Accounting For Livestock – Part 1

By David Russell, Chartered Accountant, farming accounting and taxation specialist.

David is the national guru on livestock valuation for taxation purposes and published a book on the topic in 2004. This issue contains the first of a series of articles he will produce for Professional Dairy Heifer Grower.

Changes in numbers and values of livestock on hand from one year to the next can have quite an impact on taxable profit and tax payments.  There is no silver bullet that will take out the tax issues, but it is sometimes helpful to understand how taxable profit is calculated and what you might do to manage the tax bill.

For taxation purposes, livestock are classified as trading stock.  When you purchase trading stock you are entitled to a tax deduction equal to the purchase cost.  When you sell trading stock the sale proceeds are taxable income.

We then have to add in another element to complete the calculation of the total profit or loss arising from livestock.  That element is the number and the value of livestock on hand at the start of the income year and the number and value of livestock on hand at the end of the year.

If the numbers in each age group remain static from one year to the next, this “numbers and values” calculation has little or no effect on income.  We then end up with just the sale of any natural increase plus culls as our taxable income from livestock.  The profit for the year is the net sales value of all stock that was bred and grown on the farm and was surplus to our requirements after maintaining the herd or flock at the same level as it was the previous year.

Changing Herd Size

If we increase the numbers on hand we have to recognise those additional animals as taxable income for that income year.  Quite logical I suppose;  we could only build up numbers by not culling so many, or by retaining more young stock to increase the overall scale of our farm business.  We have therefore suppressed our cash income and must recognise the non cash income in the form of more stock on hand.

Alternatively, we could have increased numbers by purchasing additional animals.  That purchase cost would be tax deductible (reduced profit) but is offset by non cash income in the form of the extra animals on hand at year’s end.

Valuation Methods

If there are changed numbers from one year to the next, the way we value livestock can be quite critical.  Our taxation law gives us a fairly broad range of choice:

  1. We can use herd scheme values.  These are national average market values which are announced by Government about May 20th each year.
  2. We can use national standard cost (NSC).  These are values that are partly derived from some (Government produced) cost of production data each year, and partly derived from the cost of any purchases for that class of stock for that year.
  3. We can use a market value or replacement price valuation which can be obtained by an individual farmer for their herd or flock, or perhaps just one class of stock, e.g. just the rising one year heifers.
  4. We can use an individual farm based cost of production formula called self assessed cost.
  5. Or we can use a combination of some of these methods.

In our accountancy practice we generally use market value/replacement price for the rising one year heifers and a combination of herd scheme and national standard cost for the rising two year heifers and mixed age cows.

I will discuss the pros and cons of all the valuation methods and why we use which method for which farmer in what circumstances, in future issues of Professional Dairy Heifer Grower.