Case Analysis- Inventory or Property Plant and Equipment

Overview and Introduction
Red Hen Company, which operates for producing and processing and selling fresh eggs. After its first year, it began to prepare financial statements. However, the accountancy found it’s hard to identify these egg-producing flocks as inventory or as property, plant and equipment. This essay will cite accounting standards and rules from FASB, identifying the definitions related to inventory and fixed asset, and discuss the related details in company’s specific situation. Finally, the essay will provide recommendations on how to present the hens in the financial statement, and draw a conclusion based on the previous recommendations.
Identification Based on Accounting Principles and Specific Situation
When preparing financial statements at the end of its first operating years, Red Hen Company has to identify the classification of its egg-laying flocks. Whether the items should appear in the inventory section under the current asset, or be treated as fixed asset?
Admittedly, the egg-laying flocks can be identified as fixed asset (Property, plant, and equipment), which used to create and distribute an entity’s products and services [FASB ASC 360-10-05]. Specifically, egg-laying flocks could be treated as equipment. [FASB ASC 905-360-25-4] points out “except for animals with short productive lives classified as inventory, breeding animals, livestock (which includes cattle, hogs, sheep, and goats) production animals shall be recognized as fixed asset”. “Egg-laying flocks are typical representative of production animals, which provide a service or primary product other than their progeny”, similar to dairy cow produce milk. [FASB ASE 905-360-20] regulates poultry (eggs) belongs to production animals. So the flocks could be identified as fixed asset.
Alternatively, the egg-laying flocks could be identified as inventories. [FASB ASC 330-10-15] defines the items belong to inventory have to meet any of the following the criteria: “The items are held for sale in the ordinary course of business, or in process of production for such sale, or to be currently consumed in the production of goods or services to be available for sale.” Furthermore, Inventories can be divided into raw material, which are the goods directly or indirectly consumed into production, work-in-process, which are the goods stay in the process of production, and finished goods, which are the goods waiting for sale. In the situation of Red Hen Company, when the estimated 2 year life of laying hen ended, they will sell to soup companies. It seems like the egg-producing flocks are raw materials, they are indirectly consumed into the production to produce eggs. For the chickens what have been assumed are their production abilities and lifetime. The process that the chicken holding for sale to soup company is resemble to the inventories waiting for finally flowing into the market. As inventories, their terminal value is to create sales value (eggs sales value and the sales value of chickens flow to soup company).
Besides, according to [FASB ASC 905-360-25-4], “Animals with short productive lives, such as poultry, may be classified as inventory. Due to the short productive life of poultry, the cost of flocks may be classified as inventory,” The definition of current asset is items which are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle on the business, or one year whichever is longer. In this situation, the laying hens with 2 years short-life (company’s operating cycle is 2 years) could be identified as inventories.
Recommendations on preparing Financial Statement
In order to make the accounting more accuracy, presenting the egg-laying chicken eggs as inventories is more recommendable. [FASB ASC 905-330-35-3] figures out, “The production costs recognized of chickens raised for an egg-laying unit, less estimated salvage value of the chickens, shall be amortized over the egg-laying period.” Based on the given accounting standard, the production costs of the egg-laying hens should include the initial cost of the hatched baby chickens add the cost of materials including forage, as well as labor cost and some other allocated indirect cost during the prematurity period. Then the total production costs less estimated salvage value should be amortized into each egg. So the Red Hen Company should recognize “cost of goods sold (eggs)” by unit amortized production cost on egg multiples the total amount of eggs sold. The “the cost of goods sold (chickens)” is the estimated salvage value of the chicken, which depends on the industry’s (egg-laying) regulations and the specific situation of Red Hen Company.
However, recognizing the chickens as fixed asset is applicable as well. The production cost less estimated salvage value divided by its useful life can be recognized as depreciation expense appearing on Income statement.
Conclusions
Recognizing the egg-laying flocks as inventory and fixed asset are both applicable. The former is more preferable. Because it can reasonable to estimate the “cost of goods sold” of each egg and chicken, then the Red Hen company can better grasp the cost structures of products, which can be a powerful tools for company in decision making, further to control the profit.