Understanding Basic Accounting Concepts: Assets, Liabilities, Equity, Income, Expenses, Schemes and Mind Maps of Business Finance

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Instructor Guide

Module 2: Accounting

83

The Business of Indian Agriculture

MODULE 2: Accounting

Total time: 7 hours, 30 minutes Lessons This module covers the following lessons:

• Basics of Agribusiness Accounting & Bookkeeping.
• Journals and Ledgers.
• Preparing Financial Statements.
• Analyzing Financial Statements.
• Preparing for Credit Applications. Room Setup: Table rounds of 5-6 participants each. Each table with participant workbooks, pens and notepaper. Two flipcharts and easels with marker pens in front of room. [Instructor Notes]: If this is the first lesson of the training, you will want to spend time with welcoming remarks, introductions, an overview of the agribusiness curriculum, and the agenda for the day. It may also be helpful to establish ground rules for communication and conduct during the training sessions.

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LESSON 1: Basics of Agribusiness Accounting & Bookkeeping

Total time: 1 hour, 45 minutes Lesson Topics This lesson covers the following topics:

• What is agribusiness accounting and bookkeeping?
• Basic accounting concepts.
• The importance of recordkeeping. Learning Objectives Upon completion of this lesson, participants will:
• Understand the basic definition of accounting and its importance to agribusiness, and will know the difference between accounting and bookkeeping.
• Understand basic accounting concepts, including assets and liabilities, equity, income and expenses, inventory and depreciation.
• Understand the importance and basic considerations of recordkeeping. Definitions Accounting: the business function that involves the preparation, review and understanding of the financial situation of an agribusiness. It has two purposes: to provide an accurate picture of the financial situation of a business, and to develop a set of standard financial documents that others can use to assess the finances of the business. Accrual Accounting: the type of accounting that records income when it is earned (not yet received) and expenses when they are incurred (not yet paid). Assets: financial holdings that represent a company’s net worth by accounting for the things of value in a business. Assets include cash on hand, cars and trucks, property and land, equipment, and outstanding claims. Some assets are more intangible, such as patents and trademark rights. Bookkeeping: the business function that involves the actual recording of the business transactions into various record books, journals or ledgers. Cash Basis Accounting: the type of accounting that records the cash that you receive as income when it is received, and records expenses when they are paid out. Please turn to PAGE 71 of your participant guide.

86 Cash Flow: the accounting of cash receipts and payments over a period of time. Cash flow can be analyzed as a report that summarizes past cash flow, or as a planning budget that forecasts cash flows into the future. Cost of Sales: the expenses and labor that are needed to produce the product or service to be sold. It is also referred to as the “cost of goods sold.” Depreciation: the deduction of value of a tangible asset over the useful lifetime of that item. Most businesses, including agribusinesses, can treat depreciation as a business expense. Expenses: financial flows that represent money going out of the agribusiness. Expenses can be categorized as recurring (or operating), such as monthly payments for utilities, salaries and wages, rentals and credit payments. Other expenses may be irregular (or incidental), such as repairs or one-time purchases. Income: financial flows representing money coming into the agribusiness. Income can be generated from a number of sources, such as sales of various products or services, bank interest, or rental or leased property. It can also be from investments into owner equity, and loans and credit. Inventory: this is the physical count of all the agribusiness’s assets and their value. Liabilities: financial holdings that represent a company’s obligations to pay out value from the business. Liabilities are the opposite of assets, and are those things owed by a business, including accounts payable and debt. Owner’s Equity: the difference between the business’ assets and liabilities. It is also sometimes referred to as the business’s “net worth.” Profit and Loss: the agribusiness’s revenue minus the cost of sales. It is also referred to as the “profit margin.” It is often considered the agribusiness’s bottom line - whether the agribusiness is making money or not. Recordkeeping: the orderly recording and safe storage of all business documents and activities. Recordkeeping is a term that is often used interchangeably with bookkeeping, however, strictly speaking, bookkeeping is more specific to financial matters and accounting functions.

88 o Bookkeeping, on the other hand, is the actual recording of the business transactions into various record books, journals or ledgers. This is often done with computers, but can also be done by hand.  Recordkeeping is a term that is often used interchangeably with bookkeeping. Strictly speaking, recordkeeping involves the orderly recording and safe storage of all business documents and activities while bookkeeping is more specific to financial matters and accounting functions. o For example, bookkeeping would include the recording of transactions in journals and ledgers, and the storing of copies of the invoices (billing) of customers and of the payments received. Accounting would include analyzing the journal and ledger entries (and perhaps the stored copies) to determine the current cash flow of the business in order to prepare a Statement of Cash Flows. o Both accounting and bookkeeping are necessary, not only to run a successful business, but also to successfully apply for credit, government assistance programs, or claims for discriminatory practices.  Good bookkeeping and accounting is also necessary for business ownership restructuring, crop and other insurance, land dealings and much more.  The technical skills required for accounting and bookkeeping are not especially difficult. However, successful accounting and bookkeeping require someone who is good with details, is orderly in their work, has strong basic math skills, and above all, approaches the tasks with a good attitude. Knowing how to use a computer is a definite plus. o Accounting and bookkeeping is not for everyone. Sometimes, the best decision you can make is to recognize that accounting and bookkeeping is not for you, and to hire someone to do that work. o Finally, all financial business transactions and holdings should be separated from your personal and household finances. This means separate bank accounts, credit cards, accounting and bookkeeping.

89 Activity (20 minutes): In small groups of 2-3, have participants read the following case study and then answer the discussion questions. Then discuss as a large group. Case Study: Jeff, the Farm Equipment Repair business, and the retired dad. Jeff worked at his dad’s farm equipment repair business for years, and learned to fix just about anything. He loved his work, and he had earned a reputation as someone who you could depend on to do the job right. His dad managed the parts supply and the money side of the business. Jeff was the main mechanic, and that left him free to do what he really loved: work on tractors and other farm equipment. Last spring, Jeff’s dad retired and Jeff took over the entire business. Before, when his dad ran the business side of things, Jeff would simply toss receipts or payments in the inbox on his dad’s desk, and go on to his next chore. Now, with his dad retired, Jeff kept doing the same thing: tossing papers on his dad’s desk. Except now it was his desk, and the inbox had turned into an in-pile. Also, Jeff now had to deal with the parts supply business and so there were order forms, invoices and receipts to handle. Checks had to be written, deposits had to be made, and someone had to go through all that mail that kept coming every day. Jeff still loved to be a mechanic, so he spent as little time on paperwork as possible. In fact, he really disliked the paperwork, so he found lots of reasons to put off dealing with it. Things went along fine for a while, until one day in late March, when he got a call from the bank telling him that his checking account was over-drafted. Jeff put the phone down, walked over to his desk, and looked at the mountain of papers. He had been thinking about applying for a loan to buy a new work truck. Now the bank was telling him his checking account was empty. He realized he didn’t know what to do, or where to start. Questions: What basic accounting and bookkeeping issues does Jeff need to understand and appreciate? Besides the bank overdraft, what other problems do you see for Jeff’s agribusiness? What do you think Jeff should do?

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TOPIC 2: Basic Accounting Concepts

[Instructor Notes]: This topic provides students with knowledge of basic accounting concepts, including assets and liabilities, equity, income and expenses, inventory, and depreciation. Time: 45 minutes Materials: Flipcharts, marker pens, Crossword Puzzle. Learning Outcome: Students will understand basic accounting concepts, including assets and liabilities, equity, income and expenses, inventory and depreciation. Activity (30 minutes): There are nine major accounting concepts defined below. Divide the class into groups of 3-4, and assign each group a few of the concepts to read, discuss and present to the rest of the class. Encourage them to think of examples from their experiences with business. Give them about 15 minutes to read and prepare and 2-3 minutes to present, and then discuss the concepts with the entire class.  There are a number of basic accounting concepts that need to be understood before accounting decisions can be made for a successful agribusiness. In this lesson, the following basic accounting terms will be introduced and discussed, which will lay a foundation for the next lessons in the Accounting module: o Types of Accounting - Cash Basis or Accrual: there are two main types of accounting, and you can choose the one that fits your agribusiness the best.  Cash Basis accounting records the cash that you receive as income when it is received, and records expenses when they are paid out.

• Cash Basis accounting works well for businesses that do not have large inventories, or are service-orientated. It is the simpler type of accounting and is favored by small businesses.
• Many farm operations use Cash Basis accounting because it is easy to shift income and expenses into different tax years by timing the transactions.  Accrual accounting records income when it is earned (not yet received) and expenses when they are incurred (not yet paid).
• In this type of accounting, revenues are matched with their associated expenses, and are recorded when the business activity happens, not when money is exchanged.
• It is a more complicated type of accounting, but provides a more accurate financial picture. For this reason, most large businesses use Accrual accounting.

92 o Income and Expenses: these financial concepts represent money coming into the agribusiness (as income) and money going out of the agribusiness (as expenses).  Income can be made from a variety of sources, such as sales of products or services, bank interest, or rental or leased property. It can also come from investments in owner’s equity, and from loans and credit.

• If an agribusiness has multiple product lines or service offerings, it may make sense to have separate income accounts so that you can track the income of each line of your agribusiness. However, too many income accounts can become difficult to manage.
• The term revenue is often used interchangeably with income. Strictly speaking, revenue includes all sources of money coming into the company, while income is money coming in minus expenses (often called net income).  Expenses can be categorized as recurring (or operating), such as monthly payments for utilities, salaries and wages, rentals, and credit payments. Other expenses may be irregular (or incidental), such as repairs or one-time purchases.
• Expense accounts can also be separated by different business lines if they are unique to particular products or services.
• A reserve or emergency fund is often kept as an account for unexpected expenses. o Cost of Sales: this is the expenses and labor that were needed to produce the product or service to be sold. It is also called the “cost of goods sold.”  It can include packaging, storage and transportation costs.  In many service-related agribusinesses, there may be no cost of sales involved. o Profit and Loss: this is the agribusiness’s revenue minus the cost of sales. It is also referred to as the “profit margin.” It is often considered the agribusiness’s bottom line - a measure of whether the agribusiness is making money or not.  If revenue minus cost of sales is positive, then a profit is being made.  If revenue minus cost of sales is negative, then a loss is happening.

94  There are two main methods of determining inventory value: book value and market value.

• Book value represents the original cost of an item minus depreciation. This is usually used for tax purposes and estate planning.
• Market value represents the book value minus additional costs (such as transportation or marketing costs). This is typically used for insurance and credit purposes.
• There are many variations of the two main inventory methods. Whichever method is chosen, it should be used consistently throughout the years. o Depreciation: this is the deduction of value of a tangible asset over the useful lifetime of that item.  Most businesses, including agribusinesses, can treat depreciation as a business expense.
• Depreciation of agricultural machinery, buildings, equipment and storage facilities represents a major agribusiness expense.
• Capital improvements, such as a new roof, remodeling or building additions are also subject to the same depreciation principles.  There are various ways to calculate depreciation. One popular and simple method is called straight-line depreciation. The depreciation per year is calculated by dividing the value of the asset over the expected life of the item. Activity (15 minutes): In small groups of 2-3, have participants discuss and complete the Crossword Puzzle. Go through the answers as a large group and discuss any questions. [Instructor Notes]: Recap the topics in the lesson and the learning objectives. Ask participants if the learning objectives were achieved.

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TOPIC 3: The Importance of Recordkeeping.

[Instructor Notes]: Highlight the title and learning objectives for this topic. This topic provides students with an understanding of the importance of good recordkeeping and the basic steps needed to develop and use a recordkeeping system. Time: 30 minutes Materials: Flipcharts, marker pens, Planting and Harvesting Worksheet. Learning Outcome: Students will understand the importance and basic considerations of recordkeeping.  Recordkeeping is the orderly recording and safe storage of all important business documents and activities. Recordkeeping is a term that is often used interchangeably with bookkeeping, however, strictly speaking, bookkeeping is more specific to financial matters and accounting functions. o Recordkeeping involves the documenting and storing of evidence of all the major functions, systems and processes associated with a business. o Recordkeeping is based on a basic principle that, “if it isn’t in writing, then it didn’t happen.” o Recordkeeping is necessary for a variety of critical agribusiness needs, including:  Applying and securing capital loans and investments;  Tracking crop inputs and yields and/or herd management;  Making insurance claims for crop and/or livestock losses;  Applying for conservation programs;  Preparing financial statements and performing basic accounting;  Paying taxes;  Strategic and budget planning;  Managing employees;  Tracking customers and marketing;  Tracking inventory, equipment and machinery;  Managing product and/or service development and delivery;

97  This includes making backup copies in case your primary copy is lost or damaged. Depending on the frequency of entries, you may want to make regular backup copies on a daily, weekly or monthly basis.

• Backup copies should be kept in an entirely separate system and location. So, for example, if you have a system that resides on your office computer, then your backup should be on an external storage device outside your office (and perhaps building). Or, the data could be stored in a “cloud” (online storage) app.
• For very important documents, people often use a bank’s safe deposit box and/or fireproof safe storage boxes.  Because your business information is sensitive, it should always be password protected.  If you have field logs to record, consider using durable materials such as heavy stock paper and water-proof containers.  Let’s go through some selected examples of recordkeeping. In the tables below, review the record templates with the information given. o To record harvest data, record the harvest date, crop, field and the quantity harvested. If your harvest will be stored or delivered in certain ways, you can add additional information such as a lot or other identifying number.  You can also add information about the harvesting equipment used and when it was cleaned, buyer’s information or storage locations. **CROP HARVEST RECORD Harvest Date Crop or Product Field

Quantity Harvested Lot #** 08/27 Sweet Corn 2 25 bushels 32 08/29 Tomatoes 4 59 lbs. 13 o To record sales data, record the sales date, item, quantity sold, buyer and price. You can add additional information such as lot or other identifying number that would allow to you track the items to the harvest record.  Your buyer information could also link with a customer record template, which would contain more information about each customer and their purchasing history.

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SALES RECORD

Sell Date Item Units Buyer Unit Price 08/30 Sweet Corn 150 ears Lakeside Market 4/$ 09/02 Tomatoes 30 cartons CSA $2/cnt. Activity (15 minutes): In small groups of 2-3, have participants discuss and complete the Planting and Harvesting Worksheet. Go through the answers as a large group and discuss any questions. [Instructor Notes]: Recap the topics in the lesson and the learning objectives. Ask participants if the learning objectives were achieved. References Farmers Legal Action Group (FLAG). nd. Recordkeeping Instructions and Templates for Small-Scale Fruit and Vegetable Growers. St. Paul, MN: FLAG. Intertribal Agriculture Council. 2004. A Guide to Financial Record Keeping for Farmers and Ranchers. Billings, MT: Intertribal Agriculture Council. Ricketts, Cliff and Kristina Ricketts. 2009. Agribusiness: Fundamentals and Applications, 2nd Edition. Clifton Park, NY: Delmar Cengage Learning.

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The Business of Indian Agriculture

MODULE 2: Accounting

LESSON 1: Basics of Agribusiness Accounting & Bookkeeping

TOPIC 2: Basic Accounting Concepts

Crossword Puzzle

Answers 1 2 3 4 5 6 7 10 13 8 11 12 9 ACROSS 1 The physical count of all the agribusiness’s assets and their value. 5 The deduction of value of a tangible asset over the useful lifetime of that item. 6 The preparation, review and understanding of the financial situation of an agribusiness. 7 The state of cash receipts and payments over a period of time. 9 The agribuisiness’s revenue minus the cost of sales. 10 The difference between the business’s assets and liabilities. 12 The expenses and labor needed to produce the product or service to be sold. 13 Financial holdings that represent a company’s obligation to pay out value from the business. DOWN 2 Financial flows representing money going out of the agribusiness. 3 The type of accounting that records income when earned and expenses when incurred. 4 The recording of business transactions into record books, journals and ledgers. 8 Financial holdings that represent things of value owned by the company. 11 Financial flows represented money coming into the agribusiness.

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The Business of Indian Agriculture

MODULE 2: Accounting

LESSON 1: Basics of Agribusiness Accounting & Bookkeeping

TOPIC 3: Importance of Recordkeeping

Planting and Harvesting Record

Instructions: Complete the Planting and Harvesting Record below as follows: Crop: name of the crop. Field: where the seed or plant is planted on your farm. Planting Date: date the crop seed was planted, or date the crop plant was transplanted to the land. Acres or # rows: number of acres or number of rows planted for each crop. Harvest dates: dates the crop is harvested. Harvest units: amount of harvest in units appropriate for each crop. The information you are to record is as follows:

• You planted five acres of sweet corn seed in field # 3 on May 17, and harvested 1,100 crates on August 4th.
• Ten rows of zucchini seed were planted in field # 1 on May 22, with 500 lbs. harvested on July 20.
• You planted 25 acres of alfalfa seed in field #5 on May 10, with the first cutting on July 10, which yielded 7 tons per acre. **PLANTING AND HARVEST RECORD Crop Field # Planting Date Acres or

rows

Harvest Date Harvest Units**