By Phil Kenkel, Bill Fitzwater Cooperative Chair, Oklahoma State University.
Fixed assets are a necessary evil for agricultural cooperatives. Along with fixed assets comes the topic of depreciation. Depreciation can be thought of in at least three ways. The layman’s concept of depreciation is the decline in market value with use or obsolescence. We all expect a truck to depreciate when we drive if off the lot. That’s a great example to explain depreciation to teenagers but doesn’t help us much in agribusiness where the current market value of a grain facility is difficult to determine. The accounting concept of depreciation is the process of allocating the appropriate portion of an asset’s cost to the periods during which the asset generates revenue. The tax concept of depreciation is the process of deducting the cost of an asset over the time period allowed by the IRS.
In most cooperatives, depreciation methods are driven by tax rules. Accelerated depreciation (taking the most rapid depreciation that IRS will allow) increases depreciation expense and thereby reduces net income and patronage distributions while increasing cash flow. This “conservative” approach also impacts the balance sheet. For example, under textbook accounting depreciation, a steel grain bin would have some value for up to 25 years. In practice most cooperatives would depreciate it over 10 years based on IRS class life tables or take more rapid bonus depreciation if it available. The grain bin becomes fully depreciated and has no value reflected on the balance sheet for more than half of its actual useful life.
Depreciation practices are just one reason why financial statements prepared on a book basis will differ from those prepared on a tax basis. Cooperatives should continue to use available strategies to reduce taxable income. However, as your board and your banker strategize over the strength of your balance sheet, it might be useful to consider how it would look if the fixed asset values were more in line with their actual remaining life. That path takes you into some other interesting differences between tax and book values.
Published July 19, 2012.