We will be examining the changes you need to make in handling Agricultural inventories as you move from traditional agriculture financial reporting to more up to date statements that follow Generally Accepted Accounting Principles.
When applying GAAP to production agriculture, accountants turn to the manufacturing-sector for guidance. Manufacturing inventories fall into three classifications:
• Direct materials
• Work in process
• Finished goods
Direct materials inventories are raw "ingredients" in stock waiting for use in the manufacturing process. In production agriculture, direct materials include seed, chemicals, fertilizer and feed. These inventories are normally valued at cost in both traditional agricultural and GAAP financial statements.
Work-in-process inventories are all partly completed units found in production at any given point in time, e.g. cars on an assemble line. The agricultural equivalent of WIP inventories consists of growing animals and crops. Few farming operations today calculate and report true WIP. Instead, they rely on "quick and dirty" surrogates.
In cropping operations, that surrogate is the "(Cash) Investment in Growing Crops" line found on most agricultural balance sheets. It's an easy value to determine–just total up the cost of the crop inputs "in the ground" at the time of the statement. Unlike true WIP, though, Investment in Growing Crops fails to account for the labor and indirect costs (such as fuel, repairs, depreciation and rent) also invested in that growing crop, therefore understating assets and overstating these expenses in the accounting period.
Corporate livestock firms already account for WIP, although most use historical cost estimates based on weight or days-on-feed rather than monitoring actual group-cost variances. Family operations (and their lenders) are even less informed, usually basing livestock inventories on purely arbitrary "market" values. WIP calculation for livestock is much more complex than for crops, because of daily, rather than seasonal, activities and the challenges of capitalizing development costs for replacement breeding animals and gestating and lactating "pre-weaned" animals.
Finished-goods inventories are goods fully completed but not yet sold. Harvested crops in storage are the best example of agricultural finished goods. Feeding livestock, though, only achieve the "finished goods" status on the day they are loaded on the truck heading for the processing plant. Nearly every agricultural financial statement reports these inventories at current market value. The "New World" approach follows a nearly twenty-year-old document published by the American Institute of Certified Public Accountants entitled, Statement of Position 85-3. It concludes with principles for valuing work-in-process (#38) and finished goods (#39) inventories:
38. All direct and indirect costs of growing crops should be accumulated and growing crops should be reported at the lower of cost or market.
- The product has a reliable, readily determinable and realizable market price.
- The product has relatively insignificant and predicable costs of disposal.
- The product is available for immediate delivery.
In other words, work-in-process must be reported at lower of cost or market, finished goods may be reported at lower of cost or market as at sales price less estimate cost of disposal. The major challenge is that whether you choose to report inventories at cost or lower of cost or market, you must be able to determine your work-in-process costs. That's why we emphasize managerial accounting as the first step in moving our clients to financial reporting.