The FFSC was in general agreement that it
should not prescribe specific financial statement forms. Rather, it should develop general
guidelines to allow for sufficient uniformity of reporting for standardized ratio analysis
and comparative analysis. While many of the issues related to financial statement format
are included in the discussion of specific types of accounts and transactions in the
remainder of the Report, the general background and overall format issues are summarized
in this section.
Balance Sheet (Statement of Financial Position)
The following excerpts are reprinted from paragraphs 26 and 27 of Statement
of Concepts No. 5 (FASB, December, 1984):
26. A statement of financial position provides information about
an entity’s assets, liabilities, and equity and their relationships to each other at
a moment in time. The statement delineates the entity’s resource structure—major
classes and amounts of assets—and its financing structure—major classes and
amounts of liabilities and equity.
27. A statement of financial position does not purport to show
the value of a business enterprise but, together with other financial statements and other
information, should provide information that is useful to those who desire to make their
own estimates of the enterprise’s value. As a result of limitations stemming from
uncertainty and cost-benefit considerations, not all assets and not all liabilities are
included in a statement of financial position, and some assets and liabilities that are
included are affected by events, such as price changes or accretion, that are not
recognized. Statements of financial position also commonly use different attributes to
measure different assets and liabilities.
In general, current practice in agriculture is consistent with the
above definition of a statement of financial position. Primary areas of disagreement
relate to the selection of "measurement attributes" for various categories of
assets and the interpretation of recognition criteria (discussed later). There may also be
some disagreement with the statement that a balance sheet (if prepared using market
values) "does not purport to show the value of a business enterprise." However,
on further reflection, it seems reasonable that even a market value-based balance sheet
represents only an estimate of tangible asset market value, and true value can only be
determined from an actual sale of the asset(s) to a third-party purchaser.
The general FFSC recommendations relating to balance sheet format are
as follows:
| 1. |
Segregation of assets and liabilities into current and non-current
categories on the balance sheet is required. In considering guidelines for further
segregation of non-current assets and liabilities, the FFSC determined that materiality
should guide the preparer as the major determinant of whether a specific asset and
liability category should be separately identified on the balance sheet. At a minimum, the
balance sheet should separately identify the following non-current asset categories: a)
machinery and equipment, b) breeding livestock, c) buildings and improvements, and d)
land. Other non-current asset categories expected to be disclosed on the majority of
agricultural balance sheets include investments in capital leases, investments in
cooperatives, investments in other entities, retirement accounts, and personal assets.
Under non-current liabilities, at a minimum, the balance sheet should separately identify
the following categories: a) real estate debt and b) notes payable, other than real estate
debt. The FFSC considered at length whether or not to adopt a balance sheet format that
includes a further segregation of non-current assets and non-current liabilities into
intermediate and long-term classifications. This particular format is in fairly wide use
in the agricultural sector, arising from the substantial investment in, and different
financing arrangements for, real estate and all other capital assets. Indeed, many
analysts find it useful to compare long-term liabilities (defined as having an initial
maturity of greater than ten years) to long-term assets (definitions vary, but generally
include real estate assets) to determine whether or not debt is structured consistently
with asset life in an operation, and to evaluate overall balance sheet structure. A
similar comparison is usually made of intermediate assets and intermediate liabilities.
While we agree that examination of the structure of an enterprise’s capital assets
and liabilities is an important part of overall financial analysis, we did not feel that
the intermediate/long-term categorization added substantively to an analyst’s ability
to perform that analysis, as long as a reasonable segregation of non-current asset and
non-current liability accounts is shown on the balance sheet. Further, as diversification
increases in the types of asset holdings, the terms of financing arrangements, and other
liabilities of farm enterprises, it is more and more difficult to develop a definition of
these two categories that can be consistently applied to all operations. For example, the
traditional definition of intermediate liabilities (original maturity greater than one
year and less than or equal to ten years) would result in the currently popular balloon
financing loans on real estate (with terms of five to ten years) being disclosed as an
intermediate, not long-term, liability. Finally, the additional balance sheet
classifications force certain liabilities—deferred taxes and personal liabilities are
two examples—to be segregated in a manner that is not particularly meaningful.
For these reasons, the FFSC believes that a migration away from the three-category
balance sheet will occur. However, in terms of the guidelines embodied in this Report, a
three-category balance sheet is acceptable in cases where the preparer feels such
segregation is substantially more informative to the user of the statement, and the
definition used to segregate the intermediate and long-term categories is clearly
disclosed in the financial statements. |
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| 2. |
A proper analysis of the borrowing capacity of an agricultural entity
requires information relative to both the cost and the fair market value of its capital
assets. If financial statements are prepared by an independent CPA in accordance with
GAAP, generally cost less accumulated depreciation will be utilized for the valuation of
capital assets. Market value information may be disclosed in the independent CPA’s
report as supplemental information, upon which the CPA expresses no opinion as to the
fairness of such information. In the preparation of personal financial statements, GAAP
allows the presentation of assets at fair market value, but for business assets this
disclosure should be shown as a single line investment amount on the balance sheet with
footnote disclosure of the individual asset and liability values.
However, as long as both market value and cost information are provided, it is
acceptable for an agricultural producer to utilize alternative balance sheet formats for
capital asset presentation. Acceptable alternatives would include the following: a)
showing market values on the face of the balance sheet with parenthetical, footnote, or
supporting schedule disclosure of cost and accumulated depreciation amounts; and b)
utilizing a double-column approach to presenting the balance sheet. |
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| 3. |
The owner equity section of the balance sheet should contain at least two
components—a valuation equity component and a retained earnings/contributed capital
component. The valuation equity component represents the difference between the net book
value (cost or other basis not charged as an expense) and the balance sheet value (net of
deferred taxes) of all farm assets whose value changes are not reflected on the income
statement—breeding stock, machinery, real estate, etc. The retained
earnings/contributed capital component—retained earnings in the business plus capital
contributions of the owners—represents the remainder of owner equity. If possible,
this component should be further segregated, and the amounts attributable to contributed
capital and retained earnings separately identified. |
Income Statement (Statement of Earnings and Comprehensive Income)
The following excerpts are general statements reprinted from paragraphs
30 and 31 of Statement of Financial Accounting Concepts No. 5 (FASB, December,
1984):
30. Statements of earnings and comprehensive income together
reflect the extent to which and the ways in which the equity of an entity increased or
decreased from all sources other than transactions with owners during a period. Investors,
creditors, managers, and others need information about the causes of changes in an
entity’s assets and liabilities—including results of its ongoing major or
central operations, results of its incidental or peripheral transactions, and effects of
other events and circumstances stemming from the environment that are often partly or
wholly beyond the control of the entity and its management.
31. Effects of an entity’s various activities,
transactions, and events differ in stability, risk, and predictability, indicating a need
for information about various components of earnings and comprehensive income. That need
underlies the distinctions between revenues and gains, between expenses and losses,
between various kinds of gains and losses, and between measures found in present practice
such as income from continuing operations and net income.
The above comments are particularly useful for FFSC consideration,
because of the distinction between "earnings" and "comprehensive
income." Earnings are defined as what the entity has received or reasonably expects
to receive for its output (revenues) and what it sacrifices to produce and distribute the
output (expenses). Earnings also include results of the entity’s incidental or
peripheral transactions and some effects of other events and circumstances stemming from
the environment (gains and losses). Comprehensive income is a broad measure of the effects
of transactions and other events on an entity during a period. It comprises all changes in
the entity’s equity recognized from transactions and other events and
circumstances—except those changes resulting from investments by owners and
distributions to owners.
For analysis purposes, the FFSC recommends the following: (a) the
general income statement format should include a calculation of gross revenues and net
farm income, both on an accrual adjusted basis; (b) a charge for unpaid family labor and
management should not be included on the income statement; and (c) incidental
revenue and expenses should be separately reported on the income statement after net farm
income. Income from non-farm related sources (wages and personal asset income) should not
be shown on the income statement, but reflected on the statement of owner equity (net
worth).
Statement of Cash Flows
Recently, there has been substantial discussion by the accounting
profession about the format and use of the statement of cash flows. Starting in 1989, GAAP
required the inclusion of the statement of cash flows, instead of the statement of changes
in financial position, in a complete set of financial statements.
Although not necessarily consistent with the prescribed GAAP format,
the historical cash flow statement has been used extensively by agricultural lenders and
agricultural producers and is, therefore, a very familiar concept. The decision facing the
FFSC was whether to recommend a format for the statement of cash flows that is consistent
with GAAP, but somewhat different from the format traditionally used by the agricultural
finance community.
The major difference between the two formats is that GAAP requires that
cash flow activities resulting from operating, investing, and financing decisions be shown
separately. Further, GAAP allows the reporting of cash flows from operating activities
using either the direct method ( by showing major classes of operating receipts and
payments) or the indirect method ( by adjusting net income to reconcile it to net cash
flow from operating activities). The accounting pronouncements that cover the Statement of
Cash Flows "encourage" enterprises to use the direct method. When the direct
method is used, a reconciliation of net income and net cash flow from operating activities
is required to be provided in a separate schedule. (An example of the direct method and
the supporting reconciliation is included in Appendix B).
The individual line items contained in a statement of cash
flows prepared in accordance with GAAP using the direct method are consistent with the
categories, or groups of categories, found on a typical agricultural cash flow statement.
Therefore, we see little theoretical or practical reason to suggest anything other than
adoption of the GAAP-consistent format. However, we do not feel the separate
schedule reconciling net income to net cash flow from operating activities needs to be
prepared when the income statement separately identifies the cash and accrual adjustment
components of major revenue and expense items. (An example of this type of income
statement is included in Appendix A.)
Statement of Owner Equity (or Statement of Net Worth)
"Owner equity" and "net worth" are terms often used
interchangeably by non-accountants and which mean essentially the same thing — the
value of the interests of the owner(s) after subtracting from the value of the assets the
total of the claims of creditors. However, the convention generally followed is:
- Use the term "owner equity" when presenting a statement for only a business
enterprise and which statement contains no information for an individual person.
- Use the term "net worth" when presenting a statement for an individual person
or a statement for a business enterprise which also contains information for an individual
person.
The format of this statement is driven directly by decisions made in
the selection of valuation alternatives on the balance sheet, as well as certain types of
non-recurring items that may, or may not, be included in the income statement. It is
critical that this statement reconcile the equity amount shown at the beginning of the
period with the end of the period.
The statement of owner equity (or statement of net worth) plays an
especially crucial role when financial statements are not derived from a double-entry
accounting system—it serves as a final check on the reasonableness of the numbers. |
