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Cooperative Auditing and Accounting - Basic Course
Cooperative Auditing and Accounting - Basic Course
Cooperative Auditing and Accounting - Basic Course
Contents
Introduction to Cooperatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
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.
A business
Owned and democratically controlled by the people who use its services
Whose benefits are distributed equitably on the basis of use
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
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
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
Business Cooperatives
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
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Financial Cooperatives
VII. Classifying Cooperatives – The ways people group cooperatives for discussion purposes
Governance System
Functions Performed
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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:
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
Members
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Directors
Officers
Employees
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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
Direct investment
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.
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:
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.
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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
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.
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
Direct investments
Carrying value
a. At cost
b. The equity method
Asset Classification
a. Long term
b. Short term
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VIII. Income statement presentation
Netted to source
Separate entry
Basis
Ownership percentage
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?
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Case Study #1
_______________
d. On or before Sept. 15 of the following year, Regional issues to Local patronage refund
income as follows:
Cash $750
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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:
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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
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.
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."
Tax-exempt cooperatives
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.
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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:
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:
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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."
______________________________________________________________________________
Cooperative Patron
Expenses
Crop $600 Crop $600
Other $300
Total $900
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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.
The patron must "consent" to include the face value of the notice in income
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
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______________________________________________________________________________
Cooperative Patron
Expenses
Crop $600 Crop $600
Other $300
Total $900
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
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
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.
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Example A. Vegepacker puts its entire $50,000 margin into a tax paid reserve.
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.
( x .15) _______________
( x .25) _______________
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Example C. Vegepacker distributes its entire $50,000 margin as nonqualified written notices of
allocation.
Year of issuance
( x .15) _______________
( x .25) _______________
Year of redemption
( x .15) _______________
( x .25) ________________
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Example C continued
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
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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
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.
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Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of
Certain Types of Regulation (on utilities, including electric co-ops)
These NSAC publications contain considerable information that meets the last test for being
considered GAAP, "Widely Recognized and Prevalent Industry Practices"
FRBC is available free to NSAC members through a link on the web site at
www.nsac.coop.
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V. Sources of Co-op GAAP
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.
b. Patronage refunds payable in cash – typically a current debt – from the date
refund is declared through payment -- generally 3-9 months.
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.
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.
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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.
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, 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.
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.
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.
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.
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