MacDonald’s Farm
2010
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Early in 1994, Denise Grey was notified by a lawyer that her recently deceased uncle had willed her the ownership of a 2,000 acre wheat farm in Iowa. The lawyer asked whether Grey wanted to keep the farm or sell it.
Grey was an assistant vice president in the consumer credit department of a large New York bank. Despite the distance between New York and Iowa, Grey was interested in retaining ownership of the farm if she could determine its profitability. During the last 10 years of his life, Jeremiah MacDonald had hired professional managers to run his farm while he remained in semi-retirement in Florida.
Keeping the farm as an investment was particularly interesting to Grey for the following reasons:
1.Recent grain deals with foreign countries had begun to increase present farm commodity prices, and many experts believed these prices would remain high for the next several years.
2. Although the number of small farms had decreased markedly in the last 20 years, large farms such as MacDonald’s using mechanization and new hybrid seed varieties could be very profitable.
3. After some downward movement in the 1980's, the value of good farmland in Iowa was beginning to appreciate at about 10 percent a year.
Included in the lawyer’s letter were data on revenues and expenses for 1993 and certain information on balance sheet items, which are summarized below:
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Beginning inventory .....…...... 0 bushels
1993 wheat production ...... 210,000 bushels
Shipped to grain elevator....180,000 bushels
Grain stored at farm
at end of 1993 ...... 30,000 bushels
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Prices:
The average price per bushel which the elevator operators had agreed to pay for wheat shipped to the grain elevator (Capital City Grain) in 1993 was $2.90. The price per bushel at the time of the wheat harvest was $2.95. The closing price per bushel on December 31, 1993, was $$3.20. The elevators also charge a receiving fee of $.10 per bushelwhich MacDonald’s pays in cash at the time of delivery.
Accounts receivable:
On 12-31-93the proceeds from 40,000 bushels shipped to the grain elevator had not yet been received from the elevator operator. There were no uncollected proceeds on December 31, 1992. The average allowance for uncollectible accounts (based on year-end receivables) in the industry was 5%.
Cash:
On 12-31-93 the farm had a checking account balance of $32,700.
Land:
The original cost of the land was $375,000. It was appraised for estate tax purposes at $1,000 per acre.
Buildings and machinery:
Buildings and machinery with an original cost of $412,500 and accumulated depreciation of $300,000 (on December 31, 1992) are employed on the farm. The equipment was appraised at net book value.
Current liabilities:
On 12-31-93 the farm has notes payable and accounts payable totaling $28,000.
Owners’ equity:
Common stock has a par value of $7,500 plus and additional paid-in capital of $450,000. There was no record of retained earnings, although it was known that Jeremiah had withdrawn large amounts of the profits in cash in the last few years in order to continue the lifestyle to which he had become accustomed in Florida.
1993 Expenses for the MacDonald Farm
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A. Production cost per bushel:
Seed ...... $0.053
Fertilizer and chemicals ...... 0.495
Machinery cost, fuel & repairs ... 0.207
Part-time labor and other costs . 0.058
Total production cost per bushel $0.813
B. Total annual costs not related to volume ofproduction:
Salaries and wages ...... $ 72,500
Insurance ...... 4,500
Taxes* ...... 32,500
Depreciation ...... 38,500
Other expenses ...... 45,000
Total costs not related to
Volume of production …...... $193,000
______*This figure excludes income taxes since the corporation was taxed as a sole proprietorship.
Looking over the data on revenues and expenses, Grey discovered that there were no monetary numbers for 1993's total revenues or ending inventory. The lawyer’s letter explained that there was some doubt in his mind about when revenue for the farm should be recognized and about the appropriate way to value the grain inventory. The lawyer’s understanding was that there are at least three alternative points at which revenue could be measured.
First, the production method could used. Since wheat has a daily valuation the on Chicago Commodity Exchange, any unsold inventory as of December 31 could be valued at market price very objectively. In this way revenue can be counted for all wheat produced in a given year, regardless of whether it is delivered to the elevator or not. A decision not to sell this wheat before December 31 is based on speculation about future wheat price increases.
Second, the sales method (also called the delivery method) could be used. This would recognize revenue when the grain is delivered to the grain elevator operators in neighboring communities.
Third, the collection method could be used. Under this approach, revenue is recognized when the cash is actually received by the farm from the grain elevator operators. Full collection often took several months because a grain elevator operator might keep wheat for a considerable time in the hope that prices would rise so he could sell at a greater profit.
Questions (answer in order):
1. Prepare the 1993 income statement and the related ending balance sheet for the MacDonald’s Farm recognizing revenue by the:
a. Sales (delivery) method
b. Collection method
- Production method
Which method would you recommend? Give you reasoning.
What would be your best estimate of cash dividends withdrawn during 1993 (show computations)?
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2. Assume that on January 12, 1994, the MacDonald Farm received a firm offer of $225,000 for 100 acres of the farm that would be used as the site of a new housing development. This development would have no effect on the production of wheat by the farm, and Ms. Grey planned to accept it. How would you account in the 1993 financial statements for the economic gain represented by this appreciation in land values?
3. Should Grey retain ownership of the farm? Explain your reasoning including any impact of the different revenue recognition methods.