Farm clients come to audit firms through their lenders. An operating line, a farm credit loan or a land purchase note usually requires statements with a CPA's report. Farms are seasonal, asset heavy and tax-driven in their record keeping, so the books a firm receives are on a cash or modified accrual basis while the lender asks for GAAP.
This guide covers inventory, program payments and the procedures that fit the farm cycle.
Start with the basis of accounting
Many farm books are kept for the tax return. Pub. 225, the IRS farmer's tax guide, covers the methods a farm may use: cash, accrual, and special methods such as the crop method. Under the crop method, the entire cost of producing a crop is deducted in the year income is realized from it. It is a tax method, and it does not produce GAAP inventory. A farm on the crop method or on cash needs a conversion to accrual for a GAAP audit. The conversion adds growing crops, harvested grain, prepaid inputs, payables, accrued interest and the program receivables described below.
If the lender accepts a tax-basis presentation, the audit is under a special purpose framework. See the cash and tax basis guide. Document the basis in the engagement letter and the planning memo.
Growing crops and harvested crop inventory
ASC 905 gives guidance for agricultural producers. For growing crops, the practice is to accumulate cost until harvest, without remeasuring the crop to fair value. Accumulated cost includes direct costs such as seed, fertilizer, chemicals and labor, plus the machinery, rent and other costs the client can allocate to the crop. Test the allocation method, because it drives the carrying amount.
Harvested crops are carried at the lower of cost and net realizable value, with one alternative. Producers may carry harvested crops at selling price less estimated disposal cost when three conditions are met:
- The product is available for immediate delivery.
- The costs of disposal are predictable and insignificant.
- The product has a readily determinable and reliable market price.
When the alternative is used, the gain is recognized before the crop is sold. The firm's inventory costing guide covers the general model.
Worked example (illustrative numbers). A farm harvests 300,000 bushels of corn at accumulated cost of $1,086,000, or $3.62 a bushel. It delivers 120,000 bushels at harvest and stores 180,000. The year-end bid is $4.05, and disposal cost is $0.15, so net realizable value is $3.90.
- Under lower of cost and net realizable value, stored grain stays at cost: 180,000 x $3.62 = $651,600. No write-down.
- Under the net realizable value alternative, stored grain is carried at 180,000 x $3.90 = $702,000. The $50,400 uplift is recognized in income before the grain is sold.
The audit needs the policy to be applied consistently, and the three conditions to be met for the crop in question.
Test the quantities
Quantity is the first-order inventory risk. Procedures:
- Observation of bins and storage. Observe the physical measurement of on-farm grain, using the client's measurement method and a recomputation of volume. See inventory observation procedures.
- Warehouse receipts and confirmations. Grain stored at elevators or warehouses is confirmed directly with the holder under AU-C 505, including whether the grain is owned, under a storage agreement, or priced under a deferred contract.
- Roll-forward. Production from acreage and yield records, less deliveries, equals the year-end quantity. Compare scale tickets to settlement sheets from buyers.
- Livestock and breeding stock. Count at the date used for the statements, test weights or head counts, and tie to sale and purchase records.
Government program payments and loans
Pub. 225 lists agricultural program payments as a separate topic, including market assistance loans, Conservation Reserve Program payments, crop insurance and disaster payments, and feed assistance. For the auditor, three questions apply to each payment stream.
- When is it earned? A payment tied to production in the year, with eligibility met by year-end, supports a receivable. A payment conditional on future events does not. Review the enrollment documents and the program notice for the conditions.
- How is it presented? Document the accounting policy and the basis for it, and apply it consistently. Payments that offset crop revenue and payments that reimburse costs are presented differently, and the policy says which is which.
- Is the farm eligible? Payment eligibility depends on program rules in the enrollment documents. A payment received and later recaptured is a liability. Obtain the program payment history from the client and compare it to deposits.
Market assistance loans need attention in both the debt and the inventory work. A loan secured by stored grain is debt, and the grain under the loan is pledged. The loan terms decide whether the grain can be sold freely.
Crop insurance indemnities and disaster payments need a documented recognition policy, usually tied to when the claim is approved. Compare the claim worksheets to the yield records, and test whether claim proceeds were for crops that are also included in year-end inventory. Counting both is a known duplication.
Other risk areas
- Land and equipment. Owned versus leased land, related-party leases at off-market rates, and machinery used by both the farm and the owner's other businesses.
- Related parties. Family partnerships and landlord arrangements are routine. Apply related party procedures.
- Debt covenants. Working capital and current ratio covenants depend on inventory values and classification of the operating line.
- Going concern. Low commodity prices and input cost swings can erode the borrowing base. Apply AU-C 570.
PBC list
- Acreage by crop and field, with leases and share arrangements
- Cost accumulation by crop, with input invoices and payroll
- Bin measurements, scale tickets, warehouse receipts and settlement sheets
- Forward contract and deferred pricing detail
- Program enrollment documents, payment notices and market assistance loan statements
- Crop insurance policies, claim worksheets and indemnity payments
- Lender agreements, borrowing base certificates and covenant calculations
- Machinery and land schedules with titles and lease agreements
- Tax return workpapers if books are tax-basis
Red flags
- Year-end grain that exceeds what yield records and acreage can support
- Elevator confirmations that disagree with the ledger, or stored grain also pledged under a loan
- Program receivables for payments that have not been approved
- Cost accumulation that drops sharply in the year of a poor crop
- Inventory carried at market with no support for the three conditions
- Crop method or cash records with no accrual conversion
Sources
- IRS Publication 225, Farmer's Tax Guide
- Accounting for crops (AccountingTools), source for the cost accumulation rule and the three conditions of the net realizable value alternative
- ASC 905 summary (Standards Hub), second source for the same cost accumulation rule and conditions
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AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error