Recently, I have read several articles about depreciation of cows or in a cow herd. What is depreciation? It is the reduction in value of a capital asset over time—usually we talk of annual depreciation.
With pieces of equipment or fixed facilities such as building, corrals and other structures, it is quite easy to understand and account for. It is the purchase price minus a reasonable salvage divided by the years of life. Various methods, rather than straight line depreciation, are used to accomplish tax objectives or to be realistic about the rate of depreciation when an asset gets older and requires more maintenance.
Cows are a different “animal.” In reality, cows appreciate until they are about 4 years of age, stay about even until they are about 6 and then begin to depreciate toward their salvage or cull cow value. That is pretty difficult to handle in any acceptable accounting format.
So, those who do a good job of accrual accounting with some enterprise structure seem to have adopted a method which keeps cows and calves in one enterprise and developing heifers in another enterprise.
So what, roughly, do most of them do? They recognize that ranches have cows to produce calves. So, they accumulate all of the cow herd costs (including cow depreciation) for the entire enterprise for a production or calendar year (12 months). They then divide that cost by the number of calves weaned and that becomes the cost per calf weaned.
The calves then carry that cost with them into the next enterprise—stocker, heifer development, feeder, etc. If they are sold when weaned, the cost is subtracted from the revenue to get profit per calf.
Now let’s consider just the heifer development enterprise. In addition to the weaning cost, the costs accrued though the heifer development process are added. Then when the heifers are preg-checked, the opens are typically sold and the pregnants are kept.
For those sold, sale revenue minus lifetime cost equals profit. Those kept for the breeding herd are put on the books (depreciation schedule) at the lifetime cost to that point. Then that number is depreciated toward a reasonable salvage or cull value over the expected lifetime of the average animal.
I happen to think that is a good way to do the accounting. However, I must also say that it is not very accurate; but the inaccuracies will be different from one operation to another. Placing a correct average cow lifetime and a correct salvage value is difficult because it keeps changing.
Then there are several other considerations:
- How to take animals off the inventory or depreciation schedule. Do you use a “first in, first out,” approach where you simply treat the inventory as if the first ones in will be the first ones out (sold or died) or do you try to remove them individually from their respective layers of inventory, which is cumbersome?
- When animals are sold or die and need to be removed from the depreciation schedule, there will be a “gain or loss in the sale of a capital asset” because the salvage value is not the same as the sale proceeds (the dead ones sell for zero). Most ranchers don’t even care or think about these items or the effect they may have on the current year’s bottom line.
In spite of the difficulties and some inaccuracies in the year-to-year profit and loss (P&L), good accrual accounting with enterprise structure is as good as you are going to get. It is helpful if you understand enough about accounting that your accountant can help you understand what the accounting is really telling you.
For those ranches, and they are many, where cows, calves, stockers and development heifers are treated as a single enterprise and that use “cash accounting,” your cow depreciation is really buried in the costs.
Cash accounting is wonderful way to do income tax reporting if your cattle inventories are growing—not so good if they are decreasing. It is simple and you can make some income adjustments by accounting for inventory increases or decreases that provide a good estimate of an accrual accounting P&L.
With cash accounting, if your size is not erratic and you will separate your costs into an enterprise structure where cow-calf and heifer development costs are accounted for separately, you can get a pretty good idea of your depreciation. Whole herd depreciation for one year will not differ much from the heifer development costs for that year. If your size is changing much from year to year or you are developing a significantly different number of heifers each year, this estimate of depreciation is not good.
There are several points to make from this:
- Depreciation is real and you should try to get some good estimate of how much it is.
- If you sell most of your cows as bred females by the time they are 6 years old, you will have very little, if any, depreciation if you market well.
- If you are accounting for your herd as a single enterprise and raising your own replacements, don’t add someone’s estimate of depreciation to your costs. It is already there.
Teichert, a consultant on strategic planning for ranches, retired in 2010 as vice president and general manager of AgReserves, Inc. He resides in Orem, Utah. Contact him at firstname.lastname@example.org. The opinions of the author are not necessarily those of beefmagazine.com or Farm Progress.