sides to every account

The examples in Step 3 indicate that some transactions result in increases in an account and some transactions result in decreases. Whether the accounting system is manual or computerized, the increases and decreases are shown in two columns-one for the increases and one for the decreases. The left-hand column is known as the debit side of the account. When an entry is made on the left side, it is known as debiting the account. The right-hand column is known as the credit side of the account. When an entry is made on the right side, it is known as crediting the account.

Two sides to every transaction

In every transaction, the farm accountant records at least one debit and at least one credit. The account that is debited is a different account from the one that is credited.

For some accounts, a debit is an increase to the account and for some other accounts it is a decrease to the account. Whether it is an increase or a decrease depends on the type of account it is. The same holds true for credits-sometimes a credit increases an account and sometimes it decreases it, depending on the type of account.

This way of recording transactions (two sides to every transaction) is known as double-entry accounting. Many farm accountants are accustomed to using single-entry accounting. Single-entry accounting does not recognize both sides of a transaction. Typically, the increases and decreases in cash are recorded in a check register as each cash transaction occurs. Running balances of other accounts are not maintained, but are updated when financial statements are prepared. In a double-entry system, running balances of accounts are maintained all the time instead of simply being adjusted when financial statements need to be prepared.

The double-entry system updates the account balances every time a transaction is recorded so that the farm manager can check the financial position of the farm business at a glance. The double-entry system contributes to the reliability of financial statements because the "two sides to every transaction" maintains a balance for all accounts.

Types of accounts

To determine which account(s) to debit and which account(s) to credit, you need to understand the type of each account involved. The type of account affects whether an increase is on the debit side or the credit side (with the decreases on the opposite side). The following discussion outlines the effect of the type of account on the debits and credits.

* Asset accounts are always increased on the debit side and decreased on the credit side.

* Liabilities and equity accounts are the opposite from assets because they are on the opposite side of the accounting equation; therefore, they are always increased on the credit side and decreased on the debit side.

* Revenues and gains increase the equity in the business, therefore, revenue and gain accounts must also increase on the credit side and decrease on the debit side, just like the equity accounts.

* Expenses, losses, and owner withdrawals decrease equity, so decreases must be on the credit side of these account and increases on the debit side.

* Contra items are recorded on the decrease side of the related account. For example, a contra asset account is recorded on the credit side because it is a decrease of an asset.

* Adjunct accounts are recorded on the increase side of the related account. For example, an item that is adjunct to an expense account is recorded on the debit side because it is an increase of an expense.

Figure 2-1 illustrates these concepts.

In the example of borrowing money, both Cash and Notes Payable increased.

Cash is an asset account; therefore, the increase will show up in the debit column, because increases are recorded on the debit side for assets. Notes Payable is a liability account; therefore, the increase will show up in the credit column, because increases are recorded on the credit side for liabilities. That result will not always be the case with every transaction. Sometimes the balance in an account decreases.

[FIGURE 2-1 OMITTED]

Some transactions will result in a decrease in one account and an increase in another account. For example, when buying parts to repair a tractor and paying for it with a check, Cash is decreased (because a payment is made) and Repairs and Maintenance is increased (because an expense for parts occurred). In another case, when a loan payment is made, Cash is decreased and the balance in Notes Payable decreased (because the amount of money owed is less because of the payment). In every transaction, there is at least one debit and one credit, but increases and decreases depend on what occurs in the transaction and the types of accounts involved.
Exercise 2-8 After studying the concepts about debits and credits,
use the transactions in Exercises 2-6 and 2-7 and classify the
accounts that are involved in each transaction. Then, from Exercise
2-7, knowing whether each account increased or decreased, determine
whether each account should be debited or credited.

Answer:
                      Type of     Increase or   Debit or
Account               Account     Decrease      Credit

1. Cash               Asset       Increased     Debit
   Notes Payable      Liability   Increased     Credit

2. Cash               Asset       Decreased     Credit
   Feeder Livestock   Expense     Increased     Debit

3. (None)

4. Cash               Asset       Increased     Debit
   Cash Sales of
   Market Livestock   Revenue     Increased     Credit
   and Poultry

5. Cash               Asset       Decreased     Credit
   Purchased Feed     Expense     Increased     Debit

PRACTICE WHAT YOU HAVE LEARNED Review the steps involved in the
analysis of financial transactions and complete Problem 2-3 at the
end of the chapter.


Journal entries

The journal is the name of the book in which transactions are initially recorded.

In a manual accounting system, this book is separate from the ledger and in computerized systems, it is a separate section of the software. Transactions are recorded in the journal in the order that they occur. Each recording, called a journal entry, consists of the date of the transaction, the accounts involved, the debits and credits, and the amount of money or value involved in the transaction.

The transactions analysis determines which accounts are involved, and which accounts to debit and credit. In every journal entry, the sum of the dollar amounts for the debits must equal the sum of the dollar amounts for the credits. This equality ensures that the accounting equation remains in balance.

In the journal entry, list the debits first and then the credits, with the credits indented. Returning to the example of purchasing repairs parts for cash, if the cost of parts was $38, the journal entry would look like this:
May 12 Repairs and Maintenance Expense         38
Cash                                           38


Notice that the dollar amount for the debit is recorded to the left of the dollar amount for the credit. This format is consistent with how debits and credits are recorded in the accounts. This format identifies the debits and the credits for easy transfer of this information to the accounts in the ledger. If $5,000 was the amount borrowed in the example, it would be recorded in the journal as follows:
May 24 Cash                            5,000
Notes Payable                          5,000


After recording the transactions in the journal, the next step is to transfer the information from each journal entry to the ledger. This transfer is called posting. In many computerized systems, the posting is done automatically. In a manual system, the farm accountant must perform the posting. For the journal entries prepared above, the information is copied to the relevant accounts in the ledger.

After posting, the accounts would contain the information in the following manner (assuming that the Cash account had a balance of $10,995 before the two transactions):
CASH

Date       Description                     Debits     Credits    Balance

Beginning Balance                                                 10,995
May 08     Repair parts for 750 tractor                     38    10,957
May 08     Borrowed money from bank         5,000                 15,957

REPAIRS AND MAINTENANCE EXPENSE

Date       Description                     Debits     Credits    Balance

Beginning Balance                                                      0
May 08     Repair parts for 750 tractor        38                     38

NOTES PAYABLE

Date       Description                     Debits     Credits    Balance

Beginning Balance                                                      0
May 08     Borrowed money from bank                      5,000     5,000


Notice that each account has a running balance, so that the farm accountant always knows the balance in each account. The balance is the net difference between the debits and the credits. Normally, asset accounts and expense accounts have more debits than credits (because increases are recorded on the debit side), so these types of accounts should have debit balances. Liability, equity, and revenue accounts normally have more credits than debits (because increases are recorded on the credit side), so these types of accounts should have credit balances.

Trial Balance

The trial balance summarizes the accounts in a list of the account titles with their debit or credit balances. A trial balance lists assets first, followed by liabilities, equity accounts, revenues, and expenses, just as in the Chart of Accounts. Assets should have balances in the debit column; liabilities should have balances in the credit column, and so on. A trial balance based on the sample ledger above would appear as follows:
TRIAL BALANCE

Accounts                Debits   Credits

Cash                    15,957
Notes Payable                      5,000
Repairs and
  Maintenance Expense       38


The purpose of the trial balance is to display the account balances without having to search through the entire ledger (which can be tedious if many accounts are used in the accounting system), and for checking that the total of all debits is equal to the total of all the credits. If these amounts are not equal, then an error in recording has occurred. The farm accountant would have to examine each entry in the ledger to determine if it was copied from the journal correctly. (The trial balance above is incomplete, so totals are excluded.)
Exercise 2-9 For the transactions in Exercises 2-6, 2-7, and 2-8,
prepare the journal entries and post the entries to ledger
accounts. Create an account for Feed Inventory Purchased for Use.
This account reports $30 worth of feed left over from last year.
Answer: (See Appendix D).

Accounting systems are based
on the "transactions approach"
in which each individual
transaction is recorded and
summarized in financial
statements. The transactions
approach contrasts with the
"economic approach," which
summarizes the effects of the
transactions on the financial
performance and financial
position of a farm business
without recording transactions
individually. (7)


CHAPTER SUMMARY

The Chart of Accounts lists the farm accounts. We refer to it when determining how to record a transaction. The Chart of Accounts will vary with each farm operation according to the specific activities engaged in by the farm business. Asset accounts are those items owned by the farm business that are producing or will produce future benefits to the farm operation. Liabilities represent obligations to be paid with cash or other assets. Equity represents the value of the farm operation to the owner(s). Revenues are the money earned by the sale of the farm products or the increase in the value of certain assets. Expenses are the costs incurred in the farm business or decreases in the value of certain assets.

Table 2-6 summarizes the activities involved in recording transactions.

The next chapter provides examples of recording journal entries during the course of a year for a farm operation.

BIBLIOGRAPHY

Farm Financial Standards Council. Financial Guidelines for Agricultural Producers. Naperville, IL, 1997. Also available online at http://www.ffsc.org.

Miller, W. Alan, and Freddie L. Barnard. "Preparing Reliable Farm Financial Statements: Conceptual and Procedural Issues." Journal of the American Society of Farm Managers and Rural Appraisers 60: 38-41.

PROBLEMS
2-1 * Match the following descriptions of asset, liability, and equity
accounts with the account names below.

Accounts Payable      a. Record of the value of feedstuffs on hand
Accounts Receivable   b. Record of the value of market livestock on
                         hand
Cash                  c. Amount of expenses paid for in advance
Feed Inventory        d. Value of trucks, tractors, implements,
                         harvesters, and so on.
Feeder Livestock      e. Amount of money used for personal expenses
  Inventory
Machinery and         f. Amount of money owed to suppliers of goods
  Equipment              or services
Notes Payable         g. Amount of money the farm business has
Owner Withdrawals     h. Amount of money owed to lenders
Prepaid Expenses      i. Amount of money owed to the farm business

2-2 * Match the following descriptions of revenue, expense, gains, and
losses accounts with the account names below.

Cash Crop Sales              a. Difference between balance sheet value
                                of asset sold and the cash received
                                from the sale
Cash Sales of Market         b. Amount of cash spent for purchase of
  Livestock                     market livestock
Change in Crop Inventories   c. Amount of cash received from sale of
                                feeder livestock
Change in Market Livestock   d. Change in value of breeding livestock
  Inventory                     due to changes in base values
Depreciation Expense         e. Amount of cash received from sale of
                                crops
Feeder Livestock             f. Market value of raised crops still on
                                hand
Gain due to Change in        g. Amount of cash spent for purchase of
  Base Values                   feed
Gain due to Change in        h. Difference between purchase price and
  Quantity                      current market value of feeder
                                livestock on hand
Income Tax Expense           i. Change in value of breeding livestock
                                due to age progression
Loss on Sale of Farm         j. Amount of income tax paid
  Capital Assets
Purchased Feed               k. Annual amount of the allocation of
                                purchase price of assets

2-3 * For each of the following transactions, complete the table below
and identify the accounts involved, the type of each account (asset,
liability, equity, revenue, expense), whether each account increases
or decreases in the transaction, and whether each account should be
debited or credited.

a. Selling hay to a neighbor.
b. Borrowing money for operating expenses from Farm Credit Services.
c. Paying the vet bill.
d. Paying back part of the money borrowed from Farm Credit Services.
e. The farm owner decides to use a personal computer for farm record
   keeping.
f. Spending money from sale of grain to pay off personal credit cards.
g. A young farmer receives 40 acres of land from parents.
h. Buying enough feed for the entire winter.
i. Buying a new tractor.
j. Buying diesel fuel and storing it on the farm.
k. Selling an old truck.
l. Spouse deposits money from part-time substitute teaching job into
   farm bank account.

Accounts Type of Each Account Increase or Decrease Debit or Credit

a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.


(1.) Farm Financial Standards Council. Financial Guidelines for Agricultural Producers. (Naperville, IL: 1997).

(2.) Ibid.

(3.) Ibid.

(4.) Ibid.

(5.) Ibid.

(6.) Ibid.

(7.) W. Alan Miller and Freddie L. Barnard, "Preparing Reliable Farm Financial Statements: Conceptual and Procedural Issues," Journal of the American Society of Farm Managers and Rural Appraisers 60, no. 1 (December 1996): 38-41.
TABLE 2-1 Example of cash account for the Farmer's account.

           CASH
Date       Description                Debits    Credits   Balance

Jan. 1     Beginning Balance                                20,000
May 12     Purchased repair                         250     19,750
             parts for 750 tractor
July 17    Sold 45 feeder pigs            900               20,650
Oct. 1     Paid principal and                    11,200      9,450
             interest to bank

TABLE 2-2 * Farm Chart of Accounts.

1000   Cash
1100   Accounts Receivable
1210   Feeder Livestock Inventory
1220   Feed Inventory
1300   Prepaid Expenses
1600   Machinery and Equipment
1650   Office Furniture and Equipment
1800   Land, Buildings and Improvements
1980   Accumulated Depreciation
2000   Accounts Payable
2100   Taxes Payable
2200   Interest Payable
2300   Notes Payable-Non-Current
2310   Notes Payable Due within One Year
3000   Valuation Equity
3100   Retained Capital
4100   Cash Sales of Market Livestock and Poultry
5000   Feeder Livestock
5020   Purchased Feed
6000   Operating Expenses
7100   Sales Costs
7200   General and Administrative Expenses
8000   Interest Income
8100   Interest Expense
8200   Gains (Losses) on Sales of Farm Capital Assets
8400   Miscellaneous Revenue
9000   Income Tax Expense

TABLE 2-3 Types of expense accounts for a farm business.

Types of       Examples of accounts
expenses

Production     Feeder livestock, purchased feed, wages expenses,
               payroll tax expense, board for hired labor, insurance
               for hired labor, rent, truck, and machine hire,
               repairs and maintenance for farm vehicles/machinery/
               equipment, small tools and supplies, repairs and
               maintenance for buildings and improvements, fuel, oil,
               gas, grease, seed, fertilizers, herbicides,
               pesticides, twine, sacks, poisons, seed tests,
               veterinarian, vaccinations, medications, breeding
               fees, registrations, disinfectants, sprays, livestock
               supplies and tools and equipment, shearing, wool twine
               and sacks, livestock inspections, office supplies,
               dues, journals and papers, bank charges, insurance,
               real estate and property taxes, electricity/water/
               telephone, depreciation expense, change in accounts
               payable, change in prepaid insurance, change in cash
               investment in growing crops.

Selling        Sales costs

General        General and Administrative Expenses

Financing/     Interest Income, Interest Expense, Change in Interest
Investing      Payable, Gain/Losses on Sales of Farm Capital Assets,
               Gains/Losses Due to Changes in General Base Values of
               Breeding Livestock

Other          Miscellaneous Revenue, Income Tax Expense, Change in
               Taxes Payable, Extraordinary Items

TABLE 2-4 * Transactions analysis.

Step 1: Financial transaction occurs.
Step 2: Determine which accounts (at least two from Chart of Accounts)
        are affected.
Step 3: For each account, determine if the balance increased or
        decreased.

TABLE 2-5 Types and examples of farm financial activities
and typical source documents.

Activities                    Source documents

Capital contributions         Contracts, titles, checks
Gifts and inheritances        Contracts, titles, checks
  --received
  --distributed to heirs
Non-farm income contributed   Checks written to farm
                                account or for purchases
Withdrawals by owners         Withdrawal slips from bank,
                                bank statements, checks
Borrowing money               Promissory note, check, deposit slip
Paying back loans             Checks, payment schedule from bank
Purchase of assets            Checks, receipts, titles
Sale of assets                Checks, bill of sale
Production/sale
  of farm products            Receipts, checks, deposit slips
Purchase of inventory         Checks, invoices, bills, statements
Purchase of supplies          Checks, invoices, bills, statements
Purchase of services          Checks, invoices, bills, statements
Payment of wages              Checks, time sheets,
                                employment contracts
Payment of taxes              Checks, bills, statements
Payment of interest           Checks, payment schedule from bank

TABLE 2-6 * Summary of Accounting Activities.

1. Financial transactions occur
2. Refer to documents involving the transaction and analyze each
   transaction according to:
     --What accounts are affected
     --Whether each account has increased or decreased
     --What is the type of each account (asset, liability, equity,
       revenue, expense)
3. Determine which accounts are debited and credited and record each
   transaction in the journal
4. Post the journal entries to the ledger
5. Prepare a trial balance and check that debits equal credits and that
balances are recorded in the appropriate debit and credit columns
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Publication:Introduction to Agricultural Accounting
Geographic Code:1USA
Date:Jan 1, 2008
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Previous Article:Chapter 1: Farm financial statements.
Next Article:Chapter 3: Journal entries.
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