How should you value your assets? Fair market value is what the market is willing to pay at the measurement date, while book basis is the original cost of the asset, less accumulated depreciation. So which should you use?
To answer the question, you must first determine who will read the information. From a lender's viewpoint, fair market value translates to the security of the note, should you default. On the other hand, if the manager of your operation wants to compare equity position between reporting periods, the book basis is more applicable.
For management purposes, we want to evaluate management practices without market swings diluting the information.
Reporting fixed assets on the book basis can be a challenge if not maintained over time. Adding to the complexity is the issue of tax (accelerated) or straight-line depreciation.
Most people take full advantage of accelerated depreciation for tax purposes, as they should. However, in order to show the cost of the fixed asset over its useful life, straight-line depreciation should be used.
As you have inferred, the method of depreciation you choose has an impact on the value of the asset reported. There are so many different readers of the financial statements- IRS, lenders, and management. While it might sound like a tall order to satisfy them all, it can be done.
Here are some tips for smooth transitions between readers:
1. Code all fixed asset purchases and disposals to the proper fixed asset account within your accounting system.
2. Let your tax accountant calculate the tax depreciation, as well as the straight-line, but book only the straight-line depreciation back into your system. Most accountants use depreciation software that can easily maintain several different depreciation methods at the same time. It is up to you to communicate purchases and disposals to him/her so that the proper depreciation is reported.
3. Maintain fair market value of fixed assets outside your accounting system.
4. Communicate with the readers of your financial information so that you are able to provide the most meaningful information to them.
Many of you by now might be asking the question of how to present other assets, like raised inventory and investment in growing crops at cost basis. We will cover that discussion in another episode of Money Matters, so stay tuned…
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Brought to you by Farm Financial Standards Council. The opinions of Brenda Duckworth are not necessarily those of Farm Futures or the Penton Farm Progress Group.