COMPARISON OF FINANCIAL MEASURES USING MODIFIED COST vs. FAIR MARKET VALUE ASSET VALUATION

All of the financial measures reported thus far have been calculated using asset values that are valued at their current market value. Therefore, to make proper use of Tables 3-14, analysts must also follow similar valuation procedures. Table 15 shows the difference in financial measures using assets valued at fair market value and at modified cost.

Land valuation procedures are summarized in the definition of terms section of this publication. The major difference between modified cost and fair market value occurs in the valuation of machinery, buildings and land. The modified cost values for machinery and buildings are simply the sum of original basis of the each asset less accumulated tax depreciation claimed on each asset. The modified cost value of crop inventory and market livestock are normally valued at the current price. Other assets are valued at cost when information is available.

Table 15 shows the difference in financial measures for farms divided into grain farms with less than 600 acres and grain farms with more than 600 acres along with hog farms with value of farm production less than $150,000 and hog farms with value of farm production greater than $150,000. All farms (including all other livestock) are also summarized in the right-most column. The sample of farms used for this comparison is farms that are reported as having valid information for both modified cost and fair market value.

The average fair market value of assets for all farms in 2005 was $1,560,797. The modified cost value of assets on these same farms was $1,041,220. Hog farms with value of farm production greater than $150,000 resulted in a relatively large difference between total asset valuation methods ($2,059,422 vs. $1,552,109) primarily due to the increase in building and machinery investment that is required for these operations. Grain farms operating more than 600 acres of land resulted in the largest difference between total asset valuation methods ($1,775,297 vs. $1,188,766). This was to be expected due to the appreciation of land values.

The difference in total asset values for all farms was primarily explained by machinery valuation. The average intermediate asset to total asset ratio for all farms was 31.3% when assets were valued at fair market value, while the same ratio was 24.4% when assets are valued at modified cost.

The median debt to asset ratio for all farms using fair market value was 27.3%, but increased to 40.2% using modified cost valuation. Profitability and liquidity ratios are also affected due to the change in asset value.

The primary purpose of this table is to show that when analyzing farm business operations, the valuation procedures used are extremely important. They are especially important when comparing an individual operation to another operation or to a sample of farms. Comparisons should not be made unless consistent asset valuation procedures have been followed.