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					The Sixty-third



                       ANNUAL MEETING

                                   of the

        NATIONAL SOCIETY OF ACCOUNTANTS
               FOR COOPERATIVES

                                will be held


                        AUGUST 3-6, 1998                          A PUBLICATION OF NATIONAL
                                                                   SOCIFFY OF ACCOUNTANTS
                                   at the                              FOR COOPERATIVES


         HYATT REGENCY AT UNION STATION
                ST. LOUIS, MISSOURI



Iln.st Chapter: Mississippi Vsillcv

Dmiiilcl \V. Deholt, General Chairman




THE COOPERATIVE ACCOUNTANT
National Society of Accountants for Cooperatives
6320 Augusta Drive, Suite 800
Springtield. Virginia 22150
(703) 569-3088




                                        3r0 I tTI T   5S1
             DRUID      U   CDBIfl
            OUENT1N         BUROXCK         CTR    FOR   COlDFS

            FrtRCO     HD
      TAXFAX                Volume I.I,   Number 2,   Summer 199S



         Kililor
  George W. Benson
                                          EDITOR
    (Jucsl Writers
    Don Frederick                JAMES L. EVANS
       Id Haltn                 7701 DALLAS LANE
     Jim Murphy               MAPLE GROVE, MN 55311
     Wayne Sine                    (612) 420-3556


     ACCTFAX

                                                                                   FUTURE ANNUAL MEETINGS

        Editor
   Philip W. Miller

                                                                    1998 ANNUAL MEETING
  Assist:)nt Editors
                                                                      (St. Louis, MO, August 3-6) Host Chapter—Mississippi Valley
  Robert 1). Beerup
  lillis M. Dunkum                                                   Chain
 Douglas W, Fleming                                                    Donald Dcbolt                                               (217) 682-5758




                                                         IN
                                                                         Donald W. Dcbolt. CPA                 P.O. Box 406, Slcwardson, IL 62463
    Guest Writers
   Philip W. Miller
 Douglas W. Fleminu
                                                                    1999 ANNUAL MEETING
                                                                     (Montreal, CN, August 2-5) Host Chapter—Northeast

                                                                     Chair:
     SMALL                                                             Gary Miller                                                  (716)326-5302
 COOPERATIVE                                                             Welch Foods, Inc.                   2 S. Portage St.. Westlidd. NY 147S7

BUSINESS FORUM


        Kditor                                                      2000 ANNUAL MEETING
                                          KST.
 Dwiiync li. Campbell                                                 (San Antonio, TX, August 7-10, 2000) Host Chapter—Texas

                                                                     Chair:
     Ciuest Writer
                                                                       Ed Bercot                                                   (210) 425-3206
 Dwaync li. Campbell
                                                                                                            2014 K. Harrison, llurlinccn. TX 78550



   UTILITY
 COOPERATIVE
    FORUM
                                    NSAC OFFICE
                           6320 Augusta Dr., Suite 800
        Kditor
 David A. Cummings             Springfield, VA 22150

     (•ucsl Writer
                          Phone                  (703) 569-3088
 Patricia I". Barganier   FAX                    (703) 569-0235
                                   TYPES OF MEMBERSHIP
                                                                                                                                              THE
REGVIAR: To be eligible for regular membership, an individual shall be employed by or
affiliated with a cooperative association or be engaged in providing professional services for
cooperatives, or shall otherwise be engaged in the furtherance of cooperative principles. For
new members the national annual membership service fee is prorated on a quarterly basis                                                 Cooperative
according to date joined: Jan. 1-March 31 = $95.00; April I-June 30 = $71.25; July 1-Scpt.
30 - $47.50; Oct. 1-Dec. 31 = $23.75. NSAC membership dues MUST include: (1) payment of
nntiimal membership service ttxs plus (2) chapter dues (listed below).

RETIRED: To be eligible for retired membership, an individual must have a minimum of five                                               Accountant
years active membership in good standing and have reached age 55 and be retired from active
business under provisions of a formal retirement plan or through amicable arrangement wilh his
or her employer which results in a complete severance or material reduction in compensation
                                                                                                                                 CONTENTS
or have retired because of permanent disability. S25.00 (national membership service fee), no
chapter dues required.
                                                                                                     Financial Derivatives Dangerous Developments
                             CHAPTER MEMBERSHIP AND DUES                                                 By Philip Miller                                            3
Chapter membership is required as a condition of membership in NSAC. Eleven chapters have            Record Gross Revenues Do Not Translate Into Higher Net
been organized using state boundaries as set forth below. Members usually affiliate with the           Margins For Largest Co-ops
chapter covering the state they live or work in. However, NSAC recognizes that due to
                                                                                                         By David S. Chesnick                                        8
professional, geographic or other reasons, members may prefer to affiliate with a different
chapter or with more than one chapter. Bylaw provisions entitle members to affiliate with a          Patron Demand Deposit Account Financing By Cooperatives:
chapter/chapters of their choice.                                                                      Prospects and Pitfalls
Dues are assessed on the basis of all chapters chosen. Please designate the chapter(s) you wish to
                                                                                                         By Ken D. Duft                                              15
hold membership in. If no choice is made, a chapter assignment will be made based on address.
                                                                                                     Continued Expansion of Assets Shows Greater Reliance
OCCUPATION CODES                                  CHAPTERS AND CHAPTER DUIiS
                                                                                                       on Debt by Farmer Co-ops
             Cooperative Employees                Capitol (DE. DC, MD. PA, PR.                           By David S. Chesnick                                        32
Accountant                                   I      VA. WV)                                   S2H
                                                                                                     CoBank, ACB—New Capital Markets Products
Attorney                                     -
                                                  Far Western (AZ. CA. HI. NV, UT)            S2<)
Auditor                                      3                                                           By Mary E. McBride                                          42
CEO                                          4
                                                  Gnat Lakes (MI. Wl)                         S 7    The ABCs of LLCs—Limited Liability Companies Offer New
CFO                                          5
Controller                                   (>   Mid-Central (IN. KY, OH, TN)                S 5      Options For Rural Businesses
Tax Person                                   7                                                           By Donald A. Frederick                                      58
Treasurer                                    8    Mid-Wat (CO, KS, NE, NM. OK)                $ 5
Bookkeeper                                   9                                                       Leveraging the Future: Higher Debt Levels Among Large Ag
Other                                       HI    Mississippi Valley (AR, IA, 1U MO,
                                                                                                       Co-ops May Be Cause for Concern
          Professional Service Suppliers            MS)                                       Sin
Accountant                                  11                                                           By David S. Chesnick                                        65
                                                  North Central (MN, ND, SD)                  S10
Auditor                                     12
Attorney                                    13    Northeast (CT. ME. MA, NH.
                   Miscellaneous                    NJ. NY, RI. VT)     t                     $10
Academician                                 29
                                                  Pacific Norttrnvst (AK. ID, MT,
Other. Education                            30                                                       Editor's Page                  2    Small Cooperative
Cooperative Service Co. Employee            31
                                                    OR. WA. WY)                               $1<)
Finance: FCS                   '            32                                                                                             Business Forum            74
                                                  South Atlantic (AL FL GA. NC                       Utility Cooperative Forum    54
           Other                            33      SC)                                       $25
Retired                                     50                                                       TAXFAX                       48     New Members                 78
Other                                       W
                                                  7tam-<LA.TX)                                «H>
                                                                                                     ACCTFAX                      22     National/Chapter Officers
           Members are entitled to affiliate with the chapter/chapters of their choice.                                                    And Directors             82
                                                                                                     NSAC Membership
 Approval of this application is subject to final endorsement by the Executive Committee.              Application                95     NSAC Committees             89
                                                                                                    Referred by:
                                                  EDITOR'S PAGE                                                                         Member Name


      Deadlines for                    Many times we hear about innovation and                                                             Chapter

       submitting                  being innovative in the accomplishment of
                                                                                                                           1998 MEMBERSHIP APPLICATION
         articles.                 our task or jobs.
                                                                                                                NATIONAL SOCIETY OF ACCOUNTANTS FOR COOPERATIVES
                                      What does it really mean to be innovative?
                                                                                                                                      NATIONAL OFFICE
      Spring Issue                 Is this to find new solutions to old or even                                     6320 Augusta Drive, Suite 800 • Springfield, Virginia 22150
        January 1                  new problems as they arise? Obviously.                                                      (703) 569-3088 Fax (703) 569-0235
                                   Could it be to find a solution to a problem
     Summer Issue                  that doesn't yet exist? Yes. Did we know we                      Name                                                      Title.

          April 1
                                   needed or wanted the mini-computers until                        Badge Name.                                                 E-MaiL
                                   they were presented to us? No.                                   Firm Name
                                      • Innovation—to make changes: do some                         Cooperative Employees only: The primary focus of my cooperative is:
        Fall Issue
                                   thing in a new way—a new idea, method, or                             □ Agricultural (specify type)                               □ Other (specify type).
          July 1
                                   device.                                                          Firm Address^                            ...                              .      _^_
                                     • Ingenious—showing or calling for intel
      Winter Issue
                                   ligence, aptitude, or discernment.                               Business Phone (           )                               Fax Number (         )_
        October 1                    Experience has indicated that most inno                        CEO or General Manager's Name.
                                   vation occurs in response to a problem that
                                   needs a solution. However, ingenious inno                                                            PROFESSIONAL INFORMATION
                                   vation can lead to solutions of problems that                                                     (see reverse for this line of information)
                                   have not yet arrived.
                                                                                                    CHAPTER                                                                  OCCUPATION CODE.
   Articles must be                  Innovation in a service industry or position                   Number of years in cooperative activity:
  typewritten, double              may be in finding interesting new solutions to                   Are you a certified public accountant?            Yes D    No D
 spaced, leaving wide              the many problems that present themselves.                       PREVIOUS EMPLOYERS
margins. Originals are             However, true or ingenious innovation would                                        Name offirm                       City/State                  Dates                     Title

 preferred, or send a              more likely be in presenting customers with                      1.
                                   ideas and solutions before they become prob                      2.
    very clean copy.
                                   lems. Service providers should take it upon                      Other professional organizations
    Computer disks
                                   themselves to address arising issues that
      are welcome.
                                   might affect their customers.                                                                        EDUCATIONAL INFORMATION
                                     Sharing among professionals can help
                                                                                                                     Name of School                     City/State                  Year                    Degree
                                   make this happen.
                                                                                         JLE

Articles and other information which appear in The Cooperative Accountant do not neces
sarily reflect the official position of the NATIONAL SOCIETY OF ACCOUNT                                                              PERSONAL INFORMATION (optional)
ANTS FOR COOPERATIVES and the publication does not constitute an endorsement of
views or information which may be expressed.                                                        Birthdate                                        DMDF              Spouse's Name.

                                                                                                    Home Address.
Tlte Cooperative Accountant (ISSN 0010-8391) is published quarterly by the National Society of                                                                            Home Phone (           )_
Accountants for Cooperatives at Springfield, Virginia 22150. Second-class postage paid at
Springfield, Virginia and at additional mailing offices. Tiie Cooperative Accountant is published
                                                                                                    Signnlurc
as a direct benefit/service to the members of the Society and is not available to those that are
eligible for membership. Subscriptions are available to University libraries, Government agen       Each application must be accompanied by one check for both national anil chapter dues. Dues
cies and other libraries (where there is already a current member) at a rate of $60.00 a year.      rates are listed on the reverse. Retired members are not required to pay chapter dues.
Land Grant Colleges may receive a complimentary copy. Single copies are available at a rate of
$15.00 an issue. Postmaster: Send address changes to National Society of Accountants for
Cooperatives, 6320 Augusta Drive, Suite 800, Springfield. Virginia 22150.                           Please charge my payment in the amount of $                             to:

                                                                                                    □ Visa      □ MasterCard       Q American Express   □ Card #.                              Exp. Dale.

                                                                                                    Cardholder Signature.                                                  Print.
94                          CoMMimEi-s i-xiR 1997-1998


TECHNOLOGY COMMITTEE                                                                                            FINANCIAL DERIVATIVES
                                                                                                              DANGEROUS DEVELOPMENTS

 Chair
                                                                                                                      By Philip W. Miller
   David Anloni                                                         (215) 299-4790
     KPMG Peat Manvick, LLP                   1600 Market St., Philadelphia, PA 19103
                                                                                           This article is a follow-up to my       securities3. As you study the follow
                                                                                         article in the Spring 1998 TCA titled     ing summaries of the two bills and
 Vice Chair:
                                                                                         "Financial Derivatives & Hedging—         the ensuing reactions to them, you
     Larry H. Schafer                                                  (202)626-8700
       National Council Farmer Cooperatives                  50 "F" Street NW, #900,     Current & Proposed Reporting1."           will understand my use of the term
                                                               Washington, DC 20003      The last section of that article was      "dangerous developments." The ti
                                                                                         headed CONTINUING PROB                    tles of the two bills alone have to
 Committee Members:                                                                      LEMS. As you can see from my title        send chills down the spines of our
     Dwayne Campbell                                                      Wayne Sine
                                                                                         above, those "Continuing Problems"        accounting standards setters.
     Bernard Carlson                                                  George Benson
     Austin Maggioncalda                                                Myron Fleck      have escalated into "Dangerous De            Senator Faircloth's bill, s. 1560, is
     Richard H. Otsen                                                   David Haves      velopments." In that earlier article, I   titled ACCURATE ACCOUNT
                                                                                         stated, "Both the SEC and FASB            ING STANDARDS CERTIFICA
                                                                                         have encountered tremendous resis         TION ACT OF 1997. The bill sum
                                                                                         tance to the new rules and proposed       mary (as introduced)4:
                                                                                         standards for (financial) deriva
                                                                                         tives. ... The urgings from the Sen          "Declares that accounting stan
                                                                                         ate to the FASB stopped just short           dards developed by the Financial
                                                                                         of being threats."                           Accounting Standards Board as of
                                                                                                                                      November 13, 1997, governing the
                                                                                            Well, the Senate and the House            treatment of derivatives and simi
                                                                                         of Representatives both jumped               lar instruments shall not be con
                                                                                         completely over the "threats" stage          sidered to be generally accepted
                                                                                         and proceeded directly into the "ac          accounting principles. Prohibits
                                                                                         tion" state. On November 13, 1997,           their use by a depository institu
                                                                                         Senator Lauch Faircloth (R-NC) in            tion for purpose of compliance
                                                                                                                                      with Federal banking law unless
                                                                                         troduced a bill in the Senate that
                                                                                                                                      the appropriate Federal banking
                                                                                         would require the Federal banking
                                                                                                                                      agency certifies in writing to the
                                                                                         agencies to make certain certifica           Congress that such standards: (1)
                                                                                         tions to Congress regarding new ac           reflect more accurately depository
                                                                                         counting standards for derivatives           institution assets, liabilities, and
                                                                                         before they become effective2. And,          earnings; and (2) will not have the
                                                                                         on February 5, 1998, Congressman             effect of diminishing the use of
                                                                                         Richard Baker (R-LA) (chairman of            risk management practices that
                                                                                         the House Banking Capital Markets            would have the effect of inhibiting
                                                                                                                                      the safe and sound operation of a
                                                                                         and Securities Subcommittee) intro
                                                                                                                                      depository institution."
                                                                                         duced a bill in the House to amend
                                                                                         the Securities Exchange Act of 1934
                                                                                         to provide an opportunity for judi        Congressman Baker's bill, h.r. 3165,
                                                                                         cial review concerning the adoption       is titled FINANCIAL ACCOUNT
                                                                                         of accounting principles applicable       ING FAIRNESS ACT OF 1998.
                                                                                         to issuers of federally—registered        The bill summary (as introduced)5:


Summer 1998                                            Cooperative Accountant            The Cooperative Accountant                                                 iR 1998
                Financial Derivatives Dangerous Development                                                     Committees for 1997-1998                             93

   "Amends the Securities Exchange        of FASB, was called to testily before      Legislative Sub-Committee Members:
   Act of 1934 to prescribe guidelines    the U.S. Senate Subcommittee on              Alice O. Harmon, Jr.—Chair                                       Richard L. Cisne
   under which the Securities Ex          Securities chaired by Senator Phil           David Antoni                                                    Richard H. Olson
   change Commission (SEC) must                                                        Maria J. Aspinwall
                                          Gramm and the U.S. House of Rep
   review and approve accounting
                                          resentatives Subcommittee on Capi
   principles proposed by an ac
                                          tal Markets, Securities and Govern         State Tax Sub-Committee Members:
   counting standards board as a pre
                                          ment     Sponsored     Enterprises,          Donald A. Frederick-Co-Chairman                              Dwaync E. Campbell
   requisite to SEC treatment of: (1)
                                          chaired by Congressman Richard               Richard C. Leverenz-Co-Chairman                                  David F. Antoni
   such proposals as generally ac
                                                                                       Austin B. Maggioncalda                                        Teresa H. Castanias
   cepted accounting principles; and      Baker6. Understanding that the               James P. Murphy                                             Jason James Cardinet
   (2) industry financial statements      FASB proposal on derivatives was             Craig MacQuaid                                                     Wayne E. Sine
   as being non-compliant with gen        being strongly opposed by the finan          Thomas H. Davis                                                  Tony D. Burrell
   erally accepted accounting princi      cial institutions and banking com            Richard C. Lcvercnz                                                  Rex Carlson
   ples.                                                                               Kevan D. Acord                                                  Richard L. Cisnc
                                          munities, entrenched supporters of
   Includes within such guidelines:       the subcommittee members before
   (I) SEC consideration of investor      which he was testifying, Mr. Jenkins
                                                                                    TCA COMMITTEE
   protection, and the promotion of       provided a clear outline of what and
   efficiency, competition, and capital   why the FASB had proceeded as
   formation; (2) SEC consultation        they had. To summarize his key             Chain
   with Federal banking agencies; (3)                                                  Larry Robertson.
                                          points:                                                                                                         (916) 988-3641
   a public file of the record engen                                                                                           154 Winding Canyon Ln., Folsom, CA 95630
                                             • "This project is all about the
   dered by a proposed accounting
   principle; and (4) the availability          public's right to know.
   of judicial review."                      • Our (the FASB's) due process          Vice Chain
                                                has ensured that all interested        Wayne E. Sine                                                     (804) 281-1301
Section 19 of the Securities Ex                 parties, including financial in          Southern States Cooperative               P. O. Box 26234, Richmond, VA 23260

change Act of 1934 would be                     stitutions, have been heard
amended by adding at the end of the             from—and listened to.                Committee Members:
heading of Section 19 the following;         • (The FASB's) proposal is re             Robert D. Beerup, Chair, Accounting & Auditing Committee
OVERSIGHT OF ACCOUNTING                         sponsive to most of the con            George Benson, TAXFAX Editor
                                                                                       Dwaync E. Campbell, Chair, Small Cooperative Commttec
PRINCIPLES, which in a nutshell is              cerns raised by financial institu
                                                                                       David A. Cummings. Editor. Utility Cooperative Forum
exactly what both the bills are lead            tions and others.                      Atlee O. Harmon, Jr.. Chair, Tax Committee
ing to; FEDERAL OVERSIGHT                    • The FASB is not opposed to              Philip Miller, ACCTFAX Editor
OF ACCOUNTING PRINCIPLES.                       derivatives ... (The FASB's)           James L. Evans, TCA Editor
   As of this writing, neither bill has        goal is to protect the public in
yet to be voted on. The Senate bill (s.         terest by making sure that in        Vice Presidents:
1560) has been referred to the Sen             vestors and creditors have the          John C. Christie                                              Ralph T. Lawrence
ate Banking, Housing, and Urban                 information they need to un            Matthew A. Connors                                             Joseph L. Loworn
Affairs Committee4. The House bill            derstand companies that they             Randall W. Currie                                             G. Michael Murphy
                                                                                       Thomas H. Duffcy                                                  Wayne E. Sine
(h.r. 3165) has been referred to both         might want to invest in.
                                                                                       David R. Garcia                                                      Ann Young
the House Commerce Committee                • The information about deriva             Dan Kent
and the House Finance and Hazard              tives and hedging reported in
ous Materials Committee5.                     financial statements today is in
                                               complete, inconsistent, and just
      STRONG REACTIONS
                                               plain wrong. Better informa
    Prior to the introduction of both          tion is badly needed by all con
bills, Edmund L. Jenkins, Chairman             sumers.



Summer 1998                                      The Cooperative Accountant         The Cooperative Accountant                                          Summer 1998
92                             Committed for 1997-1998                                                      Financial Derivatives Dangerous Developments                     5

TAX COMMITTEE                                                                                   • (The FASB) has worked long           are successful, I believe there is a
                                                                                                   and hard to find an appropriate     real threat to the future of private-
 Chair:                                                                                            solution. We understand that        sector standard setting. Opponents
     Atlec O. Harmon, Jr                                                   (813) 222-2010          not everyone is pleased with        of the FASB proposal have already
       KPMG Peat Marwick                  100 N. Tampa St., Suite 2400, Tampa, FL 33602            the results, but no solution will   persuaded two lawmakers to intro
                                                                                                   please everyone. However, we        duce legislation that would seriously
 Vice Chairs:
                                                                                                   have found a workable solution      disrupt the FASB's ability to set
     Larry Boeshart                                                         (816) 459-5135
                                                                                                   and the time for action is now."    standards independently." In dis
       Farmland Industries, Inc.         P.O. Box 7305. Dept. 54, Kansas City, MO 64116
     Bcrnic Carlson                                                         (612)533-1957                                              cussing the importance of informa
       Paul Julin & Co.             5637 Brooklyn Blvd., Ste. 300, Minneapolis, MN 55429      It certainly appears that misters        tion available to investors and its re
                                                                                              Gramm, Faircloth and Baker were          lation to the cost of capital, Mr.
 Committee Members:
                                                                                              listening to Mr. Jenkins—and             Foster said, "The more information
   Kcvan D. Acord                                                     Robert Edward Lee
                                                                                              sprung into "action." Do the words       you have about something, the less
   David Anloni                                                      Richard C. Levcrenz
     Maria J. Aspinwall                                                Joseph L Loworn        "special interests" come to mind?        uncertainty there is and, conse
     George W. Benson                                                    Craig MacQuaid       Are the banks and financial institu      quently, the lower the premium you
     Hdmond 1£. Bercot                                            Austin B. Maggioncalda      tions so fearful of full disclosure of   will demand for your investment. In
     Josiah Ulaisdetl                                                    J. Gary McDavid
                                                                                              their derivatives dealings that they     other words, better disclosure results
     Tony D. Burrell                                                    Michael Mclntyre
     Donald W. Butwill                                                Mike Mciscnhcimcr       would sacrifice the whole accounting     in a lower cost of capital. It is pretty
     Dwayne E. Campbell                                                   Howard J. Mills     standards setting process? The an        clear from the actions of some of the
     Rex Carlson                                                        James P. Murphy       swer is obviously a resounding YES!      people who prepare financial state
     Teresa H. Castanias                                               Henry E. Neely, II         After introduction of the two        ments that they aren't buying the
     Richard [.. Cisne                                                         Rick Olson
                                                                                              bills, Mr. Jenkins and the FASB arc      argument about more information."
     Thomas H. Davis                                                   Katherine A. Pace
     Robert Der                                                             Brian Pawling     now in the position of having to de      In discussing the impact of Congres
     Tina Dorn                                                           Jason A. Reschly     fend the whole private-sector stan       sional intervention, Mr. Foster said,
     Dennis J. Hdstrom                                                 Lariy J. Robertson     dards setting process—not just their     "I recognize that it is human nature
     Robert C. Estcs                                                       ' Liirry Schafer   proposal on derivatives. Mr. Jenkins     to try to influence the rules—any
     William J. Faik                                                    Daniel R. Schultz
     Myron J. Fleck                                                        Wayne E. Sine      response to the Senate bill: "We're      rules—to an individual's or organi
     Allen F. Floyd                                                       John Single tary    disappointed that the bill was intro     zation's advantage and we expect
     Ron Foster                                                          John E. Thomas       duced and we're sorry to see this has    that. But if you want the institution
     Donald A. Frederick                                              Richard A. Toftness     happened." The bill is, "a direct        that is setting the rules to survive,
     James Griebcl                                                         John F. Tullie
                                                                                              broad-side against private-sector        you must be willing to abide by
     Ronald P. Mennen                                                    Robert F. Wacck
     John P. Henry                                                      Daniel S. Welylok     standard setting3."                      them ... If a group of constituents
     Robert M. Kenost                                                                            Mr. Neel Foster, a highly re          that is dissatisfied with a proposal or
                                                                                              spected member of FASB, in a re          a standard issued by the FASB has
 Audit Procedures & Recent Examination Issues Sub-Committee Members:                          cent speech given at the University      the ability to successfully appeal to
     Tony D. Burrell                                                     Craig MacQuaid
     Bernard A. Carlson. Jr.                                            Michael Mclntyre
                                                                                              of California-Berklely, was much         Congress to overrule that standard,
     Teresa H. Castanias                                                    Larry Schafer     more verbose in his response to the      the authority and the viability of the
     Thomas H. Davis                                                       Wayne E. Sine      chain of events7: "The FASB once         FASB will soon vanish ... If you
     Myron J. Fleck                                                    John A. Singletary     again is under fire, this time for our   want accounting standards set in the
     Ron Foster                                                            John F. Tullie     derivatives and hedging project. In      private sector, and I think if you give
     Austin B. Maggioncalda                                             Robert F. Wacek
                                                                                              spite of extensive due process ...       it much thought you will, you have to
                                                                                              our process is being attacked in         support the process—always—not
                                                                                              Washington. The reason is simply         just when you like the answer." Neel
                                                                                              that some people don't like the an       Foster has been a member of FASB
                                                                                              swer. If those pursuing this agenda      since 1993 and was just rcappointcd

Summi-r 1998                                         The Cooperative Accountant               The Cooperative Accountant                                        Summhk 1998
               Financial Derivatives Dangerous Developments                                                        Committees for 1997-1998                            91


for his second 5-year term. Prior to      several constituents comment that           MEMBERSHIP DEVELOPMENT COMMITTEE (Continued)
joining FASB, he was treasurer of         the Board should be prepared to
                                                                                       National Committee Members:
Compaq Computer Corporation.              provide assistance on a timely basis."
                                                                                         Teresa H. Castanias                                         James S. Krzyminski
    In addition, others have de              While not reported as being re              David Cummings                                                   Edward Nishio
nounced the proposed legislation.         lated to this fray, SEC Chief Ac             Chapter Membership Chairs:
The AICPA has formally petitioned         countant, Michael H. Sutton, re                Capitol—Robert Rathbone                           Mississippi Valley—Jan Dooley
the House Committee on Banking            signed his post in January after               Far Western—Joe Marchini                     North Central—Roger Van Someren
                                                                                                      Allen C Ludlow                           Northeast—Scott Cleveland
and Financial Services to keep the        nearly three years of service2. Mr.
                                                                                         Great Lakes—Tyrone A. Lein                         Pacific Northwest—Jeff Milner
FASB independent of government            Sutton was deeply involved in the              Mid-Central—William T. Hopper                 South Atlantic—Wendell W. Hcflin
intervention3. The AICPA asserted,        new SEC disclosure rules for deriv             Mid-West—Steve Stoecklcin                             Texas—G. Michael Murphy
"a single significant legislative inter   atives. The financial and banking
ference in the objective process fol      community has also roundly criti
lowed by the FASB is a major step         cized these new rules. In fact, the
down a slippery slope to that very re     SEC rules along with the FASB pro
                                                                                      NSAC/LTA COORDINATING COMMITTEE
sult (government interruption)." Also,    posal started this whole hub-bub. Mr.
the Boston Security Analysts Society,     Sutton also worked very closely with         NSAC Members:                                                     LTA Members:
                                                                                         George Benson                                                  Larry C. Boeshart
a 2,400-membcr association of char        the FASB on its proposal and deliber
                                                                                         William Duvisson                                                 David M. Hayes
tered financial analysts wrote Senator    ations. Did this whole issue drive him         Allen Floyd                                                          Barry Jcncik
Faircloth saying3, "We have read with     away? I hope not—but who knows!                James P. Murphy                                                 Kendall Manock
dismay S 1560 ... when it comes to           In summary, I would ask you to              Edward Nishio                                                       John Rcbanc
accounting, it is always best to pursue   closely consider the impact of all
truth and to disclose it fully."          this. There have been several new
                                          FASB standards issued over the past
                                                                                      SMALL COOPERATIVE COMMITTEE
                                          few years that I have strongly dis
        OTHER RELATED
                                          agreed with—to name a few: post-             Chain
         DEVELOPMENTS                                                                    Dwayne Campbell       .            .....                    .".  (800) 611-6731
                                          retirement benefits; fair value of
                                                                                           Collins, Butler & Co., P.C.              901 West Maple Ave., Enid, OK 73701
   The FASB has extended the ef           marketable securities; stock options;
fective date in the derivatives pro       transfer of financial assets. I deplore      Vice Chair and SCOOP Editor.
                                                                                         Ed Bercot                                                         (956)425-3206
posal, from December 15, 1998 out         the proposals on consolidations. But
                                                                                           Ed Bercot CPA                            2014 E. Harrison. Harlingen, TX 78550
to years beginning after June 15,         I still support the process! If we al
1999 and January 1, 2000 (for calen       low the legislative process to put the       Committee Members:
                                                                                         Ray Brazington                                                        Dan Kent
dar-year companies)8 This would al        FASB out of business, what will re
                                                                                         Bernard Carlson                                                       Don Krull
low enterprises the time to under         place it? We need to have and will
                                                                                         Dale Carlson                                                      Robert E. Lee
stand and apply the standard. In a        have rules. I do not want the govern           CHIT Church                                                     Allen C. Ludlow
related move, the FASB has ap             ment involved in setting accounting            Donald W. Dcbolt                                              Charles C. McCoy
pointed a task force to assist in pro                                                    Jayne T, Deifc                                              Michael D. Mclntyre
                                          rules, I already have too many life
                                                                                         Stanley Dreycr                                               Mike Meisenheimer
viding timely guidance on a new           issues to deal with that arc tainted by
                                                                                         James L. Evans                                                   Edward Michel
standard. The Task Force will iden        the political sways of governmental            Tom Finn                                                          Brian Pawling
tify implementation issues and make       interference.                                  Allen Floyd                                                     Ernest G. Potter
recommendations to the FASB". In                                                         Ron Foster                                                          Harry Rolfi
                                                                                         Donald A. Frederick                                             Michael P. Rose
announcing the Task Force, Ed
                                                                                         Dan Hubbard                                                     James H. Welch
mund Jenkins said that, "The new                        FOOTNOTES
standard is necessarily complicated       1.   Miller, Philip W., "Financial Deriva
because derivatives arc complicated            tives & Hedging," The Cooperative
financial instruments. We have had             Accountant, Spring IW8.


Summer 1998                                       The Cooperative Accountant          Tim Cooperative Accountant                                          Summer 1998
90                             Committees for 1997-1998                                                        Financial Derivatives Dangerous Developments


CONSTITUTION & BYLAW COMMITTEE                                                                   2.   AICPA: Journal of Accountancy           rics: Status Report," November 26,
                                                                                                      "News Report," February, 1998.          1997.
 Chair:
     Ralph W. Miller                                                            (309)557-2329
                                                                                                 3    AICPA: Journal of Accountancy,     7.   Financial Accounting Standards
       IL Agricultural Auditing Assn.                   1218 N. Jefferson St., Dixon, IL 61021        "News Report," April, 1998.             Board, "Financial Accounting Sc-
                                                                                                 4    WWWThomas.loc.gov, "S. 1560             ries: Status Report," February 27,
                                                                                                      Summary " April 22, 1998.               1998.
CONVENTION PLANNING & RESOURCE COMMITTEE                                                         5    WWWThomas.loc.gov, "H.R. 3165      8.   AICPA, "The CPA Letter," Febru-
 Chain                                                                                                Summary," April 22, 1998.               ary/March 1998.
     Philip Blakney                                                          (509)663-1661       6.   Financial Accounting Standards     9.   AICPA, "The CPA Letter," April,
        Cordcll, Nehcr & Company                       P.O. Box 3068t Wenatchee, WA 98807             Board, "Financial Accounting Se-        1998.

 Vice Chair:
   Donald Debolt                                                              (217)682-5758
       Donald W. Debolt, CPA                              P.O. Box 406, Stewardson, IL 62463

 Committee Members:
     John A. Jex (1997)                                                     Ed Bercot (2000)
     Gary Miller (1999)                                                Larry Romuald (2002)
     Ed Nishio                                                       James P. Murphy (2001)


EDUCATION COMMITTEE

 Chain
     Paul Julin                                                                 (612)533-1957
       Paul Julin & Co.                 5637 Brooklyn Blvd., Ste. 300, Minneapolis, MN 55429

 Vice Chair:
     Bill Erlenbush                                                            (309)557-6000
        Growmark, Inc., 1701 Towanda Ave., Bloomington, IL 61701

 Committee Members:
     Dwayne Campbell                                                     Donald A. Frederick
     William Davisson                                                          Brian Pawling
     Stanley Dreyer                                                           Stephen Piecara
     Allen Floyd                                                           Larry J. Robertson


LONG RANGE PLANNING COMMITTEE

 Chair:
     H. B. Flach                                                             (818)986-4800
       Sunkist Growers, Inc.                             P.O. Box 7888, Van Nuys, CA 91409

MEMBERSHIP DEVELOPMENT COMMITTEE

 Chain
     Ernest G. Potter                                                          (815)265-4741
       May, Cocagne & King, PC                           219 N. Central St., Gilman, IL 60938

 Vice Chain
     Edward C. Michel                                                          (316)227-3522
       Lindburg & Vogcl, Chartered                      P.O. Box 1512, Dodge City, KS 67801




Summer 1998                                              The Cooperative Accountant              The Cooperative Accountant                                        Summer 1998
                                                                                                                                                                                       89


 RECORD GROSS REVENUES DO NOT TRANSLATE INTO HIGHER                                                                        COMMITTEES FOR 1997-1998
           NET MARGINS FOR LARGEST CO-OPS
                                                                                                  ACCOUNTING & AUDITING COMMITTEE

                By David S. Chesnick, Agricultural Economist                                       Chain
                 USDA Rural Business-Cooperative Service                                             Robert Beerup                ,                                       (309)557-2325
                                                                                                       Illinois Agricultural Auditing                  306 Garden Rd., Normal, IL 61761

                                                                                                   Vice Chain
Editor's note: This is the first of three
                                                                                                     Robert W. McMillcn, III                                             (508)371-3842
articles which provide an overview of       Figure 1 — Sources of Total Revenue
                                                                                                       Welch Foods, Inc.                3 Concord Farm, 555 VA Rd., Concord, MA 01742
how the nation's 100 largest agricul
                                             $ billion                                             Committee Members:
tural cooperatives (based on gross
                                              80                                                     Edward W. Bangel                                                    Michael E. Flinn
sales) performed in 1996. This article                                              Other
                                                                                                     Margaret H. Bertolino                                                    Allen Floyd
was first published in Rural Coopera                                                Operating
                                                                                                     Dwayne E. Campbell                                                         Paul Julin
                                                                                   . Income
tives September/October 1997.                                                                        Thomas H. Davis                                                William F. Leimbach
                                                                                                     William Davisson                                                      Jay McWatters
   The nation's 100 largest agricul                                                 Farm Supply
                                                                                                     Donald W. Debolt                                                     Philip W. Miller
tural cooperatives reported record                                                                   Robert Der                                                         James P. Murphy
revenues for the second year in a                                                                    Lawrence M. Dicke                                                 Larry J. Robertson
row in 1996. Operating revenues to                                                                   Bill Erlenbush                                                 Lawrence J. Romuald
                                                                                                     James L. Evans                                                    Robert A. Werner
taled more than $74 billion, up
                                                                                                     H. B. Flach                                                         Kenneth L. Wise
nearly $11 billion from the 1995                                                                     Douglas W. Fleming
record (figure 1). However, net mar                                                 Marketing
                                                                                                   FASB Sub-Committee Members:
gins for the year were down.
                                                                                                     Larry J. Robertson — Chair                                     William F. Leimbach
   Strategic alliances, higher grain                                                                   Thomas H. Davis                                                   Philip W. Miller
prices and increases in value-added                                                                    H. B. Flach                                                     Robert A. Werner
                                                                                                       Paul Julin
processing by cooperatives were ma
jor contributors to the rise in reve                                                              AUDIT COMMITTEE
nues. However, 52 percent of that                                                                  Chair:
increase was realized by just two co               1992    93       94   95   96                     Ed Nishio                                                             (916)973-3035
operatives—Farmland Industries                                                                         CoBank, ACB                         P.O. Box 13010-A, Sacramento, CA 95813-3010
                                             Prior years restated
Inc., Kansas City, Mo., and Harvest                                                                Vice Chair.
States Cooperatives, St. Paul, Minn.                                                                 George Benson                                                        (312)372-2000
They represented nearly a quarter of                                                                   McDermott, Will & Emery                      227 W. Monroe St., Chicago, IL 60606
total operating revenue for the 100         just 10 cooperatives. Grain sales ac                  CHAPTER DEVELOPMENT COMMITTEE
largest co-ops, up from 20 percent in       counted for about 65 percent of the
1995.                                                                                              Chair:
                                            total increase, followed by milk
                                                                                                     James S. Krzyminski                                                   (202)626-8700
   Marketing sales continue to show         sales, which accounted for about 20                        National Council Farmer Cooperatives50 F St., NW, Sic. 900, Washington. DC 20001
tremendous gains, increasing more           percent of the increase.
                                                                                                   Vice Chain
than 18 percent, to $55 billion, from           Farm supply cooperatives en                          Wendell W. Heflin                                                     (770)427-3262
the $46 billion recorded in 1995.           joyed substantial salus gains in 1996,                     National Cooperative Bank                     P.O. Box 1134, Kcnnesaw. GA 30144
This increase doubles the gain made         following a year of relatively small                   Committee Members:
the previous year. While three-             gains in 1995. Farm supply sales rose                    Edward J. Allison                                                     Gary E. Miller
quarters of the cooperatives that           15 percent, to nearly $19 billion.                       Kent W. Erhardt                                                      Edward Nishio
market their members' products had          However, 70 percent of that gain was                     Joe Guidetti                                                          Brian Pawling
higher sales in 1996 than in 1995, 75                                                                Ronald P. Hennen                                                    Ernest G. Potter
                                            due to five cooperatives. Sales in                                                                                               Greg Taylor
                                                                                                     Jeff Milner
percent of the gain was generated by        creased for nearly every category of

Summer 1998                                           Thi- CooplkaTIvr Accountant                 Till- Cooperative Accountant                                           Summer 1998
88                        Chapter Offkt.rs & National Directors                                     Record Gross Revenues Do Ncn Transi^te Into Higher Net Margins          9


SOUTH ATLANTIC CHAPTER                                                                          farm supplies, with 85 percent of the    continue to show small declines in
 National Director                                                                              increase attributed to higher feed,      each of the past 5 years. In 1992,
      W. F. (Chip) Pohl                                                       (770) 393-5265    fertilizer and petroleum sales.          total-operating expenses consumed
        Gold Kist, Inc.                                    P.O. Box 2210, Atlanta. GA 30301        Other operating revenues were         11 percent of total revenues. By
                                                                      chippohl(«'goldkist.com   down nearly $46 million. These rev       1996, this ratio was down to 7 per
 President:                                                                                     enues are generally earned from ser      cent. This would imply that cooper
      James R. Camp                                                           (803) 799-5000
                                                                                                vices (such as storage, handling,        atives are continuing to improve on
        AgFirsl Farm Credit Bank                      1401 Hampton St., Columbia, SC 29201
                                                                                                spreading and other services pro         the use of their resources.
 Vice President:                                                                                vided to members). Although service
      Joseph L. Uworn                                                         (205)353-6843
                                                                                                revenue contributes an average of        Other Income and Expenses
        Alabama Farmers Cooperative. Inc.             P.O. Box 2227, Decatur. AL 35609-2227
                                                                                                only 1-percent of total operating rev        Income and expenses not directly
 Secretary-Treasurer:
                                                                                                enues, some cooperatives rely            related to the day-to-day operations
      J. Robin Haynes                                                         (803) 799-5000
        AgE:irst Farm Credit Bank                     1401 Hampton St.. Columbia. SC 29201      heavily on service revenue to boost      fall into the category of "other in
                                                                                                their bottom line. For example, one      come and expenses." These include
 Membership Chain
   Wendell W. Heflin                                                          (770)427-3262     cooperative received more than 35        patronage refunds received from
        National Cooperative Bank                        P.O. Box 1134, Kennesaw, GA 30144      percent of its operating revenue         other cooperatives, interest income
 Newsletter Editor                                                                              from receipts for services.              and expense, gain/loss on the sale of
      Frank Michael Messina                                                  (205)934-8827          Cost of goods sold increased         equipment, and any other income/
        University of Alabama. Hirni.       Business Engineering Complex, 1150 10th Ave., S.,   SI0.8 billion in 1996, up 1 percent      expense not related directly to oper
                                                   1MB Station, Birmingham, AL 35294-4460
                                                                                                from 1995. This gain nearly sur          ations. These expenses often relate
TEXAS CHAPTER                                                                                   passed the increase in total operat      to financing and investing activities
 National Director:                                                                             ing revenues, due most likely to in      of the cooperative.
   Charles C. McCoy                                                            (817)461-2674    creases in grain prices paid to             Increased debt by cooperatives
     Avsociated Milk Producers. Inc.                      P.O. Box 5040. Arlington. TX 76005                                             pushed up their interest expenses.
                                                                                                members. However, substantial in
                                                                           mccoyeC" ampi.com
                                                                                                crease in farm supply sales, which       Interest expense jumped 18 percent,
 President:                                                                                                                              or $91 million, to a record $591 mil
                                                                                                carry higher margins, should have
      Greg Taylor                                                             (806)785-5982
        Williams, D. & Company. PC             5211 Brownlield Hwy., Ste. 214 P.O.Box 16289     produced a relatively smaller in         lion in 1996. This marks the third
                                                                     Lubbock, TX 79407-6289     crease in the cost of goods sold.        year in a row for double-digit in
                                                                                                    Operating expenses rose nearly       creases in interest payments. On the
 Vice President & Treasurer:
      G. Michael Murphy                                                        (817)347-3321    4.5 percent, to $5.4 billion; largely    other    hand,    interest   revenue
         Deloitte & louche, LLP         301 Commerce St., #2950, Fort Worth, TX 76102-4140      reflecting increased labor costs. La     dropped 4 percent from a high of
                                                                        gmurpliyC'dUits.eom                                              $103 million in 1995.
                                                                                                bor statistics obtained from 44 of the
 Secretary:                                                                                     largest agricultural cooperatives           Patronage refunds (cash and non-
      April P. Graves                                                         (409)543-4101     showed labor expenses increased 7.5      cash) received from other coopera
        Farmers Cooperative El Campo                      P.O. Box 826, El Ciimpo, TX 77437
                                                                                                percent from the previous year. If       tives climbed 16 percent. Of the
 Membership Chair:                                                                              this sample is representative of the     $162 million in patronage refunds,
      G. Michael Murphy                                                        (817)347-3321
                                                                                                population, nearly 60 percent of the     27 percent was in cash. The rest were
         Deloitte & Touchc. LLP         301 Commerce St.. #2950. Fort Worth, TX 76102-4140
                                                                         gmurphy@dttus.com      increase in operating expenses will      allocated non-cash patronage re
                                                                                                be attributed to labor expenses.         funds. Seven cooperatives would
     Newsletter Editors:
      Greg Taylor                                                              (806)785-5982       Despite increased operating ex        have had an operating loss without
        Williams, D. & Company. PC            5211 Brownfield Hwy., Ste. 214, P.O. Box 16289    penses, mergers and consolidation        patronage refunds.
                                                                     Lubbock, TX 79407-6289     among cooperatives in the past few
      April P. Graves                                                          (409)543-4101    years havt helped streamline their       Net Margins
         Farmers Cooperative El Catnpo                    P.O. Box 826, El Campo. TX 77437
                                                                                                operations. For example, operating          In 1996, net margins before taxes
                                                                                                expenses as a percent of total sales     and extraordinary items were $1.3

                                                         The Cooperative Accountant             The Cooperative Accountant                                      Summer 1998
StMMIR 1998
10 Record Gross Revenues Do Not Translate Into Higher Net Margins                                            Chapter Officers & National Directors                               87


                                                                                        NORTHEAST CHAPTER
Figure 2—Net Margins/Losses                     Figure 3— Distribution of Net Income
                                                                                          National Director
$ billion                                       5 million                                   Margaret H. Bcrtolino                                                   (97^ 689-4442
                                                 1.5                                          Agri-Mark, Inc.                                 p.o. Box 5800, Lawrence, MA 01842
                                 After Lossos                                             President & Membership Chair
                                                                                            Scott Cleveland                                                         {603)643-2667
                                                                                              Hanover Consumer Cooperative Society               P.O. Box 633, Hanover, NH 03755
                                                                                                                                                        scolt_cleveland(a valley.net

                                                                                          Vice President:
                                                                                            Ralph T. Lawrence                                                        (413)821-0215
                                                                                              CoBank, ACB                               P.O. Box 9061, Springfield, MA 01102-9061
                                                                                          Secretary:
                                                                                           Timothy Benjamin                                                         (716)264-3142
                                                                                              Agrilink Foods                90 Linden Oaks, Box 20760. Rochester, NY 14602-0607
                                                                                         Treasurer
                                                                                           JohnF. Feeney                                                            (315)449-7446
                                                                                              Agway, Inc.                                 P.O. Box 4933, Syracuse, NY 13221-4933
                                                                                                                                                               jfeeney(a agway.com

                                                                                          Newsletter Editor
                                                                                           Jay McWattcrs                                                            (716)854-1830
                                                                                              KPMG Peat Marwick, LLP         12 Fountain Plaza, Suite, 601, Buffalo, NY 14202-2222
                                                       1992   93       94   95   96
      1992      93     94   95     96
                                                Prior years restated
Prior years restated
                                                                                        PACIFIC NORTHWEST CHAPTER

                                                                                          National Director
                                                Non-operating Revenue
billion. This is down 12.5 percent                                                         Jame,sP. Murphy                                                          (206)233-7787
                                                   Non-operating revenues include             Dcloitte & Touchc, LLP               7(M) 5th Ave., Ste. 4500. Seattle, WA 98104-5044
from the 1995 record. Higher cost of
                                                gains or losses from discontinued                                                                              jimirphy@dttus.com
goods sold and labor expenses were
                                                operations, accounting changes and
the main reasons for the lower mar                                                       President:
                                                other extraordinary revenue or ex          JayneT. Deife                                                            (509)982-2549
gins. Despite the decline, net mar
                                                penses not associated with opera              Leffel, Otis & Warwick. PS                      8992 Road X NE. Marlin, WA 98832
gins from operations still posted the
                                                tions. In 1996, these revenue sources                                                                        jaymedeofc<2 aol.com
second highest level since USDA be
                                                reached $5.5 million, up 90 per cent     Vice President:
gan tracking the largest agricultural
                                                from 1995. However, that was not           David R. Garcia                                                        (503) 386-3111
cooperatives.
                                                enough to boost net margins above             Diamond Fruit Growers, Inc.                    P.O. Box 180, Hood River, OR 97031
   One cause for the drop in net
                                                1995 levels.                             Secretary-Treasurer:
margins was the number of cooper
                                                                                           Maureen G. Shaffer                                                       (208)746-3611
atives suffering losses during 1996.                                                         Jurgens & Company. PA          Bollingcr Plaza. P.O. Box 499, Lewiston, ID 83501-0499
Nine cooperatives ended 1996 with a             Distributions of Net Margins
loss, up from six co-ops in 1995. Net                                                    Membership Chair
                                                   Cooperatives not only had fewer
                                                                                           Jeff Milncr                                                              (509)745-8551
margins before losses were $1.4 bil             margins to distribute in 1996, but            Central WA Grain Growers, Inc.                  P.O. Box 649, Watervillc, WA 98858
lion in 1996 (figure 2). Losses                 also paid out less cash as a percent
amounted to $86.6 million. How                                                           Newsletter Editor:
                                                age of total margins allocated (fig
                                                                                           Wemly L. Brodahl                                                          (509)659-0130
ever, 73 percent of the loss was at             ures 3 and 4). In 1995, the largest          Ritzville Warehouse Company                      201 E. 1st Ave., Ritzville. WA 99169
tributed to one cooperative.                    agricultural cooperatives paid out                                                                           wawhcat@ritzville.org


Summer 1998                                              The Cooperative Accountant     The Cooperative Accountant                                                Summer 1998
86                      Ciiaptgr Officers & National Directors                                    Record Gross Revenues Do Not Translate Into Higher Net Margins                    11


MISSISSIPPI VALLEY CHAPTER                                                                                                                       due to a single cooperative. Al
                                                                                           Tgure4-Patronage Refunds
 National Directors:                                                                                                                             though these non-qualified patron
     George W. Benson                                                    (312) 372-2000                                                          age refunds add flexibility to the dis
                                                                                           $ million
       MeDermoCt, Will & Emery                    227 W. Monroe St., Chicago, IL 60606                                                           tribution mix, they are slowly losing
                                                                                           1.2
                                                                    gbenson@mwe.com                                                              favor with cooperatives. In the 1980s
     Allen F.Floyd                                                       (573)876-5316
                                                                                                                                                 as many as 15 cooperatives used this
       MFA Incorporated                   201 Ray Young Dr., Columbia, MO 65201-3599                                             Non-qual!fted
                                                                   allenfloyd@aol.com                                                            form of allocation, but the number
                                                                                                                                 Non-cash
 President:                                                                                                                                      dropped to six co-ops in 1996.
     Tony D. Burrcll                                                    (309)557-2329                                                               Whether by regulation or cooper
       IL Agricultural Auditing Assn.                1701 Towanda Ave., P.O. Box 2901                                                            ative policy, dividends usually play a
                                                           Bloomington, IL 61701-2901
                                                                                                                                                 minor role in distributing coopera
 Vice President and Newsletter Editor:
                                                                                                                                                 tives' net income. However, the
     John C. Christie                                                    (501)221-1000
       Hudson, Cisne & Company                  11412 Huron Ln., Little Rock, AR 72211                                                           amount of dividends paid has in
 Secretary-Treasurer:                                                                                                                            creased in recent years. Before 1992,
     Tim J. Mellencamp                                                   (314)342-3250                                                           the average amount of dividends
       CoBank ACB                                 P.O. Box 504, SL Louis, MO 63166-0504                                                          paid ranged between $13 million and
 Membership Chain                                                                                                                                $18 million. Since 1992, that amount
     Janice Dooley                                                         (314)342-3224                                                         has steadily increased, from $20 mil
       CoBank, ACB                                  1415 Olive St., St. Louis, MO 63103
                                                                                                                                                 lion to $27 million in 1996. Divi
                                                                                                                                                 dends paid on stock investment dif
NORTH CENTRAL CHAPTER
 National Directors:                                                                                                                             fers from patronage dividends or
                                                                                                 1992   93        94   95   96
   Richard H. Olson                                                    (612)735-4882                                                             patronage refunds, which are based
       Life Balance Solutions. Inc.          1020 Autumn Alcove. Woodbury, MN 55125        ^rior years restated                                  on the amount of business done with
     Dale Carlson                                                      (507)354-3816                                                             the cooperative.
       Schuetzle. Carlson & Company          1321 North Broadway, New Ulm, MN 56073
                                                                                                                                                    Generally, unallocated equity or
 President:
   Bernard (Bernie) A. Carlson, Jr                                      (612) 533-1957                                                           retained earnings arc accumulated
     Paul Julin & Co., LLP                               5637 Brooklyn Blvd., Suite 300    $436 million (30 percent) of allo                     from non-member business. In 1996,
                                                          Minneapolis, MN 55429-3061       cated equity in cash. By 1996, this                   unallocated equity levels declined.
                                                                  bernie@skypoint.com      figure was down to $338 million (26                   Cooperatives retained nearly 30 per
 Vice President:                                                                           percent).                                             cent less of their earnings than in
   Ann Young                                                             {612)451-5269
       CENEX, Inc.                                  P.O. Box 64089, St. Paul, MN 55164
                                                                                              The value of non-cash qualified                    1995. This marks an abrupt change
                                                                    ayoung(« cnxlol.com    patronage refunds declined from                       in the trend over the past five years.
 Secretary:                                                                                $629 million in 1995 to $621 million                  In 1992, the largest cooperatives re
     Rex Carlson                                                         (701)237-3343     in 1996, a drop of 1 percent. But, as                 tained $29 million. By 1995, this
       Eide Helmcke. PLLP                       51 Broadway, Ste, 500, Fargo, ND 58102     a percent of total distribution, coop                 value stood at $240 million and in
 Treasurer:
                                                                                           eratives retained a higher percent                    1996 it dropped to $170 million.
     Eugene (Gene) M. Salzman                                            (612) 282-8276
       St. Paul Bank for Cooperatives            375 Jackson Street, St. Paul, MN 55101    age of their patronage refunds in                        Even though cooperatives have a
 Membership Chain                                                                          1996 (47 percent) than in 1995 (42                    special tax status, they still pay in
     Roger Van Someren                                                   (715)268-7999     percent).                                             come taxes. In 1996, cooperatives
       Paul Julin & Co.. LLP                            329 S. Keller, Amery, WI 54001           Although non-qualified non-cash                 paid more than $114 million in in
                                                                 rogervs@win.bright.net
                                                                                           patronage refunds represent 3.3 per                   come taxes, 19 percent less than in
 Newsletter Editon
                                                                                           cent of total net margin distribution,                1995. As a percent of net margins,
     Philip L. Erickson                                                  (612)282-8220
       St. Paul Bank for Cooperatives          375 Jackson St., St. Paul, MN 55101-1849    the value jumped 50 percent, to $44                   the largest agricultural cooperatives
                                                                      perick@spoc.com      million, between 1995 and 1996.                       paid an average tax rate of 9 percent,
                                                                                           However, most of the increase was                     unchanged from 1995.


                                                    The Cooperative Accountant                    Cooperative Accountant                                                 Summer 1998
Summer 1998
12 Record Gross Revenues Do Not Translate Into Higher Net Margins                                                     Chapter Officers & National Directors                               85


Table 1- Consolidated statement of operations, 1995-96, top 100 cooperatives                     MID-CENTRAL CHAPTER

Operating statement                 1996             199S                                         National Director
                                                                                                    Thomas H. Davis                                                         (615)793-8364
                                       Thousand DoOsrs             Difference   Percent Change
                                                                                                      Tennessee Fanners Cooperative                     P.O. Box 3003, Lavcrgne, TN 3708ft
Revenues                                                                                          President:
Marketing                        54,631,508      46,224.113        8.407,395         18.2           Edward D. McFadden                                                        (317)972-3015
Farm Supply                      18,933,572      16.421,488        2.512.084         15.3             Countrymark Cooperative, Inc.              950 N. Meridian St., Indianapolis, IN 46204
Total Sales                      73,565,080      62,645,601       10,919.479         17.4         Vice President:
                                                                     (46,483)        -6.1           Thomas H. DufTey                                                          (901)668-4446
Other Operating Revenues           711,369          757,852
Total Operating Revenues         74,276,449      63,403,453       10,872,996         17.1             Tennessee Farmers Cooperative                     P.O. Box 3003, Lavcrgne, TN 37086

Cost of Goods Sold               67,438,087      56,607,951       10,830,136         19.1
                                                                                                  Secretary:
                                                                                                    Douglas E. Nisley                                                         (219)295-1991
Gross Margin                      6,638.362       6.795,502          42,660           0.6
                                                                                                      Crowe, Chizek & Company. LLC               301 S. Main St., Ste. 400. Elkhart, IN 46516
                                                                                                  Treasurer
Expenses
                                                                                                    Max Combs                                                                 (423)828-4582
Operating Expenses                5.355,551       5.140,926         214,625           4.2
                                                                                                      Tennessee Farmers Cooperative                      Rt. 3 Box 629t Ruiledge, TN 37861
Net Operating Margins             1,482,811       1,654,576         (171,765)      -10.4
                                                                                                  Membership Chain
Other Revenues (Expenses)
                                                                                                    William T. Hopper                                                         (615)793-8329
Interest Expense                   (591,013)       (499,804)         (91,209)        18.2
                                                                                                      Tennessee Farmers Cooperative                       827 Baker Rd., Smyrna, TN 37167
Interest Revenue                     99,626         103,925           (4,299)        -4.1
                                                                                                  Newsletter Editor
Other Income                        186,086         129.476          56.610          43.7
                                                                                                    BradJ. Belcher                                                            (317)972-3142
Other Expenses                      (31,329)         (33.185)          1.856         -5.6
                                                                                                      Countrymark Cooperative. Inc.              950 N. Meridian St., Indianapolis, IN 46204
Patronage Revenue                   162,153         139,757          22,396          16.0
Net Margins from Operations       1.308,334        1.494,745        (186.411)       -12.5
Non-Operating Revenue (Expenses)      5,450               2,881        2,569         89.2
                                                                                                 MID-WEST CHAPTER

Net Margins                       1,313,784        1,497,626        (183,842)       -12.3         National Directors:
                                                                                                    Larry C. Boeshart                                                         (816)459-5135
Distribution of Net Margins                                                                           Farmland Industries, Inc.        P.O. Box 7305, Dept. 54, Kansas City, MO 64116-4116
Cash Patronage Dividends            338,204         435.972          (97,768)       -22.4           Dwayne E. Campbell                                                        (800)611-6731
Retain Patronage Dividends          620,607         628,829           (8,222)        -1.3             Collins, Butler & Co., P.C.                    901 West Maple Avc, Enid, OK 73701
Nonqualified Noncash Patronage       43,644              28.821       14,823         51.4                                                                                  dccenid@pldi.net
Dividends                            26.833              23,090        3.743         16.2         President:
Unallocated Equity                  170,330         240,291          (69.961)       -29.1           Edward L. Field                                                           (785)267-3912
Income Tax                          114.166          140,623         (26.457)       -18.8             Lindburg & Vogel, Chartered                         P.O. Box 5289, Topeka, KS 66605
Total Distribution                1,313,784        1,497,626        (183,842)       -12.3         Vice President:
                                                                                                    Dan Kent                                                                  (405)489-3309
                                                                                                      Triangle Cooperative Service Company                   P.O. Box 1189, Enid, OK 73702
                                                                                                  Secretary:
Revenues by Commodity Group                     supply cooperatives. However, the                   Brian Pawling                                                             (402)489-3309
   In 1996, three commodity groups              drop in net margins for grain and                     Cooperative Service Company                  100 High Plains Road, Lincoln, NE 68512
had lower sales than in 1995 (table             fruit & vegetable cooperatives more               Treasurer
2). However, the drop in sales for              than offset the gains made by the                   DanHubbard                                                             (405)232-7555
these three cooperatives (cotton,               other commodity groups, resulting                     Producers Cooperative Oil Mill             P.O. Box 26907, Oklahoma City, OK 73126

poultry & livestock and rice) was               in lower net margins for all cooper               Membership Chair
                                                                                                    Steve Stoecklein                                                         (785)628-2900
overshadowed by the tremendous                  atives (table 3).
                                                                                                      Lindburg & Vogel, Chartered                             P.O. Box 189, Hays, KS 67601
gains made by the other commodity                  Grain cooperatives had the larg
                                                                                                  Newsletter Editor
groups. The biggest gainers were                est increase in sales, up 41 percent to             Craig MacOuaid                                                            (816)459-5136
grain, diversified, dairy and farm              $16.4 billion. The average prices for                 Farmland Industries. Inc.        P.O. Box 7305. Dept. 54, Kansas City. MO 641164)005


Summer 1998                                                 The Cooperative Accountant           The Cooperative Accountant                                                 Summer 1998
84                   Chapter Officers & National Directors                                                   Record Gross Revenues Do Not Translate Into Higher Net Margins 13

FAR WESTERN CHAPTER
                                                                                                      Table 2-Total revenue by commodity group, 1995-96, top 100 cooperatives
 National Directors:
     William F. Leimbach                                            .-.          (510) 287-2742       Total revenue                             1996                1995

       Deloitte & Touche, LLP        1111 Broadway, Stc. 2100, 17th FL, Oakland, CA 94607-4036                                                     Thousand Dollars             Difference   Percent Change
     Edward H. Nishio                                                              (916) 973-3035
       CoBank, ACB                              P.O. Box 13010-A, Sacramento, CA 95813-3010           Cotton                                 2,346,263           2,694,323       (348,060)      -12.9
                                                                            cnishio@cobank.com        Dairy                                 16,460,584          16,707,931      1,752,653         10.5
     Teresa H. Castanias                                                         (916) 448-4700       Diversified                           17,120,864          13,780.646      3.340,218         24.2
       KPMG Peat Marwick, LLP                 400 Capital Mall, Sic. 800, Sacramento, CA 95814        Fruit & Vegetable                      7,473,799           7,101,667       372,132           5.2
                                                                           tcastanta.s@kpmg.com       Farm supply                            9,193,881           8.137.604      1.056,277         13.0
 President:                                                                                           Grain                                 16,390,219          11,635,134      4,755,085         40.9
     Owen P. Hamilton                                                              (916) 923-5100     Poultry & Livestock                    1,122,000           1.175.679        (53,679)        -4.6
       Farmers Rice Cooperative                         P.O. Box 15223, Sacramento, CA 95851          Rice                                   1,108,834           1.157.156        (48,322)        -4.2

 Vice President:                                                                                      Sugar                                  1,060,005           1.013.313        46,692           4.6

     Henry Wallace                                                                 (916)898-6879
       California Stale University       School of Agriculture, 8101 Rd. 30, Glenn, CA 95943
                                                                 hwallacefeoavax.csuchico.edu         Tabte 3- Net margins by commodity group, 1995-96, top 100 cooperatives
 Secretary-Treasurer:                                                                                 Net margins                               1996                1995
     Matthew A. Connors                                                        (916)498-7121
                                                                                                                                                   Thousand Dollars             Difference   Percent Changs
       Deloitte & Touche, LLP         400 Capitol Mall. Ste. 2000, Sacramento, CA 95814-4424
 Membership Chain                                                                                     Cotton                                    70,862              64.691          6,171          9.S
     Joseph M. Marchini, Esq                                                 (209) 432-5400x209       Dairy                                    216,559             190,661        25.898          13.6
       Baker, Manock & Jensen                        5260 N. Palm. Ste. 421. Fresno, CA 93704         Diversified                              365.339             339.809        25,530           7.5
 Newsletter Editor:                                                                                   Fruit & Vegetable                          14,441            143,646       (129,205)       -«9.9
     James R. Craycroft                                                             (916) 448-4700    Farm Supply                              558,024             506,655        51.369          10.1
       KPMG Peat Marwick, LLP                  400 Capitol Mall. Sic. 800, Sacramento, CA 95814       Grain                                     76,037             249,539       (173,502)       -69.5
                                                                            jcraycroft(rt; kpmg.com   Poultry & Livestock                         1,317                 355          962         271.0
                                                                                                      Rice                                       11,029             10,211           818           8.0
GREAT LAKES CHAPTER
                                                                                                      Sugar                                       2,812               (7,941)      10,753          *

 National Director:
                                                                                                      ' Cannot take percentage increase from a negative base.
   Ralph W. Miller                                                               (309)557-2329
     Illinois Agricultural Auditing Assn.             1218 N. Jefferson Street, Dixon, IL 61021
 President:                                                                                           all grains in 1996 neared record lev                      Operating expenses increased a
     Robert D. Beerup                                                              (309)557-2325
                                                                                                      els. However, the high prices also                        modest 5 percent while net margins
       Illinois Agricultural Auditing Assn.                306 Garden Road, Normal, IL 61761
                                                                                                      pushed up payments to members                             rose 8 percent, to $365 million.
 Vice President:
                                                                                                      and caused gross margins to drop 10                          Due to a combination of higher
     Randall W. Currie                                                          (517)842-3101
       McCartney & Company, PC                           P.O. Box 2!6, Breckenridgc, MI 48615         percent, to $593 million. Operating                       prices and larger quantities, total
 Secretary:
                                                                                                      expenses increased 20 percent, to                         revenues for dairy cooperatives hit
     Don Hanson                                                                    (608)873-9800      $492 million, half of which was due                       $18.5 billion, up 10 percent from
       St. Paul Bank for Cooperatives                   125 Veterans Rd., Stoughton, WI 53589         to higher labor costs. Consequently,                      1995. However, higher prices also
 Treasurer:                                                                                           net margins of $76 million were the                       pushed up cost of goods sold by 12
     James J. Hartmann                                                         (608) 232-2900         lowest in the past five years.                            percent, to $1.8 billion. This lowered
       Clifton Gunderson LLC               440 Science Dr., Ste. 400, Madison, WI 53711-1056
                                                                                                         The diversified cooperatives had                       gross margins by 4 percent. Despite
 Membership Chair
                                                                                                      the second highest increase in total                      higher labor costs, dairy coopera
     Tyrone A. Leim                                                             (414)563-4487
       Julin, Paul & Company                  N. 3525 TrielofT Rd #61, Ft. Atkinson, WI 53538         revenues, up 25 percent, to $17 bil                       tives cut operating expenses by 5
 Newsletter Editor:                                                                                   lion. Most of the increase was due to                     percent, thereby minimizing the ef
     Patricia M. Anderson                                                         (517) 453-4500      higher sales for grain (up 53 per                         fect of lower gross margins. Operat
       Cooperative Elevator Company                   7211 E. Michigan Ave., Pigeon, MI 48755         cent) and livestock (up 19 percent).                      ing income was off only 1 percent


Summer 1998                                                Tnii Cooperative Accountant                The Cooperative Accountant                                                             Summer 1998
 14 Record Gross Revenues Do Not Translate Into Higher Net Margins                                    Chapter Officers & National Directors                          83


from 1995. The $22 million increase      gross margins were down $14 mil                     CHAPTER OFFICERS & NATIONAL DIRECTORS
in patronage refunds from other co       lion. However, this group was able to
operatives helped push net margins       cut expenses by 7 per cent, or $21
up 12 percent to $214 million.           million, ultimately resulting in an      AT-LARGE
   Farm supplies had another good        8-percent increase in net margins, to
                                                                                   National Director:
year. Total revenues are up 13 per       $11 million.
                                                                                   William Davisson                                                      (309)557-6284
cent, or $1 billion, reaching $9.1 bil                                               GROWMARK, Inc.                          1701 Towanda Ave., Bloomington, IL 61702
                                            Cotton cooperatives faced a dif
lion. Even though cost of goods sold
                                         ferent situation. In 1996, cotton
and operating expenses each in
                                         prices and volume were less than in
creased by 8 percent, net margins
                                         1995. Revenues dropped 13 percent        CAPITOL CHAPTER
reached the highest level to date. At
                                         in 1996 to $2.3 billion. However, cost    National Director.
$558 million, farm supply coopera
                                         of goods sold declined by 14 percent,       Philip W. Miller                                                   (804)281-1211
tives also had the highest net mar
                                         to $2.1 billion. This combination             Southern Slates Cooperative                     Box 26234, Richmond, VA 23260
gins of all commodity groups.                                                                                                                    phil.miller@sscoop.com
                                         caused gross margins to increase 5
   After two years of net losses as a
                                         percent, to $211 million. The cotton      President:
commodity group, sugar coopera
                                         cooperatives held operating ex              David A. Cummings                                                  (804) 747-0592
tives finally turned their operations                                                  Old Dominion Electric Co-op.          P.O. Box 2310, Glen Allen, VA 23058-2310
                                         penses to a 1-pcrcent increase. Net
around, posting $2.8 million in net
                                         margins increased 10 percent to $71       Vice President:
margins. Although sales and gross
                                         million—the highest amount since            Wayne E. Sine                                                      (804)281-1301
margins have been increasing during                                                    Southern States Cooperative                P.O. Box 26234, Richmond, VA 23260
                                         USDA began tracking the largest ag
the past five years, expenses in                                                                                                                wayne.sine@sscoop.com
                                         ricultural cooperatives.
creased faster. In 1996, the rate of
                                                                                   Secretary:
increase for expenses slowed to 12          While revenues and cost of goods         John W. Greenleaf                                                     (800)225-8325
percent. Consequently, net-operat        sold both dropped 5 percent for               Farm Credit Leasing Srvc. Corp.   4 N. Park Dr., Ste. 115, Hunt Valley, MD 21030
ing margins increased 19 percent, to     poultry & livestock cooperatives,                                                                     jgreenleaf@fcleasing.com

$14 million. Sugar cooperatives also     gross and net operating margins re        Treasurer
had a 20 percent decease in interest     mained virtually unchanged. How             David F. Antoni                                                      (215)299-4790
expense, which lead the first positive   ever, the poultry & livestock cooper          KPMG Peat Marwick, LLP                   1600 Market St., Philadelphia, PA 19103
net margins in the past three years.     atives continued to lose money on         Membership Chair:
   Total revenue dropped for three       operations. Net operating losses            Robert C. Rathbone                                                  (202)690-2417
commodity groups: rice, cotton, and      were $6 million in 1996 and 1995.             USDA/RBCDS/CS                           Stop 3253, 1400 Independence Avc., S.W.
                                                                                                                                            Washington, DC 20250-3253
poultry & livestock. Yet, all showed     Yet, interest and other income were
                                                                                                                                              rrathbon@rurdev.usda.gov
increases on their bottom line.          enough to offset operating losses in
   Rice    cooperative     revenues      1996, thereby pushing net margins to      Newsletter Editor:
dropped 4 percent during 1996 while                                                  Ann E. Collado                                                      (717)677-8181
                                         $1.3 million vs. $0.4 million in 1995.
                                                                                       Knouse Foods Cooperatives, Inc.   800 Peach Glen-ldaville, Peach Glen, PA 17375




Summer 1998                                                                       Tnii Cooperative Accountant                                           Summer 1998
                                                Tnii Cooperative Accountant
82                                                                                                                                                                              15

             NATIONAL OFFICERS & EXECUTIVE COMMITTEE                                                PATRON DEMAND DEPOSIT ACCOUNT FINANCING BY
                                      1997-1998                                                         COOPERATIVES: PROSPECTS AND PITFALLS

President:
                                                                                                                             By Ken D. Duft*
  James P. Murphy                                                         (206)233-7787
     Deloitte & Touche, LLP               700 5th Ave., Ste. 4500, Seattle WA 98104-5044
                                                                      jmurphy@dttus.com        For nearly two decades, I have            and expand modestly our under
Vice President:                                                                             been observing and analyzing the at          standing of the rather innocent ori
  Allen F. Floyd                                                          (573)876-5316
                                                                                            tributes, operational affects, and           gins of this cooperative practice.
     MFA Incorporated                     201 Ray Young Dr,, Columbia, MO 65201-3599
                                                                                            prospective limitations of patron de
                                                                      allenfloyd@aol.com
Secretary-Treasurer:                                                                        mand deposit account financing by            Background:
  Edward H. Nishio                                                        (916)973-3035     agribusiness cooperatives. Insofar as           As noted by Bartsch and Dahl
  CoBank, ACB                              P.O. Box 13010-A, Sacramento, CA 95813-3010      the practice appears to have origi           gren, cooperatives have always
                                                                    enishio@cobank.com      nated in my own state of Washing
Past President:                                                                                                                          sought new or alternative forms of
                                                                                            ton back in the 1970's, it has long          debt financing.1 The incentives for
  William Davisson                                                        (309)557-6284
                                                                                            attracted my attention and I have, on        this search may include the need for
    GROWMARK, Inc.                            1701 Towanda Ave., Bloomington, IL 61702
                                                                                            a number of occasions, shared my             lower cost sources of capital, restric
Executive Committee Member
                                                                                            views and concerns with my profes            tive lending limits (loan covenants),
  George Benson                                                           (312)372-2000
                                                                                            sional colleagues. Aside from these          or a simple desire to explore innova
     McDermott, Will & Emery                        227 W. Monroe St., Chicago, IL 60606
                                                                     gbenson@mwe.com        few opportunities afforded me by my          tive and/or more promising alterna
                                                                                            academic peers, cooperative litera           tives. Regardless, some understand
                              EXECUTIVE DIRECTOR                                            ture has been mostly void of any
                                                                                                                                         ing of the general environment from
                                                                                            mention of this practice; its pros
BarbraC. Mickey                                                             (703)569-3088                                                which this new procedure evolved is
                                                                                            pects and pitfalls.                          clearly needed.
  NSAC—National Office                 6320 Augusta Dr., Suite 800, Springfield, VA 22150
                                                                    bhickey@nsacoop.org        I was, therefore, extremely                  Grain and apple marketing coop
                                                                                            pleased to find the article by Bartsch       eratives in eastern and central
                            NATIONAL DIRECTORS                                              and Dahlgren which appeared in the           Washington, respectively, have tra
                        (See Chapter Listing for Address)                                   Winter 1997 issue of The Cooperative         ditionally marketed their commodi
                                                                                            Accountant. It represented, to my            ties under a pool system. An initial
William Davisson                       At-Large                           (309) 557-6284
Philip W. Miller                    Capitol Chapter                       (804)281-1211
                                                                                            knowledge, the first professionally          payment followed shortly the physi
                                                                                            circulated mention of what has be            cal delivery of wheat/apples at har
William F. Leimbach              Far Western Chapter                      (510)287-2742
                                                                                            come a more generally-accepted fi            vest time, after which subsequent
Teresa H. Castanias              Far Western Chapter                      (916) 448-4700
Edward H. Nishio                 Far Western Chapter                      (916) 973-3035
                                                                                            nancial practice; and the liability ex       pool payments were advanced to the
                                                                                            posure it raises. While Bartsch and          producer-members as the post-
Ralph W. Miller                  Great Lakes Chapter                      (309) 557-2329
Thomas H. Davis                  Mid-Central Chapter                      (615) 793-8364
                                                                                            Dahlgren describe in rather precise          harvest marketing season pro
Larry C Bocshart                  Mid-West Chapter                        (816) 459-5135
                                                                                            terms, the legal ramifications and           gressed. With the advent of ex
Dwayne E. Campbell                Mid-West Chapter                        (800) 611-6731
                                                                                            the securities' concerns associated          tended government grain storage
                                                                                            with this practice, I am of the opin         programs and controlled atmo
Allen F. Floyd                 Mississippi Valley Chapter                 (573) 876-5316
                                                                                            ion that numerous other deficiencies         sphere apple storage technology in
George Benson                  Mississippi Valley Chapter                 (312) 372-2000
                                                                                            exist and warrant public scrutiny. My        the early 1970's, late season pool set
Richard Olson                   North Central Chapter                     (612) 735-4882
                                                                                            objective will be to outline in this         tlements grew larger and more com
Dale Carlson                    North Central Chapter                     (507) 354-3816
                                                                                            paper some of those other concerns           mon; as final pool payments ex-
Margaret H. Bertolino             Northeast Chapter                       (978) 689-4442
James P. Murphy                Pacific Northwest Chapter                  (206) 233-7787
W. F. (Chip) Pohl               South Atlantic Chapter                    (770) 393-5265
                                                                                            Professor of Agribusiness Management and Finance, Department of Agricultural Economics
Charles C. McCoy                    Texas Chapter                         (817) 461-2674    Washington State University, Pullman, WA 99164-6210,


Summer 1998                                           The Cooperative Accountant            The Cooperative Accountant                                             Summer 1998
16             Patron Demand Deposit Accounting Financing                                                        New Members                            81


tended even later into the calendar      operative was now performing func        MARK THORPE, Supervising Se            P.O. Box 1111, Lake Wales, FL
year following harvest. Under these      tions not unlike those of a commer         nior II, KPMG Peat Marwick,          33859
circumstances, producers and or-         cial bank (particularly if the account     LLP, 111 N. Orange Ave., Suite
chardists asked their cooperatives to    balances exceeded the immediate            1600, Orlando, FL 32801                    TEXAS CHAPTER
initiate a "service of convenience" by   capital needs of the cooperative).
                                                                                  MARY TROTTER, Manager Gen            RANDALL J. KAUFMAN, Partner,
which undistributed pool proceeds           Early on, the practice, as de
                                                                                    eral, AgFirst Farm Credit Bank,      Williams, Rogers, Lewis & Co.,
could be used to offset springtime       scribed above, was viewed as a win/
                                                                                    1401 Hampton Street, Columbia,       2308 W 5th, Plainview, TX 79072
purchases of seed, fertilizer, chemi     win proposition. Patrons were af
                                                                                    SC 29201
cals and orchard supplies. As a re       forded the opportunity to earn                                                DAVID MORALES, Principal, Gow-
sult, final pool balances were held by   modest rates of interest on pool pro     CLAY WORDEN, Tedder. James,            land, Quinton, Strealy & Assn.,
the cooperative, with member con         ceeds left undistributed in their co       Worden & Assoc, 200 E. Robin         5934 S. Staples, Suite 224, Corpus
sent, as a form of "prepayment"          operatives. The cooperatives, simul        son Street, Suite #425, Orlando,     Christi, TX 78413
against the members' soon-to-be          taneously, had found a convenient          FL 32801
                                                                                                                       TOMMY NELSON, CPA, Scott,
purchased production supplies.           source of debt capital, which accrued
                                                                                  THOMAS L. YORK, Manager, Cost         Singleton & Fincher, 4815 King
Rather rapidly, this practice grew       lower interest costs and carried no
                                                                                    Accounting, Citrus World, Inc.,     St., Suite A, Greenville, TX 75401
more common and more generally           restrictive loan covenants or exter
accepted throughout Washington           nally imposed credit limits. Even as
State. As noted by Bartsch and           the practice grew more common in
Dahlgren, such pre-pay program           Washington state, and subsequently
balances do not accrue interest and      spread eastward to other states,
are not, therefore, regulated as if      some initial concerns were being ex
they were genuine investments.2 As       pressed by observant academicians
generally prevailing interest rates      as early as 1989.3 Soon thereafter,
rose throughout most of the 1970\s,      cooperative system lenders and com
however, cooperative members grew        mercial banks, each for separate rea
more concerned about the "oppor          sons, began to raise concerns and
tunity costs" associated with their      reflect nervously about the long-
non-interest bearing pool payment        range impacts of the practice. Early
balances carried in their names at       in the 1990's, an Arkansas-based co
their marketing cooperative. It was      operative bankruptcy spawned litiga
only natural that those who volun        tion surrounding the practice and
teered to leave such balances would      the Eighth Circuit Court of Appeals
ultimately ask that some "modest"        found that such deposits were not
rate of interest be paid against those   viewed as securities and, thereby,
balances by their cooperatives. It       not protected by SEC regulations4.
was at this point that an "operational   Soon thereafter, however, in Reves
convenience" transitioned into a         vs. Earnst & Young, the U.S. Su
more commercial (and potentially         preme Court reversed that finding;
troublesome) arrangement, i.e. in        thereby raising the numerous legal
terest-bearing account balances          concerns noted by Bartsch and
were now created against which           Dahlgren.5
member-patrons could charge pro
duction expenses OR draw cash ad         Prospects and Pitfalls:
vances on demand, as needed for             As described above, and as was
other purposes. In essence, the co       evident during the high interest rate


Summer 1998                                     The Cooperative Accountant        Tiif: Cooperative Accountant                                Summer 1998
80                               New Mkmbhrs                                                    Patron Di-mand Deposit Accounting Financing                      17


RANDALL EDGAR, Partner, Price            KATHLEEN LINCE, Grower Ac              periods extending through the                originally generated as a result of
  Watcrhouse, LLP, 59 James Brite          countant, Trout-Blue Chelan,         1980's, it was somewhat painless for         member patronage, i.e. the delivery
  Circle, Mahwah, NJ 07430                 Inc., P.O. Box 669, Chelan, WA       the cooperative to pay their deposi          of commodities to their marketing
                                           98816                                tor-patrons a rate of interest set to        cooperative. As rates of interest re
NANCY POPPENHOUSE, Fiscal
                                                                                fluctuate within the range between           mained at attractively high levels
  Manager, The ICA Group, 20             LESLIE J. MONKS, Controller,
                                                                                the cooperative's cost of borrowed           over extended periods of lime, some
  Park Plaza, Suite 1127, Boston,          Burlcy Design Cooperatives, 4020
                                                                                capital and the depositors' interest         patron depositors recognized a fi
  MA 02716                                 Stewart Road, Eugene, OR 97402
                                                                                rates on CD's at their local commer          nancial opportunity and expressed
                                                                                cial bank. The prospects of a win/win        an interest in supplementing such
                                                                                scenario were, therefore, very real;         patronage-sourced deposits with
       PACIFIC NORTHWEST                  SOUTH ATLANTIC CHAPTER
                                                                                with some cooperatives accruing pa           personal funds not necessarily linked
            CHAPTER
                                         STEPHEN L. APPEL, Partner,             tron demand deposit account bal              to their cooperative relationship.
JAMES G. AMSEL, Assistant Con              KPMG Peat Manvick, LLP, 111          ances approaching $100 million.              Monies generated from other agri
  troller, Trout-Blue Chelan, Inc.,        North Orange Ave., Suite 1600,       Both the earnings and the conve              cultural enterprises, or from ven
  P.O. Box 669, Chelan, WA 98816           Orlando, FL 32801                    nience afforded patrons were judged          tures (or sources) unrelated to agri
DENNIS J. COLLERAN, SR. V.P.             JEFFERY C. BRYAN, Partner,             attractive. Participating cooperatives       cultural production, were soon being
     Finance & CFO, AGRIPAC,               Crisp, Hughes, Evans, LLP, 225       reduced their lines of credit and op         added to such deposit account bal
     INC., P.O. Box 5346, Salem, OR        Peachtree St., N.E., Suite 600, At   erating debts commensurate with              ances. This raised the question of
     97304                                 lanta, GA 30303                      their ability to build patron demand         the tax treatment (at both the coop
                                                                                deposit account balances. Coopera            erative and patron level) of interest
RONI DEVON, Controller, Gold             JOHN ECONOMIDIS, Controller,           tive boards met to regularly adjust          paid on deposits not patronage-
  Digger Apples, P.O. Box 128,             Winter Haven Citrus Growers          the interest rates paid on these bal         sourced.
  Oroville, WA 98844                       Assn., P.O. Box 312, Winter Ha       ances so as to remain within the
                                           ven, FL 33882                        market rate range noted above.               2) Non-Member Demand Deposit
DAN DUFFEY, Accountant, Coop
  erative Supply, Inc., 1923 Sher        STEPHEN L. HENRY, Controller,          Aside from some of the legal con             Accounts
  man Ave., Cocur D'Alene, ID              Dunkin' Donuts SE Distr. Cntr,       cerns which first surfaced in 1989,             The attractive rates of interest
     83816-1709                            296 Southfield Parkway, Forest       the practice appeared to have a              paid on such accounts during the
                                           Park, GA 30297                       bright future for cooperatives.              1980's soon began to attract the at
JOHN C. FOLTZ, Associate Profes                                                    But, as the saying goes, "All that        tention of other potential investors,
  sor, University of Idaho, Depart       MIKE LYNCH, HI, Controller, Sil
                                                                                glitters is not gold." By the late           e.g. particularly cooperative man
  ment of Agricultural, Economics,         ver Springs Citrus, P.O. Box 155,
                                                                                1980's academicians were already dis         agement and employee groups most
  Moscow, ID 83844-2334                    Howey-in-Hills, FL 34737-0155
                                                                                cussing the practice and contemplat          familiar with the program provi
JAMES M. HASON, General Man              STUART MELLISH, Controller,            ing its potential pitfalls. The sources of   sions. Before long, individual em
  ager, Walla Walla Farmers Coop           PSCU Service Centers, Inc., 560      their concerns are varied and reflect        ployees and/or cooperative plant
  erative, P.O. Box 928, Walla             Carillon Pkwy, St. Petersburg, FL    some regional biases and experiences.        employee groups (labor unions)
  Walla, WA 99362                          33716                                Yet questions well beyond those              were asking for the opportunity to
                                                                                linked to securities and regulatory          leave a portion of their cooperative
MARK T. HAUGER, Assistant Man            MICHAEL K. POWER, Controller/
                                                                                matters began to surface. The follow         wage/salary earnings as deposits in
  ager, Union Warehouse & Supply           CFO, CPG-Pepsi Bottlers, Inc.,
                                                                                ing section is an attempt to list, de        such a program.
  Co., P.O. Box 70, Grangeville, ID        2849 Paces Ferry Road, Suite 240,
                                                                                scribe and evaluate those pitfalls              As one might expect, such invest
  83530                                    Atlanta, GA 30339
                                                                                                                             ment program opportunities were
TERRENCE L. KUENZI, Principal,           CHRISTOPHER H. SCOTT, Chief            1) Patronage vs. Non-Patronage               not constrained to cooperative pa
  Mackcy, Hanson, Kuenzi & Co.,            Operations Manager, North            Sourced Deposits                             trons/employees, alone. Before long,
     1395 Liberty St. SE, Stc. 200, Sa     Georgia Farm Credit, ACA, P.O.          As described above, patron de             members of the general public (of
     lem, OR 97302                         Box 2536, Gainesville, GA 30503      mand deposit account balances were           ten not in any way affiliated with the


Summer 1998                                    Tut; CoorERAiivn Accountant      The Cooperative Accountant                                           Summer 1998
18            Patron Demand Deposit Accounting Financing                                                       New Members                               79


cooperative) began to explore op        clined to solve this problem by          KENNETH J. BOHATKA, Manager              204 R Court, P.O. Box 568, Be-
portunities to deposit personal funds   voluntarily suggesting that they be        of General Accounting, Milk            loit, KS 67420
under terms generally prescribed by     paid lower rates of interest.              Marketing, Inc., 8257 Dow Circle,
the program. Even when participa                                                   P.O. Box 368017, Strongsville,
                                        4) A Large Producer Bias                                                        MISSISSIPPI VALLEY CHAPTER
tion in such programs were subse                                                   OH 44136-9717
quently restricted to "members             Cooperative boards of directors,                                             J. SHANNON MCGOWIN, Man
                                                                                 REBECCA A. CARROLL, Energy
only", some individuals, or groups of   although elected as a result of pre                                                ager, Audit Services, MFA, Incor
                                                                                   Accounting Manager, Country-
individuals, elected to become coop     scribed democratic processes, are                                                  porated, 201 Ray Young Dr., Co
                                                                                   mark Cooperative, 902 N. Merid
erative members largely, or solely,     sometimes comprised of a large                                                     lumbia, MD 65201
                                                                                   ian, Indianapolis, IN 46204
for the purpose of gaining access to    number of heavy-volume producers
                                                                                                                        ROBERT WEBB, Vice Pres./Corp.
this program of cooperative finance.    and/or long-time producers nearing       C. DAVID HARPE, CPA, C. David
                                                                                                                          Controller, CF Industries, Inc.,
   At this point it became evident      retirement age. This coincidental           Harpe, CPA, 5555 North Tacoma
                                                                                                                          One Salem Lake Drive, Long
that the original purpose underlying    and resultant board composition             Ave, Suite #213, Indianapolis, IN
                                                                                                                          Grave, IL 60047
the patron demand deposit account       may produce a potential conflict re        46220
program had been so expanded and        lating to programs of patron financ                                             JOHN W. WEUBBE, Vice Presi
                                                                                 JOHN W. WEUBBE, Vice Presi
diluted that numerous additional        ing. For example, the conflict arises                                             dent, Bank of America NT&SA,
                                                                                   dent, Bank of America NT&SA,
questions concerning its legitimacy     when those same directors become                                                  1955 Buckingham Dr., Wheaton,
                                                                                   1955 Buckingham Dr., Whcaton,
began to surface.                       the major participants in the pro                                                 IL 60187
                                                                                   IL 60187
                                        gram and interest paid depositors
                                                                                                                        PAUL ZABEL, Controller, Will Du-
3) Setting Rates Within the Range       accrues individually, or collectively
                                                                                                                          Page Service Co., 100 Manhattan
    As the "prime" rate plummeted       to those who are charged with the
                                                                                       MID-WEST CHAPTER                   Road, Joliet, IL 60433
during the mid-1980's, cooperative      responsibility of setting the interest
boards of directors were hard           rates paid on such accounts. And,        BOURK      DREYER,    President,
pressed to transmit such rate adjust    for those patrons nearing retire           Quint-Dreyer & Co., PC, PA,            NORTH CENTRAL CHAPTER
ments to patron demand deposit ac       ment, high patron demand deposit           5799 Broadmoor, Suite 712, Mis
                                                                                                                        CHUCK BEYER, Asst. Controller,
count earnings. Several months of       account earnings provide an oppor          sion, KS 66202
                                                                                                                          Atwood-Kellogg, 730 Second Ave
ten transpired between those            tunity for them to extract monies        BRIA N HEITHOFF, Manager of              South, Minneapolis, MN 55402-
occasions when director considered      from the cooperative (as interest)         Financial Services, United Power,      0905
appropriate reductions in interest      more rapidly than would be true for        Inc., Box 929, Brighton, CO
                                        proceeds paid as patronage under                                                MICHAEL REIMLE, Audit Man
rates paid on patron demand deposit                                                80601
account balances. As a result, rates    normal equity capital redemption                                                  ager, Coopers & Lybrand, LLP,
paid often rested on the upper end      programs.
                                                                                 JERRY MATHISTAD, Panhandle               650 Third Avenue South, Minne
of the rate range. And, as multi                                                   Rural Electric Membership, P.O.        apolis, MN 55402
tiered rates emerged from the Banks     5) Questions of Depositor Security         Box 677, Alliance, NE 69301-
                                                                                                                        JOHN ROWEKAMP, Technical
for Cooperatives System during the         Quite aside from the legal ques         0677
                                                                                                                          Support, Udcnberg & Associates,
late 1980's, some cooperatives dis      tions raised by Bartsch and Dahl-        GREGORY E. REDMOND, Con                  107 Woodlake Drive SE, Roches
covered that they were paying pa        gren, additional questions relating to     troller, Producers Cooperative,        ter, MN 55904
tron depositors rates higher than       depositor security can be viewed.          P.O. Box 323, Girard, KS 66743
 those judged prudent, sometimes        For example, most Washington state
                                                                                 SHERR1E M. ROGERS, Office                   NORTHEAST CHAFFER
 even higher than the current cost of   cooperatives with active programs of
                                                                                   Manager, Cooperative Agricul
 borrowed funds. That, which had        patron demand deposit accounts,                                                 TIMOTHY V. CROWLEY, Domes
 first been judged as providing a
                                                                                   ture Services, 411 West 2nd, Oak
                                        manage such funds and are subject                                                 tic Tax Manager, Ocean Spray
 means for lowering their cost of cap                                              ley, KS 67748                          Cranberries, Inc., One Ocean
                                        to the investment/expenditure deci
 ital, was now more costly. Patron-     sions of management and directors.       MIKE R. WILKISON, Office Man             Spray Dr., Lakeville-Midcllcboro,
 depositors, of course, were not in     Because of the very nature of these        ager, Farmway Cooperative Inc.,        MA 02349


Summer 1998                                    The Cooperative Accountant        The Cooperative Accountant                                    Summer 1998
78                                                                                          Patron Demand Deposit Accounting Financing                     19


         NSAC WELCOMES THE FOLLOWING NEW MEMBERS                             cooperative organizations, most          6) Questions of Accountability
                                                                             funds thereby generated are evi              Cooperative auditors are not in
                                                                             denced as inventories, with residual     agreement regarding the correct
        CAPITOL CHAPTER                   and Payne, LLP, 430 N. Vineyard,
                                                                             amounts invested by the cooperative      treatment of grower demand deposit
                                          Suite 202, Ontario, CA 91764
STEVEN F. CUNNINGHAM, Presi                                                  in assorted securities of various        accounts.6 Although most have gen
  dent & CEO, IMARK Group,              KARIN LINDBERG, Controller, Al-      types and terms. Whereas most com        erally agreed to the listing of such
  Inc., 6009 Oxen Hill Road, Oxon         varado Street Bakery, 500 Martin   mercial financial institutions provide   balances as a "current liability",
  Hill, MD 20745                          Ave., Rohnert Park, CA 94928       security for their depositors through    there seems to be little agreement as
                                        MICHELE M. PEREZ, Tax Staff          FDIC, FSLIC, etc., no counterpart        to how the "demand" feature is to be
CRAIG HINKLE, Senior Cost Ana
                                          Accountant, Deloitte & Touche,     security exists for cooperative depos    disclosed. In essence, it becomes the
  lyst, Knouse Foods Cooperative,
                                          LLP, 146A W. 37th Ave., San        itors and the liquidity of inventories   most current of all current liabilities,
  Inc., 800 Peach Glcn-Idaville
                                          Mateo, CA 94403                    and securities may be subject to         i.e. while trade accounts payable are
  Road, Peach Glen, PA 17375-
                                                                             question. Although inventories can       presumed to carry a float period, de
  0001                                  ROBERT STUEVE, Owner, CPA,
                                                                             be sold, it is questionable whether      mand deposits constitute mandatory
REX P. HONODEL, Insurance Con             Robert A. Stueve, CPA, 605 15th                                             and immediate payment. In re
                                                                             such a forced sale could generate
  troller, Southern States Coopera        Street, Suite B, Modesto, CA                                                sponse to this concern, some Wash
                                                                             funds sufficient to meet patron re
  tive Inc., 6606 West Broad St.,         95354                                                                       ington state cooperatives have con
                                                                             quests for large-scale withdrawals.
  Richmond, VA 23230                    BILL WILLIAMS, Supervisor,           Residual monies tied to mixed term       verted all or a portion of such
                                          Vavrinek, Trine, Day & Co., LLP,   securities may also be inaccessible in   deposits to a form of debenture note
D. KEITH REID, Division Control
                                          1312 E. Shaw Avenue, Suite 103,    the very short run. Forced liquida       which requires 30 or 60 days notice
   ler, Southern States Cooperative
                                          Fresno, CA 93710                   tion of either asset may cause the       prior to withdrawal.
   Inc., 6606 West Broad St., P.O.
                                                                             cooperative to incur substantial pen         Some financial analysts are begin
   Box 26234, Richmond, VA 23260        GEORGE J. WOO, CPA, George J.
                                                                             alties and/or diminished inventory       ning to speculate about the impact
                                          Woo, CPA, 1085 W. State St., El
KAREN TURNER, Manager, Stock                                                 valuation.                               such deposits have on the limited
                                          Centro, CA 92243
  Records, Southern States Coop                                                 As the market value of invento        liability characteristics of a coopera
  erative Inc., 6606 West Broad St.,                                         ries may vary over the post-harvest      tive corporation. For example, pa
  Richmond, VA 23260                       GREAT LAKES CHAPTER               season, some, but not all, coopera       tron liability is normally limited by
                                        MIKE DOHERTY, Coop Special-          tives limit their deployment of de       measures of patron's equity (mem
FRANK WELLNER, Asst Vice Pres
                                                                             mand deposit balances such that          bership stock, retained patronage,
  ident Finance, Ag Cooperative           ist/Ag Economist, USDA-RD,
                                                                             they never are collateralized by in      etc.). However, should a foreclosure
  Dev. Int'1/VOCA, 50 F St. NW,           402 N. Kays, Normal, IL 61761
                                                                             ventory in excess of 60 percent of       or forced liquidation result in a loss
  Stc. 900, Washington, DC 20001        MORGAN R. KLEMM, Controller,         their deposits' balance outstanding.     of all or a portion of the total de
                                          Equity Coop Livestock Sales        Also, some cooperatives secure a         mand deposit account balance, pa
                                          Assn, E 10890 Penny Lane,          seasonal line of credit from a com       tron losses (for those who elected to
     FAR WESTERN CHAPTER                  Baraboo, WI 53913                  mercial lender for purposes of secur     leave such deposits) may exceed the
EDGAR CAJIUA, Chief Financial                                                ing patron deposits against large-       corporate net worth limitations.
  Officer, Manos Janitorial Cooper         MID-CENTRAL CHAPTER               scale withdrawals. However, where            7) Cooperative management gen
  ative, 2869 38th Avenue, Suite 3,                                          the cooperative also operates with a     erally welcomed the advent of pa
                                        WENDELL D. BARNETT, Control
     Oakland, CA 94619-1105                                                  long-term loan, that loan may be se      tron demand deposit accounts. The
                                          ler, Premier Ag Coop., Inc., 766
                                                                             cured by physical assets, including a    participating cooperative's need for
TZE-KI LAM, Staff Accountant,             West Main Street, Greensburg,
                                                                             claim against inventories. When this     seasonal borrowing was reduced
     Vavrinek, Trine, Day & Co., LLP,     IN 47240                           exists, patron-depositors may be         and, in some cases, even eliminated.
     1312 E. Shaw Avenue, Suite 103,    JACOB J. BIERLEY, 2710 Country       found to be secondary claimants of       Management was not highly re
     Fresno, CA 93710                     Club Road, Indianapolis, IN        such inventories under conditions of     strained in the manner by which
TODD LANDRY, Manager, Eadic               46234                              loan foreclosures.                       such monies were deployed. Some


                                              Tin; Cooperative Accountant    The Cooperative Accountant                                        Summer 1998
Summer 1998
20             Patron Demand Deposit Accounting Financing
                                                                                                        Small Cooperative Business Forum                        77

limits on funds required for capital    Will the cooperative declare such          ing. This may be difficult if the cash     —Disguising thefts as cash pay
expansion and plant modernization       earnings on Form 1099, and,                register tapes are mutilated, de         ments for supplies.
were removed and lessened. And, of      thereby, treat them as a form of pa        stroyed, or printed using very faint        —Claiming reimbursement for
course, patrons were pleased with       tronage payment to its members?            ink. If this occurs, other methods       personal purchases.
the higher rate of return on funds      Or, should they be declared as other       such as spotters, surveillance, or in
deposited.                              investment income and not directly                                                     —Cash shortages.
                                                                                   ventory comparisons must be used.
   Yet to some degree, the cooper       linked to patronage activity?8                                                        —Increase use of petty cash fund.
                                                                                       —Comparison of sales prices to
ative philosophies of "operation at                                                list prices.
cost" and "limited return on in         Conclusions:                                   —Comparison of inventory sold        Detection Methods for Theft of
vested capital" are, thereby, subject       A cooperative patron demand de         over a particular period to the re       Cash on Hand
to compromise as decisions reflect      posit account-financing program            corded sales during the same period.
ing this new form of patron invest      that began in Washington State                                                        —Surprise cash counts.
                                                                                   If sales are less than what they
ment become evident. For example,       nearly two decades ago and subse           should have been according to the
not all patrons are afforded equal      quently spread across the U.S. is just     inventory, the shortfall could have          This listing of cash fraud is by no
access to this procedure, as many are   now receiving a form of professional       resulted from cash thefts.               means all inclusive of the schemes
financially unable to participate.      scrutiny. Bartsch and Dahlgren de             —Inventory of returned mer            that can occur in the theft of cash. It
And as rates of return on demand        clared the program to be, "A Liabil        chandise.                                is only a list of some typical ways the
deposits eclipse in importance the      ity Trap for Everyone". As evi                —Matching sales returns with          theft of cash can occur. In many
goal of service to membership, par      denced by those authors' views,            original sales.                          cases, the lack of segregation of du
ticipating cooperatives are poten       patron demand deposit financing               —Confirming sales returns with        ties creates an opportunity for em
tially confronted with different, per   does expose the participating coop         customer.                                ployee fraud. At your local coopera
haps conflicting, stresses. How will    erative to numerous and serious le           —Analyze voids and sales re            tive you should always be aware for
commercial entities that tradition      gal questions. However, the program        turns.                                   the lack of segregation of duties and
ally lend funds to cooperatives re      has persisted for at least 20 years                                                 do what is possible to see that duties
act? These and other related ques       and its legal uncertainties are, in my     Scheme: Theft or Cash on Hand            get rotated. Employees should take
tions remain unanswered and may         opinion, superccded by other ques             Individuals with access to cash       vacations and their duties should be
serve to alter U.S. cooperative oper    tions relating to operational/finan        drawers, petty cash funds, vaults,       performed by other personnel when
ations in ways not yet envisioned.      cial matters and those linked to basic     and other cash on hand, can steal        they are away. If you are concerned
   8) The IRS treatment of cooper       cooperative philosophy.                    cash in several ways.                    that fraud may be occurring at your
ative earnings/savings has long been        The program evolved because it                                                  cooperative, please consult with
an area of confusion and misunder       was first perceived to meet real           Symptoms of Theft of Cash on             your general manager or your Board
standing, at least amongst the gen      needs of cooperatives and the con          Hand                                     of Directors.
eral public. Patronage-sourced co       venience of their patrons. Some ex            —Trading a personal check for            I have only discussed cash fraud
operative earnings (if nonqualified),   pectations have been fulfilled as          cash but never depositing the check.     here. Additional articles will follow
when allocated in accordance with       some participating cooperatives still      Periodically, the check may be re        dealing with fraud of other assets,
Section 521 provisions, have been       strongly support the patron demand         placed by a check with a later date or   such as accounts receivable and fixed
judged exempt from corporate taxa       deposit program and profess its fu         the "loan" may be repaid.                assets.
tion and declared at the personal       ture prospects. Yet the program, it
level, whether received in cash or in   self, carries with it numerous other
the form of certificates of equity.7    pitfalls; in particular those related to
But how will the IRS treat interest     depositor security, tax treatment,
earned on patron demand deposit         conflicts of interest, and inherent
accounts? This question is particu      challenges to basic cooperative phi
larly relevant when such deposits are   losophy pertaining to fair and equi
judged to be nonpatronage-sourced.      table treatment of members. Coop-

Summer 1998                                    The Cooperative Accountant          Tiiu Cooperative Accountant                                       Summer 1998
76                    Small Cooperative Business Forum                                               Patron Demand Deposit Accounhng Financing                        21


bank tellers must be unaware that         Symptoms of Voids and Sales               eratives now participating in such a              ence in Agriculture; International
they are not allowed to give cash         Returns Schemes                           patron demand deposit account pro                 Compromise," Aug. 8, 1990, Reho-
back on those commercial accounts,           —Unusual or unexpected voids           grams, or contemplating doing so,                 vat, ISRAEL.
and there must be a lack of segrega       or sales returns. (Unusual increase       must assess all the prospects and pit        4.   Baarda, James R., "Demand Notes
tion of duties at the company.            in voids/sales returns or unusual         falls before electing to proceed with             Note Securities," Farmer Coopera
                                          number or amounts of void/sales re        or terminate such programs.                       tives, Jan. 1989, p. 25.
Symptoms of "Less Cash" Scheme            turns relating to an employee or cus                                                   5.   Baarda, James R., "Unusual Co-op
   —"Less Cash" on deposit tickets.       tomer.)                                        Selected References and Citations            Financing Method Causes Prob
   —Deposits per the bank state                                                                                                       lems," Farmer Cooperatives, May
                                             —Mutilated or destroyed cash           1.   Bartsch, Eric A. and Joel J. Dahl-
                                                                                                                                      1990, p. 23.
ment that do not match the compa          register tapes and tapes with faint            gren, "Interest Bearing Patron
ny's copy of deposit tickets.                                                                                                    6.   Enberg, Russell C, "Financing
                                          ink. (This may indicate efforts to             Credit Balances-A Liability Trap for
                                                                                                                                      Farmer Cooperatives," Banks for
   —Cash sales or receipts differing      conceal the bogus voids or returns.)           Everyone," The Cooperative Accoun
                                                                                                                                      Cooperatives, 1965, p. 21.
from normal or expected pattern.             —Cash sales or receipts differing           tant, Winter 1997, p. 45.
                                                                                    2.   Bartsch and Dadlgren, Ibit, p. 46-47.   7.   Neeley, Morrison, "Federal Income
   —Cash deposit totals diifering         from normal or expected patterns.
                                                                                    3.   Duft, K.D., "An Economic Assess              Taxes," F.C.S. Information Report
from normal or expected pattern.             —Cash deposit totals differing
                                                                                         ment of General Ledger Financing             100, USDA, Washington, D.G, Sept.
   —Inventory discrepancies.              from normal or expected patterns.
                                                                                         by U.S. Agricultural Cooperatives,"          1976.
   —Unusual or unexplained recon             —Inventory discrepancies (Sales
                                                                                         paper prepared for presentation to      8.   Askill Mac. Jr., "Cooperatives: Tax
ciling items on bank reconciliation.      returns cannot be accounted for, or            International Assoc. of Agricultural         Treatment of Patronage Refunds,"
   —Unusual journal entries affect        inventory levels are inconsistent with         Economists, Interconference Sym              Virginia Law Review, 2(Dec. 1956):
ing cash accounts.                        the level of returns and voids report          posium, "The Cooperative Experi              1087.
   —Lack of segregation of duties.        ed.)
                                             —Unusual activities on the daily
Detection Methods                         cash register tape.
   —Comparison of bank deposits              —Discrepancies between sale
to cash receipts records.                 prices and list prices. (Selling prices
   —Proof of cash bank reconcilia         reported on return tickets do not
tion.                                     match list prices.)
   —Review of bank reconciliation.           Clerk can also commit fraud with
   —Review of journal entries.            sales returns. There are many types
   —Using alternate parties to per        of sales return schemes which in
form bank reconciliation on a sur         clude:
prise basis if segregation of duties is      A. Fictitious sales returns. A clerk
a concern.                                can process refunds for merchandise
                                          not returned and steal the refund.
Scheme: Voids and Sales Returns              B. Inflated refunds. The clerk can
Schemes                                   process refunds at full retail prices
   Clerk may make a $100 cash or          for goods purchased at a discount
credit card sale and properly record      and steal the difference.
the sale in the store's accounting sys
tem. After the customer leaves the        Detection Methods for Voids and
store with the merchandise, the clerk     Sales Returns Schemes
may then void the sale. The clerk            —Void schemes can be detected
then steals the $100 from the cash        by reviewing the daily cash register
register and replaces the cash with       tape and noting unusual activity
the fake documentation.                   when a particular employee is work-


Summer 1998                                        The Cooperative Accountant       The Cooperative Accountant                                            Summer 1998
22                                                                                                                                                                    75




                ACCTFAX               GENERAL EDITOR
                              Philip W. Miller, Assistant Controller
                                Southern States Cooperative, Inc.                                                         GUEST WRITER
                                      6606 W. Broad Street
                                         P.O. Box 26234
                                      Richmond, VA 23260                                                                Dwayne E. Campbell
                                         (804) 281-1211


                                      ASSISTANT EDITORS
     Robert D. Bccrup                      Ellis M. Dunkum             Douglas W. Fleming
     Illinois Agricultural Auditing        Coopers & Lybrand           Farmland Industries




         FAS 132                                      • provide detail regarding net         Detection Methods for Skimming             —Unusual journal entries or un
 EMPLOYERS* DISCLOSURES                                 benefit cost for the period;         of Cash                                 usual items on the bank reconcilia
ABOUT PENSIONS AND OTHER                                                                        —Skimming is often first identi      tion.
                                                      • key assumptions and how
 POSTRETIREMENT BENEFITS                                                                     fied through analytical procedures.       —Differences between daily list
                                                        changes in those assumptions
                                                                                                —Using spotters to perform sur       of receipts and deposits on bank
   In February 1998, the FASB is                        would affect the calculations;
                                                                                             veillance.                              statements.
sued Statement of Financial Ac                           and
                                                                                                —Using alternate parties to per
counting Standards No. 132 ("FAS                                                                                                     Detection Methods for Theft of
                                                      • amounts and types of the em          form employees' duties.
132"), "Employers' Disclosures                                                                                                       Daily Deposits
                                                        ployer's securities held by the         —Making inventory comparisons.
about Pensions and Other Postre-                                                                                                        —Comparison of bank deposits
                                                        plan.                                (Analysis of gross margin trends by
tirement Benefits."                                                                                                                  to cash receipts records.
                                                                                             locations, departments, etc.)
   FAS 132 does not deal with mea                                                                                                       —Proof of cash bank reconcilia
surement or recognition issues.                    The    FASB distinguishes between
                                                                                             Scheme: Theft of Daily Deposits         tion.
Rather, the FASB's intent is to im                 public and nonpublic entities in this                                                —Review of journal entries.
                                                                                                The perpetrator may steal an en
prove disclosure related to pensions               pronouncement, and significantly re                                                  —Review of bank reconciliation.
                                                                                             tire deposit or part of the deposit;
(FAS 87 and FAS 88) and other pos-                 duces the disclosure requirements                                                    —Using alternative parties to
                                                                                             such as all the cash. Thefts of daily
tretircment benefits (FAS 106) by                  for nonpublic entities. Detail of the                                             perform bank reconciliation on a
                                                                                             deposits occur after the sale is re
providing information that is                      disclosure requirements are con                                                   surprise basis when lack of segrega
                                                                                             corded so it leaves a paper trail.
".. .more comparable, understand                   tained in Exhibit 1 (public entities)                                             tion of duties is a concern.
able, and concise..." (the FASB has                and Exhibit 2 (nonpublic entities).
                                                                                             Symptoms of Theft of Daily
a unique definition of "concise").                                                                                                   Scheme: "Less Cash Schemes"
                                                       Employers may not combine de          Deposits
                                                   fined benefit pension plan disclo           —Cash sales or receipts differing        "Less cash" schemes involve di
Defined Benefit Plans                              sures with other postrctirement ben       from normal or expected patterns.       verting cash from a deposit. In com
                                                   efits disclosures. However, generally       —Cash deposits total differing        mercial checking accounts, cash re
   Following are key categories of                                                                                                   ceipts are normally deposited intact.
                                                   disclosures required may be aggre         from normal or expected patterns.
disclosures required by FAS 132:                                                                                                     Thus, there are no "less cash" lines
                                                   gated for all of an employer's de             —Lack of segregation of duties.
     • reconcile the change in the                 fined benefit pension plans and may       (The person making the daily depos      on the deposit slips. However, some
       benefit obligation;                         be aggregated for all of an employ        its also prepares the bank reconcili    perpetrators write "Less Cash
     • reconcile the change in the fair            er's defined benefit postretirement       ation.)                                 SXXX" and receive cash back from
       value of plan assets;                       plans.                                       —Missing deposit slips.              deposits. For this fraud to occur,


                                                             The Cooperative-; Accountant                                                                   Summer 1998
SUMMER 1998                                                                                  Tut; Cooperative Accountant
                                                                                                                                                             23
74




        SMALL COOPERATIVE                                                                                     GUEST WRITERS



         BUSINESS FORUM                                                            Douglas W. Fleming                    Philip W. Miller
                                                                                   Manager, SEC Accounting               Assistant Controller
                          GENERAL EDITOR                                           Farmland Industries, Inc.             Southern States Cooperative, Inc.
                          Dwayne E. Campbell                                       3315 N. Oak Trafficway                6606 W. Broad Street
                       Collins, Butler & Co., P.C.                                 Kansas City, MI 64116                 Richmond, VA 23260
                          901 West Maple Ave.
                             Enid, OK 73701
                              (580) 233-1144


                                                                                 Defined Contribution Plans              Exhibit 1
         EMPLOYEE FRAUD                  Symptoms of Skimming                                                            Disclosures for Public Entities
                                                                                    For defined contribution plans,
                                           —Cash sales or receipts differing                                                1. Reconciliation of beginning
     At a recent meeting an insurance                                            an employer must disclose:
                                         from normal or expected patterns.                                               and ending balances of the benefit
representative stated that in the past                                              a) the amount of cost recognized
                                         (Unusual decrease in sales or cash                                              obligation showing separately the ef
year, loss due to employee fraud had                                             during the period; and
                                         receipts from one month to the                                                  fects during the period of each of the
increased substantially.                                                            b) a description of the nature and   following:
                                         next).
    Fraud within cooperative organi        —Cash deposits totals differing
                                                                                 effect of any significant changes dur        a) service cost;
zations has been a topic of recent       from normal or expected patterns.
                                                                                 ing the period.                              b) interest cost;
NSAC Annual Meetings. The Audit          (Cash deposits are not consistent                                                    c) contributions by plan partic
ing Standards Board of the AICPA                                                                                         ipants;
                                         with reported daily sales).             Multiemployer Plans
has issued Statement on Auditing            —Inventory discrepancies. (In                                                     d) actuarial gains and losses;
Standards 82; Consideration of                                                      For multiemployer plans, an em            e) foreign currency exchange
                                         ventory levels are much lower than
Fraud in a Financial Statement Au        expected based on the recorded sale     ployer must disclose:                   rate changes;
dit which became effective for audits                                                a) total contributions to multiem        f) benefits paid;
                                         volume.)
of financial statements for periods         —Unusual amounts or patterns         ployer plans (contributions for pen          g) plan amendments business
ending on or after December 15,          of cash over/short. (Cash over/short    sion and other postretirement bene      combinations;
 1997. Employee fraud is a problem       reflects discrepancies between cash     fits may be combined); and                   h) divestitures;
that should concern the Board,           balances and the reported transac          b) a description of the nature and         i) curtailments;
Management, Accounting Person            tions for the day. Unusual cash over/   effect of any significant changes dur        j) settlements; and
nel, Membership, and Auditors of         short amounts may indicate that         ing the period.                               k) special termination benefits.
cooperative organizations because it                                                                                        2. Reconciliation of beginning
                                         cash is being stolen.
seems to be occurring more often. I         —Missing Sales Invoices.                                                     and ending balances of the fair value
will discuss in this presentation some                                           Effective Date and Implementation
                                            —Receipts in currency decrease,                                              of plan assets showing separately the
of the common schemes, symptoms,         while customers checks and credit          FAS 132 is effective for fiscal      effects during the period of each of
and detection methods involving          card receipts increase or remain        years beginning after December 15,      the following:
cash fraud.                                                                      1997. Restatement of disclosures for            a)   actual return on plan as
                                         constant.
                                            —Customer Complaints. (Cus           earlier periods provided for compar     sets;
Scheme: Skimming All or Part of a
                                         tomers complain about not getting       ative purposes is required unless the           b) foreign currency exchange
Cash Sale
                                         sales receipts.)                        information is unavailable.             rate changes;
  Skimming is stealing the proceeds
from cash sales before it is recorded.      —Declining Gross Profit.
                                                                                 The Cooperative Accountant                                       Summi-r 1998
                                                  The Cooperative Accountant
 Summer 1998
24                               ACCTFAX
                                                                                                              Leveraging the Future?                          73

        c) contributions by the em          7. Amount included in other
                                                                                                                          the drop in the cotton, grain and
ployer;                                  comprehensive income as a result of      Figure a- Returns on Operations         fruit/vegetable groups. Diversified
      d) contributions by plan partic    a change in the additional minimum
                                                                                  Percent                                 and rice cooperatives had the largest
ipants;                                  pension liability.
                                                                                   12
                                                                                                                          increase in their return on assets.
      e) benefits paid;                    8. Assumptions used including:
      f) business combinations;               a) assumed discount rate;                                                     The last ratio compared in this
      g) divestitures; and                    b) rate of compensation in                                                  report (Figure 9) is the return on
                                                                                   10
      h) settlements.                    crease;
                                                                                                                          member equity. It is calculated by
   3. The funded status of the plans.         c) expected long-term rate of                                               dividing the net margins after inter
   4. Amounts not recognized in the      return on plan assets;                                                           est and taxes by total member eq
statement of financial position, such         d) health care cost trend rate                                              uity. Interest is a return to creditors
as unrecognized net gain or loss (in                                                                                      while taxes are a return to govern
                                         used for the next year;
cluding asset gains and losses not yet                                                                                    ment, so interest and taxes must be
                                              e) general description of the
reflected in market-related value).                                                                                       removed to get the true return on
                                         direction and pattern of the change
   5. Amounts recognized in the                                                                                           equity.
                                         in the assumed health care cost
statement of financial position:
                                         trend rate after the first year;                                                   After four years of improving re
      a) unamortized prior service
                                              f) the ultimate rate used for                                               turns on member equity, the trend
cost;
                                         the health care trend rate;                                                      dropped in 1996. Forty-seven of the
      b) unamortized net obligation
                                              g) when the ultimate health                                                 100 largest agricultural cooperatives
or net asset existing at date of appli
                                         care trend rate is expected to be                                                had lower returns to member equity
cation of FAS 87 or FAS 106;
                                         achieved;                                                                        in 1996. Most were found in the
      c) net pension or other postrc-
                                              h) the effect of a 1% increase             1992       93   94   95    96
tirement benefit prepaid assets or                                                                                        grain and fruit/vegetable cooperative
                                         and a \% decrease in the assumed         Prior years restated
accrued liabilities;                                                                                                      groups. Within the other commodity
                                         health care cost trend rate on:                                                  groups, there were enough gainers
      d) if an additional minimum li
ability is recognized, then disclosure             i) the service and interest    gest hit to their net income in 1996.   to offset any cooperatives with de
                                         cost components of net periodic post-    Cotton cooperatives were the only       clining return on member equity.
of the related intangible asset; and
      e) amount of amortization in       retirement health care benefit cost;     other group that had a decline in       The largest gains made by the differ
                                         and                                      return on total assets. However, cot    ent commodity groups were the
cluded in other comprehensive in
come related to any intangible asset             ii) the accumulated post-        ton cooperatives continued to have      dairy, diversified and the poultry/
recognized as an offset to the addi      retirement benefit obligation for        the highest ratio of any group, 18.3    livestock cooperatives. Sugar coop
tional minimum liability.                health care benefits.                    percent. All of the other commodity     eratives finally had positive returns
   6.   Amount of net cost recog           9. The amounts and types of se         groups realized increases in return     to member equity given that the
nized, showing separately:               curities of the employer and related     on asset ratios. However, they did      prior two years they averaged nega
      a) service cost;                   parties included in plan assets.         not increase enough to overcome         tive returns.
        b) interest cost;                   10. The future annual benefits of
        c) expected return on plan as    plan participants covered by insur
sets;                                    ance contracts issued by the em
     d) amortization of the unrec        ployer.
ognized transition obligation/asset;        11. Significant transactions be
     e) recognized gains/losses;         tween the employer or related par-
        f) prior service cost recog      tics and the plan during the period.
nized; and                                   12. If an alternative amortization
     g) gain/loss recognized due to      method is used to amortize prior ser
a settlement or curtailment.             vice amounts or unrecognized net

Summer 1998                                        Tun            Accountant      The Cooperative Accountant                                      Summi-k 1998
                            LEVERAGING Till: FuTURB?                                                                 ACCTFAX                                     25
72


                                                                                    gains/losses, then disclosure of that     tirement benefit prepaid assets or
were the main reason for the decline
in the average ratio - most likely due           -Net Operating Margin              alternative method.                       accrued liabilities;
to higher prices paid to member-                                                       13. Any substantive commitment              b) if an additional minimum li
                                         Percent
producers. Grain cooperatives suf                                                   used as the basis for accounting for      ability is recognized, then disclosure
                                           2
fered the largest drop, declining                                                   the benefit obligation.                   of the related intangible asset; and
from 10.8 percent to 7.7 percent be                                                    14. For special or contractual ter           c) amount of amortization in
tween 1995 and 1996. Dairy and                                                      mination benefits:                        cluded in other comprehensive in
fruit/vegetable cooperatives dropped                                                     a) the cost of providing those       come related to any intangible asset
from 8.4 to 7.8 percent and 23.9 to
                                          0.5
                                                                                    benefits; and                             recognized as an offset to the addi
22.6 percent, respectively.                                                              b) a description of the nature       tional minimum liability.
   Net operating margins look at the                                                of the event.                                5. Net benefit cost recognized.
profitability of cooperative opera                                                     15. When disclosures required             6. Amount included in other
tions. It is calculated by taking the                                               are aggregated for more than one          comprehensive income as a result of
gross margin and subtracting operat                                                 defined benefit pension plan or           a change in the additional minimum
ing expenses and interest, then divid                                               more than one defined benefit post-       pension liability.
ing by total revenue. Non-operating                                                 retirement plan:                              7. Assumptions used including:
items (patronage refunds, interest        0.5                                            a) the aggregate benefit obli             a) assumed discount rate;
income, gains/losses on the sale of                                                 gation and aggregate fair value of             b) rate of compensation in
assets, and any other extraordinary                                                 plan assets for plans with benefit ob     crease;
revenues or expenses not directly re                                                ligations in excess of plan assets; and        c)   expected long-term rate of
lated to operations) are not included                                                    b) the aggregate pension accu
                                                                                                                              return on plan assets;
in the calculation.                              1992       93   94   95    96      mulated benefit obligation and ag              d) health care cost trend rate
   Figure 8 shows that after hitting a    Prior years restated                      gregate fair value of plan assets for
                                                                                                                              used for the next year;
record high of 1.7 percent in 1995,                                                 pension plans with accumulated
                                                                                                                                   c) general description of the
net operating margins slipped to 1.2                                                benefit obligations in excess of plan
                                            Cotton cooperatives had the high                                                  direction and pattern of the change
percent, near the pre-1994 average.                                                 assets.
                                         est net operating margins, 6.1 per                                                   in the assumed health care cost
Lower margins and higher operating                                                     16. An explanation of any signif
                                         cent, a dramatic improvement from                                                    trend rate after the first year;
expenses squeezed operating mar                                                     icant change in the benefit obliga
                                         4.4 percent in 1995. Farm supply co                                                       f) the ultimate rate used for
gins in 1996. The number of cooper                                                  tion or plan assets not otherwise ap
                                         operatives also had high net operat                                                  the health care trend rate; and
atives with operating losses dropped                                                parent  in the other disclosures
                                          ing margins. However, they dropped                                                       g) when the ultimate health
substantially, from 23 co-ops in 1992                                               required by FAS 132.
                                          from 4.5 percent in 1995 to 3.9 per                                                 care trend rate is expected to be
to 13 co-ops in 1993. Throughout the
                                          cent in 1996.                                                                       achieved.
next three years, the number of co                                                  Exhibit 2
                                             Return on total assets is calcu        Disclosures for Nonpubiic Entities           8. The amounts and types of se
operatives operating with a loss
                                          lated by taking net income before            1. The plan's:                         curities of the employer and related
climbed steadily, reaching 21 in
                                          taxes and interest divided by total             a) benefit obligation;              parties included in plan assets.
1996. Most of the cooperatives with
                                          assets. This ratio looks at the overall         b) fair value; and                     9. The future annual benefits of
 operating losses were in the sugar,
                                          return on total assets. After inching           c) funded status.                   plan participants covered by insur
 grain and poultry/livestock commod
                                          up throughout most of the 1990s, the         2. Contributions by the:               ance contracts issued by the em
 ity groups. Although the sugar and
                                          return on total assets took a down              a) employer; and                    ployer.
 poultry/livestock groups still posted
                                          ward turn in 1996.                              b) participants.                        10. Significant transactions be
 operating losses, their 1996 losses
                                            The two commodity groups that              3. Benefits paid.                      tween the employer or related par
 were smaller than in 1995. The
                                          contributed most to this decline             4. Amounts recognized in the           ties and the plan during the period.
 higher prices paid to members of the
                                          were grain and fruit/vegetable co         statement of financial position:              11. The nature and effect of sig
 grain commodity group pushed their
                                          ops. These two groups had the big-              a) net pension or other postrc-      nificant nonroutine events, such as
 operating losses higher.

                                                    The Cooperative Accountant      This Cooperative Accountant                                         Summer 1998
 Summkr 1998
32                                                                                                                                                                 65


      CONTINUED EXPANSION OF ASSETS SHOWS GREATER                                       LEVERAGING THE FUTURE? HIGHER DEBT LEVELS AMONG
           RELIANCE ON DEBT BY FARMER CO-OPS                                                LARGE AG CO-OPS MAY BE CAUSE FOR CONCERN

         By David S. Chesnick, USDA/RBS Cooperatives Services                                        By David S. Chesnick Agricultural Economist
                         Agricultural Economist                                                       USDA Rural Business-Cooperative Service


Editor's note: This is the second of      term and long-term debt together in        Editor's note: This is the third of the    cumulating a record amount of debt
three articles. Tfiis article was first   creased 13.4 percent while total eq        three article series about financial re    to fund their expansion. As cooper
published in the September/October        uity increased by only 7.5 percent         sults of the 100 largest agricultural co   atives become more leveraged, slight
issue of Rural Cooperatives.              (table 1).                                 operatives. This article first appeared    changes in revenue can have a tre
   The balance sheets of the nation's                                                in the November/December 1997 issue        mendous effect on whether or not a
100 largest cooperative show that                                                    of Rural Cooperatives.                     cooperative has patronage refunds
                                          Current Assets Climb Slightly
they continued to experience signif                                                     Latin proverb states: "No gain is       to return to members at year end.
                                             While the growth of total assets in
icant growth in 1996, although not                                                   as certain as is that which proceeds       Increased sales help the coopera
                                          1995 was fueled by the expansion of
quite as dramatic as the growth spurt                                                from the economical use of what you        tives maintain a liquid position.
                                          current assets, the growth of current
seen in 1995 (figure 1). The rate of                                                 already have." In other words, the         However, higher expenses, espe
                                          assets in 1996 lagged behind growth
growth in combined assets was                                                        use of a cooperative's resources in        cially for labor, continue to eat into
                                          in total assets. Current assets (com
nearly 9 percent in 1996, down from                                                  an efficient manner should produce         the bottom line, as illustrated in the
                                          prised of cash, accounts receivable,
15 percent in 1995, but still is a                                                   a healthy return to members.               slumping profitability ratios, exam
                                          inventory and "other" current as-
strong indicator of economic health                                                                                             ined below. While some coopera
                                                                                        This raises an interesting ques
for the nation's largest cooperatives.                                                                                          tives are positioning themselves for
                                                                                     tion. How do you determine whether
                                          Rgure i —Asset Composition, Top 100                                                   the 21st century, others may find the
   The balance sheet certainly does                                                  a cooperative is using its financial
                                                      Cooperatives, 1992-96                                                     next century will not be so favorable.
not tell all, but it does provide a                                                  resources efficiently? The first two
                                          $ million
good snapshot of the overall finan                                                   articles of this series examined the
                                          30
cial strength of the business at one                                                 combined income statement and              How USDA Evaluates Co-op
point in time. The assets side of the                                                balance sheet of the nation's largest      Performance
balance sheet presents all the re                                                    agricultural cooperatives. This third
                                                                                                                                   The tools USDA uses to analyze
sources that the cooperative has in                                                  and final article in the series will try
                                                                                                                                cooperative financial performance
vested. The other side indicates the                                                 to interpret this data to determine
                                                                                                                                include four types of primary mea
sources from which these invested                                                    how well cooperatives are using their
                                                                                                                                surements:
funds were financed. In other words,                                                 resources.
                                                                                                                                  • Liquidity, which shows the co
we see what the cooperative owns                                                        The nation's 100 largest agricul             operative's ability to meet
and who lays claim to these assets.                                                  tural cooperatives have experienced            short-term obligations.
   Total combined assets for the top                                                 phenomenal growth in sales and as            • Leverage, which shows the risk
100 U.S. agricultural cooperatives                                                   sets during the past few years. How            associated with financing and
stood at $25.6 billion in 1996, a $2-                                                ever, a few cooperatives accounted             the cooperative's ability to
billion increase from 1995. The di                                                   for most of the gain. The big ques             meet its long-term and short-
versified and grain cooperative                                                      tion that needs to be examined is:             term obligations.
groups recorded the largest gains.                                                   are cooperatives putting themselves          • Activity, which shows the effi
Nearly two-thirds of the total com                                                   in a position where a downturn in              ciency with which the coopera
bined increases in total assets were                                                 the economy can cause tremendous               tive uses its assets.
                                               1992    93        94   95   96
attributed to these two commodity                                                    damage?                                      • Profitability, which shows the
groups. This expansion was fueled by      Prior years restated
                                                                                        As expressed throughout this se             net return on the cooperative's
higher levels of debt. Both short-                                                   ries of articles, cooperatives are ac           operations.


Summf.r 1998                                        Tin; Cooi'f.kativf. Accountant   The-: Coopi-rativh Accountant                                      Summer 1998
72                         Liivi-:nAGiN(i nil-; Futuki?                                                               ACCTFAX                                     25


were the main reason for the decline                                                 gains/losses, then disclosure of that     tirement benefit prepaid assets or
in the average ratio - most likely due            - Net Operating Margin             alternative method.                       accrued liabilities;
to higher prices paid to member-           Percent                                      13. Any substantive commitment               b) if an additional minimum li
producers. Grain cooperatives suf                                                    used as the basis for accounting for      ability is recognized, then disclosure
                                             2
fered the largest drop, declining                                                    the benefit obligation.                   of the related intangible asset; and
from 10.8 percent to 7.7 percent be                                                     14. For special or contractual ter          c) amount of amortization in
tween 1995 and 1996. Dairy and                                                       mination benefits:                        cluded in other comprehensive in
fruit/vegetable cooperatives dropped                                                      a) the cost of providing those       come related to any intangible asset
                                           0.5
from 8.4 to 7.8 percent and 23.9 to                                                  benefits; and                             recognized as an offset to the addi
22.6 percent, respectively.                                                               b) a description of the nature       tional minimum liability.
   Net operating margins look at the                                                 of the event.                                5. Net benefit cost recognized.
profitability of cooperative opera                                                      15. When disclosures required             6. Amount included in other
tions. It is calculated by taking the                                                are aggregated for more than one          comprehensive income as a result of
gross margin and subtracting operat                                                  defined benefit pension plan or           a change in the additional minimum
ing expenses and interest, then divid                                                more than one defined benefit post-       pension liability.
ing by total revenue. Non-operating                                                  retirement plan:                             7. Assumptions used including:
items (patronage refunds, interest         0.5                                            a) the aggregate benefit obli              a) assumed discount rate;
income, gains/losses on the sale of                                                  gation and aggregate fair value of              b) rate of compensation in
assets, and any other extraordinary                                                  plan assets for plans with benefit ob
                                                                                                                               crease;
revenues or expenses not directly re                                                 ligations in excess of plan assets; and
                                                                                                                                    c)     expected long-term rate of
lated to operations) are not included                                                      b) the aggregate pension accu
                                                                                                                               return on plan assets;
in the calculation.                                1992      93   94   95    96      mulated benefit obligation and ag
                                                                                                                                    d) health care cost trend rate
    Figure 8 shows that after hitting a    Prior years restated                      gregate fair value of plan assets for
                                                                                                                               used for the next year;
record high of 1.7 percent in 1995.                                                  pension plans with accumulated
                                                                                                                                    e) general description of the
net operating margins slipped to 1.2                                                 benefit obligations in excess of plan
                                              Cotton cooperatives had the high                                                 direction and pattern of the change
percent, near the pre-1994 average.                                                  assets.
                                           est net operating margins, 6.1 per                                                  in the assumed health care cost
Lower margins and higher operating                                                      16. An explanation of any signif
                                           cent, a dramatic improvement from                                                   trend rate after the first year;
expenses squeezed operating mar                                                      icant change in the benefit obliga
                                           4.4 percent in 1995. Farm supply co                                                      f) the ultimate rate used for
gins in 1996. The number of cooper                                                   tion or plan assets not otherwise ap
                                           operatives also had high net operat                                                 the health care trend rate; and
atives with operating losses dropped       ing margins. However, they dropped
                                                                                     parent in the other disclosures
                                                                                     required by FAS 132.                           g) when the ultimate health
substantially, from 23 co-ops in 1992
                                           from 4.5 percent in 1995 to 3.9 per                                                 care trend rate is expected to be
to 13 co-ops in 1993. Throughout the
                                           cent in 1996.                                                                       achieved.
next three years, the number of co                                                   Exhibit 2
                                              Return on total assets is calcu                                                     8. The amounts and types of se
operatives operating with a loss                                                     Disclosures for Nonpublic Entities
                                           lated by taking net income before            1. The plan's:                         curities of the employer and related
climbed steadily, reaching 21 in
                                           taxes and interest divided by total            a) benefit obligation;               parties included in plan assets.
1996. Most of the cooperatives with
                                           assets. This ratio looks at the overall        b) fair value; and                      9. The future annual benefits of
operating losses were in the sugar,
                                           return on total assets. After inching          c) funded status.                    plan participants covered by insur
grain and poultry/livestock commod
                                           up throughout most of the 1990s, the         2. Contributions by the:               ance contracts issued by the em
ity groups. Although the sugar and
                                           return on total assets took a down              a) employer; and                    ployer.
poultry/livestock groups still posted
                                           ward turn in 1996.                              b) participants.                        10. Significant transactions be
operating losses, their 1996 losses
were smaller than in 1995. The                   The two commodity groups that          3. Benefits paid.                      tween the employer or related par
higher prices paid to members of the       contributed most to this decline             4. Amounts recognized in the           ties and the plan during the period.
grain commodity group pushed their         were grain and fruit/vegetable co         statement of financial position:             11. The nature and effect of sig
operating losses higher.                   ops. These two groups had the big-              a) net pension or other postrc-     nificant nonroutine events, such as


                                                     The Cooperative Accountant      The Coophrative Accountant                                         Summer 1998
Summer 1998
26                                 ACCTFAX                                                                    Leveraging the Future?                                 71


amendments, combinations, divesti          owners. FAS 130 allows comprehen            Cotton, rice, and poultry/livestock
tures, curtailments, and settlements.      sive income to be presented in a sep     cooperatives averaged less revenue               —Gross Profit Margin
                 Douglas VV. Fleming       arate statement or in an expanded        in 1996 than in 1995. This, coupled
                                                                                                                             Percent
                                           income statement.                        with greater investments in fixed as
                                                                                                                              15
                                              The new United Kingdom stan           sets, depressed their turnover ratios.
     FASB SPECIAL REPORT:
                                           dard, "Reporting Financial Perfor        Sugar cooperatives did not produce
     REPORTING FINANCIAL
                                           mance," requires a second income         enough revenue to cover their in
        PERFORMANCE
                                           statement that supplements the pri       vestments so they experienced a sig       12
   In January 1998, the Financial          mary profit and loss statement. The      nificant drop in their fixed asset ra
Accounting Standards Board issued          new statement would be a "state          tio. Revenue for farm supply
a Special Report, "Reporting Finan         ment of total recognized gains and       cooperatives was greater than invest
cial Performance: Current Develop          losses," including those reflecting      ment, but one cooperative had such
ments and Future Directions." The          gains and losses attributable to         a dramatic drop in its ratio that is
report was co-authored by L. Todd          shareholders.                            depressed the overall average turn
Johnson of the FASB and Andrew                The new New Zealand standard          over ratio for that commodity group.
Lennard of the United Kingdom's            also requires a companion "state
Accounting Standards Board. As in          ment of financial performance," or       Profitability
dicated in its title, the report has two   "statement of movements in equity."         Because cooperatives often have
broad objectives. The first objective      The new standard, titled "Presenta       other objectives in addition to gen
derives from new standards for re          tion of Financial Reports," requires     erating returns for their members,
porting financial performance re           a reconciliation of beginning and        their profitability ratios may be
cently adopted by several members          ending balances of equity and a pre      lower than for investor-owned firms.             1992      93   94    95    96
of the G4+1. The second objective          sentation of information about in        However, comparisons for a single        Prior y&ars restated
concerns the working group's views         vestments by and distributions to        cooperative or group of cooperatives
as to what performance reporting           owners.                                  over time can be very informative.
should be like in the future. This            The new IASC standard, "Presen        The four profitability ratios used in    percent of total revenue for the na
report mainly focuses on the report        tation of Financial Statements," ef      this report include gross margin per     tion's 100 largest agricultural coop
ing and presentation aspects of per        fectively requires that enterprises      cent, net operating margins, return      eratives. Although gross margins
formance reporting rather than the         present either a "second perfor          on total assets and return on mem        have increased during this time,
recognition and measurement as             mance statement": or a "statement        ber equity.                              gross margins as a percent of total
pects.                                     of changes in equity."                      Gross margins are the excess of       revenues have dropped. However,
   New standards for performance              This special report discusses the     revenues above the cost of goods         not all is gloom and doom. Cotton
reporting have been recently intro         similarities and diiTcrences between     sold. All operating and non-operat       and sugar cooperatives reversed
duced in the United Kingdom, New           the four new standards. They are         ing expenses plus payment of pa          their downward trend and posted an
Zealand, the United States and by          similar in that they all require: per    tronage refunds, dividends and in        increase in gross margins. Cotton co
the International Accounting Stan          formance reporting on an all-inclu                                                operatives increased their gross mar
                                                                                    come taxes must be covered by the
dards Committee ("IASC"). Of               sive basis; an overall summary mea                                                gin percent from 15.4 percent in
                                                                                    gross margins. Gross margins also
those, the only one you most likely        sure of financial performance; and       indicate the pricing policy of the co    1995 to 17.2 percent in 1996 while
would be familiar with would be            all permit or require that some items                                             sugar cooperatives moved from 20.7
                                                                                    operative. In other words, is the co
FASB Statement No. 130, "Report                                                                                              to 22.8 percent during the same
                                           of financial performance be reported     operative charging enough for the
ing Comprehensive Income." Under                                                                                             time.
                                           outside the P&L or income state          products sold or paying too much for
its definition, comprehensive income       ment. They are significantly different   member products to cover its ex             The largest decline in gross mar
includes all changes in equity during      in other aspects, including: what        penses.                                  gin percents occurred in the dairy,
a period except those resulting from       kind of companion or supplemental           Figure 7 illustrates the five-year    grain and fruit/vegetable coopera
investments by or distributions to         statement should be used; which          trend for average gross margin as a      tives. These three commodity groups

Summer 1998                                       I'm- Coon KATivii Accountant      The Cooperative Accountant                                           Summer 1998
70                         Leveraging thh Future?                                                                   ACCTFAX                                     27


crease was caused by both higher                                                    items of financial performance are      Journal titled, "Two New Rules Will
record revenues and a higher pro                   - Fixed Asset Turnover           reported in which statement; how to     Change How Firms Account for
portion of assets held as investments                                               distinguish between those items re      Computer-Related Costs." The
                                          Percent
in cooperatives. In 1995, investments                                               ported in the P&L and those re          phrases that had him concerned
                                           20
in other cooperatives represented                                                   ported outside it; and whether cer      were, ".. .a new ruled passed by the
6.75 percent of total assets. By 1996,                                              tain items reported outside the P&L     Financial Accounting Standards
that number stood at 7.45 percent.                                                  can later be reported within the        Board requires companies to imme
Compared to other commodity                                                         P&L.                                    diately write off costs for hiring con
                                           15
groups, dairy, cotton and poultry/                                                     The report discusses the future      sultants to install or overhaul com
livestock cooperatives average less                                                 directions in standards for perfor      puter systems...," plus, "The rule
assets, which helps explain their high                                              mance reporting by asking three         took effect November 20 (1997)."
turnover ratios.                                                                    questions:                              The reason for his concern; we are
   The second activity ratio, fixed as     10                                           1. Should all financial perfor      well into a $10 million project to
set turnover, looks at how efficiently                                              mance be reported in a statement of     install a new wholesale support sys
the cooperative uses its fixed assets.                                              financial performance?                  tem, utilizing J.D. Edwards' soft
It must be noted that this ratio could                                                 2. Should all financial perfor       ware. Several consulting groups are
be misleading. A cooperative with                                                   mance be reported in a single finan     assisting us with the effort, with fees
fully depreciated assets could have a                                               cial statement?                         in the $ millions. The project budget,
high ratio due to the low book value                                                   3. Should components of financial    approved more than a year ago, an
of its fixed assets. On the other hand,                                             performance be reported and, if so,     ticipated that the consulting costs
a cooperative that is expanding its                                                 what should those components be         would be capitalized along with the
operations could have a temporarily              1992       93   94    95   98      and in what order should they be        hardware and software costs. In fact,
depressed ratio because the new ca        Prior years restated                      reported?                               the budget for the project was pre
pacity is not fully used at this time.                                                 The report presents its answers to   pared using the rules proposed (and
Therefore, other information—such         chasing new equipment to replace          these questions, and its views of fu    later finalized) in the AICPA State
as the average age left on the fixed      their old, worn-out fixed assets at a     ture reporting in great detail. Other   ment of Position on Internal Use
assets and how much new equipment         record pace.                              chapters include discussions of         Software. Having to immediately ex
is purchased—will be needed to help          With this in mind, we turn our         which components of financial per       pense the consultants' fees (retroac
interpret the fixed asset turnover ra     attention to figure 6, which illus        formance should be reported.            tive to November 20) would have
tio.                                      trates the fixed asset turnover ratio        For a copy of the Special Report,    been a dramatic and unanticipated
    Cooperatives arc purchasing fixed     for the past five years. This ratio is    contact: FASB Order Department,         hit to earnings.
assets at a record rate. In 1996, co      up from 17.8 in 1995 to 18.1 in 1996.     401 Merritt 7, P.O. Box 5116, Nor-         As the primary accounting stan
operatives purchased $1.5 billion of      Cooperatives are expanding their          walk, Connecticut, 06856-5116. Ask      dards watchdog for my firm, I was
fixed assets, the highest amount          operations and their fixed asset turn     for product code SRRFP.                 expected to know what this WSJ ar
since USDA began tracking it. Net         over ratio is also increasing. This                           Philip W. Miller    ticle was talking about, plus I would
fixed assets also hit a new high of       would imply that the average coop                                                 have had the responsibility to have
$7.6 billion during the same period.      erative is using its assets more effi                                             adequately forewarned management
                                                                                             EITF ISSUE 97-13
The average age left on fixed assets      ciently to generate higher sales.                                                 about such a dramatic pending
                                                                                            REENGINEERING
is calculated by dividing their net       However, not all commodity groups                                                 change. 1 was dumbfounded! I had
                                                                                           CONSULTING COSTS
fixed assets by current depreciation      reaped the benefits of their fixed as                                             no idea what FASB standard could
expense. The average age left for         set investments. Only four out of            On Thursday, March 5, 1998, I        have slipped by me. And, it was on a
fixed assets owned by the largest 100     nine commodity groups showed              received a very concerned phone call    subject that I have been following
cooperatives is 8.81 years, the long      higher efficiencies. These include        from our Vice President of Informa      closely for TCA (see my article on
est it has been in 10 years. This fur     dairy, diversified, fruit/vegetable and   tion Systems. He had just finished      the AICPA SOP in the Fall 1997
ther indicates cooperatives arc pur-      grain.                                    reading an article in the Wall Street   TCA).


Summhr 1998                                        The Cooperative Accountant       The Cooperative Accountant                                      Summer 1998
28                                ACCTFAX                                                                        LEVERAGING THIi FUTURE?                            69


   As it turns out, the WSJ article          Answer: Generally, the costs in
was referring to the FASB Emerging         volved with reengineering business               - Times-Interest-Earned            Figure s - Local Asset Turnover
Issues Task Force (EITF) Issue No.         processes should be expensed, pri         TTmes                                     Times
97-13, "Accounting for Costs In            marily according to existing gener
                                                                                       7                                         A
curred in Connection with a Con            ally accepted accounting principles.
sulting Contract That Combines             The primary support for this posi
Business Process Reengineering and         tion can be found in Paragraph 24 of
Information Technology Transfor            APB 17, "costs of developing, main
mation." It took me half the morn          taining, or restoring intangible assets
ing on the internet to identify this
                                           which are not specifically identifi
"new standard". Make no mistake,
                                           able, have indeterminate lives, or are
this is a new standard—new GAAP.
                                           inherent in a continuing business
Since the inception of the EITF, now
                                           and related to an enterprise as a
in its eleventh year, and with the
                                           whole should be deducted from in
release of SAS 69 which defines
                                           come when incurred."
GAAP hierarchy (EITFconcensuses
= categoryc), the EITF has effec              Question 2: How should total
tively been issuing "instant GAAP."        costs of the various activities in
I have warned you about this on nu         cluded in a consulting contract be
merous occasions in ACCTFAX. In            allocated if some of those costs are
this case, after a study of EITF 97-
                                           eligible for capitalization?
13, we determined that the impact                                                            1992      93   94   95    96             1992       93   94     95   96
would not be material. Very little of         Answer. Generally, the total con       Prior years restated                      Prior years restated

our consulting fees were related to        sulting contract price should be allo
"reengineering" efforts. However, a        cated to the various activities based                                               Activity
                                                                                        As expected with the surge in
quick read of the WSJ article did          on the relative market prices (fair
raise concerns.                                                                      debt accumulation, the average TIE           Where the first two types of ratios
                                           values) of the separate activities,
   Simply put, EITF 97-13 requires                                                   dropped from 6.5 in 1995 to 4.9 in        examined the capital structure and
                                           based upon objective evidence -
expensing of contractual costs in                                                    1996 (figure 4). Pushing this decline     the cooperative's ability to meet its
                                           preferably vendor-specific evidence.
curred in a general reengineering ef                                                 were dairy, fruit/vegetable and grain     fixed obligations, the next two look
fort. The issue addresses:                    You may not agree with the EI-         cooperatives. However, dairy co-ops       at the operating performances. Ac
    1. Whether certain costs of consult    TF's reasoning, nor relish the results    still maintain the highest average        tivity ratios reveal how much reve
ing contracts that combine business        of applying their standards, but as       TIE of all commodity groups. De           nue is generated by each dollar in
process reengineering and informa          they usually are, the consensuses are     spite the large increase in the debt of   vested in the cooperatives assets.
tion technology transformation should      straightforward,      fairly  simply      diversified cooperatives, their TIE       The higher the ratio the more effi
be eligible for capitalization or should                                             ratio continues to improve. Another       cient the assets are used.
                                           worded, short and direct. This makes
be immediately expensed, and               them that much more difficult to re       surprise is the trend for poultry/           The first activity ratio, local asset
   2. how to separate costs eligible                                                 livestock cooperatives. With all the      turnover, is calculated by dividing to
                                           fute. Like it or not, "instant GAAP"
for capitalization from costs that                                                   accumulation of debt over the past        tal revenues by local assets. Local
                                           is a reality. Copies of the consensus
should otherwise be expensed as in                                                   few years, their TIE (while still be      assets are total assets less invest
                                           can be obtained from the FASB Or
curred.                                                                              low average) showed substantial im        ments in other cooperatives.
                                           der Department, 401 Merritt 7, P.O.
   Question I: What activities in                                                    provement. Less positive, 10 cooper          The average local asset turnover
                                           Box 5116, Norwalk, Connecticut,
cluded in a business process reengi                                                  atives did not have enough income         for the largest agricultural coopera
                                           06856-5116.
neering consulting contract are eligi                                                to cover their interest expense. This     tives hit a five-year high of 3.83 (fig
ble for capitalization?                                         Philip W. Miller     is up from six co-ops in 1995.            ure 5) in 1996. This dramatic in-


Summer 1998                                       The Cooperative Accountant         Tiii- Cooperative Accountant                                          Summer 1998
68                         LEVERAGING Tllli FuTURl:?                                                                 ACCTFAX                                    29


                                                                                     ACCTFAX BULLETIN BOARD                  GASB Technical Bulletin
       - Debt-To-Asset Ratio              Figure 3- Long-term Debt-To-Equlty                                                    The Governmental Accounting
                                          Ratio                                                                              Standards Board has published a
                                                                                    SEC Chief Accountant Steps Down
                                                                                                                             new technical bulletin on deposits
                                           0.5                                         SEC Chief Accountant Michael
                                                                                                                             and investments for certain bank
                                                                                    H. Sutton resigned his post in Janu
                                                                                                                             holding company transactions, TB
                                                                                    ary after nearly three years of ser
                                                                                                                             no. 97-1, "Classification of Deposits
                                                                                    vice. The SEC Chief Accountant is
                                                                                                                             and Investments into Custodial
                                                                                    the senior advisor to the SEC and
                                                                                                                             Credit Risk Categories for Certain
                                                                                    staff on accounting issues and also
                                                                                                                             Bank Holding Company Transac
                                                                                    works closely with the FASB on is
                                                                                                                             tions." For a copy, call the GASB
                                                                                    sues that will impat public compa
                                                                                                                             order department at (203) 847-0700,
                                                                                    nies. Sutton in particular worked
                                                                                                                             ext. 555—code no. GTB01.
                                                                                    very closely with the FASB on its
                                                                                    financial instruments projects. He
                                                                                                                             Year 2000 Items
                                                                                    also was a strong supporter of the
                                                                                                                                The SEC has issued a staff legal
                                                                                    IASC in their efforts to establish a
                                                                                                                             bulletin (no. 5) requiring public
                                                                                    core set of international accounting
                                                                                                                             companies to disclose substantial
                                                                                    standards. Before joining the SEC,
                                                                                                                             year 2000 related computer costs, in
                                                                                    Sutton worked with Deloittc & Tou-
                                                                                                                             cluding:
                                                                                    che for 32 years.
                                                                                                                                1. The cost of Y2K compliance if
       1992       93                              1992      93   94   95       96                                            material,
Prior years restated                      Prior years restated                      Top Ten Technologies                        2. The cost or consequence of in
                                                                                        In February, the A1CPA posted        complete or untimely Y2K compli
                                                                                    its annual list of the top ten technol   ance.
run view of financing, they provide a     dous increases in the amount of
                                                                                    ogies that it feels will most impact        The requirements were effective
useful comparison. After showing          long-term debt incurred compared
                                                                                    businesses throughout the next year.     for 1997 company filings. This addi
substantial declines throughout the       with member equity. The ratio for
                                                                                    This year's list is dominated by com     tional guidance was issued by the
1980s, this trend reversed in 1994.       sugar cooperative jumped from 0.56
                                                                                    munications technologies:                SEC following urging from the
Since 1994, the priority of debt fi       in 1995 to 0.84 in 1996 while the
                                                                                        1. Internet, intranet, private net   AICPA. A copy can be obtained at
nancing has taken on a more prom          poultry/livestock    cooperatives
                                                                                    works and extranets                      the SEC Web site at www.sec.gov.
inent role for the top agricultural       jumped from 0.77 to 0.96.
                                                                                      2. The Year 2000 Issue                    President Clinton has issued an
cooperatives. Figure 3 illustrates this      The last leverage ratio is times         3. Security and controls               executive order for all government
point. In 1994, value stood at 0.42,      interest earned (TIE). This ratio is        4. Training and technology com         agencies to be year 2000 compliant.
by 1996 long-term debt-to-equity          primarily used to look at interest        petency                                  Clinton ordered that no critical fed
reached 0.48.                             payments and determine whether               5. Electronic commerce                eral programs experience disruption
     The biggest users of long-term       the cooperative has enough net in            6. Communicationstechnologies—        because of the Y2K issue. He also
debt continue to be the diversified       come to cover those payments. It is       general                                  ordered federal agencies to cooper
cooperatives. These co-ops held $1.7      calculated by dividing earn- ings (be        7. Telecommuting/virtual office       ate with state and local governments
billion of long-term debt and were        fore interest and taxes) by interest        8. Mail technology                     and private-sector operators of crit
the only group of cooperatives with a     payments. A note of caution is              9. Portable technology                 ical national and local systems, such
ratio of more than 1. Their long-         needed here. This ratio looks at the         10. Remote connectivity               as banking, telecommunications,
term debt to equity ratio was 1.33.       minimum payments needed. It does             For more details check AICPA On       healthcare, transportation and en
Sugar and poultry/livestock cooper        not include other fixed payments such     line, http://www.aicpa.org/members/      ergy. In addition, he established a
atives also have experienced tremen       as principle and lease payments.          div/infotech/topl098.htm.                President's Council on Year 2000

Summer 1998                                         The Cooperative Accountant      The Cooperative Accountant                                      Summer 1998
30                               ACCTFAX                                                                     Leve-raging the Future?                             67


Conversion to report to the presi        counting for assessments related to     cooperatives are still maintaining a       Leverage
dent at least once every three           insurance activities. For a copy, con   current ratio well above 1. Poultry/          If assets are the building blocks
months on the progress being made        tact the AICPA order department at      livestock cooperatives were the least      for a cooperative's future, the capital
by the federal agencies on resolving     (800) 862-4272—product code no.         liquid, with current liabilities greater   structure is the cement that holds it
their Y2K problems.                      014898CLC2.                             than current assets.                       together. Equity is the basic risk cap
   The American Bankers Associa                                                                                             ital put up by members of the coop
tion (ABA) has announced a com           New SAS Exposure Draft                     The quick ratio is calculated the       erative. There must be some equity
prehensive plan to provide banks            The Auditing Standards Board         same way as the current ratio, but         within the capital structure to help a
with education and information nec       has issued an exposure draft for a      inventories are excluded from the          co-op bear the risk associated with
essary to prepare their computer sys     proposed new auditing standard,         current assets. Many analysts believe      doing business. Debt is the use of
tems for Y2K. The plan includes          "Restricting the Use of an Auditor's    that inventories cannot be converted       someone else's capital for a fixed
more than 60 educational products,       Report." The proposal would pro         to cash as quickly as the other cur        cost. Thus, if the fixed cost of the
national conferences and telephone       vide auditors with guidance on when     rent assets during liquidation. Also,      debt is lower than the returns those
seminars, plus an industry mentor-       an engagement requires a restricted-    if the inventory needs to be liqui         funds generate, the excess returns
ship alliance. For more info, call the   use report and what to include in       dated, the cash value will in all like     will accrue to the members. On the
ABA at (800) 338-0626.                   such a report. The comment period       lihood be much less than the book          other hand, if the revenues are less
   The FDIC has taken its first Y2K      is open through May 1. For a copy,      value. Therefore, it can be argued         than the fixed cost of the debt, mem
related enforcement actions, against     contact the AICPA order depart                                                     ber equity takes will have to absorb
                                                                                 that the quick ratio is a better mea
three Georgia banks that have pre        ment at (800) 862-4272—product                                                     the loss. This is the concept of lever
                                                                                 sure of liquidity. Despite the drop in
pared inadequately for Y2K. The          code no. 800117CLC2.                                                               age.
                                                                                 the current ratio, the quick ratio in
FDIC ceasc-and-desist orders were                                                                                               The first leverage ratio, debt-to-
                                                                                 creased slightly in 1996. Coopera
issued to ensure that information        New SEC Staff Accounting Bulletin                                                  asset, is calculated by dividing total
                                                                                 tives did not have as large of an in
systems, internal controls and com          The Securities and Exchange                                                     liabilities by total assets. This repre
                                                                                 ventory buildup as they had in 1995.
puter operations will not fail on Jan    Commission has issued its Staff Ac                                                 sents assets claimed by outside inter
                                                                                 This is evident by the way the cur
uary 1, 2000.                            counting Bulletin No. 98, which re                                                 ests. Figure 2 shows how this ratio
                                         vises certain previous SABs to bring    rent ratio dropped while the quick
   The AICPA is offering a Year                                                                                             has been moving during the past five
2000 Dilemma CPE video course.           them into line with FAS no. 128,        ratio increased. Cotton, dairy and
                                                                                                                            years. Except for 1994, creditors are
The course includes a 2-hour video       "Earnings Per Share." For a copy,       rice cooperatives were the excep           laying claim to more assets each
presentation and the AICPA publi         contact the SEC web site at: ww-        tion. Cooperatives in all three of         year. However, two commodity
cation, "Solving the Year 2000 Di        w.sec/gov/rules/acctrcps/sab98.txt.     these commodity groups had larger          groups (farm supply and cotton) are
lemma." The 8 CPE credit course                                                  increases in their inventory in rela       bucking this trend and are using a
will be available May 29 and will cost   Web Sites of Interest                   tion to other current assets, thereby      higher percent of equity to finance
SI29.00. Contact the AICPA order            www.benchin.com—reviews over         lowering their quick ratio.                cooperative operations in 1996. Of
at (800) 862-4272—product no.            100,000 computer products.                                                         these two groups, only cotton coop
                                                                                    The poultry/livestock commodity
18100LA04.                                  www.softwarecenter.com—re                                                       eratives had a ratio of less than one-
                                                                                 group shows some interesting
                                         views 650 software vendors and                                                     half. On the other hand, poultry/
                                         20,000 software titles.                 trends. While generating the lowest
AcSEC SOP 97-3                                                                                                              livestock members owned less than
  The Accounting Standards Exec             www.computainment.com—re             current ratio, this commodity group        20 percent of their cooperatives' as
utive Committee has issued its State     views software intended for home        has one of the highest quick ratios.       sets. The other commodity groups
ment of Position 97-3, "Accounting       use.
                                                                                 Poultry/livestock cooperatives do          all had slight increases in the ratio of
by Insurance and Other Enterprises          www.softsearch.com—reviews           not carry much inventory. Less than        total debt to assets and did not de
for Insurance-Related Assess             22,000 software vendors and 110,000     2 percent of their total current assets    viate much from the total average.
ments," effective for fiscal years be    software titles.                        include inventory, while the average           The second leverage ratio is long-
ginning after December 15, 1998.            www.softmatch.com—matches            for all the largest cooperatives is        term debt-to-equity. Since both eq
The SOP provides guidance on ac          software buyers with sellers via info   more than 45 percent.                      uity and long-term debt take a long-


Summer 1998                                     The Cooperative Accountant       The Cooperative Accountant                                          Summer 1998
66                                             Ll-VERAGING THE FUTURE?                                                                                                     ACCTFAX                                 31


                                                                           assets include cash, marketable secu                            on software conferences and trade          Disclosure Effectiveness (agenda
         i - Liquidity Ratios                                              rities, accounts receivable, invento                            shows.                                  prospectus)
Ratio                                                                      ries and other debt that is to be paid                             www.vfauditmall.com—provides            Issued: 7/31/95 Comment Dead
2.0
                                                                           to the cooperative within the current                           views on the internal audit function.   line: 11/30/95
                                                                           fiscal year. Creditors who have a                                  www.calcpa.org/townhall—offers
                                                                                                                                                                                     Consolidated Financial State
                                                                           short-term interest in the coopera                              a new site for web surfing CPAs via
                                                                                                                                                                                   ments
                                                                           tive will want to know if it can satisfy                        an electronic town hall format.
                                                                           its commitment in case the coopera                                                  Philip W. Miller       Issued: 10/16/95 Comment Dead
 1.5
                                                                           tive has a cash-flow problem. Figure                                                                    line: 1/15/96
                                                                           1 illustrates both current and quick                              MAJOR EXPOSURE DRAFTS                    Accounting for Removal of Long-
                                               Current                     ratios from 1992 to 1996.                                             OUTSTANDING                       Lived Assets
                                                                              The current ratio is calculated by
 1.0                                                                                                                                       Financial Accounting Standards             Issued: 2/07/96 Comment Dead
                                                                           dividing total current assets by total
                                               Quick                                                                                       Board (FASB):                           line: 5/31/96
                                                                           current liabilities. As figure 1 shows,
                                                                           the liquidity of the largest agricul                            Recognition and Measurement of            Using Cash Flow Information
                                                                           tural cooperatives has slowly eroded                            Financial Instruments (DM):
                                                                                                                                                                                      Issued: 6/11/97 Comment Dead
0.5                                                                        since 1993. The major cause of this                                Issued: 11/18/91 Comment Dead
                                                                                                                                                                                   line: 10/31/97
                                                                           decline was the increased reliance                              line: 5/31/92
                                                                                                                                              Distinguishing between Liability       Accounting for Derivatives &
                                                                           on short-term debt over the past few
                                                                                                                                           and Equity Instruments (DM):            Hedging Activities
                                                                           years. Cash balances were also down
                                                                           6.5 percent in 1996.                                               Issued: 8/21/90 Comment Dead            Issued: 9/02/97 Comment Dead
          1992      93          94         95             96                                                                               line: 12/31/90                          line: 10/14/97
                                                                              Table 1 lists the ratios by com
Prior years restated
                                                                           modity type for 1996. The liquidity
                                                                           trend in cotton, dairy, grain, poultry/
Liquidity                                                                  livestock and rice cooperatives is de
   The most common liquidity ratios                                        clining. On the other hand, diversi
used today are the current and quick                                      fied cooperatives strengthened their
ratios. Both evaluate the coopera                                         liquid position, but were unable to
tive's short-term liquidity, measured                                     pull up the overall average. The rest
by the degree to which it can meet its                                    of the commodity groups remained
short-term obligations. Liquidity im                                      steady over the past five years. Ex
plies the ability to convert assets into                                  cept for grain and poultry/livestock
cash in the current period. Liquid                                        cooperatives, the largest agricultural

T*s*» i—Ratios by commodity type (or 1996
                                                       long-Term                                                                  Rccum
                                               Detrt     Debt      T«n*»      Toul       Fhsd                 Net      On Total     Oi
                       CuniM    Out*            To        To       beam)     Aueti      too        Pn»      Opening    ton        Mtnton
                         R»SO   Rrto       Auca         Equly      E*nwl     Turnowr    Turnover   Mtrgtn                Bl£       E<Mir
                                        Ll*>                                                                         /VCOT——

Cotton                   1.78    122       4937          027       650        5.11      2445       17^4      605        16.30     1822
Daay                     126    0.90       6251          0 3J      003        5.47       2515      7.85      1.31       7.63      18.41
                         IBS     1.15      66.34         1.33      4.48       2.52       114S      11.54     1.11       8.48      14.40
                         1.37   063        6761          0.7Q      184        219        12.15     22.66     029        3.56       301
Farm Suppty              1.52   0.78       55.37         0.33      7.49       269        12.70     15.18     3 as       9.41      12.88
Groin                    1.08   052        65 58         058       195        372        1382      7.72      -054       C.47       8.72
PouitrytAiiojtoC*        0.97                                                           66.65      2,23      ■1.24      364        4.65
                                0.96       61.23         0.9S      2.95       7.43
Rice                     132    051        58 94         030       151        228        636       30.10     056        5.14       2.10
Sugar                    1.33              57.66         084       2.41       1.33       2.24      22.80     043        2 OS       131
                                065




SlJMMEK 1998                                                                           The Cooperative Acco•UNTAN1                         The Cooperative Accountant                                   Summer 1998
32                                                                                                                                                                65


      CONTINUED EXPANSION OF ASSETS SHOWS GREATER                                      LEVERAGING THE FUTURE? HIGHER DEBT LEVELS AMONG
           RELIANCE ON DEBT BY FARMER CO-OPS                                               LARGE AG CO-OPS MAY BE CAUSE FOR CONCERN

         By David S. Chesnick, USDA/RBS Cooperatives Services                                       By David S. Chesnick Agricultural Economist
                         Agricultural Economist                                                      USDA Rural Business-Cooperative Service


Editor's note: This is the second of     term and long-term debt together in        Editor's note: This is the third of the    cumulating a record amount of debt
three articles. This article was first   creased 13.4 percent while total eq        three article series about financial re    to fund their expansion. As cooper
published in the September/October       uity increased by only 7.5 percent         sults of the 100 largest agricultural co   atives become more leveraged, slight
issue of Rural Cooperatives.             (table 1).                                 operatives. This article first appeared    changes in revenue can have a tre
   The balance sheets of the nation's                                               in the November!December 1997 issue        mendous effect on whether or not a
100 largest cooperative show that                                                   of Rural Cooperatives.                     cooperative has patronage refunds
                                         Current Assets Climb Slightly
they continued to experience signif                                                    Latin proverb states: "No gain is       to return to members at year end.
                                              While the growth of total assets in
icant growth in 1996, although not                                                  as certain as is that which proceeds       Increased sales help the coopera
                                         1995 was fueled by the expansion of                                                   tives maintain a liquid position.
quite as dramatic as the growth spurt                                               from the economical use of what you
                                         current assets, the growth of current
seen in 1995 (figure 1). The rate of                                                already have." In other words, the         However, higher expenses, espe
                                         assets in 1996 lagged behind growth                                                   cially for labor, continue to eat into
growth in combined assets was                                                       use of a cooperative's resources in
                                         in total assets. Current assets (com                                                  the bottom line, as illustrated in the
nearly 9 percent in 1996, down from                                                 an efficient manner should produce
                                         prised of cash, accounts receivable,                                                  slumping profitability ratios, exam
15 percent in 1995, but still is a                                                  a healthy return to members.
                                         inventory and "other" current as-
strong indicator of economic health                                                                                            ined below. While some coopera
                                                                                       This raises an interesting ques
for the nation's largest cooperatives.                                                                                         tives are positioning themselves for
                                                                                    tion. How do you determine whether
                                         Hgure i —Asset Composition, Top 100                                                   the 21st century, others may find the
   The balance sheet certainly does                                                 a cooperative is using its financial
                                                      Cooperatives, 1992-96                                                    next century will not be so favorable.
not tell all, but it does provide a                                                 resources efficiently? The first two
                                         $ million
good snapshot of the overall finan                                                  articles of this series examined the
                                         30
cial strength of the business at one                                                combined income statement and              How USDA Evaluates Co-op
point in time. The assets side of the                                               balance sheet of the nation's largest      Performance
balance sheet presents all the re                                                   agricultural cooperatives. This third        The tools USDA uses to analyze
sources that the cooperative has in                                                 and final article in the series will try   cooperative financial performance
vested. The other side indicates the                                                to interpret this data to determine        include four types of primary mea
sources from which these invested                                                   how well cooperatives are using their
                                                                                                                               surements:
funds were financed. In other words,                                                resources.
                                                                                                                                  • Liquidity, which shows the co
we see what the cooperative owns                                                       The nation's 100 largest agricul             operative's ability to meet
and who lays claim to these assets.                                                 tural cooperatives have experienced             short-term obligations.
   Total combined assets for the top                                                phenomenal growth in sales and as             • Leverage, which shows the risk
100 U.S. agricultural cooperatives                                                  sets during the past few years. How             associated with financing and
stood at $25.6 billion in 1996, a $2-                                               ever, a few cooperatives accounted              the cooperative's ability to
billion increase from 1995. The di                                                  for most of the gain. The big ques              meet its long-term and short-
versified and grain cooperative                                                     tion that needs to be examined is:              term obligations.
groups recorded the largest gains.                                                  are cooperatives putting themselves           • Activity, which shows the effi
Nearly two-thirds of the total com                                                  in a position where a downturn in               ciency with which the coopera
bined increases in total assets were                                                the economy can cause tremendous                tive uses its assets.
                                               1992    93       94   95   96
attributed to these two commodity                                                   damage?                                       • Profitability, which shows the
groups. This expansion was fueled by     Prior years restated                          As expressed throughout this se              net return on the cooperative's
higher levels of debt. Both short-                                                  ries of articles, cooperatives are ac           operations.


Summer 1998                                        Tin; Cooi'LRATivi-; Accountant   The Coopkrativi- Accountant                                        Summer 1998
64                           The ABCs of LLCs                                                                          Continued Expansion of Assets                                          33

from assigning its rights and respon      authorizing LLCs and the IRS
                                                                                              tomb i-Combined balance shoot—Top 100.1995-96
sibilities to any other entity. States    "check the box" tax rules the most
may take different attitudes toward       important developments in business
whether converting an existing busi       formation since the advent of the
                                                                                              Current Asset*
ness to an LLC is an assignment of        general      business    corporation.
                                                                                                Cosh                                       849.657        908.920      (59.063)    (6.60)
that contract to another entity, re       Whether this becomes a fact will                      Accounts Receivable                      5,716.496      5.219,664     496,632       0,52
quiring the consent of the other par-     take many years to determine. But                     Inventory                                6.413,999      6.032,713     331.286       5.45
                                                                                                Olhor Curroni Assets
tics to the agreement.                    certainly the LLC is becoming a
                                                                                                                                         I.040.4S3      1,030.300       10.153      0.93

                                                                                                   Total Current Assets                 14.020,805     13.241,597     779.208       568
    Other administrative issues may       popular vehicle for organizing busi                 Investment

arise, such as whether the time and       nesses. It will be both a tool of co                  Bank o! Cooparatives                       435.016       400.031        26.98$      6.61

money will have to be expended to         operatives and potent competition for                 Other Cooperatives                       1.475.156      1,164.458     290,698     24.54
                                                                                                Other Investments                          773.445       699,343       74.102      1060
re-title assets held by the existing      the cooperative form of doing busi                       Total Investments                     2,683.617      2.231.632     391.785      17.09
business and whether transfer taxes       ness. It offers both challenges and op              NetPP&E                                    7.638.136      6.879,190     758.946      11.03
will be due if ownership of the assets    portunities to rural residents and their            Other Assets                               1.302.491      1.185,849     106.642       892

is transferred to a new LLC.              advisers as we plan together to posi                     Total Assots                         25.645.049     23.60S.468   2.036381        &63
                                                                                             Current Ltobtimes
    Some business consultants are         tion rural businesses for a prominent                 Short-term Oebl
calling the combination of state laws     place in the 21st Century.                               Currant Portion O) Long-term Debt       893,768       406,921      491.867     120.66
                                                                                                   Banks tor Cooperatives                1.897,484      1.B48.247      51.237       2.78
                                                                                                   Commercial Banks                        728.987       626.882      102.105      16.29
                                                                                                   Notes Issued by Cooperatives            322.651       261.739       60.912     23.27
                                                                                                   Other Nonfinandal Entitles               27.047        24.394         2.653     10.68
                                                                                                   Commercial Paper                        108.699       147.767       (39.068)   (26.44)
                                                                                                   Government Sources                                     27.464
                               CORRECTION                                                                                                   44.9S1                     17,517     63.78
                                                                                                   Other Sources                             5.436          4.459         977     21.91
                                                                                                      Total Srton-term Debt
On page 64 of the article Gold Kist for Dummies in the Spring 1998 issue of                                                             4.034.073      3.345.873      688.200     20.57
                                                                                                Accounts Payatte                        3.497.859      3.176.943      320,916     1010
The Cooperative Accountant, the second line of Table 2 should have read:                        Member Payable*                           403.939        478.747       (74.808)   (15,63)
                                                                                                Patron and Pool UaWfces                  1.436,020      1.531.972      (95.052)    (6.20)
                                                                                               Other Current Uabaities                   1632.793       1 505.034
 P     $43.20      1992,     -$8         ($28 in taxes less $20 cash received)                                                                                        127.759     -&&
                                                                                                  Total Current UatxBbBS               11.005364      10.038^69       967.015      9.63
                                                                                             LOftQ. I(JJ II) DdittI
                                                                                               Bank (or Cooperatives                    2.729.007      2.445.978      283.029     11.57
                                                                                               Bond Issued by Cooperative               1.295.591      1.069.879      225,712     21.10
                                                                                               Commercial Banks                           683.878        395.416      283.462     72.95
                                                                                               Insurance Companies                        419^25         445,643      (26,418)    <5-93)
                                                                                               Industrial Development Bonds               196,760        212,641      (15,881)    (7.46)
                                                                                               Capital Lease                               57,702         54,460        3,242      5.95
                                                                                               Olher Nonfinancial EnMios                     6.4S2         6.769         (317)    (4.68)
                                                                                               Qovcrrunant Source                            1.064           930          134     14.41
                                                                                               Other Sources                              208.797        128.304       80.493,    62.74
                                                                                                  Total Long-term Debt                  5,533,496      4.760,020      838,476     17.61
                                                                                                Less Current Portion                    4.699.708      4,353.099     346,609       7.96
                                                                                             Other Liabilities and Deferred Credits       674.362       618.943        55.419      8.95
                                                                                               Totci NoncuTont Ua&iSies                 5.374. 070     4 972.042     402.028       8.09
                                                                                               Tbial Uab&IJes                          16.37fl RM     15 010 611    1.369.043      9.12.
                                                                                             Minority Interest                            227.034        187.745       39.289     20.93
                                                                                             Member Equity
                                                                                               Preferred Stock                          1.749,589      1.619,691     129,893       8.02
                                                                                               Common Slock                              600.817        568.909        31.908      561
                                                                                               Equity Certificates ond Credits          5,022.916      4,654,440     368.478       7.92
                                                                                               Unallocated Capital
                                                                                                                                        lfi6ft,P.J7    ).567.072      STfmff      _£25_
                                                                                                 Told Equity                            0,038.361      8.410.112     628.249       7.47
                                                                                                 Total Liabilities and Equity          25.645,040     23.608,468    2,036.581      8.63




Summer 1998                                      The Cooperative Accountant          The Cooperative Accountant                                                                      Summer 1998
34                          Continued Expansion of Assets                                                               The ABCs of LLCs                                 63


                                                    Accounts receivable ended the          would likely constitute a prohibited      per-Volstead association with single
Figure 2—Combined Current Assets, Top            year at $5.7 billion, a $497 million      second class of stock. This would de      tax status. The word "cooperative"
            100 Cooperatives, 1992-96            (9.5 percent) increase, the largest       prive the venture of single tax treat     never appears in Capper-Volstead.
$ billion                                        gain in current assets. This increase     ment.                                     It covers an "association" of produc
15                                               in accounts receivable was propor            The deal would also be difficult to    ers with one-member one-vote or an
                                                 tional to the increase in sales in        do as a traditional cooperative.          eight percent limit on dividends that
                                 Other
                                                 1996. Nearly half of this increase can    Donna, a non-producer, could not          does a majority of its business with
                                                 be attributed to diversified coopera      have a voting interest. Also, earnings    members.
                                                 tives with farm supply and grain co       are not being allocated on the basis
                                 Iftvoittorids   operatives accounting for most of         of use. This arrangement can be eas       Why Isn't Everyone Using LLCs?
                                                 the rest.                                 ily organized as an LLC. All that is          If the LLC has so much to offer, it
                                                    The next largest increase was in       required is a properly prepared "or       is fair to ask why every possible busi
                                                 inventories, which climbed 5.4 per        ganization agreement."                    ness isn't changing to LLC status.
                                                 cent in 1996. This increase of $331           But let's assume the three pro        There are good reasons not to rush
                                                 million boosted the total to $6.4 bil     ducers like the cooperative approach      into an LLC.
                                                 lion. However, the increase in inven      of distributing margins on the basis          • Lack of a body of law on issues
                                                 tories did not keep up with the sales     of use. They would probably be free       such as liability, governance, and
                                                 level. This could mean cooperatives       to divide their share of the earnings     member rights—While an LLC may
                                                 do not expect to sustain the higher       among themselves on the basis of          sound good in the abstract, no body
                                 Cash            sales volume in 1997 or they arc be       fruit provided while Donna got her        of administrative and judicial rulings
                                                 coming more efficient with their in       25 percent share each year (or more       exist to offer guidance when difficult
     1992    93        94   96                   ventory management. This is espe          if necessary to meet her minimum          questions concerning organization
Prior years restated                             cially true with the diversified          return requirement).                      and operation of an LLC arise.
                                                 cooperatives, which had a 25 percent         Think about your response to this      When early users of LLCs have
                                                 increase in revenues but only a .5        question; "Is this a cooperative?" If     problems, they will bear the cost of
                                                 percent increase in inventory. Dairy,     you can comfortably answer yes,           being test cases to establish the de
sets) showed a modest gain of 6 per
                                                 farm supply and grain co-ops—             then you should have little trouble       tailed rules for conducting business
cent, to $14 billion, when compared
                                                 which had the largest increase in in      envisioning how the LLC model             as an LLC.
to 1995's growth rate of 14 percent.
                                                 ventories—all had revenue increase        might contribute to solving perhaps           • Tax problems of conversion
The percent of total assets repre
                                                 as well. Cotton and rice cooperatives     the most pressing problem facing co       from the corporate form—As men
sented by current assets declined
                                                 had elevated inventory levels but the     operatives, raising adequate equity       tioned above, conversion of a corpo
from 56.1 percent in 1995 to 54.7
                                                 revenues declined, which is cause for     capital. Like transferable delivery       ration into an LLC can be a complex
percent in 1996.
                                                 concern.                                  rights, if properly structured, the       event for tax purposes. Again, as
   Most of the gains in current assets                                                     LLC can facilitate cooperative            conflicts arise between corporations
were in the form of inventory and                Investments Hit Record Highs              growth through adequate capitaliza        wanting to change and IRS, the first
accounts receivable (figure 2). Cash                Cooperatives invest in both non-       tion without subverting accepted co       to do so will run the risk of becoming
balances declined $60 million, to                cooperative and cooperative ven           operative characteristics.                embroiled in administrative pro
$850 million, by the end of 1996.                tures (table 2). Investment in non-          One last thought. If this group felt   ceedings over issues without estab
That represents a 6.5 percent drop               cooperative businesses generally          it needed the limited antitrust pro       lished precedents.
from 1995. Although dairy, fruit &               indicates investments in joint ven        tection available under the Capper-           • Other legal issues are not re
vegetable and grain cooperatives in              tures or other for-profit subsidiaries.   Volstead Act, it would have to limit      solved in all states, and may be
creased their cash position, it was              Investments in other cooperatives         voting participation to producers.        treated differently, at least in the
not enough to overcome the decline               usually indicates business done with      But it could still form as an LLC,        short run, by different states. For ex
registered by all other commodity                other cooperatives, including Co-         allocate earnings on some basis           ample, an existing business may have
groups.                                          Bank and St. Paul Bank for Coopcr-        other than use, and qualify as a Cap      entered into a contract thai forbids it


Su.mmer 1998                                            Thk Coopkrativi- Accountant        Tm CoopiiRAiivi: Accountant                                        Sl'MMFR 1998
62                           The ABCs or LLCs                                                                Continued Expansion of Assets                                  35


partnership that has been converted       and comfortable working with each
                                                                                    Table 2— Co-op investment from 1992 -1996, Top 100 agricultural cooperatives
(into an LLC) shall be deemed for         other. They are confident that if the
all purposes the same entity that ex      venture isn't successful it can be dis                               1992         93           94           95            96

isted before the conversion."             solved without undue harm to any                                                            thousands
    The IRS takes the same ap             participant. If they wish to continue
                                                                                    Bank for Cooperatives     359,448     371,913     385,986      408,031       435,016
proach. It has held that the conver       the venture beyond the time period
sion of a partnership into an LLC is      set in the articles of organization,      Oiher Cooperatives

a nontaxable event.                       they can simply amend the articles to       20 percent or less      718,439     777,004     790.618      905.681      1,109,370

    • Some corporations wilt convert      provide for a longer life.                  More than 20 percent    139,628     181,530     229.211      278,577       365.786

to LLCS. However, this is generally          The implications for new and de        Other Businesses
treated as a liquidation of the corpo     veloping cooperatives, and those            20 Percent or less       47,468      39,087      39,181      157,423       123,837
ration. Tax liability can arise; for ex   who work with them, may depend on           More than 20 percent    200,616     177,924     168,856       61,900       101,913
ample, if property held by the corpo      how they respond to this new tool.        Other Investments         393,279     388,079     566,021      480,020       547,695
ration has appreciated in value. This     The following simplified example il
will discourage some corporations         lustrates how the LLC might be used         Total Investment       1,858,878   1.935,537   2,179.873    2,291,832     2,683.617

from changing to LLC status.              to expand opportunities for local
                                          people to form businesses to help         atives. Total investment increased           tives increased 6.6 percent, to $435
Impact on Cooperative                     themselves.                               17.1 percent, to $1.9 billion, a new         million. Grain cooperatives were the
Development                                  Example—Allen, Barbara and             record that surpassed the previous           only commodity group that substan
   Even before IRS adopted the            Carl, three fruit growers, want to        mark of $1.6 billion set in 1984.            tially increased their investments in
"check the box regulations," the          start a packing and shipping busi            Cooperative investment in other           financial cooperatives. The diversi
LLC was proving a popular vehicle         ness. They need financial support         cooperatives (excluding financial co         fied and cotton cooperative groups
for established cooperatives to orga      and Donna-, a dentist in their com        operatives) increased almost 25 per          each decreased their investment
nize joint ventures with other coop       munity with no ties to farming, is        cent, to $1.5 billion. Out of a total        while the rest of the commodity
erative and non-cooperative firms.        interested in helping finance the         increase of $291 million, 70 percent         groups were close to the overall av
On the marketing side, an LLC             venture.                                  reflected an ownership level of less         erage increase.
could be used by a cooperative and a         The four of them decide to form        than 20 percent and usually repre               Investments in non-cooperative
commercial firm to develop a new          the business, each taking a 25 per        sents allocated non-cash patronage           businesses increased 10.6 percent, to
branded product. The cooperative          cent interest. However, since Donna       refunds. Diversified cooperatives            $773 million in 1996. This increase
might provide raw product to the          is putting up most of the start-up        provided the bulk of the increase            was stimulated mostly by a few di
LLC, which manufactures it into a         capital, she would like to receive the    with farm supply and grain coopera           versified, grain and sugar coopera
finished product under license from       bulk of any tax losses occurring in       tives each contributing their share.         tives, which invested in value-added
the commercial food company and           the venture's first two years and a          Investments that exceeded 20              businesses. Dairy cooperatives had a
sells it to third parties.                guaranteed annual return of 10 per        percent ownership in other cooper            50 percent drop in non-cooperative
   On the supply side, a cooperative      cent on her investment.                   atives increased 31 percent, to $87          investment due to consolidations.
could form an LLC with a chemical            Discussion—As they search for          million. When investments exceed             However, the combined amount of
company to produce fertilizer. The        the proper business structure, the        20 percent ownership, it usually rep         non-cooperative investment to total
LLC sells the fertilizer to both firms,   group might well discard a partner        resents joint ventures established to        assets has remained steady at 3 per
which then resell it to their members     ship as it doesn't provide total liabil   move more member products into               cent over the past two years.
and customers, respectively.              ity protection and a general business     the marketplace or to add value to
  The cooperatives involved in            corporation because it isn't eligible     the product. Leading the way in this         Fixed Assets Continue to Expand
these ventures aren't concerned           for single tax treatment.                 area was the dairy cooperative                  Businesses invest in fixed assets
about perpetual existence or limits          This business plan might be diffi      group, which was responsible for 80          (plant, property and equipment) in
on transferability of interests. The      cult to do as a Subchapter S corpo        percent of the total increase.               order to build for the future. Coop
LLC members are little in number          ration. Donna's ownership interest          Investment in financial coopera            eratives are no exception and have


Summer 1998                                      The Cooperative Accountant         The Cooperative Accountant                                                Summer 1998
                                                                                                                    Tin- ABCs of LLCs                               61

36                         Continued Expansion of Assets
                                                                                      tions designed to insure compliance        corporation is taxed twice, at the
                                                                                      with the old Kintner regulations. For      corporate level when earned and at
                                            Current Liabilities Push Upward
                                                                                      example, Virginia has amended its          the owner level when distributed. An
Figures—Yearly Change in Fixed Asset           Current liabilities climbed 9.6
                                                                                      law to remove the requirement that         LLC qualifies for single tax treat
            Investment, 1981-36             percent in 1996, to $11 billion, sur
                                                                                      all other members must agree before        ment; alt income and losses pass
$ million                                   passing all other liabilities. Leading
                                                                                      an interest in an LLC can be trans         through to the members. Also, mem
10                                          the increase was short-term debt,
                                                                                      ferred. Now the members arc free to        bers of an LLC need not comply
                                            which increased 21 percent to more
                                                                                      set out their own rules on transfer        with corporate formalities such as
                                            than $4 billion (figure 5). However,
                                                                                      ring interests in the articles of orga     annual meetings, keeping minutes,
                                            this does not mean cooperatives are
                                                                                      nization or the operating agreement.       and electing directors and officers.
                                            relying more on short-term borrow
                                                                                                                                      • Subchapter "S" Corporation—
                                            ing to finance their operations (fig
                                                                                      LLCs vs. Other Business Forms              Some closely held corporations are
                                            ure 6). Current portions of long-
                                                                                         The LLC gives its member-own            eligible for single tax treatment un
                                            term debt were the driving force          ers substantial flexibility in designing   der Subchapter S of the Internal
                                            behind much of this increase. With a      financial and governance structures        Revenue Code. To qualify, they


                            I.I
                                            total combined increase of short-         compared to other business forms.          must comply with restrictions on the

                  i
                                            term debt of $688 million, current        When this is combined with single          number and type of members and
                                            portions of long-term debt ac
                                                                                      tax treatment and limited liability for    can't have more than one class of


            I
                                            counted for 71 percent of this in         members, the total package is an at        stock. An LLC has no such limita
                                            crease.
                                                                                      tractive option to people forming          tions.
                                               Current portions of long-term
                                                                                      businesses. This section compares               • Cooperative—An LLC can't
                                            debt were up 121 percent from 1995        key differences between LLCs and           delay the pass-through of earnings to
                                            to $899 million in 1996. All com          other options.                             its members; there is no equivalent
     1981   83858789        91    939596    modity groups showed higher cur              • Sole proprietorship—An LLC            to "non-qualified" retains for an
                                            rent portions of long-term debt. This     offers limited liability for the owner,    LLC. But LLC members can allo
Prior years restated
                                            is due to higher fixed capital expen      protection not available to a regular      cate earnings and losses and assign
                                            ditures over the past few years. Yet,     sole proprietorship. While some            votes among themselves as they see
                                            most of the increases cannot be at        states require multiple owners to          fit.
                                            tributed to higher long-term debt.        form an LLC, they are gradually
invested       heavily in fixed    assets
                                            Eighty percent of the increase can be     amending their laws to authorize           Implications of LLCs
throughout the past two years. Dur
                                            attributed to one cooperative reclas-     one-member LLCS.                              The emergence of LLCs has in
ing this time, their total investment       sifying its debt from long- term to          • Partnership—Both a partner            teresting implications for persons in
in fixed assets is greater than in the      current debt.
                                                                                      ship and a multi-owner LLC arc gen         volved in business organization.
prior 14 years combined (figure 3).            Short-term borrowing from com          erally permitted pass-through, single         These include:
Fixed assets, which account for 30          mercial banks increased 16 percent,       tax treatment under Subchaptcr K of           Fewer new businesses will form as
percent of all assets, increased 11         to $729 million. Diversified cooper
                                                                                      the Internal Revenue Code. An LLC          partnerships or Subchapter "S" cor
percent to end 1996 at S7.6 billion.        atives rely more on commercial            provides limited personal liability for    porations. The LLC offers better li
Although more than two-thirds of            banks to fund their operations than       all members, regardless of the extent      ability protection than a partnership
the largest cooperatives invested in        other commodity groups. Yet, all the      of their involvement in managing the       and more governance flexibility than
fixed assets, a large part of this in       other commodity groups—with the           venture. In a partnership, at least        an "S" corporation.
crease can be attributed to only a          exception of grain and cotton—            one partner actively involved in              • Many existing partnerships will
few cooperatives. These few cooper          relied more on commercial banks to        managing the operation usually is          convert to LLCS. Under many state
atives were distributed throughout          fund their operations in 1996.                                                       laws, this conversion is not a signifi
                                                                                      personally liable for its obligations.
various commodity groups. As figure            Although the cooperative banks                                                    cant event. For example, Virginia
                                                                                         • General Business Corpora
4 illustrates, all commodity groups         hold 47 percent of total short-term       tion—Income of a general business          law provides "a general or limited
increased their amount of fixed as          debt ($1.9 billion), they only realized
sets.                                       an increase of $51 million. Only
                                                                                      The Cooperative Accountant                                         Summer 1998

Summer 1998                                           The Cooperative Accountant
60                           The ABCs of LLCs                                                               Continued Expansion of Assets                             37


Many people were left with the Hob-      Insurance Act or a similar federal
son's choice of incorporating to         statute.                                    Figure4-Net Property, Plant, & Equipment, by Commodity Group
achieve limited liability or forming       Any other business with two or
their business as a partnership to       more owners may choose to be taxed
qualify for single tax treatment.        as a partnership or a corporation. A
                                         single-owner business can elect to be
                                         treated as a corporation, or simply
IRS "Check the Box" Regulations
                                         disregarded as an entity separate
   A new set of tax rules frees all      from its owner. For example, a co
taxpayers from having to choose be       operative conducting an activity
tween limited liability or single tax    through a single-member LLC can
treatment. On January 1, 1997, IRS       treat the LLC as a division for tax
abandoned the Kintner regulations        purposes. All tax consequences re
and adopted a self-classification ap     lating to the LLC will be included in
proach for determining the tax status    the cooperative's tax return. A single
of unincorporated businesses. The        individual who forms an LLC is
new rules are commonly called the        taxed as a sole proprietorship unless
"check the box" regulations because      he or she chooses corporate status.
they permit most unincorporated             The new regulations provide for
businesses to choose whether to be       default classification. Firms existing
                                                                                                                   0.4      0.6       0.8             1.2     1.4    1.6
taxed as a partnership or a corpora      on January 1, 1997 are assigned the
tion. Most don't even have to do that    same classification they had under          Prior years restated                           $ billion
much. They are automatically given       prior law. Multi-owner firms orga
the status they want. (This discussion   nized on or after January 1 are as
applies only to businesses formed in     signed partnership status. Single-          grain and cotton cooperatives in             $92 million in new notes issued. Cot
the United States. The rules where a     owner businesses are presumed to            creased the amount of short-term             ton cooperatives replaced $36 mil
foreign firm is involved are more        want to be disregarded as separate          funds borrowed from the coopera              lion worth of notes with $26 million
complex and beyond the scope of          entities.                                   tive banks. Grain cooperatives,              from government sources and $9
this article.)                              If a business wants to change its        needing large amounts of working             million of commercial paper.
   The new regulations list entities     classification, it does so by filing IRS    capital to pay for their members'               Accounts payable increased $320
that have no choice but to be treated    form 8832. Once an election is made         products, increased their short-term         million (10 percent) to $3.5 billion,
as corporations for tax purposes.        to change tax status, it can't be           debt held by cooperative banks by            yet, as a percent of total sales, it
This includes businesses organized       changed again for five years without        $227 million. Short-term debt of cot         remained fairly steady at 5 percent
under a state, federal or tribal law     IRS approval. Some experts have             ton cooperatives increased $11 mil           throughout the past five years. Di
that describes or refers to them as      suggested the new rules should be           lion. All other commodity groups             versified, farm supply and, to a lesser
incorporated or a corporation. Vir       called the "don't check the box" reg        carried less short-term debt from co         extent, dairy cooperatives accounted
tually all-existing cooperatives are     ulations because, in truth, most busi       operative banks.                             for nearly the whole increase in
covered, as they are organized pur       nesses will want the status they are           Other fund sources—including              trade accounts payable.
suant to a state cooperative or gen      assigned and should do nothing. Un          commercial paper, notes issued by              On the other hand, liabilities
eral business incorporation law. Cor     less a business wants to change its clas    the   cooperative,   government              owed to members in the form of cash
porate tax status is also mandated       sification, filing a form 8832 is neither   sources, and other non- financial in         patronage and cash dividends pay
for insurance companies and a state-     necessary nor recommended.                  stitutes—increased 9 percent, to             able decreased. As mentioned in the
chartered business conducting bank          The states are responding to the         $509 million. Leading the increase           earlier article, cooperatives paid out
ing activity that has any deposits in    "check the box" rules by amending           were diversified, farm supply and            less of their earnings to members.
sured under the Federal Deposit          their LLC laws to remove restric-           fruit & vegetable cooperatives, with         This shows up in the member pay-

Summer 1998                                     The Cooperative Accountant           The Cooperative Accountant                                             Summer 1998
38                            Continued Expansion of Assets                                                                  The ABCs of LLCs                                 59


                                                                                                A Bit of History                          period of dead time in the evolution
Figure 5—Current Liabilities, Top 100             Figure 6—Sources of Short-Term Debt,              While the LLC is a relatively new     of LLCs as the other states waited
          Cooperatives, 1995-96                               Top 100,1992-96
                                                                                                form of business organization in the      for IRS to rule on the tax status of
$ billion                                         $ billion
                                                                                                United States, it has been used in        Wyoming LLCS.
                                                  4.5
12                                                                                              Europe and South America since the            Finally, in 1988, IRS decided no
                               Member Payabtes                                                  19th century. For example, the suffix     one corporate characteristic, includ
                                                                                    1 Source*
                               Other Current                                                    "GmbH" after a company name iden          ing limited liability, should be ac
10
                               Liabilities                                                      tifies a German LLC; "S.A.R.L." a         corded greater weight than the oth
                                                                                                French LLC; and "E.P.E." a Greek          ers in classifying a business for tax
                               Patron & Pool
                               liabilities                                                      LLC. In South America, an LLC is          purposes. Therefore, as with any
                                                                                                referred to as a "Limitada."              other unincorporated business, an
                                                                                                    The story of LLCs here begins in      LLC qualified for tax treatment as a
                               Accounts Payable                                                 1960 when the IRS adopted rules,          partnership if it had two or less of
                                                                                                commonly called the Kintner regu          the four corporate characteristics.
                                                                                                lations, for classifying unincorpo            This stimulated the states to enact
                                                                                                rated, multi-owner businesses for tax     so-called "bullet-proof LLC stat
                                                                                                purposes. IRS identified what it re       utes. They limited an LLC to not
                               Short Term Debt                                                  ferred to as "corporate characteris       more than two corporate character
                                                                                                tics." They were (1) continuity of        istics. For example, the Virginia law
                                                                                                life, (2) centralized management, (3)     defined an LLC as "an unincorpo
                                                                                                limited liability for owners, and (4)     rated association, without perpetual
        1995           1996                                                                     unrestricted transferability of own       duration ..." It also provided "an
                                                        1992 93   94     95   96
                                                  Prior years restated
                                                                                                ership interests. If a business had       assignee of an interest in a limited
Prior years restated
                                                                                                three or more of these traits, IRS        liability company may become a
                                                                                                considered it a corporation for tax       member only if the other members
                                                                                                purposes. If it had two or less, it was   unanimously consent."
able account, which dropped $75                   This is the first time since USDA             treated as a partnership.                     As a Virginia LLC was expressly
million (15 percent), to $404 million.            began tracking the largest agricul                This approach worked relatively       barred from having "continuity of
    Funds owed to members in the                  tural cooperatives that long-term             well for 17 years, primarily because      life" or "free transferability of inter
form of patron and pool liabilities               debt has exceeded $5 billion. As              no one attempted to create an unin        ests," it had to qualify for partner
decreased by $95 million, ending the              mentioned earlier in this article,
                                                                                                corporated business structure that        ship tax status under the Kintner
year at $1.4 billion. Although dairy              fixed assets and current portion of           provided the owners with broad lim        regulations. Therefore, its access to
and fruit & vegetable cooperatives                long-term debt have shown signifi             ited liability. This changed in 1977,     single tax treatment was "bullet
had an increase in patron and pool                cant increases throughout the past            when Wyoming enacted the first lim        proof in that it couldn't be "shot
liabilities, their $79 million increase           two years. As would be expected,              ited liability company act in the         down" by IRS agents and auditors.
was not enough to offset the drop in              this coincides with the increase in
                                                                                                United States.                               This opened the door to use of
farm supply and grain cooperatives.               long-term debt (figure 7). Businesses             The Wyoming law created a di          LLCs by sophisticated taxpayers, in
This is especially surprising given the           try to match the term structure of            lemma for IRS. It had to decide           cluding some cooperatives who de
increase in grain prices.                         debt with that of their assets.               whether limited liability was so fun      veloped LLCs with other coopera
                                                     Long-term debt less current por            damental to the concept of being a        tive and non-cooperative firms to
Long-term Debt Posts Record High                  tion increased 8 percent, to $4.7 bil         corporation that an organization          carry out joint ventures. But the pro
  Total combined long-term debt,                  lion. Figure 8 illustrates the largest        where all owners had limited liability    cess of organizing diverse rural resi
including debt currently owed,                    creditors by far continue to be coop          must always be classified as a corpo      dents into a cohesive business unit
reached a record $5.6 billion in 1996,            erative banks, which held 49 percent          ration for tax purposes. IRS studied      within the confines of the Kintner
a 17 percent increase from 1995.                  of the total long-term debt. These            the issue for 11 years. This created a    regulations was pretty daunting.


Summer 1998                                                   The Cooperative Accountant        The Cooperative Accountant                                         Summer 1998
                                                                                                                      Continued Expansion of Assets                                         39
 58


                        THE ABCs OF LLCs
                                                                                            r_ Fixed Assets and Long-Term                    —Sources of Long-Term Debt,
      LIMITED LIABILITY COMPANIES OFFER NEW OPTIONS FOR
                                                                                                  Debt, Top 100,1992-96                           Top 100,1992-96
                        RURAL BUSINESSES
                                                                                                                                      $ billion
                                                                                      $ billion
                                                                                                                                       6
   By Donald A. Frederick, Program Leader, Law, Policy & Governance                    8
                                                                                                             Fixed Assets                         Other Sources-r
               USDA Rural Business-Cooperative Service                                                                                             Capital Usw* - ^-^ _ Industrial
                                                                                                                                                                           Development Bends
                                                                                                                                                                         *- Insurance Compontes

Editor's Note: Opinions expressed in        of incorporation, with the appro
this article are those of the author.       priate state official. Member rights                                                                                         — Comjnwctcl Banta


They do not reflect official policy ofthe   and obligations are set out in an
U.S. Department of Agriculture, the         operating agreement, similar to a                                                                                            - Bond Issued by Co-op

Department of the Treasury, or any          partnership agreement or corpo
other government agency. Wlien mak          rate bylaws. The operating agree                                   Long-Term Debt
ing business and tax decisions, readers     ment covers issues such as manage
should consult a professional tax ad        ment, voting rights, allocation of
visor or tax attorney. This article is      income and losses, transfer of in                                                                                            -Bonk (or Co-ops

reprinted from the July/August 1997         terests, and withdrawal.
issue of Rural Cooperatives.
    In recent years, every state has
                                            Several key traits identify an LLC:
 enacted laws enabling businesses to
 operate in a new form known as the            An LLC is a state-approved, un
                                            incorporated association. Some                  1992      93         94         95   96
 limited liability company (LLC). Re                                                                                                       1992 93     94    95     96

 cent changes in the way the Internal       times an LLC is referred to as a          Prior years restated
                                                                                                                                      Prior years restated

 Revenue Service (IRS) treats LLCs          "limited liability corporation." This
 for tax purposes has increased their       is incorrect. The fact that it is not a
appeal. This article discusses the          corporation is crucial to its qualify                                                     bonds up $226 million from 1995.
                                                                                      cooperative-lending institutions in
characteristics of an LLC, provides         ing for single tax treatment.                                                             Like the trend for all long-term debt,
                                                                                      creased the amount of debt they
some background on their evolution,            • Owners, managers, and agents                                                         bond issues have taken off in the past
                                                                                      held by 11.6 percent, to $2.7 billion.
compares them to other ways of              are protected from personal liability                                                     two years. Diversified cooperatives
                                                                                      Cotton, grain, rice, sugar and poultry
structuring a business, and looks at        for debts and other obligations of an                                                     are by far the largest users of bonds
                                                                                      & livestock cooperatives rely on this
                                            LLC by state law.                                                                         for long-term financing. Forty- four
opportunities they offer rural resi                                                   source for the majority of their long-
dents and their cooperatives.                 • Earnings (and       losses) pass                                                      percent of their total long-term debt
                                                                                      term financing. Dairy and fruit &
                                            through to the owners for federal                                                         is in the form of bonds and notes.
                                                                                      vegetable cooperatives are shifting
                                            income tax purposes under IRS ad
What is an LLC?                                                                       away from the cooperative banks                    Commercial banks also increased
                                            ministrative rules. The Internal Rev
                                                                                      and relying more on self-financing              the amount of cooperative debt they
   The LLC js a legal structure for         enue Code doesn't contain any pro
                                                                                      through issuance of bonds and other             hold to $683 million, nearly double
organizing a business that provides         vision for LLCs that is comparable
                                                                                      long-term notes.                                the $395 million in co-op debt they
its owners with the limited liability of    to Subchapter T for cooperatives.
a traditional corporation and the sin          • Similar single tax treatment is         The next largest sources of debt             held in 1995. The largest user of
gly tax treatment of a partnership.         generally available at the state level.   financing arc bonds issued by coop              commercial banks continues to be
The owners are called members, as           Exceptions exist, so anyone inter         eratives. Although bond issues are              diversified cooperatives, which ac
in a cooperative. Under a typical           ested in forming an LLC should            only used by 27 cooperatives, they              counted for nearly half of all debt
state law, an LLC is created by             check carefully in each state where       account for 27 percent of these co              held by commercial banks. Farm
filing articles of organization, com        the LLC is subject to taxation to see     operatives' total long-term debt. Co            supply and fruit & vegetable cooper
parable to a corporation's articles         how it will be taxed.                      operatives issued $1.3 billion in              atives also rely on commercial banks


Summer 1998                                        The Cooperative Accountant         The Cooperative Accountant                                                             Summi-r 1998
40                     Continuhd Expansion of Assets                                                          Utility Cooeprativk hikum



                                          However, there is a negative side to      should be taken in order to minimize      • Record retention policies
for part of their long- term financial
                                          this increase. Over the past three        any unclaimed property liability:           should be reviewed to deter
strategy.
   Other sources of debt (such as         years, the growth in member equity           • Your company should attempt            mine whether you have ade
insurance companies, government           has not kept pace with the growth in           to gain as much knowledge as           quate documentation to sub
                                          assets. As cooperatives become                 possible on the unclaimed              stantiate the reporting versus
sources, leases, industrial develop
                                          more leveraged, a downturn in the              property area of law, because          non-reporting of property to a
ment bonds, etc.) increased 5 per
                                          agricultural economy could provide             the more you are aware of the          particular state.
cent, to $890 million. Diversified and
farm supply cooperatives accounted        disastrous consequences. This will             potential issues and defenses,
                                                                                                                              • Professional assistance from «>
for 65 percent of these other sources     be especially true as the agricultural         the better potential for a satis       knowledgeable consultant may
of long-term debt.                        sector becomes more market ori                 factory audit conclusion.              be extremely helpful when
   The total combined liabilities for     ented with less government involve           • Each industry has specific is           dealing with a state or third
the largest agricultural cooperatives     ment.                                          sues that they must deal with in
                                                                                                                                 party auditor.
increased $1.4 billion, or 9.1 percent,      Preferred stock may represent in            order to ensure compliance; fa
to $16.4 billion. The bulk of the in      vestments by employees and the                 miliarize your company with
crease came from long-term debt in        general public as well as members.             the issues in its industry. For    Conclusion
cluding its current portion. While a      In other instances, retained patron            example, you can contact your
                                                                                                                               Unclaimed property audits may
few cooperatives used a wide variety      age refunds and per-unit retains are           industry association and deter     not always be avoidable, but the pain
of financing long-term, most cooper       classified as preferred stock. What            mine if similar businesses have    can be kept to a minimum if a com
atives used a single source for most      ever the reason, the combined value            experienced unclaimed prop         pany is prepared. As in other areas
of their funding.                         of preferred stock increased $129              erty audits. Then contact these    where strict compliance is expected,
                                          million, or 8 percent, to $1.7 billion         businesses to determine their      good recordkeeping is a must. If you
                                          in 1996.                                       treatment of unclaimed prop        have specific questions about your
Minority Interest                                                                        erty issues.
                                             Most of the increases were due to                                              filing or other compliance require
   When an outside investor has a                                                      • The laws of your state should
                                          reclassifications of written notices of                                           ments, seek the advice of a qualified
stake in a consolidated subsidiary of                                                    be carefully reviewed in order
                                          allocation to preferred stock, not                                                advisor early. Don't wait until the
a cooperative, those investors are                                                       to ensure that your company is
                                          due to investments from outside the                                               auditor is at the door. Remember
said to hold a minority interest in the                                                  aware of what constitutes un
                                          cooperative community. Farm sup                                                   the Scout motto, and "Be Prepared-
subsidiary. The amount of minority                                                        claimed property.
                                          plies cooperatives issued 75 percent
interest held in cooperatives subsid                                                   • Records should be reviewed to         Editor's note: Trish Barganier, a
                                          of the total outstanding preferred
iaries increased by 21 percent in                                                        determine if there are potential   graduate of Georgia State University
                                          stock.
1996, to $227 million. This is the
                                             Although there are a few cooper             categories of unclaimed prop       is a tax manager in the Atlanta op
highest amount since 1992, when the
                                          atives that use common stock as no             erty that have not been re         of Arthur Andersen, LLP where site
amount of minority interest first
                                          tices of allocation, it is generally is        ported.
                                                                                                                            specializes in nwltistate planning »v»»
reached $200 million. However, 80
                                          sued for voting rights. The difference       • If your company is not in com      an emphasis in escheat law- She ts
ercent of the increase was due to                                                        pliance, you should consider       popular author and speaker 0?*
                                          between common stock in lOFs and
acquisitions by one cooperative that                                                     preparing a voluntary compli       subject of unclaimed property a*1"-
                                          cooperatives is that cooperatives will
previously did not have a history of                                                                                        cheat issues.
                                          only issue one share of voting stock            ance report.
having minority interest.
                                          per member, where investors in
                                          lOFs can own many shares of voting
Member Equity                             stock.
  One of the more positive aspects           Common stock represents less
of studying the largest agricultural      then 7 percent of total equity out
cooperatives is that combined mem         standing. In 1996, common stock in
bers' equity set record amounts in        creased 6 percent, to $001 million.
each year but one, 1992 (figure 9).        Most of this increase was due to di-


                                                  Tut Cooi'ukativl Accountant        Tm: Coopi-rativi- Accountant
Summer 1998
58                                                                                                                    Continued Expansion of Asstrrc                                        39


                       THE ABCs OF LLCs
     LIMITED LIABILITY COMPANIES OFFER NEW OPTIONS FOR                                Figure 7—Fixed Assets and Long-Term             Figure 8—Sources of Long-Term Debt,
                       RURAL BUSINESSES                                                            Debt, Top 100,1992-96                          Top 100,1992-96
                                                                                      $ billion                                       $ billion

     By Donald A. Frederick, Program Leader, Law, Policy & Governance                  8                                               6

                 USDA Rural Business-Cooperative Service                                                     Fixed Assets                         Other Source*-
                                                                                                                                                   Capttal Uoh -f—\ _ Industrial
                                                                                                                                                                          DovofopmOtt
                                                                                                                                                                        *■ bttuTonco Compsntes
Editor's Note: Opinions expressed in        of incorporation, with the appro
this article are those of the author.       priate state official. Member rights
They do not reflect official policy ofthe   and obligations are set out in an
U.S. Department of Agriculture, the         operating agreement, similar to a
                                                                                                                                                                          Bond Issued by Co-op
Department of the Treasury, or any          partnership agreement or corpo
other government agency. Wlxen mak          rate bylaws. The operating agree
                                                                                                               Long-Term Debt
ing business and tax decisions, readers     ment covers issues such as manage
should consult a professional tax ad        ment, voting rights, allocation of
visor or tax attorney. This article is      income and losses, transfer of in
                                                                                                                                                                        - Bank lor Co-opo
reprinted from the July/August 1997         terests, and withdrawal.
issue of Rural Cooperatives.
    In recent years, every state has
                                            Several key traits identify an LLC:
enacted laws enabling businesses to
operate in a new form known as the              An LLC is a state-approved, un
limited liability company (LLC). Re         incorporated association. Some                  1992      93         94         96   96
                                                                                                                                           1992 93     94    95    96
cent changes in the way the Internal        times an LLC is referred to as a                                                          Prior years restated
                                                                                      Prior years restated
Revenue Service (IRS) treats LLCs           "limited liability corporation." This
for tax purposes has increased their        is incorrect. The fact that it is not a
appeal. This article discusses the          corporation is crucial to its qualify
                                                                                      cooperative-lending institutions in             bonds up $226 million from 1995.
characteristics of an LLC, provides         ing for single tax treatment.
                                                                                      creased the amount of debt they                 Like the trend for all long-term debt,
some background on their evolution,            • Owners, managers, and agents
                                                                                      held by 11.6 percent, to $2.7 billion.          bond issues have taken off in the past
compares them to other ways of              are protected from personal liability
                                                                                      Cotton, grain, rice, sugar and poultry          two years. Diversified cooperatives
structuring a business, and looks at        for debts and other obligations of an
                                                                                      & livestock cooperatives rely on this           are by far the largest users of bonds
opportunities they offer rural resi         LLC by state law.
                                                                                      source for the majority of their long-          for long-term financing. Forty- four
dents and their cooperatives.                  • Earnings (and losses) pass
                                                                                      term financing. Dairy and fruit &               percent of their total long-term debt
                                            through to the owners for federal
                                                                                      vegetable cooperatives are shifting             is in the form of bonds and notes.
                                            income tax purposes under IRS ad
What is an LLC?                             ministrative rules. The Internal Rev      away from the cooperative banks                    Commercial banks also increased
    The LLC is a legal structure for        enue Code doesn't contain any pro         and relying more on self-financing              the amount of cooperative debt they
organizing a business that provides         vision for LLCs that is comparable        through issuance of bonds and other             hold to $683 million, nearly double
                                            to Subchapter T for cooperatives.         long-term notes.
its owners with the limited liability of                                                                                              the $395 million in co-op debt they
a traditional corporation and the sin          • Similar single tax treatment is         The next largest sources of debt             held in 1995. The largest user of
gle tax treatment of a partnership.         generally available at the state level.   financing are bonds issued by coop              commercial banks continues to be
The owners are called members, as           Exceptions exist, so anyone inter         eratives. Although bond issues are              diversified cooperatives, which ac
in a cooperative. Under a typical           ested in forming an LLC should            only used by 27 cooperatives, they              counted for nearly half of all debt
state law, an LLC is created by             check carefully in each state where       account for 27 percent of these co              held by commercial banks. Farm
filing articles of organization, com        the LLC is subject to taxation to see     operatives' total long-term debt. Co            supply and fruit & vegetable cooper
parable to a corporation's articles         how it will be taxed.                     operatives issued $1.3 billion in               atives also rely on commercial banks


Summer 1998                                        The Cooperative Accountant         The Cooperative Accountant                                                          Summer 1998
40                      Continued Expansion of Assfts                                                       Utility Cooeprative Forum                           57


for part of their long- term financial    However, there is a negative side to      should be taken in order to minimize       • Record retention policies
strategy.                                 this increase. Over the past three        any unclaimed property liability:            should be reviewed to deter
   Other sources of debt (such as         years, the growth in member equity           • Your company should attempt             mine whether you have ade
insurance companies, government           has not kept pace with the growth in           to gain as much knowledge as            quate documentation to sub
sources, leases, industrial develop       assets.As cooperatives become                 possible on the unclaimed                stantiate the reporting versus
ment bonds, etc.) increased 5 per         more leveraged, a downturn in the             property area of law, because            non-reporting of property to a
cent, to $890 million. Diversified and    agricultural economy could provide            the more you are aware of the            particular state.
farm supply cooperatives accounted        disastrous consequences. This will            potential issues and defenses,
for 65 percent of these other sources     be especially true as the agricultural                                               • Professional assistance from a
                                                                                        the better potential for a satis
of long-term debt.                        sector becomes more market ori                                                         knowledgeable consultant may
                                                                                        factory audit conclusion.
   The total combined liabilities for     ented with less government involve                                                     be extremely helpful when
                                                                                      • Each industry has specific is
the largest agricultural cooperatives     ment.
                                                                                                                                 dealing with a state or third
                                                                                         sues that they must deal with in
increased $1.4 billion, or 9.1 percent,      Preferred stock may represent in                                                    party auditor.
                                                                                         order to ensure compliance; fa
to $16.4 billion. The bulk of the in      vestments by employees and the                 miliarize your company with
crease came from long-term debt in        general public as well as members.             the issues in its industry. For    Conclusion
cluding its current portion. While a      In other instances, retained patron            example, you can contact your
few cooperatives used a wide variety      age refunds and per-unit retains are                                                 Unclaimed property audits may
                                                                                         industry association and deter
of financing long-term, most cooper       classified as preferred stock. What                                               not always be avoidable, but the pain
                                                                                        mine if similar businesses have
atives used a single source for most                                                                                        can be kept to a minimum if a com
                                          ever the reason, the combined value           experienced unclaimed prop
of their funding.                                                                                                           pany is prepared. As in other areas
                                          of preferred stock increased $129             erty audits. Then contact these
                                                                                                                            where strict compliance is expected,
                                          million, or 8 percent, to $1.7 billion        businesses to determine their
                                          in 1996.                                                                          good recordkeeping is a must. If you
Minority Interest
                                                                                        treatment of unclaimed prop
                                                                                                                            have specific questions about your
                                             Most of the increases were due to          erty issues.
   When an outside investor has a                                                                                           filing or other compliance require
                                          reclassifications of written notices of     • The laws of your state should
stake in a consolidated subsidiary of                                                                                       ments, seek the advice of a qualified
                                          allocation to preferred stock, not            be carefully reviewed in order
a cooperative, those investors are                                                                                          advisor early. Don't wait until the
                                          due to investments from outside the           to ensure that your company is
said to hold a minority interest in the                                                                                     auditor is at the door. Remember
                                          cooperative community. Farm sup               aware of what constitutes un
subsidiary. The amount of minority                                                                                          the Scout motto, and "Be Prepared."
                                          plies cooperatives issued 75 percent          claimed property.
interest held in cooperatives subsid
                                          of the total outstanding preferred          • Records should be reviewed to          Editor's note: Trisk Barganier, a
iaries increased by 21 percent in
                                          stock.                                        determine if there are potential    graduate of Georgia State University,
1996, to $227 million. This is the
                                             Although there are a few cooper            categories of unclaimed prop        is a tax manager in the Atlanta office
highest amount since 1992, when the
                                          atives that use common stock as no            erty that have not been re          of Arthur Andersen, LLP where she
amount of minority interest first
                                          tices of allocation, it is generally is       ported.                             specializes in multistate planning with
reached $200 million. However, 80
                                          sued for voting rights. The difference      • If your company is not in com       an emphasis in escheat law. She is a
ercent of the increase was due to
                                          between common stock in IOFs and              pliance, you should consider        popular author and speaker on the
acquisitions by one cooperative that
previously did not have a history of
                                          cooperatives is that cooperatives will        preparing a voluntary compli        subject of unclaimed property and es
                                          only issue one share of voting stock           ance report.                       cheat issues.
having minority interest.
                                          per member, where investors in
                                          IOFs can own many shares of voting
Member Equity                             stock.
   One of the more positive aspects          Common stock represents less
of studying the largest agricultural      then 7 percent of total equity out
cooperatives is that combined mem         standing. In 1996, common stock in
bers' equity set record amounts in        creased 6 percent, to $601 million.
each year but one, 1992 (figure 9).       Most of this increase was due to di-

Summer 1998                                       The Cooperative Accountant        The Cooperative Accountant                                       Summer 1998
56                           Utility Cookhrativi- Fokum                                                         Continued Expansion of Asslts                                41


mally requested during an un                   accounting estimate; (2) sensitivity
claimed property audit. Examples of            to variation; (3) deviations from his     Figure9-Growth in Equity, Top 100,1992-96
records requested during an un                 torical patterns; and (4) subjectivity
                                                                                         $ billion
claimed property audit include the             and susceptibility to misstatement          10                                 .


company's chart of accounts, general           and bias. " While these are the cri
ledger or trial balance, annual re             teria for financial statement audits,                                                                          Unallocated
port, journal entries, bank reconcili          they arc indicative of what the ac                                                                             Capita]
ations, organizational chart, ac               counting profession believes arc sug
counting policies or procedures                gested factors to use in reaching a
manual, customer deposits records,             reasonable estimate for an un
and capital credits analyses. It is also       claimed property audit.
important to ensure the sufficiency                                                                                                                           Equity
of existing information that is used                                                                                                                          Certificates
                                               Audit Periods                                                                                                  & Credits
to identify the last known address of
the rightful owner.                               Depending upon the state, un
                                               claimed property audit periods may
   In the absence of holder records
                                               range from 10 years to more than 20
quantifying the amount of un
                                               years. The Uniform Unclaimed                                                                                  * Common Stock
claimed property, auditors typically
                                               Property Acts of 1981 and 1995 set
are authorized by state law to make                                                                                                                           Preferred Stock
                                               forth a ten-year statute of limitations
reasonable estimates of the amount
                                               for holders that "either specifically
of unclaimed property. In many sit
                                               reported the property to the Admin                    1992
uations, auditors arc entitled to use
                                               istrator or gave express notice to the
any reasonable method of estima
                                                Administrator of a dispute regarding
tion based on records that quantified
                                                the property".4                          versified cooperatives, which used          only commodity group to realize a
the unclaimed property of the
                                                   Conversely, the earlier versions of   common stock for payment of pa              decrease in the amount of equity
holder in a prior audit period.1
                                                the Uniform Unclaimed Property           tronage refunds to patrons who do           certificates.
   While there is no body of law that           Act (1954 and 1966) do not have a        not meet membership criteria.                  Unallocated equity is generally
determines what is a reasonable and             statute of limitations.                     Equity certificates and credits are      income from non-member business
valid method of extrapolation or es                                                      the largest segment of allocated eq         and other income on which the co
timation for unclaimed property au                                                       uity and represent more than 50 per         operative has paid taxes. It is typi
                                                How to Respond to an Audit
dits, the techniques employed must                                                       cent of total equity outstanding.           cally used as a reserve to offset losses
not be arbitrary and must provide a                The best way to deal with an un
                                                                                         Combined cooperative certificates           incurred. In 1996, unallocated equity
reasonable snapshot of the amount               claimed property audit is to prepare
                                                                                         and credits surpassed S5 billion for        was up 6 percent, to S1.7 billion.
of unclaimed property in existence.             ahead of time. Adequate prepara
                                                                                         the first time in 1996. Although cash       This represents 18 percent of total
Some guidance can also be obtained              tion includes keeping good records
                                                                                         patronage refunds were lower this           equity outstanding.
from the principles of the accounting          and filing annual unclaimed prop
                                                                                         year, a higher percentage of net mar           With the exception of grain and
profession. AU Section 342.09 of the           erty reports. Almost all companies        gins were in the form of non-cash           fruit & vegetable cooperatives, all
AICPA's Professional Standards                 will be subject to an aggressive un       patronage.                                  cooperative commodity groups in
states that "an auditor is required to         claimed property audit at some point         In 1995, a total of 44 percent of        creased the amount of their unallo
consider the following factors in do           in lime. In the event your business is    allocated equity was in the form of         cated equity. Fruit & vegetable co
ing an estimate: (1) significance to           targeted, the following precautions       equity certificates. By 1996, that per      operatives took the largest hit,
                                                                                         centage was up to 51 percent. Fruit         writing off more than $18 million
                                                                                         & vegetable cooperatives were the           from unallocated equity.
-' Uniform Unclaimed Property Act (1995), Section 2()(f).
4 Uniform Unclaimed Property Act (I9SI. J995)


Summer 1998                                             The CoorcRATtvi- Accountant      Tnii Cooperative Accountant                                          Summer 1998
42
                                                                                                                                                                      55

        COBANK, ACB—NEW CAPITAL MARKETS PRODUCTS

                By Mary E. McBride, Senior Vice President


   Today, CoBank's customers re          combined with syndicated bank debt                                            GUEST WRITER
quire varied and sophisticated finan     revolvers and term loans, are avail
cial services to successfully compete    able for both investment and sub-                                           Patricia F. Bargainer
in their markets. Globalization of       investment grade borrowers and                                             Arthur Andersen, LLP
markets, declining government sup        may be either secured or unsecured.                                             Atlanta, GA
port for agriculture, the impact of      Tenors for private placements typi
genetic engineering and information      cally range from two to thirty years.
technology and increasing expecta        While most private placement debt
tions of consumers have contributed      transactions have fixed interest rates,
to a higher-risk, fiercely competitive   floating rate structures are also
business environment for agricul         available. Private placements may
tural cooperatives. Increased com        also be combined with interest rate       function. However, although un                filed. The U.S. Supreme Court has
petition, changing technology and        derivatives to provide a tailored         claimed property is not a tax, the            provided guidance toward the reso
ongoing and impending deregula           hedge to meet risk management             skill set necessary to document an            lution of conflicting claims and the
tion will continue to challenge rural    goals. Transaction sizes range from       annual filing responsibility and pre          prioritization of property remit
utility customers. In 1997, we part      $5 million to $500 million, with most     pare for an audit defense usually re          tances to the states. In Texas v. New
nered with several financial institu     transactions in the $10 million to        sides within the tax department.              Jersey, the Supreme Court laid out
tions to broaden our menu of prod        $150 million range.                       Many companies have found it nec              priority rules to determine which
ucts and services to help our                                                      essary to assign a specific employee          state can claim the right to the prop
                                            Placements are generally avail
customers succeed in these rapidly                                                 to be responsible for unclaimed               erty left unclaimed by creditors.
                                         able under a Master Note Agree
changing and increasingly competi                                                  property filings, especially in light of      First, unclaimed property belongs to
                                         ment that allows for subsequent is
tive times. We now offer private                                                   the potential fines, penalties, and the       the creditor (person to whom the
                                         suances of notes under the original
placements, asset securitization, tax-                                             changing nature of the state laws             payment is due) and is payable to the
                                         document. With this document addi
exempt bonds, and mezzanine and                                                    governing unclaimed property. For             state of the creditor's last known ad
                                         tional notes can be issued at a much
equity products.                                                                   example, Georgia penalties for non-           dress as shown on the records of the
                                         lower cost and in a shorter time
                                                                                   compliance or failure to file can be          debtor (the paying business). If the
                                         frame than with a new placement.
                                                                                   gin at $100 per day and rise to a             debtor's records do not show an ad
Private Placement Investment             Terms and conditions, other than
                                                                                   maximum of $5,000 per year.1                  dress, or if the state of the creditor's
Banking                                  tenor and price, arc established in
                                                                                                                                 last known address does not require
   Senior debt, subordinated debt,       the Master Note Agreement and                Penalties can be avoided by en
                                                                                                                                 such property be turned over to the
144a transactions, preferred stock,      govern the subsequent series notes.       suring that an annual report is prop
                                                                                                                                 state, then the state of incorporation
common stock, convertible debt,             Financial covenants arc generally      erly filed with the appropriate juris
                                                                                                                                 could take custody of the property.2
synthetic and leveraged leases and                                                 diction. In cases where the business
                                         less restrictive on both a quantitative
asset backed securities are all avail                                              making a payment and the party to
                                         and a qualitative basis than those in
able through the private placement                                                 whom the payment is due are lo                The Audit Process
                                         the senior bank debt facilities. The
market. These instruments can be                                                   cated in different states, issues arise          In order to further ensure compli
                                         Master Note Agreement will usually
used to fund fixed asset expansion,                                                as to the proper jurisdiction in which        ance, it is important to be aware of
                                         include a cross-acceleration provi
replace permanent working capital,                                                 the annual filing report should be            the types of records that are nor-
                                         sion as opposed to a cross-default
refinance existing indebtedness and      clause. If a company violates a bank
fund acquisitions.                       covenant, yet remains in compliance       Official Code of Georgia Annotated Section 44-12-227(a)
   Private placements are easily         with the private placement cove-          2 Texas v. New Jersey, 379 U.S. 674 (1965).


Summlr 1998                                     Tnii Cooperative Accountant        The Cooperative Accountant                                             Summer 1998
54                                                                                                 CoBank, ABC—New Capital Markets Products                     43


                                                                                    nants, the company will only need to          a variety of balance sheet struc
                                                                                    negotiate an amendment or waiver              tures.

     UTILITY COOPERATIVE                                                            with its banks and not the institu          • Diversity of lenders and inves
                                                                                                                                  tors, allowing more flexibility
                                                                                    tional lenders.
            FORUM                                                                      Investors include insurance com            for funding future growth.
                                                                                    panies, pension funds, mutual funds,        • Transactions can frequently be
                            GENERAL EDITOR
                                                                                    endowments, venture capital funds,            arranged to be structurally sub
                            David A. Cummings
                                                                                    leveraged buy-out funds, leasing              ordinate to senior bank debt.
                    Old Dominion Electric Cooperative
                                                                                    companies and finance companies.            • Documentation is often orga
                            4201 Dominion Blvd.                                     The private placement market is               nized under a master note
                           Glen Allen, VA 23060                                     broad and deep, offering competitive          structure that allows subse
                               (804) 747-0592                                       rates, terms and conditions.                  quent tranches of future debt
                                                                                                                                  to be added with minimal time
                                                                                                                                  and expense.
                                                                                    The Process
                                                                                       CoBank and its partner, SPP           Alliance Partner
DEALING WITH ESCHEAT LAWS                Rico) has an area of law devoted to
                                                                                    Hambro, structure the terms of the          Established in 1989, SPP Hambro
                                         unclaimed property, many for profit
   State governments continue to                                                    transaction and SPP Hambro mar           is a private international banking
                                         and non-profit entities are unaware of
search for new sources of revenue;                                                  kets the transaction to its investor     firm dedicated exclusively to the pri
                                         their filing and remittance obligations.
as a result, many states have in                                                    group with CoBank's assistance. The      vate placement market. The New
                                         Most businesses possess some type of
creased the amount and frequency                                                    borrower provides information simi       York-based group has completed
                                         unclaimed property—in the form of
of unclaimed property audits. States                                                lar to that submitted to its senior      more than 300 financings totaling
                                         uncashed vendor checks, uncashed
are able to increase the frequency of                                               debt bank lenders and answers ques       more than $8 billion and is consid
                                         payroll checks, customer credit bal
such audits through the use of third                                                tions posed from potential investors.    ered one of the most prolific sources
                                         ances, dividends, checks, stock certifi
party contractors, who can audit on                                                 SPP Hambro arranges the documen          of deal flow in today's market. SPP
                                         cates, etc.—arising simply in the nor
behalf of many states simulta                                                       tation and assists with the closing of   Hambro maintains active relation
                                         mal course of operations. Health care
neously. The ability of states to in                                                the transaction.                         ships with more than 500 institu
                                         institutions may have patient credit
crease the frequency of unclaimed                                                                                            tional investors that provide the firm
                                         balances. Financial institutions have
property audits has also been made                                                                                           with up-to-the-minute market intel
                                         safe deposit accounts as well as dor       The Benefits
easier due to the States National Au                                                                                         ligence for locating pockets of at
                                         mant accounts. Utility cooperatives           Private placements offer a num
dit Program ("SNAP"). SNAP al                                                                                                tractive capital and maximizing dis
                                         could have uncashed patronage re           ber of benefits:
lows one state to audit a target on                                                                                          tribution capability. The firm
                                         fund checks, customer deposits or ad          • Broader access to capital mar
behalf of many states simulta                                                                                                provides customers with the greatest
                                         vance payments. Other potential cat              kets, which can lead to a wider
neously. In addition, several states                                                                                         collection of experience, technology
                                         egories of intangible property that              range of funding options.
have increased the amount and fre                                                                                            and resources available in the pri
                                         may be presumed abandoned include             • Efficient market pricing and
quency of unclaimed property audits                                                                                          vate placement market. (Please also
                                         security deposits, uncashed refund              flexible loan structures. Private
through the use of their own ex                                                                                              see the section on Agricultural Co
                                         checks, unused gift certificates, bond          placements typically have
panded audit staff. As a result of the                                                                                       operative Mezzanine and Equity In
                                         interest, unidentified remittances, ex          fewer covenants than bank se
states' heightened awareness with                                                                                            vestments for information about Co-
                                         pense checks, pension checks, mineral           nior debt.
regard to unclaimed property law, it                                                                                         Bank's equity and mezzanine
                                         proceeds, royalties and so forth.            • Quick execution. Transactions
is important to ensure your company                                                                                          program specifically targeted to ag
                                                                                        can usually be closed in six to
is in compliance.                                                                                                            ricultural cooperatives.)
                                         Compliance                                     ten weeks, depending on size
What is Unclaimed Property?                 Generally, the records to deter             and complexity.                      Asset Securitizatinn
  While every state in the U.S. (as      mine unclaimed property exposure             • Easily combined with bank               Asset securitization is the process
well as Washington, D.C. and Puerto      usually reside within the accounting           debt and syndications to create      of separating certain assets from a


Summer 1998                                     The Cooperative Accountant          The Cooperative Accountant                                       Summer 1998
44             CoBank, ABC—New Capital Markets Products                                                                    TAXFAX                                   53

company's balance sheet and using             ple of historical losses, dilution, fees,   consider processing for purposes of     the IRS of exempt status to a coop
those assets as collateral for the is         and yield.                                  Section 521.                            erative which intended to process its
suance of securities. Securities are             Pricing for a securitization varies         The denial of exempt cooperative     members' corn by feeding it to hogs.
typically rated, priced and sold on           based on the size and complexity of         status to the above cooperative is
the quality of the underlying assets.         the transaction but generally the fol       similar to another reported denial by                      Edward L. Hahn
Credit enhancement in the form of             lowing components are included:
over-collateralization, guarantees or            • Rating Agency Fees
letters of credit is typically provided          • Structuring Fees
to increase credit quality and lower             • Legal Fees
funding costs. Assets are sold to a              • Liquidity Fees
third party entity or "conduit" that             • Credit Premium Administra
issues securities—either commercial                 tion/Servicing Fees '
paper or medium term notes. Re
payment of the securities is directly         The Process
tied to the cash flows from the as
                                                 CoBank and its partner, MBIA
sets.
                                              Structured Finance, structure the
   Relatively predictable and uni             transaction beginning with a thor
form assets are the most easy and             ough analysis of the assets to be se-
cost-efficient to securitize. These in        curittzed. MBIA issues the securi
clude loans, leases, and accounts re          ties, provides credit enhancement
ceivable. A diversity of underlying           and arranges for the servicer and li
obligors is required, with concentra          quidity lines. CoBank's roles, in ad
tion in any one obligor usually set at        dition to that of structurer, may also
a maximum of 3-5%. In general, a              include servicer or back-up servicer,
minimum program size of $25 mil               liquidity line agent and/or partici
lion is needed, but for certain assets        pant, collateral agent, and credit en
and structures it may be possible to          hancement provider through letters
pool smaller programs and assets.             of credit.
Asset classes are broadening and se-
curitization programs for a number
of agricultural commodities are un            The Benefits
der development.                                  Benefits include:
   Advance rates or over-collateral               • A lower cost of funding, de
ization requirements are based on                   pending on asset class securi
the quality of the portfolio, the class             tized, complexity of structure,
of asset being securitized, and the                 and financial profile of origi
portfolio history. Significant over-                nating company.
collateralization may be required to              • Broader access to capital mar
compensate for a perceived weak                     kets, which can lead to a wider
ness in any variable. Reserves may                  range of funding options.
be established (or borrowing base or              • Off-balance sheet financing.
advance rates adjusted) for a multi               • Diversity of lenders and inves-


1 Fee categories may be combined or eliminated.


Summer 1998                                           The Cooplrative Accountant          The Cooperative Accountant                                     Summer 1998
52                               TAXFAX                                                         CoBank, ABC—New Capital Markets Products                        45


have caused confusion among IRS          ucts of their members, qualified as          tors, allowing more flexibility            products such as whey, meal,
field agents thus prompting the issu     exempt farmers cooperatives under            for funding future growth.                 pulp, hulls and animal wastes,
ance of the current IRS Legal Mem        Section 521.                               • Elimination or reduction in                as well as sewer pretreatment
orandum.                                    The cooperative then (unsuccess            credit risk on securitized assets.        facilities.
  James P. Murphy                        fully) cited Rev. Rul. 75-5, 1975-1        • Asset/liability management and
                                                                                                                               The issuer of the bonds is typi
                                         C.B. 166, in which the IRS ruled that        enhancement of financial ra
                                                                                                                            cally an authorized political subdivi
                                         a farmers' cooperative formed to              tios.
     DISPUTED DENIAL OF                                                                                                     sion that essentially tends its name
                                         produce and market range grasses
     SECTION 521 STATUS                                                                                                     to the project. Bonds are tax-ex
                                         by grazing its own herd of breeder       Alliance Partner
                                                                                                                            empt, variable rate with a weekly
    The IRS has had a long-standing      cattle qualifies for an exemption as a      CoBank's alliance      partner is
                                                                                                                            rate re-set and are supported by a
position of allowing Section 521 co      farmers, fruit growers, or like asso     MBIA Insurance Corporation's
                                                                                                                            CoBank letter of credit. Rates are
operatives to process, manufacture,      ciation within the meaning of Sec        Structured Finance Division, which
                                                                                                                            capped, with a current limit of 10%.
or otherwise change the basic form       tion 521. In this Revenue Ruling, the    has significant stature within the as
                                                                                                                            A typical transaction will range in
of their members' products without       cooperative maintained a small           set-backed securities market. Its pri
                                                                                                                            size from $1 Million to $50 million.
jeopardizing the cooperatives' ex        breeder herd throughout the year to      mary business is providing credit en
                                                                                                                            Maturities generally range between
empt status under Section 521.           harvest the grasses by means of graz     hancements        which      support
                                                                                                                            ten and twenty years.
    However, recently, a group of        ing cattle on the land of its members.   structured financing and asset-
Minnesota soybean processors filed       Any calves resulting from the oper       backed securities. MBIA provides             Any project, whether environ
an Application for Recognition of        ations were immediately sold by the      access to commercial paper funding        mental or industrial, must conform
Exemption Under Section 521              cooperative, and the proceeds were       through two third-party commercial        to the following criteria:
(Form 1028) which was denied. The        distributed to the members on the        paper conduits. The two conduits
                                                                                                                               • The project must be for future
cooperative planned on processing        basis of patronage. The IRS con          hold a total of more than $3 billion
                                                                                                                                 facilities—for land, equipment,
its members' soybeans by feeding the     tended that a "close reading" of Rev.    in commitments. Each is enhanced
                                                                                                                                 buildings and other structures,
soybeans to fish and marketing the       Rul. 75-5 demonstrates that the co       by MBIA's guarantee. Moody's,
                                                                                                                                 which are to be built or ac
fish.                                    operative in that ruling only realized   Standard and Poor's, Duff and
                                                                                                                                 quired.
    The IRS contended that the co        a small portion of its earnings from     Phelps, and Nippon Investors rating
operative was not processing or          the small breeder herd it maintained     services rate MBIA's claim paying           • The facilities must be capital
changing the basic form of the soy       throughout the year to harvest the       ability AAA.                                  assets. Expense items such as
beans. The IRS apparently believed       grasses and the vast majority of the                                                   operations and maintenance
that the cooperative was primarily       income received by that cooperative      Tax-Exempt Bonds                              do not qualify, although engi
engaged in the raising of fish, as dis   arose from contracts with cattle rais       Tax-exempt bonds have long been            neering; design and architec
tinguished from marketing the prod       ers who arranged for their cattle to     used to fund development and infra            tural costs may be included.
ucts (soybeans) of the members.          graze on the land. Interestingly, no     structure projects. In conjunction
    The cooperative argued, unsuc        where in Rev. Rul. 75-5 does the         with its partner, CoBank offers fund
                                                                                                                            The Process
cessfully, that Rev. Rul. 77-384,        IRS address the relative proportions     ing for two types of projects:
1977-2 C.B. 198 and Rev. Rul. 81-96,     of income received by the coopera           • Manufacturing and processing             CoBank's bond financing partner,
1981-1 C.B. 359 were "on point,"         tive from its own breeder herd ver            facilities funded by industrial      First Commerce Capital, determines
and that the IRS was too narrowly        sus the rent payments.                        revenue bonds.                       if the project is eligible and which of
defining the terms "processing" and         Although not necessarily part of        • Capital expenditures associ           the equipment-related costs and ex
"changing the basic form." Rev. Rul.     the reason for its denial of the ex          ated with processing agricul          penses qualify for tax-exempt financ
77-384 held that a cooperative oper      empt status, the IRS stated that it          tural by-products or solid            ing. CoBank structures and issues a
ating a cannery and facility for dry     believes that feeding a commodity to          wastes funded by environmen          letter of credit to support the bonds.
ing fruit and a cooperative operating    a "multi-celled animal" involves a bi         tal bonds. Eligible facilities and   First Commerce obtains all neces
a textile mill, both of which market     ological process, as opposed to a me          equipment include those for          sary state approvals, underwrites
the processed or unprocessed prod        chanical process, which it does not           the recycling or disposal of by      and markets the bonds.


Summer 1998                                     The Cooperative Accountant        The Cooperative Accountant                                        Summer 1998
46                CoBank, ABC—New Capital Markets Products                                                           TAXFAX                                    51


The Benefits                              margins as well as quality and service    tain interest income was patronage-     members to be considered "operat
  Benefits include:                       enhancements. Such strategics may         sourced as it was earned on and         ing on a cooperative basis". The
     • Tax-exempt rates are typically     include consolidation and globaliza       added to a reserve fund set aside for   1993 ruling reiterated the long
       lower than taxable rates. All-in   tion by means of acquisitions, merg       major building replacements. The        standing IRS position that all facts
       rates to the borrower may be       ers and joint ventures. These strate      judge differentiated a contrary find    and circumstances will be consid
       reduced by 2% or more,             gies usually require new sources of       ing in Thwaites Terrace on the basis    ered in light of Puget Sound Plywood
     • Investors have a weekly option     equity and may require a different        that in that case the interest income   Inc., 44 T.C. 305 (1965), acq. in de
       to "put" the bonds to the letter   capital structure. This creates partic    merely enhanced the overall profit      termining whether a cooperative was
       of credit bank (CoBank). This      ular challenges for cooperatives          ability of the cooperative.             operating on a cooperative basis.
       provides significant market li     given their unique equity and gover                       Donald A. Frederick        So why is this issue the subject of
       quidity.                           nance structures. CoBank and its                                                  an ILM if it is apparent that the
     • The credit risk to investors is    partner, Cooperative Investments                                                  controversy has been resolved? This
                                                                                      IRS LEGAL MEMORANDUM
       fully backed by a confirmed        Associates, are dedicated to the                                                  50% issue does get raised from time
                                                                                    REVISITS 50% BUSINESS ISSUE
       CoBank letter of credit. Inves     needs of agricultural cooperatives                                                to time in the context of a nonex-
       tor due diligence is therefore     and are specifically focused on the           IRS Legal Memoranda are inter       empt cooperative. The confusion
       simplified.                        development of structures and fi          nal documents used by the Service to    may stem from the 50% require
                                          nancing alternatives that will en         clarify or restate the government's     ments that are contained in the ex
Alliance Partner                          hance the capital generating abilities    position on a particular area of law    empt rules under Section 521(b)(4)
   CoBank's partner is First Com          of agricultural cooperatives.             that may not be uniformly followed      and within the Capper-Volstead Act.
merce Capital, an investment bank            Capital structures are tailored to     among the districts. These docu            Under Section 521(b)(4) the
ing division of Morgan Keegan and         an individual cooperative's needs,        ments are meant to give guidance to     Code states in pertinent part that
Co,, a full-service broker dealer.        but may include a direct investment       field agents that may have gone         "[exemption shall not be denied any
Since its founding in 1985, the firm      in the cooperative, a limited liability   "afield" from a particular IRS posi     such association which markets the
has established a national reputation     company or investments in signifi         tion.                                   products of nonmembers in an
in the area of industrial revenue         cant joint ventures or projects.              One such memo, dated January 5,     amount the value of which does not
bond financing and has managed nu         These financing alternatives can be       1993, but only recently released in     exceed the value of products mar
merous financings for corporate and       of particular benefit to agricultural     Tax Notes Today, 98 TNT 51-92, re       keted for members..." Accordingly,
agricultural clients throughout the       cooperatives with strong brand            visits the issue of whether a nonex-    marketing cooperatives cannot mar
United States.                            names. Most proposed capital struc        empt cooperative which does greater     ket more than 50% of its products
                                          tures would include some form of          than 50% of its business with non-      for nonmembers and maintain its ex
Agricultural Cooperative—                 common or preferred equity to             members can be considered "operat       empt status under Section 521. A
Mezzanine and Equity Investments          gether with subordinated and senior       ing on a cooperative basis". This is    similar 15% rule applies for exempt
   Significant changes in consumer        debt. Equity investors will typically     sue once raged as controversy           supply cooperatives.
demands, distribution systems, infor      be investing for a three to seven year    between cooperatives and the IRS as        The Capper-Volstead Act which
mation and biotechnology, interna         time horizon, but certain investors       a result of Rev. Rul. 72-602, 1972-2    provides antitrust exemption to co
tional trade barriers and government      may have no defined investment ho         C.B. 510, wherein the IRS required      operatives requires among other
regulations characterize the food         rizon and maintain the investment         that cooperatives do 50% or more of     things "that the association shall not
and agribusiness industry. As a re        for a longer time period. At the end      their business with members as a re     deal in the products of nonmembers
sult, many food and agribusiness          of this period, there are a number of     quirement for qualification under       to an amount greater in value than
companies, including cooperatives,        potential exit strategies for the out     Subchapter T. After several defeats     such as arc handled by it for mem
are developing long-term strategies       side investor. These include an ini       in Court, the IRS in Rev. Rul. 93-21,   bers". Both exempt and nonexempt
to capture opportunities for product      tial public offering on behalf of the     1993-1 C.B. 188, modified Rev. Rul.     cooperatives must follow this rule in
line extensions, product develop          limited liability company or joint        72-602 to the extent the prior ruling   order to obtain Capper-Volstead
ment and market expansion, im             venture, a recapitalization with a        required a cooperative to conduct       protection.
proved cost efficiencies and higher       combination of debt and member            more than 50% of its business with        Perhaps these two provisions


Summer 1998                                      Tin: Cooperative Accountant        Tin- Cooperative Accountant                                     Summer 1998
50                                TAXFAX                                                           CoBank, ABC—New Capital Markets Products                       47


New York. During the years in ques        erative is not subject to Code Sec        equity, sale of the position to an          • Increase the liquidity of mem
tion, 300 Owners claimed deduc            tion 277. Buckeye Countrymark Inc.,       other strategic or financial investor,        ber investment.
tions which exceeded income on its        103 T.C. 547 (1994), acqA Trump Vil       or some combination of these.
federal income tax return, producing
                                                                                                                                • Improve return on equity,
                                          lage Section 3, Inc., 69 TCM 2985            Required investor returns are
a loss of tax purposes. All of its de     (1995).                                   typical for investments of these            • Grow existing business lines.
ductions related to providing apart          The Division of Taxation insisted      types, with investors seeking returns
ments and related services to its         that even if forced to accept these                                                   • Expand product lines.
                                                                                    commensurate with the risk profile
member-tenants.                           determinations, it still did not be       of their investment. Common equity          • Provide members a vehicle to
    New York State imposes a corpo        lieve 300 Owners operated on a co         holders typically seek returns in ex          participate in the appreciation
ration franchise tax that applies to      operative basis. It asserted 300 Own      cess of 25%. The amount of control            in value of the cooperative.
housing cooperatives. It appears that     ers lacked two characteristics of a       and governance required by an out
while corporations with a loss for        cooperative enterprise, subordina         side investor varies based on the
federal income tax purposes must          tion of capital and democratic con        type of investment, i.e., subordi        Alliance Partner
pay a modest tax, those with earn         trol. The judge addressed this issue      nated debt, common equity, etc., and        CoBank's partner, the California-
ings pay a larger amount. The Divi        in light of Puget Sound Plywood, Inc.,    the level and amount of the invest       based Cooperative Investments As
sion of Taxation (Division) sent no       44 T.C. 305 (1965), acq:, Trump Vil       ment, both on a flat dollar basis and    sociates, was formed solely to invest
tices of deficiency to 300 Owners         lage', and Thwaites Terrace House         a percentage of ownership basis.         in agricultural cooperatives. Its prin
under the theory that Internal Rev        Owners Corp., 72 TCM 578 (1996).          Confidence in management is also a       cipals have deep backgrounds in co
enue Code Section 277 applied to it           In applying subordination of cap      factor. In general, standard protec      operatives and extensive experience
and, when computing its federal tax       ital, the judge noted that the mem        tions for minority investors, such as    in the food and agribusiness indus
able income for the years in ques         bers elect the trustees and officers of   board seats, negative controls, etc.     tries as well as close working rela
tion, its deduction of membership         the cooperative, who in turn deter        are required.                            tionships with the leading providers
expenses should have been limited         mine the cash requirements of the                                                  of equity and mezzanine capital,
to the amount of its membership in        building and set operating policies of    The Process                              such as investment and pension
come. Since it had modest interest        the association. Also rents estab           CoBank and Us partner, Cooper          funds.
income that the Division said did not     lished by the cooperative are limited     ative Investment Associates, L.L.C.,
qualify as membership income, this        to a level that covers costs of opera     evaluate the business and design an         CoBank is dedicated to support
income was, in the Division's view,       tion. The judge said this meets the       appropriate capital structure. Poten     ing cooperatives as they strive to
subject to the State franchise tax.       subordination of capital require          tial equity partners are sourced and     meet the new challenges in their
Thus, the Division argued, the coop       ment.                                     CoBank and Cooperative Invest            markets. These new capital markets
erative had underpaid its franchise           On the issue of democratic con        ment Associates structure, negotiate     products, together with CoBank's
tax in the years in dispute.              trol, the Division of Taxation cited      and close the investment. Strategic      traditional slate of short and long-
    A New York State Division of          Puget Sound Plywood and Trump Vil         planning, operating management           term senior debt, provide the neces
Tax Appeals administrative law            lage for its position that one-mem        and investment banking support can       sary tools to enable cooperatives to
judge ruled that the application of       ber, one-vote is required. The judge,     also be provided.                        succeed in this ever-changing busi
Section 277 was erroneous (Matter of      however, agreed with the coopera                                                   ness environment.
300 Owners Corp., No. 808709, Oct.        tive's position that Thwaites Terrace     The Benefits                                For more information, contact your
16, 1997). The judge accepted the         controlled and held that propor             • Additional equity can provide a      account officer or CoBank's Capital
cooperative's line of reasoning that      tional voting based on shares owned           number of benefits:                  Markets Division at 1(800) 542-8072.
begins with the position that a hous      is acceptable when the number of
ing cooperative that meets the stan       shares a tenant-member must pur
dards of Code § 216 is eligible for tax   chase reflects the size of the unit
treatment under Subchapter T. Park        inhabited, a measure of services re
Place Inc., 57 T.C. 767 (1972). Next      ceived on a patronage basis.
it stated that a Subchapter T coop           Finally, the judge found that ccr-


Summik 1998                                       The Cooperative Accountant        The Cooperative Accountant                                      Summer 1998
48                                                                                                                                                              49



                                                                                                               GUEST WRITERS




                   TAXFAX
                                                                                   Don Frederick, Chairman                        Jim Murphy
                                                                                   USDA/RBCDS/CS                                  Deloitte & Touche, LLP
                                                                                   5409 Point Longstreet Way                      700 5th Ave./Ste 4500
                          GENERAL EDITOR                                           Burke, VA 22015                                Seattle, WA 98104
                           George W. Benson                                        (202) 690-1411                                 (206) 233-7787
                       McDermott Will & Emery                                      Ed Hahn                                        Wayne Sine
                        227 West Monroe Street                                     Clifton Gunderson, LLC                         Southern States Cooperative
                        Chicago, IL 60606-5096                                     P.O. Box 428                                   P.O. Box 26234
                                                                                   Marshfield, WI 54449                           Richmond, VA 23260
                             (312)372-2000
                                                                                   (715) 387-6341                                 (804) 281-1301




 HARBOR MAINTENANCE TAX                  cess claims related to the bankruptcy   to purchase a Direct Broadcast Sat        its income for each annual account
  HELD UNCONSTITUTIONAL                  of a manufacturing company would        ellite (DBS) license and began the        ing period the income portion of the
                                         qualify as a Subchapter T coopera       commercial operation of a DBS             installment payment actually re
   Prior TAXFAX columns have re                                                  business as a for-profit division of      ceived during the period. Looking at
                                         tive. That ruling examined the pro
ported on the challenge brought by                                               the cooperative.                          the facts before it in this instance,
                                         posal from the perspective of the
many taxpayers to the application of                                                An unrelated firm later pur            IRS said the amount the cooperative
                                         trust establishing the cooperative.
the harbor maintenance tax to ex                                                 chased the license and all related        must recognize as income from the
                                            Ltr. 9805019 (Oct. 30,1997) looks
ports. The Spring edition reported                                               assets from the cooperative on an         sale of the DBS business is limited to
                                         at what appears to be the same
that the case was before the U.S.                                                installment basis. The purchaser          amounts of recapture which must be
                                         transactions from the viewpoint of a
Supreme Court and scheduled for                                                  agreed to pay interest to the cooper      recognized under Section 1245 plus
                                         trust joining the cooperative. In
argument in March.                                                               ative on the unpaid balance of the        the income portion of each install
                                         wording similar to the first ruling,
   In an opinion released on March                                               purchase price until the final install    ment payment actually received dur
                                         the IRS states that based on the in
31, 1998, the Supreme Court unani                                                ment payment was made.                    ing the tax year.
                                         formation provided (1) the organiza
mously concluded that the harbor                                                    To remain eligible for exempt sta          The IRS also concluded that ex
                                         tion qualifies as a cooperative under
maintenance tax as applied to ex                                                 tus under Section 501(c)(12), a util      cept for gains that must be recog
                                         Subchapter T and (2) participation
ports was unconstitutional. United                                               ity cooperative must realize at least     nized with respect to depreciation
                                         therein will not affect a member-
States v. United States Shoe Corp., 98                                           85 percent of its income each year        and amortization previously claimed,
                                         trust's status as a "qualified settle
TNT 62-12. Cooperatives that have                                                from member payments for meeting          all other gains from the sale of DBS
                                         ment fund" under Section 468B.
paid that tax and that have not al                                               losses and expenses. The coopera          assets do not result in unrelated
                                                         Donald A. Frederick
ready sought refunds should con                                                  tive asked the Service to clarify the     business income subject to tax under
sider looking into this matter.                                                  proper treatment of the gain on the       Section 511.
                   George W. Benson          IRS DISCUSSES RURAL
                                                                                 installment sale to make sure it did                       Donald A. Frederick
                                             UTILITY COOPERATIVE
                                                                                 not violate the 85 percent rule.
                                            TREATMENT OF GAIN ON
                                                                                    The IRS referred to Rev. Rul.
     SECOND CLAIMS SERVICE                   INSTALLMENT SALE OF                                                              NEW YORK STATE FINDS
                                                                                 65-99, 1965-1 C.B. 242. In that rul         SECTION 277 INAPPLICABLE
      COOPERATIVE RULING                             PROPERTY
                                                                                 ing, which concerned gain on the
                                                                                                                                TO HOUSING CO-OP
   The Spring 1998 issue of TAX-            Ltr. 9809055 (Dec. 3, 1997) con      sale of an office building, IRS said
FAX reported on Ltr. 9803019 (Oct.       cerns a rural electric cooperative ex   that for purposes of determining             300 Owners Corporation owns
17, 1997) wherein the IRS said a         empt under Section 501(c)(12). The      whether a utility cooperative meets       and operates a housing cooperative
cooperative of trusts formed to pro      cooperative had used cash reserves      the 85 percent test, it must include in   at 300 Riverside Drive in New York,


                                                                                 The Cooperative Accountant                                        Summer 1998
Summer 1998                                     The Cooperative Accountant

				
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