Farm Inventories Part I:
Getting Production into QuickBooks

From an accounting standpoint, farms are manufacturing businesses: we apply inputs (seed, feed, fertilizer, chemicals, labor...) to our factory (land, breeding livestock, greenhouses...) and make products (harvested grain, market livestock, hanging basket plants...). Some agricultural products, like harvested grain, are put into storage and may not be sold for months. For those inventories, a question arises:  "How can I assign a value to my inventories for preparing a balance sheet with QuickBooks?"

In accrual accounting, a Work in Process (WIP) inventory account would be used to accumulate the cost of labor and supplies used in manufacturing a product. For a soybean crop, a WIP account would accumulate the cost of labor, fertilizer, seed, chemicals, fuel, and so on, while the crop is being grown. When the crop is harvested and put into storage, the amount accumulated in the WIP account would be transferred to an asset account representing the soybean inventory. In other words, the soybean crop's production costs would become the asset value of the soybean inventory.

But with cash accounting the cost of production inputs is not accumulated anywhere:  fertilizer, seed, chemicals, and other inputs are expensed at the time of purchase. So there is no accumulated production cost total available anywhere in QuickBooks for assigning to the stored crop as an inventory value. How then, can you assign a value to grain or livestock inventories for preparing a balance sheet?

Worse, how does an inventory of corn, soybeans, or livestock make its way into QuickBooks in the first place? A balance sheet lists the values of the farm's assets, but you cannot assign a value to assets (farm inventories) which do not exist in QuickBooks! The assets must be represented in QuickBooks in some way, usually as an inventory. Purchased inventories can be added to QuickBooks by entering a purchase transaction, but crops are raised, not purchased. And calves, lambs, and pigs are born, not purchased. So how can an inventory be established for them? Do they need to just "magically appear" in QuickBooks?

The solution? By setting up Inventory Part Items in a non-standard way, you can to trick QuickBooks into handling farm production inventories properly in a cash accounting situation, providing an easy way to get inventory quantities and value reflected in QuickBooks.

Here are the steps involved...

1.Set up an equity account to use in setting up Items (more on this later).

2.Set up Inventory Part Items for things the farm produces, such as corn, soybeans, or raised market livestock, but set up the Items in a special (non-standard) way.

3.Use inventory adjustments to establish quantities and inventory values; for example, the number of bushels of soybeans in storage and their net market value.

Net market value is the estimated market value of something, less transportation and other selling costs.

Once you have set up some Items and established an inventory for them, you are ready to enjoy the benefits of using them for entering sales, having inventory information available whenever you want it, getting sales reports (quantities and dollars sold), and more.

Before you set up Inventory Part Items you need to have at least three accounts in place:  an income account (where sales income will be posted), an asset account (to represent the Item's asset value on the balance sheet), and a Cost of Goods Sold (COGS) account.

COGS accounts are an accrual accounting idea. They are used for accumulating the inventory cost (or purchase cost) of Items when those Items are sold. But remember, the Items we will be setting up do not have a cost associated with them (not accounted for in QuickBooks, anyway). The only value they will have is the market value we assign to them. For that reason, we need to have an equity account to use in place of a COGS account when setting up these Items. (This is the "one weird trick" mentioned at the top of the article.) That way, when an Item is sold, the effect will be to discard its market value—something which needs to happen, since an Item's market value does not represent an actual financial (accounting) cost.

To set up an equity account for this purpose:

1.Open the Chart of Accounts window (Lists > Chart of Accounts) and select Account > New from the button menu at the bottom of the window:

The Add New Account: Choose Account Type window will open.

2.Select Equity as the account type, then click the Continue button.

The Add New Account window will open.

3.Fill in account details in the The Add New Account window:

Account Name. You may use any name you want, but Capitalized Inventory is a good choice. (To accountants, it implies inventories retained as assets rather than being expensed at the time of purchase or production.) Other choices:  Inventory Capitalization, Inventory Adjustment Offsets, or Inventory Offsets.

Tax-Line Mapping. Select <Not tax related>. (In cash accounting, tax-line mapping is mostly appropriate for income and expense accounts.)

Enter Opening Balance. There is no need to assign an opening balance. The account's balance will be determined by inventory-related transactions.

4.Click the Save & Close button to save the new account and close the window.

You should set up an Inventory Part Item for each of the farm's major outputs, especially those you may keep as an inventory such as stored grains or produce, or growing market livestock.

If you are unsure about how all of this works, there's no problem with setting up just one Item at first, to give it a try.

Let's set up an Inventory Part Item for soybeans. The Item will be used for entering sales of soybeans, maintaining soybean inventory information, getting sales reports, and representing the asset value (market value) of soybean inventories on balance sheet reports.

To set up a soybeans Item:

1.Open the Item List window (Lists > Item List), then select Item > New from the button menu at the bottom of the window.

The New Item window will open.

2.Fill in details for the new Item:

Type. You must select the Inventory Part type for Items you will use for tracking inventories.

Unit of Measure. (Not available in all QuickBooks versions.) This lets you select a specific unit of measure (or different units, depending on a QuickBooks setting) for selling the Item, such as bushels, pounds, or tons.

Cost. Leave 0.00 in this field. (It is used for suggesting a purchase price when you select the Item on a purchase form such as a Check or Bill.)

COGS Account. Select the equity account created earlier (not a Cost of Goods Sold account), so QuickBooks will discard the Item's market value instead of posting it to a COGS account when the Item is used in a sale transaction.

Sales Price. Normally you should leave 0.00 in this field. QuickBooks uses it for suggesting a retail price when you enter a sale for the Item, but the selling price of soybeans is variable, so it's best not to have a suggested selling price.

Income Account. Select the account where you want the income to be posted when the Item is sold (when it is used on a sales form such as a Sales Receipt or Invoice). The income for this Item will be posted to an income account named Sales:Grain:Soybeans.

Asset Account. Select an account to use for representing the Item's asset value in QuickBooks and on balance sheet reports. Normally you should select a current asset account (most inventories are current assets), like the Inventory:Soybeans account selected here.

On Hand, Total Value, As of. These fields are for specifying a beginning inventory quantity and value for the Item. Don't enter anything in these—you will be using an inventory adjustment (described next) to establish these.

3.Click the OK button to save the new Item and close the window, or the Next button to set up another Item.

Once you have Items set up, you can establish inventories for them by entering an inventory adjustment. To keep things simple for this example, we will make an adjustment for only the Soybeans Item created earlier. (By the way, from an accounting standpoint this adjustment will create a soybean inventory "out of thin air":  based on an arbitrarily assigned market value, not on the accounting cost associated with producing the soybeans.)

1.Open the Adjust Quantity/Value on Hand window. There are several ways to do this; one is to select Vendors > Inventory Activities > Adjust Quantity/Value on Hand from the QuickBooks menu.

2.Fill out the window as shown below:

Adjustment Type. Choose Quantity and Total Value to allow updating both the inventory quantity and value for the Soybeans Item.

Adjustment Date should be the date of the most recent known or estimated inventory quantity. The date is important because it determines when the Item's inventory became available to sell. (The date should be prior to sales transactions you enter for the Item.)

Adjustment Account. Use Capitalized Inventory account created earlier, so the adjustment will have no effect on income or expenses.

New Quantity. Enter your current estimate of the soybean inventory here in the New Quantity column. (The Qty Difference column is used when you need to add or remove a specific quantity from the quantity on hand.)

New Value. Enter the estimated net market value of the entire soybean inventory here.

Yes, it would be nicer if QuickBooks allowed entering a per-bushel value and would automatically multiply it by the number of bushels on hand, but QuickBooks requires that you enter the total value of the inventory. After you have entered the New Value though, QuickBooks does calculate an average cost for the Item (indicated by the red arrow)—in this case, the average per-bushel value that has been assigned to the soybean inventory.

3.Click the Save & Close button to save the inventory adjustment and close the window.

You will make inventory adjustments at other times too, such as to update inventory values after harvest, before preparing a balance sheet (if necessary), or to update inventory quantities and values for things like spoilage, theft, or livestock death losses. For Items representing raised farm production, always use the Capitalized Inventory equity account as the Adjustment Account.

Once you have created some Items and established an inventory for them, you can...

❖Use the Items for entering sales, on the Sales Receipts or Invoices forms. QuickBooks will automatically maintain an updated inventory quantity and value for each Item as you enter sales.

❖Have up-to-date inventory and sales information whenever you want A quick glance at the Item List (Lists > Item List) will show the current quantity on hand for any Inventory Part Item. And when you want to know how many bushels of soybeans you sold last month or last year, or to a particular customer, you can open a report such as a Sales by Item report (Reports > Sales > Sales by Item Detail).

❖Prepare market value balance sheets after updating the value of your inventories (if needed) by making an inventory adjustment.

❖Make inventory adjustments when you harvest crops or when livestock are born. At the end of soybean harvest, for instance, you can update inventories for the new quantity then in storage.

❖Do special things like:

•Track cash forward contracts. Tracking contracted quantities and dollar amounts, deliveries made on contracts, and the remaining quantities needed to fill each contract is simple to do.

•Calculate total production (bushels, pounds, etc.) and average yield. It's simple and quick to do, based on just a couple QuickBooks reports.

•Find the average selling price for a crop or group of market livestock.

•Track inventories in multiple storage locations. You can keep separate inventory information for any number of storage locations; for instance, soybean inventories stored in bins on different farms plus commercial storage...it's easier than you might expect!

For details on how to accomplish these activities see The QuickBooks Farm Accounting Cookbook™, Volume II: Raised Farm Production Inventories, Sales, and More....

Oh...and what about the Capitalized Inventory account?

As you enter sales and make inventory adjustments, the balance in Capitalized Inventory will rise and fall to offset the changes in market value that you assign to farm inventories. Because you are maintaining assets at market value rather than book (or accounting) value, the balance in Capitalized Inventory has no real meaning concerning owner's equity in the farm business, regardless of whether the balance is large or small. However, because it is an equity account, Capitalized Inventory will appear on balance sheet reports.

Mark Wilsdorf was raised in agriculture, has been deeply involved in it all of his life, and has worked with QuickBooks and accounting software for much of that time as well. He was editor of AgriComp, the first national magazine for agricultural computing, has authored several books about using QuickBooks in agriculture (The QuickBooks Farm Accounting Cookbook™ series), has done consulting work for Fortune-500 businesses serving agriculture, and has been the lead developer on QuickBooks-related software projects, including several QuickBooks add-ons.

If you wanted proof that Mark always has at least one foot in agriculture you might look around his office at home....where you would find things like a folder of soil test reports, calf obstetrical supplies, a seed sample waiting on a germination test, a stack of machinery parts catalogs, and a lariat he will never really learn to use well.

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