Agriculture Reference
In-Depth Information
process occurs. These “bits” that are going to the customer are listed as depreciation expense
for the current period.
The primary purpose of the income statement is to match precisely the expenses and the
revenue from the business generated during that period so that management can accurately
measure business profi ts and, thus, performance. This profi t can then be compared to the
asset base of the fi rm to begin to evaluate management performance and fi nancial progress.
Accounting on a cash versus an accrual basis
The
cash-basis approach
to preparing an income statement implies that revenues and
expenses occur when cash is received or paid. Many agricultural producers and some small
agribusiness fi rms use this approach. The
accrual approach
says that revenues and expenses
truly exist whenever they are earned or incurred regardless of when the cash transaction
occurs. The accrual approach is a much more accurate approach for reporting net profi t
for a fi rm, because it more closely matches the expenses incurred during a period to the
revenue earned.
If a cash-basis income statement is used, the net income reported can be misleading. Cash
net profi t can understate true accrual net income to the extent that:
•
Revenue is earned but not converted to cash—such as an increase in accounts receivable
or an increase in the amount of product stored or held in inventory.
•
Expenses are incurred during prior or later years but cash is paid this year. Examples are
a decrease in accounts payable, a decrease in accrued expenses, an increase in prepaid
expenses, or an increase in purchased supplies.
Cash net income can overstate true accrual net profi t to the extent that:
•
Revenue generated in prior years is converted to cash this year—as in the opposite of
that discussed above.
•
Expenses are incurred this year but paid in cash in a prior or later year—as in the
opposite of what was discussed above.
Cash record systems can be used to generate an “accrual adjusted” measure of net income by
systematically adjusting the cash revenue for changes in certain inventory accounts, accounts
receivable, etc., and by adjusting cash expenses for changes in accounts payable, accrued
expenses, etc. These adjustments refl ect the difference between the amounts shown in these
accounts on the beginning and ending balance sheets for the year. The difference can be
substantial. A study evaluating the difference in cash versus the accrual-adjusted net
farm income for 1,045 farm operators in Illinois found that the average annual percentage
difference for 2002-6 was 62 percent (Barnard et. al. 2010). Hence, the more accurate
approach to reporting net income is to use the accrual approach. This approach will be used
in the discussion that follows.
Income statement format
The format for the income statement varies somewhat from business to business, but such
statements generally begin with sales and subtract the appropriate expenses, with profi t
showing as a remainder.
