Canadian farm businesses have an advantage when it comes to taxes. If you can convince the Canadian Revenue Agency (CRA) that your farm business falls within the definition of farming, then you’re in luck. You can opt for cash accounting to report on business income and expenses for tax purposes.
But what exactly are these so-called benefits of cash accounting? First, we’ll dive into the definition of cash accounting and what it’s all about.
What is Cash Accounting?
Cash accounting, also known as cash-basis accounting, is an accounting method that records business income and expenses when cash is received and/or paid.
This method of accounting differs from accrual accounting, used by other businesses and Corporations, where revenue and expenses are recorded when they are incurred—not when they are received and/or paid.
The Benefits of Cash Accounting for Farm Businesses
Under the Canadian Income Tax Act (ITA), farm businesses have a special status under certain provisions. Farming and fishing operations can use the cash accounting method, for example, and has 3 key benefits which are summarized below.
Over the years, judicial interpretations have resulted in additions to this list of qualified farming businesses. According to the Canadian ITA, the definition of farming includes:
- Tillage of the soil,
- Livestock raising or exhibiting,
- Maintaining of horses for racing,
- Raising of poultry,
- Fur farming,
- Dairy farming,
- Fruit growing,
- Keeping of bees,
- Tree farming,
- Raising fish,
- Market gardening,
- Wild game reserves,
- Nurseries and greenhouses, and
- Chicken hatcheries.
1. Clear Financial Picture of Cash Flow
Cash accounting allows business owners to really truly understand how much cash they have on hand. Businesses that utilize this accounting method records transactions when money enters or leaves an account—irrespective of the date that the transaction was placed or invoiced.
For example, if Company A receives $500 from the sale of single livestock on June 1st to Company B, Company A’s business can record the sale as having occurred on June 1st. The fact that Company B ordered the livestock a month earlier on May 1st is irrelevant.
Accrual accounting, on the other hand, would have already recorded the sales transaction as having received $500 on May 1st when the order was received. As you can see, this is not a full and clear financial picture of cash flow, which is why farm businesses can benefit greatly from cash accounting if their business meets the special provisions under the Canadian ITA.
2. Simple and Straightforward Accounting
Cash accounting is a much simpler and straightforward way of accounting. Using this method, payment receipts are recorded during the period they are received and expenses are recorded in the period they are paid. Because of this, small businesses are much more in-tune with their income, expenses, assets, and liabilities.
Cash-basis accounting is also much simpler to maintain, easier to understand, and simplifies the tax filing process for businesses. This is due to the fact that individuals or businesses are able to gain tax deductions for expenses paid in cash, as well as pay taxes on revenue that’s only received in cash. It’s a win-win!
3. Benefits Extend to Multiphase Production Operations
Finally, there are some scenarios within the agricultural industry where farming operations are tied to multi-phase production operations—also known as “loops.”
An example is the pork industry. Loops can involve the planned production of pigs from sow to weanling to market hog, using dedicated farm facilities designed specifically for each phase.
In these multi-phased scenarios, there is normally more than one business involved in the life cycle operation. The feed company that owns the livestock—and benefits from the profits and bears the risk of loss—is considered to be carrying on a farming activity. However, often so does the independent contractor (i.e. farm owner) who provides a facility and care of the animals.
This, of course, depends on the circumstances, but it’s important to know that independent contractors (who hold a valid farming business under the ITA) are eligible to use cash accounting for tax reporting.
The definition of farming can be extended to independent service contractors, including:
- Feedlot operators
- Custom work operators
- Cattle drovers
- Agricultural consultants
Cash Accounting or Accrual?
If you currently run a farm business in Canada and hold a valid farming business under the ITA, definitely look into switching to cash accounting if you haven’t already. There are numerous benefits that come with this method of accounting—compared to accrual—including a better financial picture of cash flow, simpler means of accounting and filing of taxes, and even extension of benefits that you can gain as an independent contractor in the agricultural sector.
To take it one step further, let Kashoo make the farm accounting process even simpler. Try our 14-day free trial today to discover exactly how our accounting software can help financial reporting quick and easy.