There was considerable discussion and
debate among the FFSC members about the utilization of the "Value of Farm
Production" (VFP) measure on the income statement. The VFP approach is widely used in
certain parts of the country and with certain types of operations and not used at all in
other regions. Those who oppose the VFP concept suggest that a more traditional
revenue/expense format for the income statement is appropriate.
Value of Farm Production. VFP is a term that is unique
to farm earnings statements. It was developed in an effort to provide a value-added
measure and a better means of comparing two operations than total gross revenue.
Basically, it is computed as the gross revenues of an operation less the purchases of
assets that are included in the calculation of gross revenue. An example is purchased
feed, since the change in feed inventory is a normal accrual adjustment. Accountants might
first think that these items represent the cost of goods sold, but, in fact, the
deductions from gross revenue usually include only the purchase cost of materials and
almost never include any direct labor or overhead.
Further, VFP is a measure based on market value, since most of the
gross revenues include a component for the change in the market value of held inventories.
Traditionally, gross revenues included revenues (cash sales, inventory
and receivable changes) from crops, livestock products, government program payments, and
other farm income. Deductions from this amount were made for the purchase cost, primarily
of two items—feeder livestock and purchased feed—to arrive at VFP. If breeding
livestock were handled as an inventory item, then purchases of breeding animals were also
deducted to arrive at VFP.
Advantages of VFP:
- VFP provides an overall measure of production that is not distorted by purchases of
inventory late in the operating cycle. For example, a cattle feeder purchased $100,000 of
feeder cattle on December 31. This transaction, because of the practice of arriving at
gross revenues by adjusting cash sales by the change in inventory at market, would result
in a $100,000 increase in revenue, even though the newly purchased cattle would have just
entered the operating cycle of the operation. Since VFP reduces gross revenue by the cost
of purchased feeder cattle, VFP for this operation would not be affected by the late
inventory purchase. This type of distortion is also applicable to purchases of feed, as
well as purchases of grain related to CCC loan redemption.
- VFP allows for more accurate comparisons between certain types of operations. The most
common example is a comparison of a cow-calf operator who feeds out all livestock versus a
feeder operator who buys feeder livestock and feeds them to market weight. Assuming both
operations sold the same dollar amount of cattle, they would have the same level of gross
revenue. The cow-calf operator, however, would have much higher operating expenses, such
as labor, depreciation, utilities, etc., because that operation is growing its product
from birth rather than from a weight of 500-700 pounds. Therefore, in evaluating ratios
such as asset turnover or other efficiency measures, VFP proponents argue that the VFP
measure provides a better measure for comparison than does gross revenue, because the
cow-calf operator would have a substantially higher VFP than the feeder operator.
Disadvantages of VFP:
- VFP tends to be inconsistently defined among various users of the approach. Some users
deduct only the cost of feeder livestock to arrive at VFP, others deduct both feeder
livestock and purchased feed, and still others define an even broader range of deductible
items.
- VFP is often misconstrued as a true "value-added" measure. While it may
initially have been intended for that purpose, it rarely provides a true measure of
"value added" by the operation. Finally, it is an incomplete attempt to arrive
at a "gross margin" type of measure for the operation — incomplete because
it includes only a small portion of the expenses that would be included in a traditional
"cost of goods sold" classification.
Gross Revenues. There were a number of FFSC members
who argued that the income statement should reflect only a "gross revenues"
amount and then a categorization of all operating expenses, including the purchase of
"items for resale," such as market livestock, feed, and grain. Proponents of
this position maintain that the interim calculation of VFP does not add substantially to
the usefulness of the income statement, and, in some cases (the livestock producer who
buys all feed, for example), tends to underestimate the basic productive capacity of the
operation. While they acknowledge the usefulness of the VFP measure for comparing certain
types of farms (the cow-calf and feeder example provided above, for example), they argue
that, in the few cases where this type of comparison is actually necessary, the
calculation could easily be performed from information on the income statement.
FFSC Recommendation. The FFSC believes that the issue
of whether to provide, in the income statement, an interim calculation of VFP is primarily
an issue of formatting because a single income statement, which has been formatted either
to show only gross revenue or to also show VFP, will present the same amount of gross
revenue and the same amount of net farm income.
The FFSC generally believes that the Gross Revenue approach to
presenting the income statement should and will evolve as the accepted method for income
statement reporting and as the basis for calculating measures of financial performance to
be included in any national agricultural financial data base. This conclusion is reached
because of the potential for greater acceptance by the accounting profession.
The FFSC recognizes, however, that for certain types of operations, VFP
has merit as an analytical technique for evaluating the financial performance of the
business. Further, many existing data bases, especially those associated with the various
state Farm Business Analysis Associations, utilize VFP.
Therefore, the FFSC maintains its present position of continuing to
recognize both the Gross Revenue and VFP approaches.
If the FFSC eventually adopts the Gross Revenue approach as its
preferred format, these guidelines should continue to include a formal definition of VFP
because of its potential analytical value. In addition, it is recommended that even under
the Gross Revenue approach, that feeder livestock purchased for resale and purchased feed
should continue to be separately identified among the operating expenses and that
purchased items to be consumed as inputs in the production process be listed separately in
the asset section of the balance sheet so that VFP could be calculated.
Including a calculation of VFP in the income statement is at the
discretion of the preparer of the financial statements, as long as the following
conditions are met:
- If VFP is shown on the accrual adjusted income statement, items deducted from gross
revenue to arrive at VFP should include:
- Cost of purchased livestock/poultry for resale, ± the change in inventories of
purchased livestock/poultry; and
- Cost of purchased feed and grain, ± the change in inventories of purchased feedstuff.
Caution: When calculating VFP, care must be taken to avoid double
counting any inventory items being deducted from the gross revenues.
If VFP is not shown on the accrual adjusted income statement, the
expenses relating to the cost of purchased feed and grain and cost of purchased
livestock/poultry for resale should be identified separately from other operating expenses
on the income statement.
|
