Herd Basis
Definition
Herd basis is an accounting term applied primarily in agricultural businesses, where an election is made to treat a production herd (i.e., animals used for production rather than resale) as a capital asset rather than as inventory. This means that the herd is subject to capital allowances rather than being expensed upfront.
The election to adopt the herd basis is irrevocable and must be made within two years from the end of the initial accounting period affected by this decision. Once made, it applies to all subsequent tax periods and cannot be reversed.
Examples
-
Dairy Farming Operation: A dairy farm that opts for the herd basis will treat its dairy cows as a capital asset. As the cows are used for milk production and not resale, this allows the farm to claim capital write-offs over time instead of expensing the cost of cows immediately.
-
Cattle Ranch: A cattle ranch that uses cattle for breeding purposes may elect for the herd basis. By doing so, they can treat the breeding herd as a capital investment, spreading the tax benefits over several years rather than taking a lump sum deduction upfront.
Frequently Asked Questions
Q1: Can the herd basis be applied to any type of livestock?
- No, the herd basis is specifically for production herds, which are animals used for ongoing production activities rather than for immediate resale.
Q2: Is the decision to elect the herd basis reversible?
- No, once the herd basis election is made, it is irrevocable.
Q3: What is the benefit of electing the herd basis for tax purposes?
- Spreading the cost over multiple years via capital allowances provides tax advantages by allowing businesses to manage their taxable income more effectively and potentially reduce taxable income over several years.
Q4: What happens if I miss the two-year deadline for making the election?
- If the two-year deadline is missed, the business cannot retroactively elect the herd basis and must continue to treat the herd under existing tax rules.
- Production Herd: Animals kept for continuous production purposes such as milk, wool, or offspring.
- Capital Asset: Long-term assets that a company uses in its operations to produce goods or services.
- Biological Assets: Living plants or animals that are subject to agricultural activities.
- Capital Allowances: Deductions allowed for the wear and tear of certain assets over time for tax purposes.
Online References
Suggested Books for Further Studies
- Agricultural Finance: From Crops to Land, Water, and Infrastructure by Charles B. Moss
- Farm Accounting and Business Analysis: A Practical Guide by Peter Barry
- Agricultural Accounting: A Guide for Farmers and Business Managers by N. Thomas G. Abell
Accounting Basics: “Herd Basis” Fundamentals Quiz
### What is the primary use of the herd basis in agricultural businesses?
- [x] To treat production herds as capital assets.
- [ ] To evaluate the market value of livestock annually.
- [ ] To ensure immediate expensing of livestock.
- [ ] To calculate feed costs for livestock.
> **Explanation:** The herd basis allows for production herds to be treated as capital assets, spreading their cost over several years through capital allowances.
### What type of animals is the herd basis applicable to?
- [ ] Animals bred for immediate sale.
- [ ] Household pets.
- [x] Animals used for ongoing production.
- [ ] Wild animals.
> **Explanation:** The herd basis can be applied to animals that are used for ongoing production such as dairy cows or breeding cattle, not for those raised for immediate sale.
### What happens once the herd basis election is made?
- [ ] It can be reversed anytime.
- [ ] Needs to be re-elected annually.
- [x] It is irrevocable and applies to all future tax periods.
- [ ] Must be confirmed every five years.
> **Explanation:** The election is irrevocable, meaning once it is made, it cannot be reversed and will apply to all future accounting periods.
### How long do you have to make the herd basis election after the end of the first affected accounting period?
- [ ] 6 months
- [ ] 1 year
- [x] 2 years
- [ ] 5 years
> **Explanation:** Businesses have up to two years from the end of the first tax period affected to make the herd basis election.
### Does the herd basis apply to feed costs for livestock?
- [ ] Yes, it applies to all costs associated with livestock.
- [ ] No, it only applies to veterinary costs.
- [ ] No, it only applies to labor costs.
- [x] No, it specifically applies to the cost of the production herd itself.
> **Explanation:** The herd basis specifically deals with how the production herd costs are managed for tax purposes, and does not apply to feed or other operational costs.
### Which of the following benefits does the herd basis provide?
- [ ] Immediate tax deduction of herd cost.
- [x] Spreading out tax benefits via capital allowances.
- [ ] Full depreciation in the first year.
- [ ] No tax benefit.
> **Explanation:** It spreads the tax benefits via capital allowances over multiple years, rather than an immediate expense.
### What is a capital asset in relation to the herd basis?
- [ ] An inventory item sold within the year.
- [x] Long-term asset used in operations to produce goods or services.
- [ ] Cash reserves.
- [ ] Short-term investment.
> **Explanation:** A capital asset is a long-term asset used in operations, such as production herds, providing value through continuous use or production activities.
### Can the herd basis be applied retroactively if the business misses the initial two-year election period?
- [ ] Yes, with special permission.
- [ ] Yes, if the IRS is notified.
- [ ] Depends on the type of livestock.
- [x] No, it cannot be applied retroactively.
> **Explanation:** If the business misses the two-year deadline, the herd basis election cannot be applied retroactively.
### Which of the following would classify as a biological asset?
- [ ] Inventory of feed stocks.
- [ ] Financial securities.
- [ ] Building facilities.
- [x] A herd of dairy cows.
> **Explanation:** Biological assets include living organisms subject to agricultural activities, such as herds of livestock like dairy cows.
### For financial and tax purposes, what is the primary benefit of treating a production herd as a capital asset?
- [ ] To immediately liquidate assets.
- [ ] To increase immediate liquidity.
- [x] To manage and spread tax liabilities over time.
- [ ] To decrease the value of the assets.
> **Explanation:** Treating a production herd as a capital asset allows for better management and spreading of tax liabilities through capital allowances over a longer period.
Thank you for exploring the intricacies of the herd basis and testing your knowledge with these challenging quiz questions. Continue to expand your understanding of agricultural accounting essentials!
