Prepaid crop inputs are interesting. You are paying for something now that will be delivered in the future. For cash basis records, prepaid inputs are treated the same as the item they are purchasing. Seems pretty straightforward. However, for accrual basis records, we cannot expense them until we sell the crop. So what is it? And the answer is not inventory.
The technical definition of inventory is “assets that are (1) held for sale in the ordinary course of business, (2) used in the process of production for sale, or (3) materials or supplies to be consumed in the production of inventory or in the rendering of services.
The reason those words are in bold is because there is an understanding that the items held, used, or consumed would have to be in your possession in order to meet those criteria. If you are keeping accrual records, you should not combine prepaid crop inputs and inventory because they are different.
Another reason why you should not consider prepaid crop inputs as inventory is because there are different legal rights between the two. If “possession is 9/10 of the law,” there is a lot that you can do with your inventory. You can plant it, sell it, or leave it in your shed until it decomposes.
You paid for it; you have it; do what you want with it.
For prepaid crop inputs however, you are giving someone (or some company) money now and they give you a promise that they will get it to you in the future. Most of you have been around long enough to know there is not much you can do with a promise; you did it anyway because 1) you got a good deal by paying early and 2) you are trusting the other party to keep up their end of the deal. However, have you considered if the company was not around to keep up their end of the deal?
You’re last in line
In instances of bankruptcy, a person or company that has outstanding prepaid inputs with an entity in bankruptcy are treated as “unsecured creditors,” which means you are last in line to get your money or goods. The seed that you purchased may have to be sold to pay secured creditors (banks, IRS; they are generally the first in line).
You may get your seed, a refund, or neither depending upon the situation.
In the next By The Books blog, we will walk through the accounting steps to deal with prepaid crop inputs for your accrual records.
The opinions of the author are not necessarily those of Farm Futures or Farm Progress.