Since cost accounting for livestock and other farm commodities can be difficult, agricultural producers can also use the farm-price method to track their inventory. Here’s how it works.
This is part three of our four-part series on inventory valuation. Be sure to also read part one “The cost method,” part two “The lower of cost and market method” and part four “The unit-livestock-price method.”
Like other businesses, agricultural producers may value their inventories using either the cost or the lower of cost or market method. But because of how difficult it can be to identify and record costs for crops and livestock, farmers also have access to two additional inventory valuation methods: the “farm-price” method and the “unit-livestock-price” method.
Under the farm-price method, inventories are valued at their market price, less estimated costs of disposal. While this approach can simplify recordkeeping and align inventory values with the state of the market, it can also overstate the value of certain inventory types when used improperly.
Here’s how to know when NRV is appropriate, and when it’s time to use a different valuation method for your inventory.
What is the farm-price method?
Accrual-basis agricultural producers have numerous methods available to them for valuing that inventory on the balance sheet.
The farm-price method, also sometimes referred to as the ‘net realizable value’ (NRV) method, is a special method available only to farmers that values inventory at its market price, minus any expected costs of completion, disposal, transportation and selling.
The farm-price method is useful for large and complex inventories for which the cost method of inventory valuation might be impractical.
While not the most conservative measure of value, the farm-price method gives you a sense of the current market value of your assets, which can be important in periods when you’re ready to sell.
Which inventories should you use the farm-price method for?
As mentioned in our guide to the cost method, the Farm Financial Standards Council (FFSC) recommends breaking inventories down into four categories when choosing an inventory valuation method:
Inventories raised/harvested for sale
Inventories raised/harvested for use in the production process
Inventories purchased for resale
Inventories purchased for use in the production process
So when should you use farm-price/NRV? The FFSC recommends using it when inventories have:
A reliable, readily determinable and realizable market price
Relatively insignificant and predictable costs of disposal
Are available for immediate delivery
Generally speaking, that means inventories from category #1, ‘inventories raised/harvested for sale,’ should be valued using the market-price method (or as the FFSC refers to it, ‘NRV’).
If you raise or harvest goods with the intent to sell them, and those goods are ready for immediate delivery, it makes sense that those goods should be valued at what they could be sold for on the market.
According to the FFSC, farm-price/NRV is also acceptable (but not preferred) for inventories that fall into category #2 (raised/harvested for use in the production process) and #3 (purchased for resale), except for the following two inventory types:
1. Raised feedstuffs
Using farm-price/NRV for raised foodstuffs could distort income by reflecting “unrealized gains or losses” on products that are not intended to be sold in their present form.
2. Certain other feed and foodstuffs
Feed consumed by finishing livestock, or any other foodstuffs used to produce items that will eventually be resold (like milk, eggs or other products) should be valued using the lower of cost and net realizable value method (see below).
A note about taxes
According to the IRS, if you use the farm-price method to file your taxes, you must use it for your entire inventory, except for livestock that you’ve elected to inventory using the unit-livestock-price method.
When should you use another method?
When inventory items aren’t available for immediate delivery and don’t pass any of the other farm-price/NRV conditions mentioned above, the FFSC generally recommends you use one of the following inventory valuation methods instead:
1. The cost method
Under the cost method, inventory is recorded and reported on the balance sheet at its actual acquisition or production cost—i.e. the total cost to bring the goods to their present location and condition for sale or use.
The cost method is most practical when these costs can be easily tracked and identified, like veterinary care, vaccination, feed, mineral and nutrient costs tied to a specific feeder cow.
The FFSC generally recommends the cost method for items that fall into category #4: inventory purchased for further use in the production process.
These items usually have an easily-identifiable acquisition cost, and also don’t pass the FFSC’s ‘immediate delivery’ rule mentioned above, making NRV inappropriate.
2. Lower of cost and net realizable value
The FFSC recommends that inventories that fall into category #2 (raised/harvested for use in the production process) and #3 (purchased for resale) be valued at either the lower of cost and net realizable value (also referred to as ‘lower of cost and market’).
This method brings financial statements in line with Generally Accepted Accounting Principles (GAAP) and also helps producers avoid overstating the value of those assets on the balance sheet due to short term changes in market prices.
FFSC recommendations: a summary table
Here’s a summary of the FFSC’s recommendations for each inventory type:
| Inventory raised/harvested | Inventory purchased | |
|---|---|---|
| For (re)sale | Net realizable value (NRV) | Lower of cost and NRV, but net realizable value (NRV) is also acceptable** |
| For further use in the production process | Lower of cost and NRV, but net realizable value (NRV) is also acceptable* | Cost method |
*The FFSC generally recommends against using NRV for raised feedstuffs, as doing so could distort income by reflecting “unrealized gains or losses” on products that are not intended to be sold in their present form.
**Feed consumed by finishing livestock, or which will be converted into milk, eggs or other products, or any other foodstuffs used to produce items that will eventually be resold should be valued using the lower of cost and net realizable value method.
Use Ambrook to take stock of your finances
Ambrook is a complete financial platform for your agricultural operation. With Ambrook, you get a complete set of books and detailed financial insights—making it easier to value inventory, calculate your profit, and plan for the future.
With time-saving bookkeeping automation features, automatically-generated financial reports, streamlined bill pay and invoicing, and other powerful accounting and financial management tools, Ambrook takes the guesswork out of running your business. Want to learn more? Schedule a demo today.
Want to learn more about Ambrook?
This resource is provided for general informational purposes only. It does not constitute professional tax, legal, or accounting advice. The information may not apply to your specific situation. Please consult with a qualified tax professional regarding your individual circumstances before making any tax-related decisions.
