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Don't Overlook Proper Accounting for Bulk-Purchased Inputs

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Posted Jun. 30, 2006

One of the responsibilities of the Agricultural Division's research team is to allocate all resources related to research projects and farm operations. The Ag Division currently has more than 40 research and demonstration projects ongoing on six farms comprising more than 12,000 acres. To maximize our purchasing power, we often buy inputs in bulk. Examples of bulk purchases include feed, fuel, fertilizer and chemicals. A single bulk purchase may actually be used on all our farms and in a multitude of projects.

In the majority of the projects the Ag Division undertakes, we attempt to investigate the bottom line economic benefit producers could realize if they were to use the new finding or discovery on their operations. To successfully accomplish this, we must carefully break out costs to accurately account for appropriate project or farm usages of bulk-purchased items.

On the Ag Division research team, research economist Jon Biermacher is responsible for preparing and tracking each project or enterprise budget. Other members of the research team are responsible for supplying him with an accurate assessment of how a particular bulk-purchased item is allocated across multiple projects.

This is a serious management issue for Noble, as it is on many of your farms as well. Like us, many producers purchase inputs such as fuel, fertilizer, hay and feed in bulk quantities in order to obtain price discounts. Although this can be viewed as "smart shopping" on the part of the producer, it has serious implications to farm management decisions if the bulk-purchased inputs are not expensed across the enterprises correctly.

Jon Biermacher has provided the following examples of how allocating costs from bulk purchases could make differences in the profitability of a particular enterprise.

For the purposes of this example, we assume a producer is engaged in only two enterprises: (1) a cow-calf enterprise consisting of 100 head of cows and (2) an annual winter wheat crop managed for winter pasture for a stocker animal enterprise consisting of 200 head. Suppose the farm producer purchases 1,000 gallons of diesel fuel at $2.50 per gallon, for a total price of $2,500. For simplicity, assume that the fuel is the only input necessary for producing the two enterprises. Now, consider the following two scenarios:

Scenario One We assume the producer does not keep track of how much fuel is used for each of the enterprises, and, at the end of the year, he assumes he spent half the fuel expense on the cow-calf operation and half on the winter pasture/stocker operation. As a result, at the end of the year, his records show that he used, on average, $12.50 per cow for his cow-calf operation, or $1,250 for the herd. This implies, then, that he used $6.25 per animal in his stocker operation, or $1,250 for all the stocker animals.

Scenario Two We assume that the producer keeps track of how much fuel he used for each enterprise, and, at the end of the year, he realizes that the cow-calf operation actually uses only one-fifth (20 percent) as much fuel as the stocker operation. This implies that the cow-calf operation required, on average, only $5 per cow or $500 for the entire herd. Conversely, the stocker operation required $10 per head, on average, or $2,000, for all the stocker animals.

As you can see, the difference between keeping the correct account regarding the fuel expenses for each of the two enterprises has a substantial effect on the cost of the enterprise. When the cost of fuel is not accounted for correctly, as in scenario one, the cost of the herd is overstated by $750, or $7.50 per cow. This implies the cost of the stocker animals is underestimated by $3.75 per animal, or $750 for all the stocker animals.

The problem in this very simplified example may not seem serious. However, it would be compounded further if additional bulk-purchased inputs that are not accounted for correctly were added in the equation. The final result could be the difference between breaking even on an enterprise and losing money. It may be that producers have one enterprise that is actually more profitable or unprofitable, but, due to how the bulk-purchased inputs have been accounted for, they cannot correctly filter the information in order to make good production or marketing decisions. If you, like those of us on the Ag Division research team, want to get the best possible information on how a particular project or enterprise is performing from a profitability standpoint, dedicate extra time and effort to accurate allocations of bulk purchased inputs.