Why Ranchers Need Managerial Accounting

Good accounting records are at the very foundation of a good management program.  Most agricultural producers continue to utilize cash record keeping as allowed by the IRS.  However, tax accounting, in general, never accurately reflects the financial stability of an operation for several reasons including the allowance of accelerated depreciation and accounting on a cash basis.  Beef cow ranching is particularly susceptible to these issues and would benefit greatly from the use of managerial accounting (MA).  This type of accounting adjusts cash records through accrual adjustments and fully absorbs all costs, including overhead, depreciation, and management labor.  Furthermore, each ranch enterprise should be evaluated individually in order to effectively manage the operation as a whole.    

Ranchers need to be reminded occasionally that record keeping and accounting are done for more reasons than determining their annual tax liability.  MA serves to move tax accounting to the back burner.  Tax accounting and its associated rules, allowances, and credits are very simply a monetary policy tool for policy makers.  These politicians’ pass these polices with the macroeconomics in mind, such as stimulating a poor or slowing economy.  One would believe that the impact of these policies on the individual operation rarely comes to mind.  While there may be a benefit of reducing the individual’s operation tax liability, from a true financial profit standpoint, it’s doubtful that it is considered.  The premise of ranch MA is to use tax liability-reducing tools if they contribute to the overall financial improvement of the business.  However, from an analytical standpoint, the rancher and/or analysist for the business will want to calculate the true financial profit with these tax adjustments taken out of the equations.

Most ranchers continue to use cash record keeping as allowed by the IRS.  MA would be a move closer to double entry accounting and away from cash record keeping.  But this is not an argument for MA versus cash record keeping.  Understandably, there would be tax liability-reducing rules and allowances even if a rancher moved to double entry accounting, just as many industries benefit from them.  

The most common of these tax allowances deal with depreciation of capital assets.  Depreciation is an accounting procedure used to report the decline in the value of an asset due to wear, technological obsolesce and/or the passage of time.  Fiscal year depreciation expense lowers net income but does not lower cash.  Thus, it is called a non-cash cost.  It does however lower equity of the business.  Cash is required to purchase the asset, not to pay depreciation.  Depreciation spreads the cost of a fixed asset over the estimated life of the asset and separates out the difference between an annual expense and a long term investment.  

Every business, including ranching, must purchase capital assets occasionally.  Whether it is a new pickup, trailer, bulls or a mile of fence, each capital asset has a useful life of greater than one year.  The federal government uses this need in hopes of stimulating an economy.  They understand that the asset is needed, but not necessarily right away, and that any business that purchases a capital asset will have to spend dollars, thereby helping to move dollars around and subsequently stimulating the economy.  Thus, the IRS uses bonus depreciation and Section 179 of the Federal Tax Code to encourage businesses to go ahead and purchase those capital assets.  Depending on the year, a business can reduce their tax liability by taking the bonus deprecation in the first year.  While this doesn’t seem like much on a local basis, spread across all eligible businesses in every state, the impact can be substantial.  Yet, from the ranch financial standpoint, by taking the entire purchase price as depreciation in that fiscal year, the financial numbers reflect that the asset has effectively been totally used up in the first year.  Any analysist knows that is not the case.  Thus, the bottom line is if the ranch uses their tax records to determine its financial performance, the actual calculated profit will be grossly understated.  A rancher should take advantage of the tax allowance, but should not use those records to calculate their financial performance for the year.  This is an illustration for the need for MA.  

This leads to a second financial area needing MA.  Instead of purchasing replacement animals, many ranchers raise their own, especially their breeding females.  There are at least two reasons why ranchers do not depreciate their raised replacement animals.  First, the IRS continues to allow the agriculture industry to use cash record keeping, thus specific expenses that are used to develop those replacement animals are used to minimize that current year’s tax liability.  Thus, those expenses have already been used and cannot be used again as deprecation.  Second, to separate and then accumulate those expenses to develop the animal using a cash record keeping system is near impossible.  MA would do just that, separate each ranch activity, such as raising replacement animals and then accumulate them.  This occurs over the course of two years that it takes to wean a heifer, develop her and then get her bred.  This simple piece of information, the total accumulation of the development of replacement animals, can result in major financial decisions for the ranch as to whether to purchase or raise their own replacements.

Ranch management accounting has to be done in cooperation with an accurate livestock inventory system and depreciation schedule.  Livestock inventories should be reconciled with the financial accounting each year.  Differences between the beginning year inventory and the ending year inventory need to be identified as either, purchases, sales, transfers in or out, and deaths.  Each of these changes should be entered into the accounting system such that the beginning balance sheet, the profit and loss statement, and the ending balance sheet recognize the deposits, check written, and/or gains or losses calculated.   The depreciation schedule must be kept reconciled with both to have an accurate listing of all capital assets on the ranch.

At the end of the fiscal year, all activities conducted on the ranch should be analyzed for cost control and performance.  Managerial accounting, combined with production data and livestock inventories, helps to do this.  Activities such as hay production, stocker cattle, costs of producing weaned calves, replacement heifers, etc., can be improved and terminated given their performance and contribution to the overall ranch performance.  

The end result of MA, along with accurate livestock inventories and a depreciation schedule, is to calculate a set of key performance indicators (KPI).  These KPI’s are single figures that the ranch believes are critical activities to the ranch.  These can be either financial, production, or integrated figures.  A ranch will usually identify approximately ten.  These will be calculated the same way each year and will be tracked over time.  These will ultimately demonstrate whether or not the ranch is progressing towards the owners’ goals.  

Like most industries, ranch margins are tighter than in the past.  The past tax accounting, poor inventory management, and dependence on other resources have caused many ranches to be vulnerable to production, weather and marketing risks.  Ranch managers must have the best information to make decisions from.  The best information comes from managerial accounting that has been reconciled with an accurate livestock inventory and a deprecation schedule.