Which Depreciation Table Should You Use?

By Graham Gilchrist

Well, I'd be the first to admit that this question might make you pinch the top of your nose while you're reading this in your combine this August.

One of the projects I'm working on this year is an approach to better put in front of you and your management team a process to better deliver your cost of production numbers. The short version of what we're working on is to match the expense to the fiscal year where the revenue is earned from that expense.

One of the items up for debate is how to handle depreciation. Your farm has two depreciation tables. The first one is depreciation for tax. The short answer is it's useless for the cost of production discussion. 

The second one is your management depreciation table. And to refresh your memory, depreciation is a mechanism to charge your business and recoup as an expense the cash you outlaid for that capital purchase.

Here are a couple of examples to explain what I'm trying to get at.

The purchase of the new bull is allocated in that table over the next three to five fiscal years of its use, and then there would be a discount in that table for the salvage value when you sell that bull.

For that bred heifer purchase, her purchase would be allocated over the next 8 calves starting in the fiscal year that her first calf is sold. The same discount would be applied to the value of her sale as a cull cow.

Those 10 bales of four-inch, 8-foot fence posts you bought would be allocated over the next 15 years (from my experience fixing fence). Your numbers might be different depending on how long a post lasts on your place for its environmental conditions.

For machines and buildings, there certainly are tables out there to assist you in determining a depreciation schedule you should be using for management purposes. The trick is to take each of those machines and buildings and apply a suitable rate based on their use. A combine that is flipped every 10,000 acres has a different schedule than the one you bought in 1988 and is still in use today. Again, apply the salvage value discount to each machine.

So how did this fit into your cost of production calculations? Cost of production calculations have 6 categories you've got to look at. 

You have cost of goods sold, direct expenses, administration, land access costs, depreciation and interest, and cash withdrawals by the owner.

When you finally get a number at the bottom of this addition, you divide it by the production unit, i.e. calves sold or bushels sold.

So, what do you do with that number? Well, if that cost of production number is greater than the market price today, that's probably a challenge and changes are warranted. If that cost of production is lower than the market price today, then that would be a good thing.

The trick is to take the time and build the table that reflects your operation. 

Since this is a carbon newsletter, how does it relate to carbon? When we look at carbon emissions, most of the emissions on a farm come from your energy consumables, i.e. the natural gas and the diesel you purchase. So, every time you lower your footprint by a ton, you lower the amount of gasoline or energy you consume. That lowers your cost of production.

Thanks for listening.

Graham