Like it or not, bookkeeping is an essential farming chore. Financial records need to be in proper order for tax planning, conversations with suppliers and lenders, and strategic planning.
But if bookkeeping isn’t at the top of your to-do list, you may not have given a lot of thought to the method you use. There are two basic accounting methods: cash basis and accrual.
Cash basis method
Most farmers are allowed to use the cash basis method to report income and expenses for their tax returns. It’s also the simplest of the two methods. Basically, farmers report transactions when cash comes in or goes out.
This method gives farmers flexibility and allows them to change the impact of taxable income. For example, they can wait until the next calendar year to sell grain or cattle, which defers reporting the income. And they can pay for some expenses ahead of time, like fertilizer or seed that will be used in the next year. (Note: Prepaid expenses cannot exceed more than 50% of total expenses for the calendar year, and farmers have to complete a purchase, not just make a deposit.)
Capital expenses also come into play. Under this accounting method, equipment purchases that are made with cash or credit can be deducted in the current year, as long as assets are placed in service that same year.
Accrual basis method
While not quite as simple, the accrual basis method offers benefits for farmers, too. Among them, it gives farmers a better financial picture of their operations because revenue and expenses are aligned within the same reporting cycle.
Here’s how it works: If you receive an invoice for seed, it’s recorded as payable. The seed inventory or expense offsets the entry until the invoice is paid. Then, the payable is reduced to zero.
This method requires inventory to be recorded (e.g., the amount of grain in storage at current market rates). While it’s an extra step, recording inventory, prepaid expenses and payables gives you a better picture of assets and working capital. It also makes it easier to manage and predict cash flow.
Most financial institutions prefer the accrual method when they’re evaluating loan applications because it gives them more insight into your operation’s profitability.
The best of both worlds?
For many producers, it’s allowable to keep records using the accrual method, but use the cash method for tax reporting. It’s also possible to switch methods, with the help of a qualified tax professional.
Farmers need to find the right accounting method and apply it across the business so financial records are accurate and when they’re needed.
How Wipfli can help
With deep knowledge and experience in agribusiness, accounting and tax, Wipfli can help you choose the right financial reporting method for your farm. We can also create a tax strategy to meet future goals and sustain your land and wealth for generations. Contact us today.