From the egg business lays an egg answer key

Question:

The Red Hen Company produces, processes, and sells fresh eggs. The company is in the process of preparing financial statements at the end of its first year of operations and has asked for your help in determining the appropriate treatment of the cost of its egg-laying flock. The estimated life of a laying hen is approximately two years, after which they are sold to soup companies.

The controller considers the company's operating cycle to be two years and wants to present the cost of the egg-producing flock as inventory in the current asset section of the balance sheet. He feels that the hens are “goods awaiting sale.” The chief financial officer does not agree with this treatment. He thinks that the cost of the flock should be classified as property, plant, and equipment because the hens are used in the production of product—the eggs.

The focus of this case is the balance sheet presentation of the cost of the egg-producing flock. Your instructor will divide the class into two to six groups depending on the size of the class. The mission of your group is to reach consensus on the appropriate presentation.

Answer:

Communication Case 3-3, FASB codification research; inventory or property, plant, and equipment.

In the case of the Red Hen Company, a chicken egg producer, the company is preparing its first year end financial statements and there is a difference of opinion between the controller and the CFO on how to classify the laying hens on the balance sheet. The controller considers the chickens inventory, while the CFO believes the hens should be classified as equipment because they are used in production of the eggs.

According to the FASB codification 905-330-25-3, the hens may be classified as inventory, but it does not state that it is mandatory to classify them as such. In fact, it would be advisable to not classify the chickens as inventory and instead to classify them as plant, property, and equipment due to the ability to depreciate equipment but not inventory for sale. Per IRS pub 225, “Livestock purchased for draft, breeding, or dairy purposes can be depreciated only if they are not kept in an inventory account”.

Another thing we must consider when calculating best way to classify the hens and how to depreciate them is the low cost of the chicks to purchase and the low salvage value of the poultry at the end of their useful egg laying term. Day old chicks cost approximately $100 per one hundred chicks, and I estimate their salvage value to a soup manufacturer at $1 per one hundred chickens. Since depreciating approximately $0.99 per chicken over the course of its productive life may present a bit of an accounting headache, I recommend Red Hen Company take the section 179 expense deduction which allows a one-time deduction instead of depreciation.

If the chickens are classified as inventory for sale because they are sold for salvage value at the end of their useful productive lives, Red Hen’s balance sheet would show an excessive and unrealistic amount of inventory as an asset. Other accounting problems will arise when figuring cost of goods sold. Figuring two years’ worth of chicken feed, electricity, waste disposal, labor, etc. for the cost of goods sold will show a very large loss on every chicken when sold. While the revenues from the eggs produced would more than offset the loss, the numbers just do not represent the true picture of the business as an egg producer, not chicken seller.

The above discussion assumes that Red Hen Company is a large scale operation. For a small scale egg producing operation I would probably recommend that the business classify the hens as inventory to simplify their accounting process, especially if they were a private company with no shareholders. Simple accounting software should enable the small producer to use batch costing to figure the cost of goods sold and the profit margin on each egg sold. While the $0.99 depreciation per hen will make a large difference for an operation with tens of thousands of chickens, it will not make as large an impact on a few hundred bird operation.

References

Financial Accounting Standards Board. (n.d.) 905-360-35-3. Retrieved from: https://asc.fasb.org.

United States Internal Revenue Service. Farmers Tax Guide (2013). (IRS pub 225) Retrieved from http://www.irs.gov.