Chapter 8: Asset valuation, part 2--non-current assets.
Base value method
Cash surrender value
Development phase of perennial crops
Full cost absorption method
Gains and Losses on Sales of Farm Capital Assets
Group value approach
Individual animal approach
Productive phase of perennial crops
In Chapter 7, you learned about various valuation methods for current and noncurrent assets, accounting procedures specific to cash, accounts receivable, inventory, and prepaid expenses, and information disclosed in the notes and tables that accompany the financial statements.
This chapter covers the valuation of non-current assets. Specific issues are the cost of the asset and the allocation of the cost. Non-current assets are not likely sold or used up in a single year, so cost allocation occurs each year that the asset is used. The cost is reported on the balance sheet. The allocation of the cost affects the income statement and the balance sheet. This chapter also addresses the unique topic of valuing raised breeding livestock. According to GAAP, raised breeding livestock should be valued at the full cost of producing and raising the animals. These costs are difficult to verify. Furthermore, growing breeding livestock increase in value up to a point as they age. These issues make raised breeding livestock a different kind of asset that is not typical of non-farm businesses. The FFSC has developed an alternative approach for valuing raised breeding livestock, which you will learn about in this chapter.
This chapter discusses the valuation of perennial crops, the base value approach for valuing raised breeding livestock, the valuation of other non-current assets, such as purchased breeding livestock, machinery and equipment, land, buildings and improvements, and investments, how to allocate the cost of non-current assets over partial periods and with revised estimates, how to account for discarding noncurrent assets, and how to provide additional information in disclosure notes to accompany the financial statements.
CASH INVESTMENT IN GROWING CROPS AND PERENNIAL CROPS
Learning Objective 1 * To explain how to value perennial crops during the developing phase.
In Chapter 4, you learned about an account that the FFSC calls the Cash Investment in Growing Crops. The farm accountant should use this account to report the expenses paid each year during the productive phase of perennial crops. The productive phase of perennial crops refers to the years that the perennial plants are producing a crop. The accounting procedures for the productive phase of perennial crops are explained in Chapter 4.
The FFSC recommends that perennial crops should not be valued at market value prior to harvest. By reporting the value of the perennial crop for the amount spent on producing the crop, the crop is valued at "cost" before harvest. If financial statements have to be prepared after the harvest but before selling the crop, the farm accountant uses the valuation procedures for raised crop inventory that you learned about in Chapter 7. The balance sheet can report the crop at net realizable value (NRV). The market value is the appropriate value after the harvest (see Figure 8-1).
Prior to the productive phase, perennial plants go through a development phase. The development phase of perennial crops refers to the time from purchasing and planting the plants until the first year that the plants produce a crop. For some perennial plants, the development phase might be a few years. The costs associated with developing perennial crops include the purchase price of the plants, the costs of planting, and other costs necessary to bring the plants into production. The balance sheet should report the costs of a perennial crop during the development phase as a non-current asset. The allocation of these costs occurs over the estimated life of the plants. An appropriate depreciation method forms the basis for the allocation (see Figure 8-1).
Chapter 3 provides an example in which Steve and Chris had invested in an apple orchard in the year 20X1. They recorded the cost of $45,000 in the Perennial Crops account in journal entry (14). Chapter 4 shows how the Farmers depreciated the perennial crop. If Steve and Chris decided to allocate the cost evenly over the estimated 10- year life for the perennial crop, they would include $4,500 in depreciation expense for the year pertaining to the perennial crop: Depreciation expense for the orchard = $45,000/10 = $4,500
When the balance sheet reports book values (assets at cost minus accumulated depreciation), the plants and the land that they reside on should be shown separately on the balance sheet. The balance sheet shows the book value of the plants as the original cost minus accumulated depreciation. The cost of the land is not depreciated. If the balance sheet reports market values, the land and plants should be valued together at market value; it is assumed that they will sell together.
[FIGURE 8-1 OMITTED]
PRACTICE WHAT YOU HAVE LEARNED Continue the example of the Farmers' perennial crop and perform the accounting procedures for the third year in Problem 8-1 at the end of the chapter.
RAISED BREEDING LIVESTOCK
Learning Objective 2 * To define base value accounting for raised breeding livestock and explain the difference between full cost absorption and base value accounting.
The value of some purchased non-current assets is easy to determine if records of the purchases are available. When breeding livestock are raised on the farm, no purchase records exist. The cost values of raised livestock are the expenses of producing these animals. These expenses include feed, labor, livestock tools and supplies, veterinarian services, breeding fees, repairs and maintenance of machinery and fences, fuel, the cost of raising feed, and so on.
The costs of producing breeding livestock are reported as expenses in the years that they occur. The expenses are recorded in expense accounts and nothing is recorded in the breeding livestock account. This result does not reflect the value of the farm's assets because breeding livestock do not have a zero value. The balance sheet should report the cost values for raised breeding livestock. The balance sheet does not report accurate information if not reporting cost values. Furthermore, as you learned in Chapter 4, after raising crops or market livestock, the farm operation reports revenue on the income statement. To be consistent, the farm operation should report revenue from raising the breeding livestock. In addition, unlike other assets that deteriorate or lose value with use, breeding livestock increase in value as they get older, at least for a time, during their productive life. The financial statements should also report this increase in value.
To satisfy the requirement for reporting cost values, the FFSC recommends that farm operations use either the full cost absorption method or the base value method for valuing raised breeding livestock.
* The full cost absorption method entails keeping accurate records of all costs associated with the raising of the breeding livestock. The farm accountant keeps track of these costs as the raising occurs.
* The Breeding Livestock account reports the total cost of raising the livestock on the balance sheet, allocated during the useful life of the livestock as depreciation expense, similar to other non-current assets.
* When the livestock sell, the farm accountant determines the amount of gain or loss by comparing the sale price to the book value at the time of the sale.
However, the record keeping required to develop accurate costs of producing the livestock is quite complex. The amount of labor, fuel, and other costs are difficult to allocate to the raising of breeding livestock when these costs also occur for other farm activities.
The FFSC recommends an alternative method for valuing raised breeding livestock.
* The base value method designates a base value (obtained from a reputable source) for different categories of raised breeding livestock.
* The farm accountant assigns base values to replacement animals as they enter the breeding herd or flock. The balance sheet reports the total base value of the raised breeding livestock on the balance sheet in the Breeding Livestock account (see Figure 8-2.)
* The animals move through age categories during their normal life cycle. These movements into the next age category are referred to as moving through transfer points. A transfer point is the age at which the value of the animal changes.
* The base value is not allocated as depreciation expense. Instead, changes in value due to age progression occur as animals enter the breeding herd and move through transfer points. The Change in Value Due to Change in Quantity of Raised Breeding Livestock account reports these changes in value, which are included in the calculation of gross revenue on the income statement.
* When the base values are changed, Gains/Losses Due to Changes in General Base Values of Breeding Livestock reports these changes on the income statement below Net Farm Income from Operations.
* The Gains/Losses from Sale of Culled Breeding Livestock account reports the gains or losses from sales of raised breeding livestock as part of gross revenue.
[FIGURE 8-2 OMITTED]
The balance sheet can also report market values for these animals. Chapter 5 discusses the accounting for changes in market values.
Figure 8-2 summarizes the following accounting activities for raised breeding livestock:
* During the growing years, the appropriate expense accounts report the transactions involved in raising the livestock.
* When animals enter the breeding herd and when they move through transfer points, the farm accountant assigns base values appropriate for the age group.
* Balance sheet reports total value of breeding livestock in Breeding Livestock account
* Income statement reports Change in Value Due to Change in Quantity of Raised Breeding Livestock
* When base values change, the balance sheet and the income statement are affected.
* Balance sheet reports new total value of breeding livestock in Breeding Livestock account
* Income statement reports Gains/Losses Due to Changes in General Base Values of Breeding Livestock
* After selling the animals, the farm accountant calculates the gain or loss.
* Income statement reports cash received from the sale
* Gains and losses are reported in Gains/Losses from Sale of Culled Breeding Livestock or in Change in Value Due to Change in Quantity of Raised Breeding Livestock on the income statement
Exercise 8-1 Review the income statements in Chapter 1 and Appendix A. Where do you find the accounts for raised breeding livestock? Answer: The first part of the income statement where Gross Revenue is calculated shows the Gains/Losses from Sale of Culled Breeding Livestock and Change in Value Due to Change in Quantity of Raised Breeding Livestock. Gains/Losses Due to Changes in General Base Values of Breeding Livestock is located further down on the income statement after Net Farm Income from Operations and is used to calculate Accrual Adjusted Net Farm Income.
To begin to use the base value method, the farm accountant must address several issues including the selection of the base values, the animal groupings, individual animals versus groups, distinguishing between the changes in quantity and changes in base values, single versus multiple transfer points, and the long version versus the shortcut alternative for the sale of breeding animals.
Learning Objective 3 * To apply the base value approach, using the shortcut method for sales of raised breeding livestock.
Base values should represent the approximate cost of raising the animals for their age. The farm accountant can refer to data published by the U.S. Department of Agriculture or land grant institutions to establish the base values for each category. The more sources examined, and the more reliable the sources used, the more likely the base values will approximate the true cost of raising the breeding livestock. When preparing the financial statements, the disclosure notes should indicate the source referred to when assigning base values.
Base values should remain the same for several years. However, the true costs of raising breeding livestock will change over time (most likely increasing because of inflation or other factors). The farm accountant should adjust base values when costs of raising breeding livestock have increased. Changing base values should be based on evidence from the above-mentioned data sources. Frequency of adjustment for base values should be based on the effort exerted to gather the data, and to calculate the gains and losses and the extent of the effect on net income. The income statement reports the change in base values only in the year in which the base values are adjusted (Gains/Losses Due to Changes in General Base Values of Breeding Livestock).
The animal groupings must be clearly defined and have some practical and economic basis. Age groupings are an easy and convenient way to form groupings. Another approach is to select the groupings based on categories used to assign market values. An example of groups for a beef cattle herd is the following:
Calves Under 13 months of age Yearlings 13 to 24 months 2-year-olds 25 to 36 months Cows More than 36 months Bulls In service
The farm accountant assigns each category a base value, estimated from reliable data sources.
Individual versus Group Approach
The individual animal approach requires maintaining valuation records for each animal. This approach works well for operations that keep production records on individual animals with an identification number for each animal. The disclosure notes should contain summary information on the individual animals. The individual animal approach works in the following way:
* The farm accountant assigns each animal a base value at the time that the animal enters an age group.
* The base value for each individual animal changes only when the animal moves to another category.
* When the base value for a category changes, the animals in that category retain the old base value until they move to the next category. Only new individual animals that enter the changed category are assigned the new base value.
The following example illustrates the assignment of base values using two categories.
Suppose that the Farmers inherited a small herd of raised dairy cattle, consisting of three bred heifers and seven older cows that are in production. They created two groupings: Bred Heifers and Cows. They decided to keep individual valuation records because they planned to keep individual production records. They assigned the Bred Heifer category a value of $800 per head and the Cow category a value of $900 per head. At the end of the first year, they summarized the valuation data in a table as follows: Individual Animal Approach/Multiple Transfer Points/Long Version/Year 1: Base New Value Base Animal No. Category per Head Total Value Total 98-1 Bred Heifers $800 98-2 Bred Heifers 800 98-3 Bred Heifers 800 96-1 Cows 900 96-2 Cows 900 96-3 Cows 900 96-4 Cows 900 95-1 Cows 900 95-2 Cows 900 94-1 Cows 900 Total 10 head 8,700 As each of the bred heifers freshened the following year, they were moved into the Cow category and assigned a value of $900 each.
The following example demonstrates a change in base values.
Suppose that the Farmers decided to change the base value of the Cow category to $1,000 in the second year. The value of the Bred Heifer category was not changed. If any of the heifers had freshened before the Farmers changed the base value, they would be valued at the old values for the Cow category because they would have moved into the Cow category before the change. Only animals that move into the Cow category after the change are assigned the new base value. Suppose that the heifers had not freshened before they changed the base values. As each heifer freshens, the Farmers assign the new base to that animal. By the end of the year, all of the heifers belong to the Cow category with the new base value. Each of the seven original cows in the Cow category retains the old value of $900 each. They kept two heifer calves from the heifers that freshened and created a new category for Calves (under 1 year of age) with a base value of $400. At the end of the second year, the valuation table appears as follows: Individual Animal Approach/Multiple Transfer Points/Long Version/Year 2: Old New Base Base Animal No. Category Value Total Value Total 01-1 Calves $400 $400 01-2 Calves 400 400 98-1 Cows 900 $1,000 1,000 98-2 Cows 900 1,000 1,000 98-3 Cows 900 1,000 1,000 96-1 Cows 900 900 96-2 Cows 900 900 96-3 Cows 900 900 96-4 Cows 900 900 95-1 Cows 900 900 95-2 Cows 900 900 94-1 Cows 900 900 Total 12 head $9,800 $10,100 The difference between the $8,700 value assigned the first year and the old base value of $9,800 at the end of the second year is the result of three bred heifers moving to the Cow category and two new calves entering the herd, verified as follows: $9,800 - 700 = ,100 Verified: (900 - 800) x 3 = $ 300 Change in value of 3 bred heifers moving to Cow category. $400 x 2 = 800 Value of 2 new head. $1,100 They record the following journal entry at the end of the second year for the change in value due to age progression: Dec. 31 1500 Breeding Livestock 1,100 4600 Change in Value due to Change in Quantity of Raised Breeding Livestock 1,100 ($9,800 ??8,700 ??$1,100) The difference between the $9,800 old base value and the $10,100 new base value is the change in base values, verified as follows: $10,100 = 9,800 = $300 Verified: ($1,000 - 900) x 3 = $300 Change in Value of 3 head due to change in base values They record the following journal entry at the end of the second year for the change in base values: Dec. 31 1500 Breeding Livestock 300 8300 Gains Due to Changes in General Base Values of Breeding Livestock 300 ($10,100 - 9,800 = $300) The ledger account for Breeding Livestock contains the following entries: 1500 Breeding Livestock Date Description Debits Credits Balance Beginning Balance 0 1/2/X1 To set up account for 3 bred 8,700 8,700 heifers and 7 dairy cows 12/31/X2 Change in quantity and change 1,100 9,800 due to transfer 12/31/X2 Change in base values 300 10,100
The group value approach differs from the individual animal approach because individual animals do not have a base value; rather, the number of head in each category is multiplied by the base value for that group. The group value approach works in the following way:
* The farm accountant determines the total base value for a group by multiplying the number of animals in each group by the group's base value at the end of the year.
* The base value for each group of animals changes when the group of animals moves to another category.
* When base value for a category changes, all of the animals in that category have the new base value.
The valuation table for the Farmers' dairy herd at the end of the first year is as follows under the group value approach:
The number of Bred Heifers is three and the number of Cows is seven. Group Approach/Multiple Transfer Points/Long Version/Year 1: Base Value New Base No. of head Category per head Total Value Total 3 Bred Heifers $800 $2,400 7 Cows 900 6,300 Total 10 $8,700 At the end of the second year, the number of Calves is two, the number of Bred Heifers is zero, and the number of Cows is 10. All of the Cows have the new base value. Group Approach/Multiple Transfer Points/Long Version/Year 2: Old Base New Base No. of head Category Value Total Value Total 2 Calves 400 800 800 10 Cows 900 9,000 1,000 10,000 Total 12 9,800 10,800 They record the following journal entries at the end of the second year for the change in value due to age progression: Dec. 31 1500 Breeding Livestock 1,100 4600 Change in Value Due to Change in Quantity of Raised Breeding Livestock 1,100 ($9,800 - 8,700 = $ 1,100) The journal entry for the change in base values records the difference between the old base values ($9,800) and the new base values ($10,800): Dec. 31 1500 Breeding Livestock 1,000 8300 Gains Due to Changes in General Base Values of Breeding Livestock 1,000 ($10,800 - 9,800 = $1,000) The ledger account would contain the following balances: 1500 Breeding Livestock Date Description Debits Credits Balance Beginning Balance 0 1/2/X1 To set up account for 3 bred 8,700 8,700 heifers and 7 dairy cows 12/31/X2 Change in quantity and change 1,100 9,800 due to transfer 12/31/X2 Change in base values 1,000 10,800
The farm accountant can use a shorter way to calculate the amounts for the journal entries for the group approach.
* The farm accountant determines the change in value due to age progression by multiplying the change in the number of head in each age group by the old base values.
* To calculate the change in value due to change in base values, the number of animals in each category affected by the change in base values is multiplied by the change in the base value.
The following example displays a table constructed for the group approach using the shorter method.
In the second year, the base values changed for the cow category. The change in the number of Calves was an increase of 2 head, and 3 Bred Heifers moved to the Cow category, so there are 3 fewer heifers and 3 more cows. The animals affected by the change in base values are the 10 cows, which is the only category with a change in base values. The base value for the Cow category increased by $100. The following table shows the change in value due to age progression and change in value due to change in base values using the shortcut version: Group Approach/Multiple Transfer Points/Short Version/Year 2/Base Values Changed: Change in Old Base Category Quantity Value Adjustment Calves 2 400 $800 Bred Heifers -3 800 -2,400 Cows 3 900 2,700 Total $1,100 Change in Category Quantity Base Value Adjustment Calves 2 0 $0 Bred Heifers 0 0 0 Cows 10 100 1,000 Total $1,000 The journal entries are the same as those indicated for the group approach using the long version.
Changes in Quantity and Changes in Base Values
As shown in the Farmers' examples above, changes in value of raised breeding livestock can occur as a result of changes in total number of animals (two new calves) or transfers to different age groups (three bred heifers moved to the cow category) and changes in base values (an increase from $900 to $1,000 for the Cow category). Both items appear on the accrual-adjusted income statement. Gross Revenue and Net Farm Income from Operations includes the change in value due to age progression but does not include changes in base values. Changes in base values are included, however, in the calculation of Accrual-Adjusted Net Farm Income. The accrual-adjusted income statement would contain these components for the Farmers' examples using the group value approach:
Change in Value Due to Change in Quantity of Raised Breeding Livestock 1,100 Gross Revenue $ Operating Expenses +/- Accrual Adjustments $ Interest Expense +/- Accrual Adjustments $ Net Farm Income from Operations $ Gain Due to Changes in General Base Values of Breeding Livestock 1,000 Net Farm Income, Accrual Adjusted $
Single versus Multiple Transfer Points
The preceding examples illustrate the use of multiple transfer points. Several age categories are set up to organize the values of the raised breeding livestock (Calves, Bred Heifers, and Cows). Changes in value occur as animals move from one age group to another. An alternative approach is the use of a single transfer point. Animals transfer only once when they enter into an "adult" category; that is, when females are bred or when they freshen, and when males enter breeding service. The single transfer point approach occurs as follows:
* Each animal or group has a base value for the adult age group.
* The base value for each individual animal or group does not change due to age progression because the animals do not move into additional categories.
* When base values for the adult category change,
* In the individual animal approach, only new individual animals that enter the changed category have the new base value.
* In the group value approach, all of the animals have the new base value.
Prior to adulthood, the animals are immature and valued according to market values. They are not distinguished from other market livestock until they become part of the breeding herd. Only a single category of mature animals has a base value. The single transfer point method is relatively simple to use and requires less bookkeeping. The method is useful for herds that do not contain a large number of immature breeding animals relative to the number of other market livestock.
If the Farmers had used a single transfer point, they would categorize the bred heifers as market animals until they freshened. Under the individual animal approach, the following valuation table would appear in the disclosure notes at the end of the first year: Individual Animal Approach/Single Transfer Point/Long Version/Year 1: Base Value New Base Animal No. Category per Head Total Value Total 96-1 Cows 900 96-2 Cows 900 96-3 Cows 900 96-4 Cows 900 95-1 Cows 900 95-2 Cows 900 94-1 Cows 900 Total 7 head $6,300 At the end of the second year (after the three heifers had freshened), the two new calves would be included with the market animals and the three heifers would now be included in the Cow category: Individual Animal Approach/Single Transfer Point/Long Version/Year 2: Old Base New Base Animal No. Category Value Total Value Total 98-1 Cows 900 $1,000 $1,000 98-2 Cows 900 1,000 1,000 98-3 Cows 900 1,000 1,000 96-1 Cows 900 900 96-2 Cows 900 900 96-3 Cows 900 900 96-4 Cows 900 900 95-1 Cows 900 900 95-2 Cows 900 900 94-1 Cows 900 900 Total 10 head $9,000 $9,300 Under the group value approach, the valuation tables would appear as follows for the first and second years, respectively: Group Approach/Single Transfer Point/Long Version/Year 1: Base Value New Base No. of Head Category per Head Total Value Total 7 Cows 900 $6,300 Group Approach/Single Transfer Point/Long Version/Year 2: Old Base New Base No. of Head Category Value Total Value Total 10 Cows 900 $9,000 $1,000 $10,000
The values for the bred heifers and calves are included in the account for market livestock until they freshen. If these animals had a low value relative to the value of the rest of the market animals, then including them in this account would have very little effect on the analysis of the financial statements. If, however, the farm operation had very few or no market animals, the analysis could be somewhat distorted.
Shortcut Alternative Version for Animals Sold or Died
The shortcut alternative version refers to valuation when animals sell or have died. The gain or loss from the sale of culled breeding livestock is the difference between the sale price and the base value of the animals sold. The loss from animals that have died is the base value of those animals.
* The base values are determined from the individual animal records under the individual animal approach.
* Under the group value approach, the farm accountant multiples the number of animals sold or died in each category by the base value at the beginning of the year. The farm accountant computes the totals for all categories and compares them with the total amounts received from selling the breeding animals to determine the gain or loss.
The following example of the Farmers' third year with the dairy herd illustrates how the shortcut alternative version works.
In the third year, eight new calves were born and the two calves that were born last year became bred heifers. The Farmers decided to sell one of the bred heifers and two of the cows in the third year (receiving $1,200 for the three head). Using the group approach and multiple transfer points, the valuation table for breeding livestock presents the following information at the end of the third year: Group Approach/Multiple Transfer Points/Short Version/Year 3/Base Values Unchanged: Base Value New Base No. of Head Category per Head Total Value Total 8 Calves $400 $3,200 1 Bred Heifers 800 800 8 Cows 1,000 8,000 Total 17 $12,000 The change in value due to age progression is $1,200, the difference between the total value at the end of the third year ($12,000) and the total value at the end of the second year ($10,800). $12,000 - 10,800 = $1,200 Verified: $1,000 x - 2 = -2000 Sale of two cows ($800-400) x 2 = 800 Transfer of 2 calves to bred heifer category $800 x -1 = -800 Sale of 1 bred heifer $400 x 8 = 3,200 Addition of 8 new calves $1,200 The journal entry for the change in value due to age progression is as follows: Dec. 31 1500 Breeding Livestock 1,200 4600 Change in Value Due to Change in Quantity of Raised Breeding Livestock 1,200 ($12,000 ??10,800 ??$1,200) The income statement would report the following: Proceeds from Sale of Culled Breeding Livestock 1,200 Change in Value Due to Change in Quantity of Raised Breeding Livestock 1,200 Gross Revenue $ Operating Expenses +/- Accrual Adjustments $ Interest Expense +/- Accrual Adjustments $ Net Farm Income from Operations $ Gain Due to Changes in General Base Values of Breeding Livestock $ Net Farm Income, Accrual Adjusted $
The example above illustrates the shortcut alternative in which the change in value due to age progression is determined by valuing only the change in numbers in each category. A new account (not shown in the chart of accounts in this book), called Proceeds from Sale of Culled Breeding Livestock, reports the amount received from the sale of the culled animals. The gain or loss on the sale is included in calculating the Change in Value Due to Change in Quantity of Raised Breeding Livestock. The advantage of the shortcut alternative is the simplicity of the method. The farm accountant counts only the number in each category on the farm at the end of the year, without having to keep records of the number sold or died. However, gains or losses from culling breeding livestock are not easy to read from the financial statements in the shortcut method.
To keep track of animals died or sold, the farm accountant can use a long version. Appendix I illustrates the long version.
PRACTICE WHAT YOU HAVE LEARNED Practice what you have learned and complete Problem 8-2 at the end of the chapter.
PURCHASED BREEDING LIVESTOCK, MACHINERY AND EQUIPMENT, LAND, BUILDINGS AND IMPROVEMENTS
Learning Objective 4 * To identify the expenditures that make up the cost of non-current assets.
The balance sheet shows purchased breeding livestock, machinery and equipment, buildings and improvements, and land at both cost and market values. As you have learned, cost value (or book value) refers to the original cost of the asset minus the total amount of that cost allocated since the purchase of the assets. The allocation is recorded as Depreciation Expense each year and is accumulated in the Accumulated Depreciation account. Accumulated Depreciation is reported on the balance sheet for all of these assets except for land. Land is not depreciated, so the book value is always the original cost. The disclosure notes can display market values (obtained from a qualified appraiser or some other reputable source) in a table, or the farm accountant can prepare two balance sheets (one with the book values and the other with market values).
The original cost of an asset includes the purchase price plus any costs incurred to transport the asset to the farm location and any other costs that occur to get the asset ready to use.
* The original cost of land includes the purchase price, closing costs with the real estate agent, costs of clearing and grading the land, plus the assumption of any liens or mortgages.
* The cost of land does not include improvements with limited lives, such as fences or tiling. These items are classified as improvements and are depreciated.
* The cost of constructing a building includes the materials, labor, and overhead, and any professional fees or permits required. The cost of removing an old building is part of the cost of land, not part of the cost of constructing a new building.
* The cost of machinery and equipment include the purchase price, the freight charges to get the asset to the location on the farm, insurance on the asset while it is being transported, and any installation or assembling costs of the machinery or equipment.
When purchasing a farm, the farm owner purchases the land, buildings, and improvements all together for a single price. These kinds of transactions are called lump-sum purchases. Even though a lump sum is paid for all of the assets, the buildings and the improvements must be valued separately from the land to calculate depreciation for each item. The length of the asset's useful life is the basis for depreciation. That basis varies with each type of asset, and with the age of the asset when purchased. In addition, the farm accountant might use different depreciation methods for different assets. The accounting procedures for lump-sum purchases involve the following concepts:
* When purchasing more than one asset together, the farm accountant has to keep track of each asset separately and record an amount for each asset.
* Part of the process of a lump-sum purchase would be an appraisal of each of the assets. If the total price paid (the purchase price) is equal to the sum of the appraised values (market values) of the individual assets, the amount recorded for each asset is its market value.
* If the purchase price for the assets differs from the sum of the individual market values, the farm accountant allocates the purchase price among the assets based on each asset's proportion of the total market value.
In Chapter 3, the Farmers had inherited land and buildings. Suppose that they had purchased the land and buildings for $325,000 instead of inheriting them. The market value for the land and buildings are $240,000 and $110,000, respectively. Because the purchase price of $325,000 differs from the sum of the market values ($240,000 + 110,000 = $350,000), the Farmers have to allocate the purchase price to value the assets. They multiply the proportion of the total market value for each asset by the purchase price to determine the amount of the purchase price allocated to each asset. Fair Market Value Allocation Land $240,000 240,000 / 350,000 = 69% 69% x 325,000 = $224,250 Buildings 110,000 110,000 / 350,000 = 31% 31% x 325,000 = 100,750 $350,000 $325,000 The proportion of the purchase price of $325,000 allocated to the land is $224,250 and the amount allocated to the buildings is $100,750 (See Figure 8-3). A table showing the allocation above should be included in the notes to the financial statements. The journal entry to record the purchase would be as follows: Jan. 2 1800 Land, Buildings, and Improvements 325,000 1000 Cash 325,00 The Farmers might decide to report both the market value and cost value: Market Book Value Land, Buildings, and Improvements $350,000 $325,000 The cost of $100,750 for the buildings is depreciated (allocated as depreciation expense) every year . The land is not depreciated. PRACTICE WHAT YOU HAVE LEARNED Practice the lump-sum procedures by completing Problem 8-3 at the end of the chapter.
Many farm operations lease non-current assets. Leasing farmland and pastureland is a common practice in the agricultural industry. Leased land is sometimes a large part of the assets of a farm operation. Leased assets require special accounting techniques, which the next chapter, on liabilities, discusses. Because of the nature of some farm leases, the farm accountant records a liability at the beginning of the lease, so the topic is more relevant for the chapter on liabilities. Leased assets are recorded only at cost, not market values. Depreciation is recorded as it is for other non-current assets. Chapter 9 discusses these topics in more detail.
[FIGURE 8-3 OMITTED]
DISPOSING OF NON-CURRENT ASSETS
Learning Objective 5 * To perform the accounting procedures for discarding a non-current asset.
The disposing of non-current assets can occur by selling them for cash, exchanging them for other assets, or scrapping them. You learned about the accounting for selling and trading assets in Chapter 3 in journal entries (10) and (11). In those examples, the accounting involves comparing the amount of cash or the market value of the other asset received with the book value of the asset sold or exchanged. The farm accountant records a gain if the value of what is received is greater than the book value of the asset disposed of (for example, the gain on the sale of the Farmers' bull in journal entry (10)). A loss is recorded if the value of what is received is less than the book value of the asset disposed of (for example, the loss on the trade-in of the truck in journal entry (11)). You learned how to calculate gains and losses in Chapter 6 (see Table 6-4). The following is what you have learned so far:
* Gains and losses on the sale of purchased breeding livestock are recorded in the account Gains and Losses of Culled Breeding Livestock, and are reported on the income statement as part of gross revenue.
* Gains and losses on the sale of raised breeding livestock are included in Change in Value Due to Change in Quantity of Raised Breeding Livestock, also a part of gross revenue.
* Gains and losses from the sale or trade-in of all other assets are recorded in the account Gains and Losses on Sales of Farm Capital Assets and are reported on the income statement below operating expenses.
When a farm operation discards an asset, the farm operation does not sell or exchange it, but scraps it instead. The typical assets discarded are worn-out machinery and equipment, too old to find replacement parts for, damaged beyond repair, or too costly to repair. In these cases, the best option is to purchase another one. When an asset is discarded, no cash or other asset is received. In some cases, the farmer has to pay a fee to get rid of the asset. For example, the demolition and removal of a dilapidated old building or hauling away old machinery might involve hiring someone with the necessary tools and equipment to do the job.
The journal entry to record the discarding of an asset involves the following.
* A credit to the asset account for the original cost of the asset.
* A debit to the Accumulated Depreciation account for the total amount depreciated since the asset was put into use.
** Many of these assets will be fully depreciated by the time that they are discarded, so the amount for Accumulated Depreciation will be the base. As you recall, the base is the amount to be depreciated throughout the entire life of the asset. When an asset is fully depreciated, it means that the base is completely allocated. The asset's book value is the salvage value when it is fully depreciated.
* If cash is paid to remove the asset, a credit is made to the cash account.
* A Loss on Sale of Farm Capital Assets is debited to balance the journal entry. Even though a sale is not involved, this loss account can be used instead of creating another account. Whether the asset is fully depreciated or not, the amount of the loss is equal to the book value of the asset discarded and any amount paid for discarding it.
Suppose that in 2006, the Farmers for some reason had to scrap the truck that was involved in the examples on depreciation methods. They did not trade it in the year 20X6, but rather kept it and purchased a new truck without a trade-in. The truck was fully depreciated by the year 20X6, so Accumulated Depreciation contains the amount of the base ($12,000), and the truck had a book value of $3,000 (the salvage value). If they did not pay anything to discard it, they will record a loss of $3,000 as follows: (Date) 8200 Loss on Sale of Farm Capital Assets 3,000 1980 Accumulated Depreciation 12,000 1600 Machinery and Equipment 15,000 If they paid someone $50 to haul the truck away, the journal entry would be: (Date) 8200 Loss on Sale of Farm Capital Assets 3,050 1980 Accumulated Depreciation 12,000 1600 Machinery and Equipment 15,000 1000 Cash 50 PRACTICE WHAT YOU HAVE LEARNED Practice what you have learned by completing Problem 8-4 at the end of the chapter.
Learning Objective 6 * To explain the valuation of investments in farm cooperatives, investments in entities other than farm cooperatives, life insurance policies, and retirement accounts.
Farm operations can invest in many types of entities. The FFSC Guidelines classifies investments as four different types:
* Investments in farm cooperatives
* Investments in entities other than farm cooperatives
* Life insurance policies
* Retirement accounts
Table 8-1 lists examples of investments in each category. Sometimes the purpose for making investments is to use excess cash to make money, but farm operations make investments for other reasons.
Investments in Farm Cooperatives
The FFSC Guidelines discuss three types of farm cooperatives--supply/manufacturing cooperatives, the Farm Credit System, and marketing cooperatives.
* Supply/manufacturing cooperatives produce or purchase goods for their members and sell them to the members at competitive prices. These cooperatives may distribute patronage refunds when they make a profit.
* Investments in the Farm Credit System involve purchases of membership to obtain credit from a particular lending institution. The lending institutions (also called "credit associations") include the Production Credit Association (PCA), the Federal Land Bank Associations (FLBA), the Federal Land Credit Associations (FLCA), and Agricultural Credit Associations (ACA).
* Marketing cooperatives provide sales outlets for farm products for their members. Members purchase shares of stock in the cooperative that entitle them to deliver a certain amount of product based on the number of their shares held.
The accounting for investments in cooperatives may involve purchasing a membership and recording income.
* If the farm operation purchases a membership, the farm accountant records the payment as a debit to the investments account and a credit to cash.
(Date) 1900 Investments in Cooperatives and Other Investments XXX 1000 Cash XXX
* Farm cooperatives sometimes allocate their profit to the member without a patronage refund. In that case, the farm accountant of each farm member records the amount of profit allocated to that farm operation as an increase to the investment account.
(Date) 1900 Investments in Cooperatives and Other Investments XXX 4800 Miscellaneous Revenue XXX
* If the farm cooperative pays out a patronage refund, the farm accountant records the amount of cash received as a decrease in the investment account. You can think of the investment like a bank account. When some money is received from the account, the amount in the account is reduced.
(Date) 1000 Cash XXX 1900 Investments in Cooperatives and Other Investments XXX
Investments in Entities Other Than Farm Cooperatives
Accounting for these types of investments involves journal entries for the purchase, for income, for market value changes (for some investments), and for selling the investment. Some investments are held for nearly a lifetime and some are held only for short periods, depending on the need for cash or to take advantage of market price changes.
* Investments in stocks and bonds are usually conducted with the aid of a stockbroker or other financial advisor to keep track of market changes and develop strategies for capitalizing on market values. The purpose for investing in stocks or bonds is to receive income or to sell the investment later for a profit.
Stocks are certificates of ownership in a company sold to the public. Bonds are IOUs issued by a company for money that the company has borrowed from the public.
The farm financial statements should report the purchase of and any income from these investments. Purchases are recorded in the investments account, just like investments in farm cooperatives.
(Date) 1900 Investments in Cooperatives and Other Investments XXX 1000 Cash XXX
Income is received in the form of dividends from investments in stock or interest from investments in bonds. Dividend income and interest income can be recorded as Miscellaneous Revenue.
(Date) 1000 Cash XXX 4800 Miscellaneous Revenue XXX
* Some assets, such as land, might be purchased strictly for future resale. Land sells either as a whole parcel or in lots for real estate development.
The purchase is recorded just as the other investments indicated above. These investments might or might not generate any income. The intention may be to own the investment until the market price increases sufficiently to produce a significant gain on the sale. Land owned for this purpose could generate income if leased to another party. In that case, rental income can be recorded as Miscellaneous Revenue just like the investments indicated above.
* Some investments are stock purchases of other companies (less than 50 percent ownership) in which the investor can exert significant influence over the operating and financing policies of the purchased company.
The accounting for these kinds of investments is similar to investments in farm cooperatives.
Changes in market values of investments should be recorded for stocks and bonds that are intended to be sold within the next year, even if market-based financial statements are not prepared. Sometimes these investments are called marketable securities to differentiate them from the investments that are not intended to be sold in the near future. When financial statements are prepared, the following journal entries should be recorded if the market values at that time are higher than the original cost of the investment.
Dec. 31 1900 Investments in Cooperatives and Other Investments XX 3010 Change in Excess of Market Value over Cost XX
The debits and credits are reversed if the market values at that time are lower than the original cost. The amount is the difference between the original cost and the current market value. The FFSC Guidelines do not recommend reporting market values for other investments, so changes in market values are not reported for them as they are for other assets in the farm business.
The farm accountant records the sale of any of the investments like other noncurrent farm assets. However, investments are not depreciated as non-current assets used in the farm operation, so there is no entry for accumulated depreciation. Gains or losses are recorded when the cash received from the sale is different from the balance in the investment account pertaining to the investment that was sold. For investments in stocks and bonds without significant influence in the management of the company, the balance includes the original cost and changes in market value for investments that will be sold within the next year. For investments in farm cooperatives and stock purchases where there is significant influence in the management of the company, the balance includes the original cost and adjustments for income and dividends. Clearly, if the farm operation has many investments, the farm accountant will have to keep separate accounting records for each investment to keep track of the adjustments.
Life Insurance Policies
Like other businesses, many farm operations will purchase life insurance policies on key people in the business and name the business as the beneficiary. Life insurance policies are a type of investment if the policy is a whole life policy. Whole life policies can be cashed in for money (called the cash surrender value) if the policyholder wishes to discontinue the coverage. Another popular type of life insurance policy is term life insurance, in which the policyholder pays the premiums to the life insurance company only until a certain age. Benefits can be received only if the insured person dies before that age. The policyholder cannot cash in a term life insurance policy if the policyholder decides to discontinue the policy. The cash surrender value of whole life policies increases each time that the policyholder pays the premium to the insurance company. The increase in cash value can be read from a report that the insurance company provides on the cash value of whole life policies. The policyholder records this increase whenever a life insurance premium is paid.
The original cost of the policy is not recorded as an investment. The first journal entry records the life insurance expense when making the payment. With each subsequent payment, the policyholder records the increase in the cash value along with the insurance expense. As a result, the investment account for the insurance policy is updated each year and is reported on the balance sheet at market value.
Suppose the Farmers pay a life insurance premium of $2,300 annually. They record the first payment as life insurance expense: (Date) 6700 Insurance 2,300 1000 Cash 2,300 The next year, the first report for the Farmers indicates that the policy has a cash value of $1,400. This increase in value offsets the insurance expense, because it represents an investment to the Farmers. The journal entry to record the payment of the insurance premium reflects these facts: (Date) 6700 Insurance 900 1900 Investments in Cooperatives and Other Investments 1,400 1000 Cash 2,300
Retirement accounts begin with a purchase or deposit. Many types of retirement accounts exist, including savings accounts, traditional IRAs, and Roth IRAs, to name a few. Retirement accounts are considered personal assets and are not reported on farm financial statements unless combined statements are prepared. If combined statements are prepared, a debit to the personal asset account and a credit to cash are recorded at the time of the initial investment. Subsequent contributions to the fund are recorded in the same way.
(Date) 1950 Personal Assets XXX 1000 Cash XXX
The fund will increase in value due to interest or dividends that accumulate from investing the retirement fund in shares of stock or bonds in mutual funds or other entities. The fund will also increase or decrease as market values of the stocks and bonds change. The purchaser of the retirement fund will receive periodic reports on the changes in value of the retirement fund. An increase in value is recorded in the following way:
(Date) 1950 Personal Assets XXX 3210 Change in Personal Assets XXX
If losses in the retirement fund occur (because of declining stock market values), the journal entry would be reversed with a credit to the personal assets account and a debit to the change in personal assets.
The FFSC Guidelines recommends that both cost and market values be reported on the balance sheet for retirement accounts. Cost value is equal to the original investment and any additional payments made into the fund. Market value is the cost value plus or minus changes due to fluctuations in the market value of the fund. For all other personal assets, only market values need to be reported.
PRACTICE WHAT YOU HAVE LEARNED Practice your knowledge of different types of investments by completing Problem 8-5 at the end of the chapter.
Learning Objective 7 * To list the information contained in disclosure notes for non-current assets.
The disclosure notes should provide tables of each category of non-current assets containing information on the original cost, accumulated depreciation, book value, and market value for each asset in each category. Each piece of machinery and equipment, each building, each improvement, each parcel of land, each vehicle, each class of raised breeding livestock and purchased breeding livestock, each investment, and each perennial crop should be listed. Each personal asset should be listed, if combined financial statements are prepared. Additional information that is useful for lenders and other parties who read the financial statements include new purchases and sales of assets in each category, with details of the dollar amounts and number of head or number of acres. Table 8-2 summarizes the typical data disclosed in the tables for each class of non-current assets. Lenders often request this kind of information.
Additional information that should be presented in the notes includes:
* The source or method of determining market values.
* The source or method of determining base values for raised breeding livestock.
* Details of the depreciation method used for each class of asset and what the computations were based on--estimated useful life, or total hours, or total miles, and estimated salvage value.
* Reasons for changing estimates or changing from one depreciation method to another.
Non-current assets can be reported at both cost and market values on the balance sheet. Base values are determined for raised breeding livestock using a variety of approaches concerning the number of transfer points, the choice between the long version and the short version for sales of animals, and the individual animal approach and the group approach. Depreciation expense is reported for all purchased assets using a number of acceptable depreciation methods. For all non-current assets, extensive disclosure information facilitates the analysis of the financial position of the farm business.
8-1 * Using the information in the chapter for the Farmers' second productive year for the apple orchard and the information below for the third year, determine the amount to be reported on the balance sheet for Cash Investment in Growing Crops. Then calculate the Change in Cash Investment in Growing Crops. Assume that the crop was not harvested by the end of the year and prepare the journal entry. Then prepare a partial income statement and balance sheet for the effects of the third year.
The financial statements for the second year reported the following:
Income Statement: Cost and Market Cash Crop Sales $2,900 Effect on Gross Revenue $2,900 Operating Expenses + Change in Investment in Growing Crops 250 Net Effect on Operating Expenses 250 Net Effect on Net Farm Income from Operations $3,150 Balance Sheet: Assets: Cash Investment in Growing Crops $2,750 The information for the third year includes the following: Cash sales of second year crop = $3,000 Cash expenditures for third year's crop = $2,600
8-2 * Continuing with the Farmers' dairy herd in this chapter and using the information below, calculate Change in Value Due to Change in Quantity of Raised Breeding Livestock and Gains/Losses Due to Changes in General Base Values of Breeding Livestock for Year 4. Start by preparing a valuation table using the group approach, multiple transfer points, and the short version for animals sold.
In the fourth year, seven new calves were born and three of the calves that were born last year became bred heifers. The bred heifer from last year moved into the Cow category. The Farmers sold one of the cows in the fourth year for $450. The base values in each group increased by $50 per head.
8-3 * Suppose that the Farmers had purchased the farm for $500,000, which included land, buildings, and improvements. The market value was $250,000 for the land, $100,000 for the buildings, and $50,000 for the improvements. Determine the amount to allocate to the land, buildings, and improvements.
8-4 * Suppose that the Farmers decided to tear down all of the buildings that they purchased in Problem 8-3 two years after they purchased the farm because they planned to sell all of the beef and dairy cattle and wanted to set up a hog operation instead. Prepare the journal entry to record the loss on the discarding of the buildings two years after the purchase.
8-5 * Identify the type of investment described by the phrases below. Some of the phrases may describe more than one category of investments.
a. investments in farm cooperatives b. investments in entities other than farm cooperatives c. life insurance policies d. retirement accounts --Investing in savings accounts, traditional IRAs, or Roth IRAs. --Investing in an entity that might pay patronage dividends to its members. --Recording the investment by debiting the Investments account. --Recording the share of profit allocated to members by debiting the Investments account. --Recording the dividends by crediting the Investments account. --Investment with a cash surrender value. --Recording changes in market value. --Investing for the sole purpose of earning income or selling the investment for a profit. --Recording the income from the investment by crediting Miscellaneous Revenue. --Investing in marketable securities. --Investing for the purpose of protecting against the loss of key people in the business. --Investing in an entity that produces or purchases goods for its members and sells them to the members at competitive prices. --Purchasing the investment by becoming a member. --Investments that are considered personal assets. --Investments not reported on farm financial statements unless combined statements are prepared. --Investing in an entity that is involved in lending to agricultural operations. --Investing for the purpose of having income in later years. --Investing in an entity that sells stocks and bonds. --Investing in an entity that provides sales outlets for its members. TABLE 8-1 Examples of Types of Investments. CATEGORIES: FARM COOPERATIVES OTHER POLICIES RETIREMENT Investments: Supply/manufacturing Stocks Life Savings cooperatives Insurance accounts Farm Credit System Bonds Traditional IRAs Marketing Land Roth IRAs cooperatives TABLE 8-2 * Information Presented in Disclosure Notes. BREEDING LIVESTOCK For Each Age Group: number of head number transferred in and transferred out number sold number died base value per head and total base value for raised animals cost and accumulated depreciation for purchased animals market value per head and total market value For the Herd as a Whole: number of head total base value for raised animals total cost and accumulated depreciation for purchased animals total market value, gains and losses on the sale of culled livestock calculations for changes in value due to age progression calculations for changes in value due to changes in base values. MACHINERY AND EQUIPMENT For Each of the Following Vehicles, Machinery, and Equipment: original cost accumulated depreciation book value market value changes due to additions and disposal PERENNIAL CROPS For Each Type of Perennial Crop: number of acres original cost and accumulated depreciation market value For Perennial Crops as a Whole: total number of acres total original cost and accumulated depreciation total market value changes due to additions and disposals LAND, BUILDINGS AND IMPROVEMENTS For Each Parcel of Land: year acquired number of acres original cost market value per acre total market value For Land as a Whole: total number of acres total original cost total market value For Each Type of Building and Improvement: year built or acquired original cost accumulated depreciation book value market value For Buildings and Improvements as a Whole: total original cost total accumulated depreciation total book value total market value changes due to additions and disposals INVESTMENTS IN COOPERATIVES AND OTHER INVESTMENTS For Each Type of Investment: book value market value For Investments as a Whole: total book value total market value PERSONAL ASSETS For Each Type of Personal Asset: market values
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|Publication:||Introduction to Agricultural Accounting|
|Date:||Jan 1, 2008|
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