Government Loan Programs

One of the major components of government farm programs is the opportunity to place crops under loan with the Commodity Credit Corporation (CCC) at a set "loan rate" for a period up to nine months. The producer has the option of either repaying the loan plus accrued interest or forfeiting the crop to the CCC and keeping the loan proceeds (no interest is charged). Because of this ability to forfeit the collateral in return for loan forgiveness, treatment of the loans on agricultural balance sheets has evolved into three basic approaches:

1. Inventory pledged as collateral on the loan is shown on the balance sheet at the higher of market value or the loan rate. The CCC loan principal amount is shown as a current liability. Accrued interest is shown only to the extent that market price of the collateral exceeds interest due.
2. Basically the same as approach number 1, except that loan and accrued interest are not shown as a current liability. They are netted against the inventory amount, and the resulting net equity, if any, is shown as inventory. The gross amount of inventory and the CCC amounts are usually disclosed as well.
3. The GAAP approach requires showing the CCC principal amount and total accrued interest as current liabilities. The inventory is shown at market value, unless that is less than the principal and interest owed. If it is, the inventory is written up to equal the total of the liabilities.

Proponents of the net equity approach, number 2, argue that it reduces distortions in the current ratio and other measures caused by heavy utilization of what is essentially "free" debt. They argue that many producers utilize the loan programs merely as a cash management tool and would not require that much outside debt funding. Further, since use is heaviest when market price is substantially below loan rates (implying large amounts of default), the loan is essentially a sale of product even though title has not yet passed.

For credit analysis purposes, the FFSC recommends adoption of approach number 1 as the acceptable method of handling CCC loans.

While the FFSC feels the GAAP approach, number 3, is the most desired method, it would create major problems for most systems utilizing a cash-to-accrual approach for deriving an accrual adjusted income statement. Since the write-up of inventory and the offsetting accrued interest charge will not be turned into cash transactions, it would have the effect of overstating both VFP and interest expense in the year the loan was reflected on the balance sheet, and then understating it in the following year. Or, conversely, it would require a continual tracking of the accrued interest amounts on individual loans that the producer may have no intention of repaying. Finally, with loan programs longer than nine months, such as the Farmer-Owned Reserve and CCC extensions, the accrued interest amount can become very large and even more potentially distorting.

The final issue related to government loan programs is the income treatment of the proceeds. There was strong agreement among the FFSC members that, for analysis purposes, CCC loan transactions should not be treated as a sale of inventory until title has passed (loan was forfeited), regardless of the "intent" of the producer or the tax treatment followed.