The introduction of the Canadian Agricultural Income Stabilization (CAIS) program this past year, has generated a great deal of discussion and concern about the adequacy of the program. Does it give sufficient protection to Canadian family farms, from both short term and long term income declines? A great deal of this concern, in my opinion, has been fostered by the failure of both governments, and most farm organizations over the past two years, to properly communicate the principles and concepts of the program to the general farming population, and the accounting community. If this had been done, there might have been some chance of fixing some of the problems before introduction. The price collapse in the beef sector and the most recent one in grains and oilseeds has certainly focused attention to the weaknesses.

Modified Accrual Concept

The most contentious issue with the CAIS program is how to deal with inventory change, because the measurement of income is done on the accrual basis to properly match income against expenses in a given period. This is done to prevent distortions which could generate unwarranted payments to producers who delay sales or accelerate cash purchases.

The Modified Accrual Concept for inventories employed by the CAIS program, is not one used in Generally Accepted Accounting Principles (GAAP). The Modified Accrual Concept (MAC) does not recognize the change in price of opening inventories affecting income in a current year. The dollar change for inventories under MAC is the change in quantity for the period times the ending price. Under GAAP, the dollar change for inventories is the opening price times the opening quantity less the closing price times the closing quantity.

Now you have to look back in time to realize what circumstances helped drive this concept. MAC was incorporated in the original farm income disaster program developed due to the disastrous hog prices in the fall of 1998. The concern at that time was that hog prices could rebound in the next fiscal year, as has happened in the past, and producers would collect large program payments and also collect recovered prices on inventory. At the time, this was envisioned by many as a one shot disaster program but the MAC concept stayed around and has morphed into the beast we have today.

The issue of inventory change should be broken down into its various components. Many producers are familiar with financial statements being prepared with inventory prices at fair market value. However, this does not really conform to GAAP. GAAP rules state that inventories are to be stated at cost. The real purpose of the inventory adjustment is to transfer the cost of purchasing or producing inventory from a prior accounting period to the period in which it is sold. This will properly reflect the profit for the period of income realization. The difficulty with inventories and farming is to practically determine cost for items produced as a result of a biological process.

During development of this article, I found that the detailed explanation with examples was far too lengthy to include here. If you wish a detailed explanation of the failure of MAC, go to the OCPA website at www. ontariocorn. org.

In summary, MAC performs differently when fair market prices are above cost compared to when fair market values fall below cost. In the latter case, MAC leaves farmers with stranded costs that are never incorporated into the income calculations for a current claim year. The current economic environment in many sectors of farming is one in which the fair market value of inventory is less than its cost. When there is a major shift in market prices as has happened to beef cattle or recently to grains and oilseeds, from market prices above costs to prices materially below cost, the difference between the cost of opening inventories (remember we are trying to use GAAP) and the realized value which is below cost, is lost and never recovered when sales occur.

The net affect of this accounting methodology is to grind down losses in a current claim year and never let you rebuild margins for future reference periods. Not only does the CAIS program run the risk of stabilizing a downward trend in farm incomes, it accelerates the decline in reference margins.

So what do you do to protect yourself from program deficiencies since it is "the only game in town?" The simple solution is do not own inventories at year end! This will synchronize the production cycle, which has the costs, with the marketing cycle, which realizes the income. This happens naturally with many vegetable and horticultural farms that do not store inventory over year end. It is very difficult for livestock farms, which are at a distinct disadvantage since they often have very high inventories at year-end relative to their sales, and are very vulnerable to MAC in a year of massive price decline.

The effect of this methodology is to leave some sectors of agriculture at a distinct disadvantage to others in the CAIS program. However, all is not lost for grains and oilseeds producers. After discussions with your accountant you may want to consider some actions listed in the website article.

One objective of any government income stabilization program is to minimize the influences on producer behaviour. Once people understand the issues, and if the current rules on inventory are not changed, this will stimulate more business changes at the farm level than anyone would have dreamed of. Producers know the industry has lost millions that have not been brought into consideration in the CAIS calculations. I believe the governments know this as well since they were embarrassed enough to provide a "top up" to 2003 CAIS payments.

To its credit, the federal government has commissioned a study which is due shortly on the methodologies of accounting for inventories for the CAIS program. I hope this will be a public document which will lead to a thorough discussion and better understanding by all stakeholders of this program.

Reference Margins and Olympic Averages

A change to the CAIS program from the Income Disaster Programs was the mandatory use of the Olympic average calculation, and the fact that data in the reference years is by default, allowable cash incomes and expenses only. This is not a requirement under trade rules and can lead to situations which are problematic in many circumstances.

With these two concepts being employed together, it is not hard to manipulate the reference margin. This was pointed out as a moral hazard in one study by the George Morris Centre. The Olympic average concept could be dropped if reference period information was calculated on the accrual basis since CAIS will soon have sufficient data to accomplish this.

This fact can also easily work against you, and has ramifications for grains and oilseed producers in 2004. Some producers will have low cash sales this fall for a number of reasons. Some may have elected not to sell hoping for price recovery. Some may have corn still in the field due to high moistures and drying costs. If your cash income is low for 2004, but not low enough to get dropped from the Olympic average calculation, which will determine coverage for 2005, this will drop your reference margin and your CAIS support level by 33% of foregone sales. This is because the calculations for historical reference periods are done on the cash basis. When filing your 2005 CAIS information, have your accountant review whether it may be advantageous to elect to supply accrual information for the reference years to support as high a reference margin, as possible for the probable dismal prices for the 2005 crop.

Program Transparency

The CAIS program needs immense improvements in transparency. Producers need hard bankable numbers which should be easily calculated by their accountant at the time of application preparation and filing. My understanding is that over 85% of CAIS applications were prepared by accountants. If this is the case, most producers would know immediately where they stand and maybe allow them to give some comfort to their financial institutions. If this is possible to do with the income tax act and tax returns, in comparison, CAIS calculations are pretty elementary.

If CAIS administration is going to continue with manual filing of inventory and accruals, detailed schedules should be included in the Statement of Program Benefits, so that keying errors and any changes to data can be verified. If data filing is to be done by the web or E-filing, then this will be less of an issue in the future, however, any changes to data submitted needs to be communicated back to the producer the same as CRAs procedures.

Detailed policy manuals need to be published as well. Many applications were filed this past year without knowledge of the policies. And then the administration wonders why some were submitted in an incomplete manner? This fact definitely contributed to filing costs, administration costs and processing delays. When you phoned CAIS administration, front line staff and many times senior staff, although wanting to help, were unaware of policies and processing procedures.

Furthermore how can a producer file an appeal when the rules and policies are not published in detail?

Deadlines

Currently, OMAF wants to operate on a March 31 deadline to submit all information for CAIS. Certainly there is some merit to having producers indicate the amount of coverage and the deposits to be made before the period of risk for the new year. However there is no reason to force the inventories and accrual information to be submitted by this date.

The rest of the country has later deadline dates, and if this is a national program with national standards, what cries out for the variation in Ontario? To complete the CAIS calculations, OMAF needs the data from CRA. This is not available until well into May, even for those individuals who file early. And corporations do not have to file until June 30. What are they going to do, sit on the data? If pre-populated schedules are used for filing the new data and it is done electronically, there will be no issue of a data keying backlog.

Furthermore if the income and expense data has not been received from CRA, CAISP administration cannot make any structural change to the data since they will not know who has triggered a payment.

The current deadline rules for CATS have the definite effect of unnecessarily driving up filing costs for producers. An accountant's office works most efficiently when a file is worked on once, when all the information is present. Often information for payables and receivables is not determined until well into the new year. If a file has to be picked up and set aside several times, costs go up and obviously the producer will get billed for the extra costs. There is also the issue that all the clients just cannot be physically done in a sixty day window, since most have to wait for their payable statements to arrive in the new year. CAIS filing costs would be minimal if the filing could be done the same time as financial statement preparation and income tax filing.

The March 31 deadline also prevents the natural sorting of priority cases from those that will not be triggering payments. Accountants will find those clients in financial distress at their door before those who are not. Naturally, they will be looked after first and filed first. Those will be the files that CAIS will be able to process first and get the cheques out first. Politicians can be comforted by the fact that those in need are being looked after on a priority basis. We do not need a repeat of 2004 with the Ministry being inundated with thousands of files with no way of determining priorities. OMAF needs to learn how to keep the monkey off its back.

Richard Wright P.Ag. Richard worked ten years in the Economics Branch of Agriculture Canada and the last twenty years as an accountant at Brose & Co, Chartered Accountants in Waterloo, Ontario. He also operates a cash crop and livestock farm at Fergus, Ontario.

---