A new year means new revisions to the FFSC Financial Guidelines for Agriculture. Stay up to date by ordering the 2020 edition of our guidelines document.

The Financial Guidelines for Agricultural Production provides recommended standards for format and content of financial reports, recommended financial measures common to all sectors of agriculture, and example statements and measures.

You can order the guidelines here.

What’s new in 2020?

In this edition of the Farm Financial Standards Council’s Financial Guidelines, there are a few important changes to note. As the FFSC integrates new GAAP pronouncements, frequent adjustments are required to the Guidelines. This edition includes updates with respect to leases, hedging, deferred taxes, revenue recognition, and guaranteed debt disclosures.

Many of the changes in this edition affect Appendix B, which is an example of accountant-prepared financial statements. The case farm has not changed. However, fairly extensive changes were made to the financial statements and accompanying footnote disclosures. The financial statements now illustrate the reporting of a couple of different types of hedging strategies (see note 8). The format of the income statement and the statement of owner equity has changed to accommodate reporting other comprehensive income (loss) from certain hedging activities. Also, the income tax rates used in the case were updated, so income tax amounts and deferred tax amounts changed (see note 4). Appendix B now illustrates the new GAAP standard on reporting for operating leases, which requires the addition of an operating lease right-of-use account to noncurrent assets in the balance sheet and the addition of current and noncurrent operating lease liability accounts (see note 11). Other new footnote disclosures were added disclosing revenue from contracts with customers (see note 7), disclosing the fair value of commodity derivatives (see note 9), and disclosing guaranteed debts (see note 12). Note 1 was also updated to incorporate a policy for derivative instruments associated with hedging and options activities. The supplementary information was also updated to conform to changes made to the financial statements. Please note that the footnote disclosures are required by GAAP, whereas the supplementary information is not. The financial measures and ratios included in Appendix D have been updated to reflect the changes made to the financial statements in Appendix B.

One significant recent change in GAAP is a new lease standard. The new standard already applies to financial reporting for publicly-held business entities. It will become effective for business entities that are not public in 2021. It was originally scheduled to go into effect in 2020 for such businesses, but on November 15 2019, the FASB decided to defer its effective date for one year to give not-forpublic business entities more time to prepare for implementing the new standard. Under prior GAAP, operating lease assets and liabilities weren’t recognized on business balance sheets. Under the new GAAP standard, operating leases with a term in excess of one year must be reported on business balance sheets in financial statements prepared in conformity with GAAP. The reporting for capital leases, which are called finance leases under the new standard, is basically the same as under prior GAAP. However, the four criteria previously used to identify a finance lease have been altered and a new fifth criterion has been added. The five criteria applicable under the new standard are discussed in the revised Appendix G in this edition. The FFSC has studied the new GAAP standards related to operating leases and recommends the GAAP approach to reporting operating leases, but also suggests an alternative approach. The recommendations regarding accounting for leases are in Section II. The revised Appendix B illustrates the application of the new requirements to an example of financial statements prepared in conformity with GAAP by an accountant.

Another recent GAAP update requires reporting revenues received from contracts with customers separately from other components of revenues. This requirement can be met by reporting this type of revenue in the footnotes to the financial statements, which is illustrated in the revised Appendix B. This type of revenue could also be separately stated in the income statement.

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by Michael Langemeier, Associate Director, Center for Commercial Agriculture

(Excerpt reprinted by permission of the author and Ag Banking Magazine. Find the full article here.)

Introduction

Repayment capacity measures include capital debt repayment capacity, capital debt repayment margin, replacement margin, term debt and capital lease coverage ratio, and replacement coverage ratio (Farm Financial Standards Council). Capital debt repayment capacity, capital debt repayment margin, and the term debt and capital lease coverage ratio address a farm’s ability to repay operating loans and to cover the current portion of principal and interest due on noncurrent loans such as a machinery, building, or land loan. The replacement margin and the replacement margin coverage ratio enable borrowers and lenders to evaluate whether a farm has sufficient funds to repay term debt and replace assets. For a farm to grow, it is essential that the replacement margin be large enough to repay term debt, replace assets, and purchase new assets, and that the replacement coverage ratio be greater than one. This article defines and illustrates the use of key repayment capacity measures.

Definitions

The capital debt repayment margin is computed by subtracting interest expense on term debt, principal on term debt and capital leases, and unpaid operating debt from prior periods from capital debt repayment capacity (accrual net farm income, off-farm income, interest expense on term debt, and depreciation minus family living expenses and income and self-employment taxes). The capital debt repayment margin enables borrowers and lenders to evaluate the ability of a farm to generate the necessary funds to repay the current portion of term or noncurrent debt. For this to happen, accrual net farm income, off-farm income, and depreciation have to be large enough to cover family living expenses, income and self- employment taxes, principal and interest on term debt, and unpaid operating debt from prior periods. It is important to note that the appropriate margin will vary among farms, and depends on the size of the farm and the type of enterprises produced.

The term debt and capital lease coverage ratio is closely related to the capital debt repayment margin. To compute this ratio, divide capital debt repayment capacity by principal and interest on term debt. A ratio greater than one indicates that the farm has enough funds to cover principal and interest on term debt.

The replacement margin and the replacement margin coverage ratio take the analysis one step further. The replacement margin is computed by subtracting cash used for capital replacement from the capital debt repayment margin. This measure enables a borrower to evaluate a farm’s ability to repay term debt and replace assets. It can also be used to evaluate a farm’s ability to acquire additional assets. Cash used for capital replacement can be measured using actual capital purchases (more specifically the portion of capital purchases that need to be paid for in the first year) or depreciation. The idea behind using depreciation is straightforward. Depreciation represents wear and tear, and obsolesce of machinery and buildings. Over the long-run, a farm needs to be able to replace machinery that is wearing out, to be able to afford new technology, and to be able to expand. We typically recommend using depreciation plus another 10 to 20 percent of depreciation as the farm’s measure of cash used for capital replacement to account for wear and tear on depreciable assets and farm growth. This amount will likely not be covered every year. However, over the long-run, it is essential that the replacement margin be positive. Without a positive replacement margin, a farm will not be able to fully replace depreciable assets or grow. Like the capital debt repayment margin, the replacement margin varies by farm size and type.

The replacement margin coverage ratio is closely related to the replacement margin. To compute this ratio, divide capital debt repayment capacity by the sum of principal and interest on term debt, unpaid operating debt in prior periods, and cash used for capital replacement. If the replacement margin coverage ratio is greater than one, the farm has sufficient funds to repay term debt and replace assets.

Find the full article at Ag Banking magazine’s Bank News website.

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