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Accounting For Accounting
No matter what kind of entity you use to operate your farm, someone has to account for all of your annual farm transactions.
Every grain sale, seed purchase, equipment sale, fertilizer application, and utility bill must be tracked, at least according to the IRS. You are growing crops, buying equipment, paying taxes, and hoping to have some money left over after everyone else has been paid, but you won’t know if there is anything left without a good accounting system.
By now, you have had discussions with your CPA, attorney, or family friend about a legal entity with which to operate. You may have created an LLC, partnership, corporation, or something else to hold title to your land and to carry on farming operations. If you haven’t set up a legal entity, that’s fine; you are a sole-proprietor farmer.
Whichever way you operate, the farming operation should maintain a separate bank account. Don’t commingle your personal transactions with your farm transactions.
If you have a legal entity, this step is important for maintaining the liability protection your entity offers. Even if you don’t, if you ever get audited, you don’t want the IRS sifting through your personal cable bills, underwear purchases, and vacation expenditures when it really just wants to see the farming revenue and expenses.
5 IRS-Friendly Tips
Here are five ways to help you produce farm financial statements that will stand up to scrutiny.
1. Maintain a comprehensive check register or transaction detail. Keep everything on the computer or maintain the old-fashioned paper check register as a backup to the computer. If you have deposits going into the bank account that aren’t revenue (such as loan proceeds), make sure those are clearly documented. If you have payments coming out of the account that aren’t expenses (like profit distributions to yourself), specify that in your check register.
2. Purchase a simple accounting program, such as Quickbooks, EasyFarm, or FarmBiz. It’s important that you or your bookkeeper fully understand the software. Record all transactions in the software that go in or out of the farm bank account. There must be proper accounts (categories) set up in the program to post transactions to, such as livestock sales, grain sales, feed, seed, fertilizer, gas, etc. If the accounts are established correctly (revenue-type accounts are marked as revenue; expense-type accounts are marked as expenses), your software can spit out a slick P&L in a few seconds.
3. Reconcile the bank account every month. Preferably this will be done by the end of the following month in order to catch anomalies quickly. Look for bank errors, unexpected charges, and unauthorized withdrawals by cyber criminals.
4. Save bank statements and receipts. Having a solid P&L is good, but backing up those numbers with invoices and receipts is critical if those numbers ever get challenged. Keep at least four years of support on hand.
5. Maintain a proper balance sheet. The P&L tracks your revenue and expenses, but there is more to the story. The balance sheet reports your cash balances, land and equipment costs, accumulated depreciation, and debts owed. In order to account for all farm transactions, these balance sheet-type accounts must be established and then updated monthly.