Accounting Case, homework help

  

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COW-CALF OPERATIONS
The cow-calf segment is the foundation of the beef cattle industry. A ranch maintains
a herd of cows, each of them expected to wean a calf once a year. Like a human, the
gestation period of a cow is approximately nine months. After birth, the cow nurses
the calf for another six or seven months until the calf is weaned from its mother’s
milk. During this time, the cow enters estrus, is impregnated, and the cycle begins
again. Thus, once a farm reaches a steady state of operations, a cow can produce a calf
each year. There were more than 750,000 cow-calf operations in the United States in
2007, the vast majority of them with fewer than 50 cows. Cow-calf operators sell their
weaned calves to a stocker operator or to a feedlot, where the calves are fattened
before being sent to a packinghouse. The end products are the various fresh beef
products such as steaks, roasts and hamburgers that are consumed by millions of
people around the world. Revenues and expenses for a cow-calf operation typically
are presented on a per cow basis, as shown for Old Mule Farms in Exhibit 2.
REVENUES
As a rule, cows produce one calf per year. Female calves are called heifers. Most male
calves are castrated and are called steers; those that are not castrated becomebulls and
may be sold or used for future breeding. Weaned heifer and steer calves are sold at
prices expressed as dollars per hundredweight (cwt), which is equivalent to dollars per
100 pounds (lbs). Thus, the sale price per pound can be determined by dividing the
cwt price by 100. The average weaning weight of calves at Old Mule Farms in 2008
was 602.6 pounds. Weaned calves sold at an average price of $108 per cwt, as shown
in Exhibit 3. Prices generally follow a cyclical pattern: high prices attract producers to
raise morecalves, but supply usually grows faster than demand does, leading to lower
market prices and producers dropping out of the market. Prices in 2008 were down
compared to prices in 2007, causing a decline in revenue.
EXPENSES
The major expense associated with cow-calf operations is feeding the cow. A healthy
cow requires a variety of forage (primarily grazed grasses), nutritional supplements
and minerals so that she remains healthy and produces a healthy, marketable calf.
Other expenses include veterinary fees and wages for labor, and the expenses of
owning and operating the farm. Subtracting per cow expenses from per cow revenues
yields the profit or loss per cow in the cow-calf operation. Exhibit 2 shows that Old
Mule Farms lost $72.51 per cow on its cow-calf operations in 2008.
HISTORY OF OLD MULE FARMS
Old Mule Farms was established in the 1930s by George Shadle, Donna’s grandfather,
and had been in the family for more than seventy years. Although the farm was only
marginally profitable during the Depression, profits increased in the 1950s and 1960s
as world demand for beef increased. Donna and Jim Green had the misfortune of
taking over the farm in the 1980s at a time when calf prices were in a cyclical decline.
At the same time, costs of forage increased. With output prices falling and input costs
increasing, profits began to decline and became losses around the turn of the century.
In the face of the squeeze on profits, Donna was forced to sell some of the land
inherited from her father to generate funds to cover the farm’s operation. Old
MuleFarms then rented pasturage from adjacent farms to feed the cows during the
eight months per year they were turned out to pasture. Donna also did what most other
cow-calf operators had done: she focused on producing heavier calves at weaning,
which generated more revenue when they were sold. When breeding cows, Donna
selected sires based on their ability to produce faster growing calves. Because faster
growthis positively correlated with mature weight and because breeding females came
from these same sires, over the years the mature weight of the Old Mule herd had
increased substantially. Donna’s experience was part of a national trend that saw
average mature cow weights increase to 1350 pounds in 2005 from 1050 pounds in
1975.
Donna had taken other measures to improve efficiency at Old Mule. She gave cows
and calves minerals and dietary supplements to maintainhealth and productivity. She
matched the herd’s forage needs with the grass growth cycle in the pastures so that the
cows obtained the best possible nutrients at the appropriate time in the breeding cycle.
She also incorporated legumes into the pastures and rotated the herd between pastures.
Although these steps increased efficiency, they did not stem the losses at Old Mule.
ATTENTION TO COW SIZE
One day during the winter of 2007, Donna was cutting a round bale of hay to feed the
herd when a thought occurred to her: some of the cows were bigger than others. There
might be a relation between the weight of the cow and the weight of the calf it
produced. Was it possible that a larger calf was not “worth” what it took to support a
larger cow? Because of this idea, she decided to use 2008 to measure the weight of
each cow and the weaning weight of each calf it produced. Perhaps if she had
numbers, she might be able to analyze the question of appropriate cow size and
manage accordingly.
Donna divided the herd into five weight groups. By coincidence, the 50 head fell into
groups of ten around each weight group. The lightest group of cows averaged 1000
pounds, while the heaviest group averaged 1400 pounds. She prepared a table
summarizing the average weaning weight of the calves produced by the cows in each
weight group (see Exhibit 4).
One night a few months later, Donna and Jim were watching The Cattle Show on
RFDtv, which featured a discussion about cow size. Donna wrote down several points
that she thought might be important:
1.We expect a cow to wean a calf close to 50 per cent of her mature weight every 365
days.
2.A key driver of direct costs is the mature weight of the cow. The heavier the cow,
the higher the forage, supplement and mineral costs she incurs.
3.Experiments at agricultural extension services had recently shown that, on a yearly
basis, a heavier cow consumes 547.5 pounds of additional dry matter, 13.56 pounds of
additional supplements, and 7.29 pounds of additional minerals for each 100 pounds
of additional weight.
Over the next few weeks, Donna and Jim discussed the implications of what they
learned from The Cattle Show. One point they were not certain about was the amount
of dry matter that their cows consumed. Because cows were in pasture for a portion of
the year, it was not possible to determine precisely the quantity of grass they
consumed. However, Donna found that it was possible to estimate the amount of dry
matter that would be equivalent to a number of acres of pasture. (Dry matter is feed,
such as hay, without water. Because grasses consumed in pasture contain water, the
weight of hay from pasture must be adjusted to remove the weight of the water. The
result is dry matter equivalent. A round bale of dried hay is used to feed cattle during
the periods when they cannot be fed sufficiently on pasture.) Donna recorded
theamounts of dry matter (see Exhibit 5) and supplements and minerals (see Exhibit
6) consumed by each of the weight classes during the year.
Donna and Jim also visited their accountant to find out what the terms driver and
direct cost meant. Their accountant explained to them that driversare the forces that
determine revenues and expenses in the cow-calf operation. Direct costsare expenses
that can be attributed to a specific driver, such as the number of cows or the weight of
a cow. Thus, labor was a direct cost that was determined by the number of cows,
which was the driver for that expense.
According to the accountant, the driver for expenses is the number of cows.
Consequently, financial statements such as Exhibit 2 are prepared by allocating
expenses on a per cow basis. However, this interpretation did not make sense to the
Greens because it did not include Donna’s observation about cow size, which was
mentioned as an absolutely critical driver on The Cattle Show. Donna and Jim
wondered if it was possible to reconcile their observation about weight with the per
cow financial statement.
THE DECISION
Now Donna and Jim were seated at the dinner table, discussing numerous issues:
What was the appropriate cow size for their herd?
Which approach best measured the appropriate size: weaning a calf thatis 50 per cent
of the mother’s weight, or comparing the value of a calf to the cost of maintaining the
cow?
What were the drivers in a cow-calf operation? Is the revenue-expense calculation
(see Exhibit 2) clear regarding drivers?
Exhibit 1
Income Statement 2007 and 2008
2007
Revenues
34,046.90
Variable expenses
27,345.00
Contribution margin
6,709.90
Fixed expenses
Net income(5,170.45)
11,872.35
(3,625.69)
2008
32,540.40
24,859.09
7,681.31
11,307.00
Exhibit 2
Revenues and Expenses per Cow, 2008 (US$)
Revenues per cow per year
Sales of calves
650.81
Costs per cow per year
Pasturage rental
Dry matter
Supplements
Minerals
Breeding
Labor
Veterinary
Marketing
Utilities & machinery
Repairs
Legal & accounting
Miscellaneous
Depreciation on facilities
Interest on equipment
Insurance
94.40
174.76
48.60
39.42
60.00
55.00
25.00
15.91
90.32
8.00
27.97
6.00
8.48
37.41
32.05
723.32
Net revenue per cow per year
-72.51
Exhibit 4
Calf Weaning Weights as Per Cent of Cow Weights
Average cow weight (lbs)
1000
1100
1200
1300
1400
Average calf
Calf weaning weight
weaning weight (lbs) as Per cent of cow weight
585
611
617
611
589
58.5%
55.5%
51.4%
47.0%
42.1%
Exhibit 5
Annual Dry Matter (DM) Cost Per Cow US$
Cow weight Daily DM Annual DM
intake (lbs) intake (lbs)
Dry Matter (DM) cost
grazing, 2/3
hay, 1/3
Total DM
@ $0.01/lb
@ $0.04/lb cost (US$)
1000
21.0
7,665
51.36
101.18
152.53
1100
22.6
8,249
55.27
108.89
164.16
1200
24.1
8,797
58.94
116.11
175.05
1300
25.6
9,344
62.60
123.34
185.95
1400
27.0
9,855
66.03
130.09
196.11
Exhibit 6
Annual Supplements Minerals Cost Per Cow, US$
Cow weight
1000
1100
1200
1300
1400
Supplements
40.50
44.55
48.60
52.65
56.70
Minerals
32.85
36.14
39.42
42.71
45.99
Total
73.35
80.69
88.02
95.36
102.69
After reading the case, prepare a 2-4 page written response to answer the following questions:
1. What is the appropriate cow size for the herd using the 50% weaning rule?
2. Compare the value of a calf to the cost of maintaining the cow as an alternative means of
determining appropriate cow size. Hint: Calculate marginal revenue and marginal
expense. Which method (50% weaning rule or marginal analysis) do you think provides
the best measure? Why?
3. What are the drivers in a cow-calf operation? Is the revenue-expense calculation (see
Exhibit 2) clear regarding drivers? Why or why not?
4. How would you change the detailed statement of revenues and costs so that it provides
information that would help Green make her decision?
5. To what extent is the Greens’ confusion a result of the failure of the accounting system?
6. How would the results of Old Mule Farms’ operations change if revenues or expenses
were allocated in a different manner?
Note: Be sure that you specifically answer the questions in your response. For example, in #3,
be sure to identify whether or not you believe the revenue-expense calculation is clear and then
explain why or why not.

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