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Tax Planning: Accrual financial statements provide the best for management decisions

Accrual is the way to go with farm financial statements, according to a farm accounting specialist.

“Cash accounting only measures cash, and that has nothing to do with profitability,” says Beverly Johnson, a partner at KPMG Enterprise in Saskatoon. Accrual accounting is the measure of profitability, she says.

Johnson has been a farm accountant for 30 years. She’s also a professional agrologist, and farmed with her family on a mixed operation near Hanley for several years.

Years ago farmers tended to do their annual statements on a cash basis, but most of Johnson’s clients use accrual statements now. They often keep their books on a cash basis, and then convert to accrual themselves, often with the help of accounting programs such as Ag Expert. Alternately, they have an accountant do it for them.

“Investments have always been big in farming but we’re talking millions and millions now. They have to be able to know profitability just to make decisions. Do I buy more equipment? Do I rent land? What can I afford to pay for rent?”

Accrual financial statements allow farmers to drill down to see which crops were more profitable or which fields performed better. Farmers can also evaluate the operation’s profitability and do year-to-year comparisons, she adds. To Johnson, accrual accounting forms the basis of good management.

Cash financial statements can misrepresent a farm’s true profit, Johnson says. She compares it to only looking at what’s in a farmer’s bin when his crop is still in the field.

Farmers might not do accrual accounting on paper, “but they know what they’ve got in the bin. They know what it’s worth. They know what they’re going to sell.”

Accrual accounting makes sure the financial statements capture that thinking, she says. That allows farmers to benchmark their operations so they can be compared to other farms, and get the information they need to make critical decisions.

It’s also about managing risk, she says. “And one way to manage your risk is to have a good handle on the financials.”

Tax versus management accounting

When it’s time to pay income taxes, there are some differences between accrual and cash systems. For example, accrual removes the flexibility to manipulate income. And under accrual accounting, you expense inputs when you use them, whereas cash allows you to prepay for two years in advance.

“What I would say is don’t let your management accounting system drive tax decisions. To me, those are two different things,” says Johnson.

Instead, Johnson encourages farmers to do accrual statements, and then manage taxes based on information pulled from those statements. Farmers can make the best decisions by knowing their true profitability. Managing taxes then becomes one of those decisions, she says.

There are a few things farmers can do to make year-end smoother, too. Johnson recommends taking some time at year end to take stock of inventory in the field, in the bin, and the inputs that have been purchased but not yet used. It’s also a good idea to know what grades you’ve got in the bin and what the net price will likely be, she says.

Farmers need a fairly detailed analysis of what’s on-hand for year-end, but they shouldn’t be scared off from doing it, Johnson says. People tend to think of accounting as precise, but it involves estimates, too, she says.

“Don’t stress over it. Just do it on a timely basis. Be as accurate as you can. That’s better than doing nothing.”

Finding an advisor

Agriculture is like any industry, Johnson says, in that you have some people who are “stellar” at managing the business side, while others are stronger at producing and shop work.

The excellent farmers know their numbers, she says. “They can make that extra five bushels an acre, which makes a huge difference to their overall profitability. That’s what it’s all about.”

Farmers who aren’t as strong in the marketing and financial department need to hire someone who is, just as they would hire an agronomist, Johnson says. “You might pay for it but you’re minimizing your risk because you’ve got millions on the line. Would you buy a $5 million to $10-million business and not manage it, not watch finances?”

A farmer should look for an advisor who can explain things in a way the farmer can understand, Johnson says. Rather than peppering the conversation with accounting jargon, the advisor should speak the farmer’s language. The farmer should feel comfortable speaking to the advisor.

A good advisor will also help the client understand what the information means to her farm. The advisor should understand the client’s operation and objectives. Understanding trends is also important, Johnson says.

“So if your costs per acre are constantly going up and your margins are shrinking, why is that?”

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