November 10, 2014
New Paint: A Look at Changes in Equipment Ownership Costs
By David Widmar
As farm incomes jumped in recent years, so did the interest in newer farm equipment. While the reasons producers update their equipment line can vary from increasing efficiency to managing taxable income, it’s important to understand how these changes may impact the underlying cost of production.
For a high-level look at changes in the machinery cost structure across agricultural operations, data from the Kansas Farm Management Association (KFMA) and the Illinois Farm Business Farm Management Association (Illinois FBFM Association) were used. Three components of machinery ownership were considered; depreciation, machinery investment, and machinery expense.
Depreciation is an expense meant to capture the deterioration of capital assets over time. Capital assets that are depreciated can include a lot of things, but machinery is probably the largest and most common depreciable asset in production agriculture.
Like other input expenses (see previous posts on seed and rents), depreciation expenses have increased substantially in the recent decade. Depreciation expenses from the Illinois FBFM Association data show that these expenses have increased substantially over the past decade, Figure 1. Depreciation expense per acre (left axis) increased from $21 per acre in 2004 and 2005 to $70 per acre by 2013. In ten years, depreciation expenses across the Association’s producers more than tripled, or increased at an annualized rate of more than 22%.
Figure 1. Depreciation Expense per acre (left axis) and as a percentage of farm revenue. Data: University of Illinois Extension; “Farm Income and Production Costs for 2014: Advance Report.”
Over the time period, commodity prices and farm revenue also increased, so it’s important that changes are considered relative to the changes in farm revenue. The line graph in Figure 1 (right axis) show deprecation as a percentage of revenue. This story is slightly less alarming, but shows the same general trend. From 2004-2008, deprecation accounted for 4-6% of revenue. From 2009-2012 depreciation jumped to 7%, or so, of revenue. The most recent data, 2013, showed that depreciation accounted for nearly 9% of revenue. So while the total depreciation expense was increasing in absolute terms, it has also increasing in relative terms and accounts for a larger slice of total farm revenue. Keep in mind that if revenues decline, the percentage of revenue claimed by this fixed expense will increase substantially.
Another way at looking at upgrades lines of agricultural equipment is by considering the investment in machinery. From the KFMA data, Figure 2 shows the machinery investment per acre from 2004-2013 (left axis).
Over the decade, the average machinery investment per acre grew at an annual rate of 8.2%, more than doubling as it increased from $125 per acre to more than $250 in 2013.
The second data shown in Figure 2 is an average asset turnover ratio for machinery. This was calculated by dividing the value of farm production by the value of machinery assets. A larger asset turnover measure is preferred as the assets are generating more production; a lower asset turnover is from assets producing less.
Since 2008, the ratio has declined after showing an initial increase. The increase was associated with the dramatic increases in commodity prices and relatively small increases in machinery investment. Now it appears that investment has caught up to the increases in the value of production and the ratio is falling. And while the turnover isn’t as low as in 2004, the recent trend has been for more assets relative to production. If value of production falls and machinery investment holds constant, the ratio will continue to fall.
A third way to look at upgraded lines of equipment is by examining machinery expense per acre*. KFMA data from 2004-2013 show the absolute expense per acre for machinery in Figure 3 (left axis).
While we noticed the machinery investment doubled over the ten years in Figure 2, we see that the machinery expense per acre increased by nearly 68%, or 5.9% annually. In the range of $50 per acre in 2003, machinery expense is now more than $80 per acre.
As machinery expense per acre has been increasing in absolute values, measured as a percentage of farm production (right axis), the costs as a percentage of farm production reveals that recent years (2007-2013) have been relatively lower cost than years before (2004-2006). Most recently, machinery expenses were 20% of the value of farm production. The driver behind this trend would be machinery expense increasing much slower than farm production in 2007, and then keeping pace since.
Pulling it all together
Producers need to keep in mind their purchases of equipment (depreciation), the level of investment they are operating (machinery investment), and overall machinery expenses. As farm revenues (and the value of farm production) decline in 2014, the strategies used to purchase and maintain their equipment lines will likely need to adjust.
Some of these metrics, such as depreciation expense, will be easier to adjust; producers will cut back on their capital purchases. Others, such as the machinery investment or machinery expense, will be much more difficult to adjust to the lower commodity price environment.
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- Langemeier and Ibendahl (2014) reported crop machinery cost for the KFMA data is “equal to the crop share of machinery repairs, gas, fuel, oil, auto expense, motor vehicle depreciation, listed property depreciation, and machinery and equipment depreciation, plus crop machine hire expense, plus an opportunity interest charge on crop machinery investment minus machine work income.”
Photo by Johnny Klemme