Cooperative Auditing and Accounting, Basic Course

National Society of Accountants for Cooperatives

Contents

Introduction to Cooperatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Equity Management and Inter-Cooperative Investments . . . . . . . 8

Income Tax Treatment of Cooperatives . . . . . . . . . . . . . . . . . . . . 15

Co-op GAAP and Financial Statements . . . . . . . . . . . . . . . . . . . 27

2

NSAC BASIC A&A COURSE, INTRODUCTION TO COOPERATIVES

Cooperatives are a special way of conducting business. They are owned and controlled by their

customers. This involves unique organizational and operational procedures with their own terms

and concepts. People who work for and with cooperatives will want to understand the structure

and the language so they can grasp ideas and communicate effectively with other members of the

cooperative community.

I. While there is no universally accepted definition of a “cooperative,” it is generally considered

to be:

A business

Owned and democratically controlled by the people who use its services

Whose benefits are distributed equitably on the basis of use

The user-owners are referred to as “members”

II. Member-user ownership and democratic control has certain implications:

While non co-ops focus primarily on the bottom line, cooperatives also focus on

meeting member needs at the lowest possible cost

Members must provide the equity capital, usually in proportion to use, making

equity accumulation one of the biggest challenges facing many cooperatives

Member decisions are made on the basis of one-member one-vote (not investment)

or with limited weighted voting based on patronage (use)

Members exercise their control by electing the directors (usually members),

approving articles and bylaws, and voting on major changes in the business

III. Benefits are distributed according to use (patronage)

The more a member patronizes the co-op, the more services that member receives

Earnings are allocated on the basis of use, not investment

a. Returns on equity are limited (usually not more than 8 percent per year)

b. Use-based allocations are called patronage refunds

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IV. Patronage Refund

Distribution of earnings from a cooperative to a patron

Based on each patron’s pro rata share of all business conducted with patrons during

the year

Example of computing a patronage refund allocation:

a. If ABC Cooperative earned $500 last year, and

b. If ABC Cooperative did 8 percent of it patronage business with Ms. Smith, then

c. Ms Smith is entitled to a patronage refund of $40 ($500 x .08)

d. A portion of Ms. Smith's patronage refund will likely be in cash and a portion

will be retained as an equity investment in the co-op, as determined by the

Board of Directors.

V. Cooperative History

Ben Franklin helped organize a mutual fire insurance company, the Philadelphia

Contributionship for the Insurance of Houses from Loss by Fire (1752), that is

still operating today.

The Rochdale Pioneers organized a consumer purchasing cooperative in England.

The leaders studied earlier cooperatives and developed a list of practices

consistent with success, which became known as Cooperative Principles (1844).

Early leaders of the National Grange visited Europe, gathered information about

cooperatives, and organized many cooperative stores based on the Rochdale

Principles (1875).

From the 1890s through the 1920s the number of farmer cooperatives increased to

14,000 entities marketing all types of crops and furnishing supplies and services

to their farmer-members. Improvements in transportation, technology, and

economies of scale have led to mergers reducing that number to roughly 3,000

farmer cooperatives today.

President Franklin Roosevelt's "New Deal" included public policy support that

helped stabilize and develop national networks of rural electric and farm credit

cooperatives.

Experts estimate that as of 2005 there were 21,800 cooperative businesses in the

United States with 154 million members and $273 billion in sales.

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VI. Cooperatives in the Community

Consumer Service Cooperatives

a. Housing -- Three million Americans live cooperative housing units

b. Health Care -- Health insurance co-ops; hospital purchasing co-ops

c. Child Care -- Parents often serve as teachers and sitters

Business Cooperatives

a. Wholesale Grocery -- Provide identity, brand name products, increased buying

power, and access to low-cost services such as trucking and warehousing

to 15,000 independent grocery stores.

b. Franchisees of several well-known restaurant chains - Kentucky Fried Chicken,

Dunkin’ Donuts, etc. - purchase supplies through cooperatives.

c. Wholesale Hardware -- Similar to their grocery cousins, providing products and

services to 15,000 independent hardware stores.

Farmer Cooperatives

a. Marketing -- Run the gamut from simply negotiating prices with buyers to

placing value-added products on the grocery store shelf (Land O'Lakes,

Ocean Spray, Sunkist, etc.)

b. Farm Supply and Service -- Purchase, manufacture, and distribute feed, seed,

fertilizer, fuel, soil treatments, etc., to farmers and ranchers and provide

business services that support producer operations (e.g.; cotton gins, rice

dryers).

Utility Cooperatives

a. Rural Electric Co-ops

1. Generate and Transmit power

2. Distribute power to individual member-patrons

b. Communications -- Provide not only telephone service but also cable television

and high-speed internet access to rural America

5

Financial Cooperatives

a. Credit unions have 84 million investor-borrower members

b. Farm Credit System institutions provide long- and short-term credit to farmers

c. CoBank, part of Farm Credit, is a leading lender to farmer and utility co-oops

d. NCB provides credit and financial service mainly to non-ag co-ops

e. CFC offers credit to utility co-ops, supplements USDA credit programs (RUS)

VII. Classifying Cooperatives – The ways people group cooperatives for discussion purposes

Geographic Territory Served

a. Local – One town or county

b. Super local – Several towns or counties; often formed by mergers or locals

c. Regional – Trade territory covers one or more States

d. National – Serves members throughout the country

e. International – Have foreign members as well as US members

Governance System

a. Centralized – Individual members (vast majority of co-ops)

b. Federated – Other cooperatives as members (CoBank, Electric G&Ts)

c. Mixed – Both individual and cooperative members (Land O’Lakes)

Functions Performed

a. Marketing – Market products produced by members and value-added products

manufactured from member-produced goods

b. Purchasing – Purchase or manufacture supplies used by members to provide

services and produce products

c. Service – Provide services used by members to support their marketing and

purchasing activities (insurance, credit, livestock records, etc.)

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VIII. Benefits of Cooperation

There is no reason to form a cooperative unless it will benefit the members. Among the

benefits one can receive as a cooperative member:

Access to quality supplies and services at reasonable costs

Increased clout in the market place

Share in the earnings

Local economy enhanced and protected

Ability to solve industry problems

A strong voice in shaping public policy

IX. Legal Foundation

Most cooperatives are organized as a corporation under a State law enacted specifically

for use in creating co-ops. All cooperatives will have essentially the same legal

documents. These documents are, in descending order of authority:

Articles of Incorporation

Bylaws

Board policies

X. People

Because of the close relationship among owners and customers in a cooperative, it is

important to keep the various roles people play clear and straight. Several people often

have multiple responsibilities in a co-op. They must keep them separate and distinct if

the association is to function smoothly and efficiently.

Members

a. Control the cooperative

b. Fund the cooperative

c. Patronize the cooperative

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Directors

a. Establish policies that guide the operations of the cooperative

b. Long-range planning

c. Hire and fire the CEO

Officers

a. Provide leadership to the directors, staff, and members

b. Perform the same functions as officers in other organizations

Employees

a. Understand the organization and operation of cooperatives

b. Perform your duties fully and faithfully

c. Represent the cooperative favorably on the job and in the community

8

NSAC BASIC A&A COURSE, EQUITY MANAGEMENT AND

INTER-COOPERATIVE INVESTMENTS

Equity is the life-blood on any business organization. It is the most at-risk capital (last in line for

repayment in case of insolvency) and essential to attract debt financing. The unique way

cooperatives are organized and governed makes attracting equity particularly challenging for

many cooperatives. This module looks at how centralized cooperatives obtain equity from their

members and then how cooperatives finance joint business operations, whether technically a

federated cooperative or some other structure, with other cooperatives.

EQUITY MANAGEMENT

I. Cooperatives accumulate equity from four sources:

Direct investment

a. Cash purchases of common voting stock (or membership certificates in so-

called non-stock co-ops) and non-voting preferred stock

b. Necessary to capitalize a new cooperative

c. How nonmembers invest in cooperatives, usually by purchasing non-voting

preferred stock

Retained patronage refunds

a. Earnings allocated to patrons, retained to capitalize the cooperative

b. The primary method of building equity in most established, profitable co-ops

Per-unit retains

a. A portion of the sales proceeds due patrons for product sold through the

cooperative, retained to capitalize the cooperative

b. Used by some marketing co-ops

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Non-patronage earnings

a. Incidental earnings from activities not directly related to business with or for

patrons

b. Usually placed into a tax-paid reserve

II. Special Point: Retained patronage refunds and per-unit retains can be allocated in either

"qualified" or "nonqualified" form

Qualified allocations transfer the Federal income tax liability for the value of

retains through to the patrons when the allocation is made. (Note: at least 20

percent of a qualified patronage refund must be paid to the patron in cash)

Nonqualified allocations are taxable to the cooperative until redeemed with a cash

payment to the patron

The mechanics and implications of qualifying or not qualifying retained allocations are

explained in the tax section of this manual.

III. Equity Redemption

Cooperatives are the only business structure that has a tradition of regularly redeeming

some of their equity (retained patronage refunds and per-unit retains) for cash. While this

has the desirable result of placing much of the burden of financing a cooperative on those

currently using its services, the practice complicates the challenge of accumulating

sufficient equity.

Cooperatives normally use one of (or a combination of) three methods of managing their

equity redemption program:

Systematic revolving fund

a. Many cooperatives strive to redeem one prior year's equity each year.

b. Usually it is the equity that has been outstanding the longest. For example, if a

cooperative is on a 10-year revolving cycle, in 2008 it will redeem

retained patronage refunds and per-unit retains issued in 1998.

10

c. Equity accounts of current patrons are adjusted each year for additions of

retained allocations and subtractions of old equity that is redeemed

d. Equity of former patrons is all redeemed over the life of the revolving cycle

Special plans

a. Under special plans, the occurrence of a specific event or condition triggers

redemption, either at once or over a period of years

b. The most common events are death, retirement, and/or reaching a certain age

Base Capital Plans

a. First, the cooperative determines its total equity need

b. Each patron is assigned an equity contribution level based on patronage of

recent years (base period)

c. Each year a patron's contribution level is recomputed to reflect changes in the

co-op's equity needs and the patron's share of patronage over the new base

period

d. Under-invested patrons normally receive only the minimum required cash

patronage refund (20 percent if the allocation is qualified)

e. If a patron's retained allocations from prior years plus the current year's

allocation exceeds the assigned equity contribution level, the patron

usually receives the difference in cash

INTER-COOPERATIVE INVESTMENTS

IV. Cooperatives make investment in other cooperatives to meet challenges and capture

opportunities that they can't do as efficiently on their own.

Inter-cooperative investments are made to enhance existing operations and to

expand into new lines of business by gaining access to:

a. A source of supplies, both items that are resold to members for use in their

business and items for use by the cooperative itself in its operations

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b. A market for products produced by the members and for value-added products

the co-op makes from member products

c. Important services such as affordable debt financing

The investment can be either an ownership interest in another cooperative or a joint

venture with one or more other cooperatives

V. Inter-cooperative investments usually involve two components:

Direct investments

Retained patronage refunds

VI. Balance sheet presentation

Carrying value

a. At cost

b. The equity method

Asset Classification

a. Long term

b. Short term

VII. Timing of recognizing patronage refunds

When notification is received

When patronage occurs

When the refund is received

When to recognize non-qualified allocations (when received or when redeemed?)

12

VIII. Income statement presentation

Netted to source

Separate entry

IX. Footnote disclosures

Basis

a. At cost or equity method

b. Allocations received policy statement

c. Practicality exception

d. Table of material investments

Ownership percentage

a. Statement of underlying value

b. Statement of any impairments

c. Refunds received

d. Purchases of goods from

SFAS 107 disclosures

a. Fair value of financial instruments

b. Repeat of practicality exception

Impairment questions

a. Can the investor demonstrate that it is probable that the carrying amount of the

investment is fully recoverable?

b. Does the investee have unallocated losses that exceed unallocated equities?

13

Case Study #1

a. Local Cooperative invests $1,000 in common stock of Regional Co-op

Prepare Journal Entry on books of Local

b. Local Cooperative accrues $3,600 patronage estimate in Regional Co-op as of

12/31/XX

Prepare Journal Entry on books of Local

c. What is the total Local investment in Regional at 12/31/XX?

_______________

d. On or before Sept. 15 of the following year, Regional issues to Local patronage refund

income as follows:

Cash $750

Qualified written notice $3,000

Total patronage $3,750

Prepare Journal Entry on books of Local

e. What is the total Local investment in Regional at Sept. 15?

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Case Study #2

At December 31, xx, Midstate Milking Cooperative had an investment in Class “E” stock, at

cost, in CoBank totaling $ 5,340,000. In the following year, Midstate completed the following

transactions with CoBank:

a. Purchased Class E” stock quarterly equal to 10% of interest paid of $5,480,000.

Prepare Journal Entry on books of Midstate

b. In January, Midstate received notice of qualified patronage allocation of $390,000

from CoBank, which included the minimum qualifying amount in cash and the

remainder in allocated equities.

Prepare Journal Entry on books of Midstate

c. Calculate Midstate investment in CoBank after above entries

d. Determine interest expense to be reported in Midstate's reports

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NSAC BASIC A&A COURSE, INCOME TAX TREATMENT OF COOPERATIVES

Cooperatives are not exempt from income taxation! Member-owners and their cooperatives are

taxed much the same as the vast majority of American businesses, including competitors in the

supply, marketing, and service industries.

I. The basic corporate income tax structure can be summed up in the three tenets and a simple

formula.

A. Tenets

i. The corporation is a taxable entity

ii. Not all income is taxable

iii. Contributions to capital are treated differently than income

B. Tax = (income - deductible expenses) x rates

II. Similarly structured businesses in the same industry are usually permitted to deduct

essentially the same expenses. Thus the tax code is usually not a significant factor in

determining the success or failure of like competitors.

TAX TREATMENT BY BUSINESS TYPE

Business type Times Margin Taxed Level

Proprietorship 1 Owner

Partnership 1 Owner

Limited Liability Company 1 Owner

Limited Co-op Ass’n 1 Owner

Corporations:

Investor-General 2 Corporation/Owner

Subchapter S 1 Owner

Cooperative 1 Owner

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Of the seven types of business in this country, only investor-general corporations pay

income tax at both the business and owner levels. And only 12 percent of American

businesses are investor-general corporations.

III. Subchapter T, Internal Revenue Code, sections 1381-1388 is the main body of cooperative

income tax law. It is available to any corporation "operating on a cooperative basis."

But some cooperatives have a special tax status:

Tax-exempt cooperatives

a. Utility co-ops (electric, telecommunications, water, etc.) that derive at least 85

of their income from providing services to members (I.R. Code sec.

501(c)(12)). Utility co-ops that don’t meet the 85 percent test are taxed

similarly to Subchapter T cooperatives under common law.)

b. Credit unions without capital stock (I.R. Code sec. 501(c)(14)(A))

c. Cooperative hospital service organizations that purchase supplies and

provide administrative services to members (I.R. Code sec. 501(e))

Earnings generated for the sale of "personal, living, or family items" to patrons are

free of taxation at both the co-op and the patron levels (I.R. Code sec. 1385(b)(2).

Special rules for Sec. 521 farmer cooperatives are discussed later in this section.

IV. The general rule for income tax treatment of cooperatives:

Net margins (earnings) on business conducted with or for patrons

Are taxable income to only the cooperative or the patron

If they are distributed or allocated to patrons

On the basis of business done with the cooperative

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V. The primary tool for allocating earnings to patrons on the basis of use is the patronage

refund. A patronage refund (patronage “dividend” in I.R. Code) is:

An amount paid by a cooperative to a patron

Based on the quantity or value of business done with or for the patron

Under a pre-existing legal obligation

Determined by reference to the margins earned on all business with or for patrons

For example, if a cooperative has a net margin of $1,000 for the year, and 6 percent of the

cooperative's business is with Ms. Jones, then Ms. Jones' patronage refund is $60.

VI. Patron v. Member – Many people use these terms interchangeably. In most instances a

person will be both, but professionals working with cooperatives must recognize the

difference.

Patron – A person with or for whom a co-op does business "on a cooperative

basis;" that is, a person who is eligible to receive a patronage refund.

Member – A person allowed to vote on issues decided by the membership.

One key point in tax where the distinction is important is that a person can be a patron

and thus eligible to receive patronage refunds without being a member of the cooperative.

VII. Payment Period - The time period during which a cooperative can make a patronage refund

eligible for single tax treatment. It starts at the beginning of the tax year and ends:

Subchapter T co-ops: 8½ months after the close of that tax year

Exempt co-ops: 4½ months after the close of that tax year

Taxable utility co-ops: 2½ months after the close of that tax year

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VIII. Payment Options - Patronage Refunds

Cash

Written notice of allocation - Document representing portion of a patronage refund

retained by a cooperative as an investment by a patron. Tax treatment depends on

whether the notice is "qualified" or "nonqualified."

IX. Tax Treatment of Cash Distribution

Deductible by the cooperative in the year earned

Taxable income to the patron in the year received

X. Tax Treatment of Qualified Written Notice of Allocation

Deductible by the cooperative in the year earned

Taxable income to the patron in the year received

Redemption for cash is a non-taxable event

______________________________________________________________________________

EXAMPLE OF TAX TREATMENT -- CASH AND QUALIFIED ALLOCATION

Cooperative Patron

Income $1,000 Income

Expenses

Crop $600 Crop $600

Other $300

Total $900

Margin $100 Refund $100

Taxable Income 0 Taxable Income $700

__________________________________________________________________________ ___

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A. Any business is allowed to deduct the payment to the patron for the crop ($600)

and other expenses ($300).

A cooperative may also deduct the margin earned when it sold the producer's crop

($100), provided the cooperative returns the margin to the patron as a qualified

patronage refund allocation.

B. The patron includes the $600 crop payment and the $100 patronage refund in

taxable income.

XI. How to "qualify" a written notice of allocation

At least 20 percent of the total patronage refund must be in cash

The patron must "consent" to include the face value of the notice in income

XII. How to obtain "consent"

Bylaw making consent condition of membership; only binding on members

Written consent form

Qualified check, one that includes a statement on the back that endorsing and

cashing the check constitutes consent

XIII. Nonqualified allocations -- Paper distributions that do not meet the requirements for

qualified status

Taxable to the cooperative in the year earned

No immediate tax consequences for the patron

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______________________________________________________________________________

EXAMPLE OF TAX TREATMENT -- NONQUALIFIED ALLOCATION

Cooperative Patron

Income $1,000 Income

Expenses

Crop $600 Crop $600

Other $300

Total $900

Margin $100 Refund $100

Taxable Income $100 Taxable Income $600

______________________________________________________________________________

A. If a nonqualified allocation is used in our example, the cooperative has taxable

income of $100. The patron only reports the $600 crop payment as income.

B. When the nonqualified allocation is redeemed, the cooperative gets a refund of

the tax it paid in the year the nonqualified allocations were issued. At this time,

the patron includes the $100 cash received in taxable income.

XIV. Per-unit retains (portion of the proceeds of sale, based on dollar value or physical volume

of products marketed) receive tax treatment that parallels patronage refunds

Qualified retains are deductible by the cooperative, taxable income to the patron

Test for qualification is the same, except there is no 20 percent cash payout

requirement.

Nonqualified retains are taxable to the cooperative in the year collected, deductible

by the cooperative and taxable to the patron in the year redeemed.

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XV. Section 521. Farmer cooperatives meeting a number of organizational and operational

tests may claim two additional deductions

Dividends on stock

Income from business with the United States and other nonpatronage income

distributed on a patronage basis

XVI. Filing and forms. All cooperatives must file annual Federal income tax returns, even if

they have no taxable income.

Beginning with tax years ending after 12/31/2007, all Subchapter T cooperatives

will file new IRS Form 1120-C

Non-exempt utility cooperatives file Form 1120

Tax exempt cooperatives file Form 990

Cooperatives must also file other forms required, including Form 1099-PATR to

report distributions to patrons (both cash and noncash)

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WORKSHEETS, COOPERATIVE INCOME TAXATION

VEGEPACKER COOPERATIVE

Statement of Operations

Total Sales $500,000

Cost of Goods Sold 400,000

Gross Margin $100,000

Operating Expenses 40,000

Interest Expense 5,000

Depreciation 5,000

Net Margin $50,000

Assumptions

The corporate income tax rate is 15 percent on all taxable income up to $50,000.

Half of any distribution to patrons will go to persons with a marginal tax rate of 15

percent, the other half to persons with a marginal rate of 25 percent.

Two representative patrons, A and B, each provide eight percent of Vegepacker's

product. Patron A is in the 15 percent tax bracket and Patron B in the 25 percent bracket.

23

Example A. Vegepacker puts its entire $50,000 margin into a tax paid reserve.

Cooperative tax ($50,000 x .15) $7,500.00

Addition to equity $42,500

Patron tax, when equity is redeemed for cash

($21,250 x .15) $3,187.50

($21,250 x .25) 5,312.50

Total taxes paid $16,000.00

Note: This results in the same tax treatment as if Vegepacker was an investor-owned

corporation.

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Example B. Vegepacker adopts the traditional cooperative tax treatment. It does all its business

with or for member-patrons and distributes 20 percent of its margin of $50,000 in cash and 80

percent in qualified written notices of allocation.

Total Tax Obligations

Cooperative tax ( x .15) _______________

Addition to equity _________________

Patron taxes in total

( x .15) _______________

( x .25) _______________

Total taxes paid _______________

Individual Patron Cash Flow Analysis

Patron A: Individual refund allocation $4,000

Cash received ($4,000 x .20) 800

Tax owed ($4,000 x .15) 600

Cash flow $200

Patron B: Individual refund allocation $4,000

Cash received ( x ) ________

Tax owed ( x .25) ________

Cash flow ________

25

Example C. Vegepacker distributes its entire $50,000 margin as nonqualified written notices of

allocation.

Total Tax Obligations

Year of issuance

Cooperative tax ( x .15) _______________

Addition to equity _________________

Patron taxes in total

( x .15) _______________

( x .25) _______________

Total taxes paid _______________

Year of redemption

Cooperative tax ( x .15) _______________

Patron taxes in total

( x .15) _______________

( x .25) ________________

Total taxes paid ________________

26

Example C continued

Individual Patron Cash Flow Analysis

Year of issuance

In this example the patrons receive no cash and have no tax liability, so there is no cash flow to

analyze.

Year of redemption

Patron A: Individual redemption payment $4,000

Cash received 4,000

Tax owed ( x .15) ________

Cash flow $ ________

Patron B: Individual redemption payment 4,000

Cash received _________

Tax owed ( x .25) _________

Cash flow $ ________

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NSAC BASIC A&A COURSE, CO-OP GAAP AND FINANCIAL STATEMENTS

This overview discusses how the unique characteristics of cooperatives are translated and

reported to users of cooperative financial statements. It point outs the terminology that lets the

reader know that he or she is viewing the financial statements of a cooperative.

I. GAAP Applicability

Generally accepted accounting principles (GAAP) are equally applicable to all

business enterprises, including cooperatives

GAAP hierarchy – FASB Statement of Financial Accounting Standards No. 162:

FASB Statements and Interpretations

FASB Staff Positions

AICPA Accounting Research Bulletins

APB Opinions

FASB Technical Bulletins

AICPA Industry Audit & Accounting Guides

AICPA AcSEC Statements of Position

AICPA AcSEC Practice Bulletins

Consensus Positions of the Emerging Issues Task Force (“EITF”)

“Q’s and A’s” Published by FASB Staff

AICPA Accounting Interpretations

Widely Recognized and Prevalent Industry Practices

FAS No. 162 will replace AICPA SAS 69 as the defining document for GAAP

hierarchy 60 days after the SEC approves PCAOB changes to AU 411.

The only major change from SAS 69 is the insertion of "FASB Staff Positions" in the

number two slot on the list.

II. AICPA GAAP Specific to Cooperatives:

AcSEC Statement of Position 85-3, “Accounting by Agricultural Producers and

Agricultural Cooperatives,” released in 1985. A copy is included in the A&A

Guide, discussed below.

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a. Defines an "agricultural producer" and an "agricultural cooperative" in a

generally accepted manner

b. Accounting issues discussed:

• Accounting for inventories by producers

• Accounting for development costs of land, trees, and vines,

intermediate-life plants, and animals

• Accounting by patrons for products delivered to cooperatives

• Accounting by cooperatives for products received from patrons

• Accounting for investments in and income from cooperatives

Audit and Accounting Guide, “Audits of Agricultural Producers and

Agricultural Cooperatives,” first published in 1987. This guide is updated

on a regular basis, with assistance from NSAC. To order a copy, go to

www.cpa2biz.com.

Key issues covered in Part II – Agricultural Cooperatives, include:

a. Introduction – Cooperative history, structure, and functions

b. Background – Relations between co-ops and members, including related-

party transactions and the applicability of FAS 57; income taxation;

regulatory issues; market orders; and governmental support programs.

c. General accounting considerations – Discusses planning the audit, audit

risk, materiality, misstatements, use of assertions, internal control

environment, risk assessment procedures, and use of information

technology.

d. Special accounting and auditing considerations – Discusses marketing

cooperatives operating on a pooling basis and accounting for losses when

a cooperative has multiple departments and functions.

e. Specific accounting principles and auditing considerations – Inventories

(FAS 151); investments in other cooperatives (APB 18 and FIN 46);

equities and member investments; and deferred income taxes (FAS 109

and FIN 48).

29

Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of

Certain Types of Regulation (on utilities, including electric co-ops)

Key issues discussed include:

a. Allowances for the costs of funds used during construction

b. Intercompany profits

c. Recording of deferred income taxes

d. Recording revenues collected in one period and refunded in a later period

e. Leases (reaffirms use of FAS 13)

III. NSAC-created GAAP

These NSAC publications contain considerable information that meets the last test for being

considered GAAP, "Widely Recognized and Prevalent Industry Practices"

The Cooperative Accountant (TCA), the quarterly technical journal of NSAC. It

contains articles on current accounting, tax, legal and finance issued of

importance to cooperatives. TCA is provided free to NSAC members.

Financial Reporting by Cooperatives (FRBC) – Contains information and language

extracted from the database of over 40 actual cooperative financial statements,

sorted by financial statement classification. Each major section includes a

discussion of the accounting principles relevant to that area of the financial

statement followed by examples of actual financial statement footnote disclosures.

FRBC is available free to NSAC members through a link on the web site at

www.nsac.coop.

IV. GAAP that can be Worrisome for Cooperatives

FAS 57 – Related Party Transactions

FAS 107 – Disclosures about Fair value of Financial Instruments

FAS 109 / FIN 48 – Income Taxes / Uncertainty in Income Taxes

FAS 133 – Accounting for Derivatives and Hedging Activities

FAS 141 – Business Combinations

FAS 150 – Accounting for …Liabilities and Equities

30

V. Sources of Co-op GAAP

For FASB items: www.fasb.org

For NSAC items: www.nsac.coop

For AICPA items: www.aicpa.org

VI. Audiences for Cooperative Financial Statements

Cooperative financial statements must contain sufficient information to serve the needs of a

variety of constituencies. A primary difference in the cooperative arena is that the customers are

also the members and shareholders (the owners) and, therefore are entitled to comprehensive

financial information about the business. Cooperative financial statements typically contain

information relative to, and used by:

Members Patrons

Investors Creditors

Management Others

The financial statements, usually contained within an annual report, can be one of the best

opportunities for a co-op to communicate with its members during the year.

VII. Balance Sheet differences

Co-op specific assets

a. Advances to members

b. Investments in other cooperatives

c. Co-op related joint ventures

d. Co-op related subsidiaries

e. Inventories (in a marketing co-op, products held may belong to patrons)

f. Related party transactions (often requires extensive footnote disclosures)

Co-op specific liabilities

a. Grain payables – As seen in the statements of grain marketing co-ops, can

consist of deferred payment contracts, delayed pricing contracts, unpriced

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basis contracts, priced not paid contracts – all of which generally represent

grain whose title has passed to the co-op to be paid for later.

b. Amounts due to patrons/members for pool proceeds – As seen in the

statements of marketing co-ops which generally segregate each

year’s/season’s crop to be marketed in to separate commodity pools.

Producers are advanced some percentage of the expected proceeds at the

time their produce is delivered to the co-op. At the time the pool is closed,

a final distribution is determined for each producer participating within the

pool – creating the liability to the member. Pools are generally not closed

until all inventory in that pool is sold.

Co-op specific liabilities and equity

a. Advances from members – Most likely seen in a federated system where

advances made to parent cooperative from equity-rich member co-ops, in

the form of interest-bearing short-term loans.

b. Patronage refunds payable in cash – typically a current debt – from the date

refund is declared through payment -- generally 3-9 months.

c. Member ownership stock

d. Member equity reserves

VIII. Operating Statement differences, co-op specific sales/cost/expense items

Purchases by Patrons – Seen in purchasing co-op statements – as opposed to Sales or

Sales to Customers. It emphasizes the unique aspects of the purchasing

cooperative structure.

Marketing for Patrons / Members – Seen in Marketing co-ops statements. May

show more than one category, depending on the variety of products marketed for

members, for example:

Grain marketed for members

Livestock marketed for members

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Patrons’ pool proceeds – Seen in marketing co-ops statements, represents the gross

proceeds applicable to the members participating in a specific pool of

commodities that has been marketed; i.e., the inventory for that pool is completely

sold and the pool has been closed.

IX. Statement of Owners' Equity differences -- This, of all the required statements, is the

one that is most co-op specific. In most instances it is a stand-alone statement, as

opposed to being part of the Income Statement. It is often presented in a roll-forward

format, starting with the prior year’s ending balances. It will detail roll-forwards of the

major equity classifications, including Patrons Equity and Retained Earnings.

Depending on the level of detail contained within the statement, this area will show

activity associated with the year; e.g., Allocations added from Refunds Declared, any

Redemptions of prior-year Allocations, and any transfers to Retained Earnings.

X. Statement of Cash Flows differences

Non-cash patronage refunds received – Cooperative memberships in other co-ops

often result in receipt of patronage refunds from those co-ops. Since the

allocation portion is non-cash, it has to be deducted from net income in the Cash

Flows statement to reconcile back to Cash Provided by Operations.

Redemption of non-cash patronage refunds received – Since redemptions of the

allocations most often occur in later years, and were included in net income in

prior years, the amounts have to be added back to net income in the Cash flows

statement to reconcile back to Cash Provided by Operations.

Patronage refunds paid in cash – The cash portion of any patronage refunds actually

paid during the year that may have been declared in the immediately preceding

year is shown as a deduction of cash to reconcile back to Cash Provided by

Financing Activities.

Redemption of patrons’ equity - The allocation portion of any patronage refunds

revolved during the year are shown also as a reduction of cash to reconcile back

to Cash Provided by Financing activities.

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Purchase of investments in other cooperatives – Again, as co-ops invest in other co-

ops, any cash invested will be shown to reconcile back to Cash Used in Investing

Activities.

XI. Notes to Financial Statements

Lines of business -- Lines of business are usually detailed within the Summary of

Significant Accounting Policies section of the notes. Here you will find exactly

what cooperative activities the co-op is primarily involved in.

Investments (in other co-ops) -- The Summary of Significant Accounting Policies

will contain the investment policies of the co-op; e.g., whether investments are

stated at cost or have to be accounted for by the equity method.

Investments in other co-ops, if material, will warrant a separate note which will

detail the level of investments, the aggregate or underlying equity of the

investments, any patronage refunds received from the investees during the year,

and often the amount of any business conducted with the investees during the

year.

Income taxes -- The Summary of Significant Accounting Policies will discuss

exactly what treatment the co-op is afforded. If a patronage refund has been

declared for the current year, the detailed Income Taxes footnote/table will

probably reconcile the statutory federal tax rate to the effective rate, providing

good information on the exact effects of the tax treatment afforded to the co-op.

As with most other businesses, the tax footnote will also provide details on

current and non-current deferred tax assets or liabilities. This area will detail the

effects of any Non-Qualified Patronage Refund Allocations (either issued or

received) on these deferred tax assets/liabilities.

Capital stock table -- This note can also be a good source of information about who

can be a member of the co-op, who can use the services of the cooperative, and its

policy on issuing dividends on equity.

Fair value of financial instruments -- This note, which was spawned by FASB

Statement No. 107, relates directly back to investments in other cooperatives.

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Because there is no established market for these securities, most investments in

other cooperatives are carried at cost (or the equity method) until some overriding

event triggers either a disposal or a clearly illustrated reason to impair the value of

the investment; e.g., the investee incurs losses that severely deplete its equity

position.

XII. The Management's Discussion and Analysis (MD&A) -- The MD&A will only appear

in the “annual report” and not in the “audit report.” It is designed primarily for the casual

user of the information, and not necessarily someone with a background in

finance/accounting. The MD&A will most likely be primarily non-financial and will

highlight the more positive aspects of the co-op’s business year. But, since the “audit

report” along with the auditors signed opinion is also contained within the “annual

report,” this section should not contain unsubstantiated information, sometimes referred

to as “fluff.” Since the signed audit opinion is a part of the report, the auditor reserves

the right to review and agree to the information contained in this section.

Key elements of the MD&A may include:

Chairman / CEO letter -- This letter is usually directed toward members and other

primary stakeholders of the co-op (lenders). It will usually be very carefully

drafted to create a positive image of top management.

Operations review -- Since the annual report is one of the best opportunities for a

co-op has to address its members, this section can contain more specifics about

operations for the year: openings, closings, commodity level sales information,

new products and services, etc.

Financial summary --This is usually a one-page narrative of financial results,

financing activities, credit info, etc.

Graphs, charts, tables -- Visuals will often be used to convey high-level multi-year

financial information – Sales, EBITDA, Total Assets, Financial Ratios or Loan

Covenant information – to make it easier for non-accountants to understand.