The process of perfecting the farm accounting standards leading to introduction of management accounting procedures in farm businesses is continuously progressing as farm has to be managed better to make it profitable to survive.
Crops have several usages, like soybean can be grown for animal feed to be consumed at farm or it can be sold as an oilseed grain. It is feed for livestock and in other situation it is an accounting profit center.
Farm equipment is equally complex cost of transport equipment can be charged as input cost for producing crop, it can be hire out thus a profit center having altogether dissimilar influence on crop costs.
FFSC is creating fundamental concepts like sound table of accounts for getting financial information, to make it a robust enterprise to manage it, by considering cost or profit centers. A farm should have clear accounting system as it is a complex business and also needs huge capital. The management accounting techniques suitable for use in farm accounting as discussed in case study 1 of Farm Financial Council Management Accounting titled John and Mary Farmer represents a management accounting practice that uses activity based accounting (ABC) method.
Activity-Based Costing is used to find out costing of a particular produce. ABC is a truthful cost management technique. The ABC try to find out exact cost for an agricultural produce, by considering indirect costs, and cost that are specific to a produce, there is no arbitraries in ABC. In ABC technique produce needs specific activities that use specific funds, that use of funds should be included in the total cost.
Knowing true costs of growing the produce makes it easier for farmer to find out their true position about the farm profitability. This also helps the farmer to calculate the break-even points and analysing options to improve on their farming activities.
Case Facts: The John and Mary Farmer case facts are following.
Production data (1) the crops grown are two Soybeans and Corn. (2) The area of crop is 1060 acres (3) John and Mary Farmer produce corn and soybeans on their 1060 located of the mid west in the Corn Belt out of which 480 acres are under corn cultivation while remaining 480 acres is used to raise soybeans. (4) Ownership pattern 340 acres are their own, 480 acres on crop-share arrangement and 320 acres cash rented, these 800 acres are taken from 5 owners.
Cost Centers Method of Accounting:
John and Mary Farmer want to know about (1) cost of production between farms and (2) total profitability among the produces on yearly basis and their differences. They are in search of a managerial accounting procedure method that can collect data for decision making purposes in future.
The approach of case is activity based costing; they have created cost centers to support managerial accounting process. The cost center for his farm equipment, work shop and maintaining the farm equipments expenses and production cost centers every phase of production system. Thus it forms a profit center for each crop (Corn or Soybeans) for all years. There would be separate cost center for common expenses, sales expenses and office expenses including the cost of finance.
The solution is a progressive form of managerial accounting in which the farmer John and Mary will get broad indication from their balance sheets and cost center data about the areas of control over costs. The agriculture produce gets a price as dictated by the market and the farmer has no choice on selling price of his crop, therefore the profitability of farm depend on the cost. The variable that farm owner can control is cost. This ABC system of farm accounting helps management to take vital decisions for their enterprise.
The ABC management accounting system as followed in John and Mary Farmer case gives FBS software generated reports (1) Service center allocations to Crop Production Center (2) Corn Own Farm Cost Center which takes internal sales at cost price (3) Corn marketing project showing production and processing expenses $ basis as well as bushel basis. And thus Farmer gets to know about (4) Corn Profit Center Income Statements and (5) Inventory changes.
The exclusive accounting method used in the case study of The Factory Tour wherein Steinway is making piano rims as a single continuous piece and using the activity based pricing makes it prudent to use it in farmer enterprise as well.
The proposed accounting system in the John and Mary Farmer case will give information to the farmer that the farmer can use for making the cost down so that the profitability should improve. The system is complex for an ordinary farmer and he will have to use sophisticated software to use the management accounting techniques as used in the case study.
While the alternative solution suggested in the case deals with the relationships of centers with accounting system which is basic and traditional. It uses three centers (i) support cost that accounts for costs of equipment use, work shop and maintenance costs (ii) Production or Operation Cost Center includes costs of harvesting, drying processing and storage, the general expenses, admin and sales costs forms part of production cost. These cost centers are made for each year separately.
However if the farming enterprise does not use ABC that is activity based costing as used in Farmer Council Case there are some decisions that a farmer can not take on the basis of the management accounting reports. Some farm decision become dysfunctional and can not be taken on the basis of traditional system of cost allocation based accounting. The components of cost going into a crop production or in processing or in marketing are not separately in the alternate solution as given in the Farmer Council Case.
The first solution given in case, based on Activity Based Costing method of accounting, is more appropriate to be adopted as an accounting method for a farm that helps better decision making by the owner of enterprise which the very purpose of a management accounting system. Ideally enterprise should follow the GAAP of reporting its financial performance; however in absence of GAAP the Activity Based Costing method of preparing and reporting farm management is more appropriate than traditional system.
A number of farmers do not follow GAAP; the farmers do keep records using the cash system of accounting. Their farm financial statements follow the cash system, while GAAP asks for using the accrual system of accounting, difference in cash and accrual methods being their dealing with the timing of expenses and revenues.
Farmer counts revenues, in cash system, in period of time when he received the money and expenses in period of time when he paid for the expense. In accrual system, revenues are received in the period when they are earned, that is when sale takes place, and expenses when they are incurred, i.e. farmer is expected to pay for expenses.
Accrual system is better than cash system as it matches revenues for time periods with expenses that it made to earn the revenues. Another derivation from GAAP of farm accounting is in valuation of assets on farm balance sheet. Farm balance sheets report farm assets based on the market valuation. In GAAP system the assets are valued on their historical cost, accounting for depreciation etc.
When farm management has no control over prices, farmer has to focus on cost reduction using the target costing. Therefore the cost management in accounting process becomes a necessary tool for farmer to control and budget farm costs, which can be better achieved by the accounting method (Activity Based Costing) as suggested in the Farmer council case.