Questi on on Machinery costs

[MMG900]

Hi,

I've a question on figuring machinery costs for breakeven analysis.   What figures go into this?  Current value of the equipment times a percentage for depreciation?   tax depreciation numbers?

Background for my question is that I run 70s/80s vintage equipment 30 and 40 series JD tractors, 20 series combine, etc.   All paid for and depreciated.  I budget repairs separately.

One thought I had was to take 20% of the current market value of the equipment and divide by the acres to get a per acre cost to pencil in.

Thanks in advance for your thoughts,

[hardnox]

Good question.

Do you think 20% of FMV annually will keep you in business if you have to replace a major piece with somewhat less vintage stuff every other year or so?

That's just conceptual. Might not need to buy something that often but at some point it is like a sinking fund because one day it will all be in a heap.

My guess is that's a good mehcanic/operator/shopper can probably make that work.

[hardnox]

If you actually execute that, without depreciation you're going to get taxed on that.

Guess it would argue for doing something incremental mnost years.

[MMG900]

Thanks for the reply!

reply to your first question- 20% agreed may not be enough, just threw that out there, but to be honest, if something completely died, I would not replace it with something high dollar, maybe upgrade a series or two and find a well maintained used machine.  The tractors, we overhaul, fix, and keep running.  Example: We've got a 4440 with a bizillion hours but it starts when I need it, AC and radio work, all the glass is in the cab-if I sold it today, it would bring within 10% of what I paid for it in 1987- the repairs thru the years have been budgeted and expensed.  I don't have 10,000 acres to get over in a 5 day planting window, so this system works for us-certainly not everyone.

reply to question 2.  yes, I pay a chunk of income tax, but paying off land debt very agressively.  Debt principle is after tax and I don't work for JD

Still looking for an answer to my original question. 

[sw363535]

I use an accelorated replacement cost with a ten year life.. 

And that gets tough on that age of equipment.  It gets hard to find good replacements and the idea of upgrading to the 50 series if a good one can be found is part of the equation.  But more than likely being an opportunist, I would find a good replacement.  But I would still set the replacement price for cost purposes about 30 to 50% higher than expectations.

---------------

I envy your "paid for" position, but often the higher cost of maintaining  cancels out a lot of the savings from actual purchase cost of aged equipment.  That is said to emphasize -- I would set the replacement cost artificially high for breakeven analysis.  A lot of the cost of ownership gets hidden in the "repairs" column...

[MMG900]

Thanks SW- good suggestion.  I'm in agreement with your points.

I'll always be in the "used" side of the equipment market as my acreage base won't handle new equipment prices.  You make a good point about the cost of maintaining equipment, that's why I budget repairs separately.  Why this system works for me is good maintance, keeping a roof over key equipment and also starting with quality equipment- that doesn't mean colorblindness either.

After my last post I thought about the 4440 mentioned above (while I watched the Royals:)  .  I paid $18k for it in 1987 with 4000 hrs.  I estimated in round numbers I've spent another $20k in repairs over the 28 crops I've grown with it.  It's still worth close to the original $18k, so I've spent an average of $715/year in repairs-not to be confused with standard maintance like oil/filters.  I concede the problem is that the bulk of that cost came in two large bites.

My mindset on fixing used equipment versus trade up is how serviceable will the repair make the equipment and for how long vs. the risk of the unknown of another used piece of equipment.   In the case of my 4440, I'd rather invest in an overhaul versus buying another similar sized used tractor and having risk to spend big $$ on it anyway.  I guess I prefer the devil I already know.   Planter is a different discussion and would rather update periodically.

Thanks for the input- thoughts to ponder.  I'm thankful I got started farming in 1984 as it has shaped my perspectives.

[sw363535]

I came back to the farm in 1975.  We had just bought two 4430's, new in 73, they were 13,500 each as i recall.. and the neighbor retired and had bought one the same time we did.  We bought it at his sale for 15,500 in '74.  Tractor buyers were on a waiting list and his used equipment brought more than new price... We ran those a lot of hours.... The best buy for the $$ I've ever had.... Prices went up from there rapidly..  The best tractor for a long time was the 4960 fwd for our area because we are row crop and wheat combination.

Anyway, you have the key to success spelled out.  Matching out the acres, equipment and work load to the need and allowing room for reward.... 

 --------- and as you say looking back seeing what you have spent.....clears up the picture and affirms your choices.

[buckfarmer]

I had to think about this a day just to make sure I was close on my numbers. Your operation sounds a lot like mine. My equipment cost, minus repair and maintenance, are only about six percent of my total equipment value. I may be lower than some since I'm kind of diversified (grain, livestock, and timber). On the other hand repair and maintenance are high, per acre, since I can't really figure a good way to calculate how much should be attributed to things like logging and feeding cows that don't have anything to do with the number of acres farmed. Would 20% be the same as replacing all your equipment every five years. So I think my total equipment cost is about $15 per acre, mepair and maintenance about $10 of that.

[AgrifamilyBiz]

MMG900,

You bring up a question, most farmers struggle with.   I am going to limit my response to just the cost/expense of the machine you are using and assume you are picking up fuel, repairs, oil etc in other line items on your P&L. 

First - Tax depreciation is a worthless number for figuring breakevens so I'm going to set that aside.  

One method would be do take the actual change in market value on individual pieces of machinery and use that number.   If a tractor depreciates by $2,000 in a given year due to use, then that is the true cost.  That is cumbersome and can kill you when you go from years like 2013 to 2015 where many pieces of equipment dropped in real value by 30% or more.   I don't like that method.

Using a fixed % (20%) of market value of equipment that is fully paid for and previously expensed isn't quite correct either.   I see alot of bankers use this as a shortcut and it is better than nothing.     If somethign has been "expensed" over many years and fully paid for by previous crops, then you are inflating costs.   You are essentially creating a "Phantom" cost.   Unless you are setting that amount aside as reserve account for future purchases, you are not  accurately reflecting current expenses.   In your scenario with a 40 series John Deere, you are paying for that again and again and again when in reality, it has been paid for many years ago.  

The proper way to actually account for machinery costs is to take the basis/purchase cost of the machinery and write off enough every year until it is paid for or quits depreciating.  In some cases after 5 or 10 years you leave a value on the equpment it just won't ever fall below.        In a perfect world, this schedule would match or follow actual declines in market value.  Generally a separate book value depreciation schedule should be maintained and that number used for machinery costs.   Your accountant can do this for you in their software and run both tax and book/cost  depreciation schedules for you.  The advantage of having him/her do that is they will include basis from old machinery in the depreciation on new items traded for.   I've seen CPA's use schedules of 10% which stop depreciating after 5 or 7 years so the "book" value of the machinery never gets to zero for cost calculations.

If you look at some of the more advanced farm software, it handles both cost and market columns on the balnce sheet for the analysis you are talking about.

In the conversation, there was also the mention about major repairs and replacement costs.  Those are two more topics I can address if you would like further discussion.   Engine overhauls, major rebuilding of corn heads, major repairs on a planter, etc are expenses that are tricky on how to handle.  Do you expense backwards where the parts were worn out or expense going forward where you anticipate they will be worn out?

Dave

Agrifamily Consulting, Inc.

[MMG900]

Thanks Dave,

Your answer is more of a "pure" accounting answer and probably most correct, but I'm more aligned for my own operation to Buckfarmer.  I want to have enough budgeted that if I need to replace a piece of equipment in a pinch, I've got room.  If I don't spend the budget item  in a given year, the money isn't set aside, its used to do one of the following investments or a combination of extra land principle, livestock, reduced level of operating note.

As far as an engine overhaul or other major ticket item, that is in the repairs budget and figured to do one major item to something each year.  I realize that's not the book answer but prefer to stay ultra conservative.  At 20%/year that would as someone pointed out let me "rollover" my equipment line every five years and I think I'll use that number.   This year is the deepest I've got to diving into the details of the finances.

I appreciate all your thoughts- each one of you has been a help.  Stay safe this winter!