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Depreciation Blues: A Write-Off Hangover is Plaguing Bottom Lines
The good news is that machinery depreciation costs are dropping. The bad news is that depreciation represents the largest chunk of the overall cost for power and equipment, according to a University of Illinois analysis of Illinois Farm Business Farm Management (FBFM) records. Even though equipment purchases have dropped substantially since 2014, the fact is, depreciation from purchases made before 2014 are still haunting bottom lines.
“In 2018, for grain farms enrolled in the Illinois FBFM program, the cost for power and equipment was $146.37 per acre,” says Brad Zwilling, a farm business analyst with that group.
Individual costs break down as follows:
• Machinery depreciation – $65 an acre
• Fuel and oil – $22 an acre
• Repairs – $31 an acre
• Custom hire and leasing – $19 an acre
• Utilities – $7 an acre
• Light vehicles – $2 an acre
Of those expenses, depreciation accounts for 44% of the total.
In the grand scheme of things, the 2018 depreciation cost per acre was $2 less than 2017. But it’s nearly 200% higher than in 2007, when depreciation cost was $22 an acre. From 27% in 2007, the depreciation cost as a percentage of the total power cost climbed to 48% in 2016, Zwilling notes.
This cost of depreciation is beginning to decline as the schedule of depreciation for earlier purchases matures. “In 2015 and 2016, the cost of actual purchases per acre was less than the cost of depreciation,” says Zwilling.
Another positive change regarding the depreciation hangover is that the Tax Cuts and Jobs Act of 2017 reduced the depreciation period for new equipment purchases to five years from the previous seven years. The depreciation period for used equipment, however, stays at seven years.
With that law, you are allowed to immediately write off capital purchases up to $1 million. That includes breeding livestock and single-purpose structures such as grain bins. The phase-out on this expensing provision kicks in when a farm reaches $2.5 million in purchases.
Expensing Off a Purchase
Considering the impact depreciation is having on the bottom line, you may be tempted to expense an entire purchase price the year it was made. Yet, that tactic has its drawbacks. The incentive of a deduction can cloud decision making about purchases, driving a decision to purchase despite warning flags from other avenues of the operation, such as a well-planned, long-term schedule of machinery use and replacement. “We tell farmers that when they’re buying a piece of equipment and looking at costs on a per-acre basis, it makes more sense to spread the cost of the purchase over multiple years rather than just one year.”
As part of their 2017 analysis of power and equipment costs, FBFM analysts looked for a correlation between economic depreciation cost and farm size. “There is, in fact, a correlation between size and cost if you’re in the largest or the smallest groups of farms. There’s no correlation for the farms that are in the in-between sizes; they fluctuate from year to year.”
In 2016, farms of 500 acres or less had depreciation costs amounting to 42% of total power and equipment costs. Farms of 1,000 to 2,000 acres had depreciation costs that were 50% of the total power cost. Depreciation for farms larger than 5,000 acres was 41% of the total.
No One Tactic to Use
There’s no silver bullet to reduce equipment costs. Rather, a lot of little things, including long-term planning, can make a difference. “Capital budgeting can help. Stick to a budget that tells you when to replace equipment – when you’re no longer realizing a good economic return from a piece of machinery or when it’s becoming costly to maintain.”
Keeping up with maintenance to extend machine life and reduce breakdowns also lowers iron costs. Most importantly, “Keep good records so you know what your actual costs are,” Zwilling says.