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-no. 137 

General Report No. 137 

29 _ 

October 1966 







methods and policies used in making 



by selected farmer cooperatives 






Farmer Cooperative Service 



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Historic, archived document 

Do not assume content reflects current 
scientific l<nowledge, policies, or practices. 



The Farmer Cooperative Service conducts research studies and service 
activities of assistance to farmers in connection with cooperatives en- 
gaged in marketing farm products, purchasing farm supplies, and supplying 
business services. The work of the service relates to problems of manage- 
ment, organization, policies, merchandising, product quality, costs, 
efficiency, financing, and membership. 

The Service publishes the results of such studies; confers and advises 
with officials of farmer cooperatives; and works with educational agencies, 
cooperatives, and others in the dissemination of information relating to 
cooperative principles and practices. 

Farmer Cooperative Service is indebted to the 18 regional 
associations for their cooperation in this study. The author 
is also indebted to David Volkin, Chief, Business Administra- 
tion Branch, Management Services Division, Farmer Coopera- 
tive Service, and D. Morrison Neely, Deputy Director, 
Research and Operations Division, Office of General Counsel, 
for their substantial contributions to this manuscript. 



Highlights * 

Objectives and procedures 1 

Patronage refunds defined 2 

Tax Aspects of Patronage Refunds 5 

Pooling and Elements of Patronage Refunds 6 

Fundamental factors considered 8 

Methods used in computing patronage refunds 10 

On a total business basis 11 

On a divisional basis '■^ 

On a departmental basis 

Combination of methods 

1 R 
Procedures used in distributing refunds 

Noncash refunds and patron consent ^^ 

Treatment of small refunds '■^ 

Section 521 cooperatives 

Problems encountered 

Literature cited 


Patronage refunds have long been a dis- 
tinctive trademark of cooperative business. 
Nowhere have they been used more exten- 
sively than by our Nation's farmer coopera- 
tives. Simply stated, patronage refunds are 
a basic tool for operating at cost and for 
returning savings to patrons. Such savings are 
the essence of agricultural cooperation. 

A knowledge of methods and policies used 
by cooperatives in computing and distributing 
patronage refunds is vital to our understanding 
and evaluation of their effectiveness. Little 
has been done in recent years to study 
patronage refund practices, using either the 
commodity or the functional approach. 

Officials of 18 farmer cooperatives were 
interviewed in the summer "^of 1965 as a 
preliminary step in such a cross-commodity 
or functional study. Some were officials of 
marketing associations; some, farm supply 
associations; some, a combination of both. 
All cooperatives were departmentalized to 
some extent. All were regionals; some of 
these were federated; some were centralized; 
and some were of mixed membership. 

Although methods of computing and dis- 
tributing refunds differed among 16 associa- 
tions, they all confirmed the importance of 
patronage refunds in their operations. Two 
associations, however, considered their pool- 
ing practices unrelated to patronage refunds. 

What are patronage refunds? Patronage 
refunds, also referred to as patronage divi- 
dends, are the amounts allocated to patrons 
based on their volume of business with the 
cooperative. Such allocations are made at 
the end of a fiscal year or other fixed period. 
They are net amounts left after all operating, 
overhead, and maintenance costs have been 
paid. These refunds are paid: (1) In cash; 
(2) in capital stock, revolving fund certifi- 
cates, letters of advice, and the like; or 

(3) by crediting patrons' equity accounts with- 
out giving written notices of such allocations. 

How are patronage refunds computed? Four 
major methods used by the cooperatives in 
computing patronage refunds were: (1) On 
a total business basis; (2) on a divisional 
basis; (3) on a departmental basis; and (4) a 
combination of methods. 

What determines which method or methods 
are used? Rates of patronage refunds are 
generally more representative, and thus more 
equitable, when closely related to a product 
or homogeneous grouping of products than to 
dissimilar items that may produce margins 
of greater variability. Thus, as cooperatives 
expand and diversify operations, effective com- 
putation and distribution of patronage refunds 
become more of a problem. 

On the basis of what is reasonable and 
practicable from a business standpoint, man- 
agement must decide the extent of operational 
division necessary in computing patronage 

How are patronage refunds distributed? 
Associations were more consistent in dis- 
tribution of patronage refunds than in com- 
putation of them. General methods used 
included cash payments, written notices of 
allocation, or book credits without written 

More than 70 percent of the refunds made 
by the 12 cooperatives during the period 
studied were paid in cash. (The 6 remaining 
cooperatives did not recognize patronage re- 
funds in their type of operations, incurred 
net losses, or did not distribute patronage 
refunds during the period studied.) The co- 
operatives retained about 30 percent for 
capital, although this amount was credited to 
patrons' accounts, with patrons receiving 
notices of the allocation. Common and pre- 
ferred stock accounted for about 75 percent 

of the value of noncash refunds. Letters of 
advice and certificates of various kinds made 
up the rest. Data in this report represent 
only a limited number of cooperatives and 
should not be construed as representative of 
cooperatives in general. 

Of the 16 cooperatives operating on a 
patronage refund basis, 9 qualified under 
Section 521 of the Internal Revenue Code of 
1954 for the different tax treatment. The 7 
associations which did not qualify made 
patronage refunds only to members. In com- 
puting taxable income, both types of asso- 
ciations — those which qualified under Section 
521 and those which did not — excluded quali- 
fied patronage refunds from their gross in- 

In general, to "qualify" patronage refunds 
under the Revenue Act of 1962, a form of 
"patron consent" is required. Bylaw consent 

was the favored method of cooperatives in 
obtaining patrons' consent (or agreement) to 
treat the noncash portion of their refunds as 
income received. It was used by 11 of the 12 
cooperatives. For nonmember patrons, co- 
operatives used either individual consent or 
qualified check (which represents at least 20 
percent of total refund and is endorsed or 
cashed on or before a specified date and 
imprinted that such action constitutes con- 
sent) or both. Only one association omitted 
bylaw consent altogether and used quali- 
fied check for both members and nonmem- 

What problems arise from patronage re- 
funds? Treatment of divisional and depart- 
mental losses, nonpatronage income, large 
vs. small patrons, small refunds, and de- 
preciation were some of the problems re- 





By Donald R. Davidson '" 

Management Services Division 
Business Administration Branch 

Patronage refunds have long represented 
one of the most practical means of returning 
net savings to members or to all patrons 
of a cooperative. The basic premise under- 
lying patronage refunds is to provide services 
at cost. This is a fundamental principle of 
cooperation. Patronage refunds are employed 
by most cooperatives to assure operations on 
a cost basis. Certain types of pooling and 
pricing at cost are other methods used to 
accomplish the same goal. 

Are patronage refunds as important to 
cooperatives today as they were 25 or 30 
years ago? Have patronage refund procedures 

kept pace and adapted to changing conditions 
in the agribusiness economy? What are the 
current methods and policies being used by 
the Nation's cooperatives to distribute their 
net savings? What is the effect of recent tax 
legislation which has changed the tax treat- 
ment of cooperatives and their patrons? 
Where are the trouble spots, and what can 
be done? 

These questions, of interest to most co- 
operatives, have prompted the Farmer Co- 
operative Service to study methods and policies 
now used by farmer cooperatives in making 
patronage refunds. Findings of this study will 
help in developing guidelines for cooperatives 
to evaluate and, where necessary, improve 
present patronage refund methods and prac- 


As the initial phase of this study, the 
author personally interviewed management 
officials of 18 regional ^ cooperatives in 1965. 

^ A regional cooperative is one that serves a district 
consisting of a number of counties, or a number of 
States, This includes all federated cooperatives — 
centralized associations serving more than 8 or 10 
counties — and cooperatives with large volumes that 
are neither strictly federated nor strictly centralized 
as they have both local cooperatives and individual 
farmer members. 

For more about regionals, see Statistics of Farmer 
Cooperatives (8). (Underscored numbers in paren- 
theses refer to items listed in Literature Cited, 
p. 22.) 

Several of these, cooperatives were major 
farm supply and marketing associations. 

This report is based on information ob- 
tained from these interviews. It provides 
some insight into the handling of patronage 
refunds by a small but important segment of 
the cooperative population. It does not attempt 
to answer all the questions on the subject. 
It does seek to bring into clearer focus the 
nature of the patronage refund; how the refund 
is computed; how it is distributed; and what 
problems are involved. The report also con- 
tains a preview of research now underway 
which is based on data obtained from a 40 
percent sample of all regional marketing and 

farm supply associations in the United States. 
Findings of this study will be published in a 
later report. 

The 18 regional cooperatives were selected 
on the basis of their size, type and diversity 
of operations, location, and willingness to 
supply needed data. Table 1 shows the mem- 
bership structure of the regionals used in 
the study. Large and small regionals, market- 
ing products ranging from milk and rice to 
wool and tobacco, and selling a variety of 
farm supplies, were used. 

Table 1. — Type and membership structure of the 18 
regional cooperatives interviewed, for this study, 
August 1965 


Membership structure 




Mixed 1 


Marketing . . 
Purchasing. , 
Diversified. , 



2 3 


2 1 




6 4 


^ Have both individual producers and cooperatives 
as members. 

Figure 1 shows the approximate location 
of cooperatives supplying information for this 
report and the number of individual patrons 
they served — either directly or through local 
member cooperatives. Altogether, a little 

more than 1,000,000 patrons were served 
through the 18 associations. 

The annual business volumes of the 12 
cooperatives engaged mainly in marketing 
ranged from $700,000 to $55 million with 
a median volume of $10 million. The total 
business volumes of the 4 diversified co- 
operatives studied ranged from $62 million 
to $179 million in 1965. The two purchasing 
cooperatives were large federated farm sup- 
ply associations with business volumes of 
$39 million and $122 million, respectively. 

Cooperative management officials provided 
information on: (1) Proportion of net sav- 
ings distributed as patronage refunds; 
(2) methods used in computing patronage 
refunds; (3) relationship of departmentaliza- 
tion^ to patronage refunding; (4) media used 
in allocating and distributing refunds; and 
(5) effects of recent tax legislation on patronage 
refund practices. These officials were gen- 
eral managers, assistant and office managers, 
secretary-treasurers, directors of finance, 
and controllers. 

Findings published in this report will pro- 
vide farmer members and other patrons of 
cooperatives with information that will help 
them gain a better understanding of patronage 
refunds made by cooperatives. It will enable 
cooperative management to make better de- 
cisions about patronage-refund policies. It 
should be useful also to other people inter- 
ested in the cooperative way of doing business, 
and to State and Federal researchers con- 
cerned with cooperative problems. 


The term "patronage refund" or "patronage 
dividend" is not as simple as it seems at 
first. What one association calls a patronage 
refund another may insist does not so qualify. 

A cooperative, like any other form of busi- 
ness, must operate efficiently. A cooperative 
returns any excess of "income" over "outgo" 
to the producers who contributed the patronage 

upon which the excess was based. Dr. Joseph G. 
Knapp calls such excess "group savings," 
because it represents the aggregate savings 
accruing to individual members who have 
used the association (4, p. 52). 

^ Departmentalization is the division of operations 
for accounting purposes. 

Providing services at cost is a fundamental principle of agricultural 
cooperation. Patronage refunds have long been the most practical 
way to return net savings to the farm. 


1 ■—-] fwSM 


i»ltl.iilll '" ■ * - - - 

The question is: Have patronage refunds kept pace and adapted to changing conditions in the agribusiness economy? 




• Marketing 
•^ Purchasing 
it Diversified 



Patrons 1 Cooperatives 

1= Less than 1,000 
n= 1,000-4,999 

m= 5,000-9,999 
T= 10,000-99,999 

JJZ= 100,000 and over 











Figure 1 

In a discussion of patronage refunds, Kelsey 
Gardner states: 

If there is any one basic principle in 
cooperation, it is service at cost for 
member-patrons. From it arises the 
fundamental cooperative concept of sav- 
ings as contrasted to profits in the usual 
business enterprise. Unfortunately, the 
belief of cooperators that net margins, 
allocated and distributed in accord with 
a legally-binding contractual obligation, 
are not income to the cooperative is not 
unanimously agreed to by some of these 
outside cooperatives (2, p. 6). 

What many fail to realize is that the co- 
operative has no income, in the usual sense 
of the word, because those who own the 
organization are at the same time its mem- 
bers and patrons. All financial and other 
benefits are simply shared in proportion to 
each farmer's use of available services. 
Thus patronage refunds need to be studied 
to determine and explain their true economic 
nature, not only for members, but also for 
the public in general. \ 

In the cooperative group venture, the pro- 
ducer theoretically can realize his savings 
in one of two ways. The first method is at 
point of contact with his association (time of 
purchase or delivery). This method is pos- 
sible only if costs and expenses can be figured 
exactly beforehand, which is generally not 
feasible. The second way to realize savings — 
as is most often the case — is through patronage 
refunds reflecting the producer's use of his 
association over a period of time (usually 
on an annual basis; or sometimes quarterly 
or for other fixed periods) (7, p. 253). As 
stated in Legal Phases of Farmer Coopera- 
tives^ (3, p. 220), patronage refunds "simply 
furnish a medium by which the undertaking 
of the association to operate on a cost basis, 
or as near thereto as possible, may be 
carried out." 

Since we have seen that it is not generally 
possible to figure exactly cooperative costs 
and expenses at the outset of a transaction, 
we can readily see why cooperatives have 
over the years found it advisable to charge 

the going rate or price for services offered 
or goods bought or sold. 

Patronage refunds thus are a convenient 
means of reflecting to the members the 
cooperative's savings in direct proportion 
to each member's business. They are also 
a means of conveniently helping the mem- 
ber finance his cooperative. 

In other words, savings are not always 
paid in cash. They are often retained for 
capital purposes. Evidences of ownership 
are issued as certificates or other forms 
showing that the member has a certain 
amount of accumulated savings credited to 
his name (9, p. 7). 

Tax Aspects of Patronage Refunds 

The most recent legislation which expressly 
spells out the tax treatment of cooperatives 
and their patrons is contained in the Revenue 
Act of 1962. It is effective for taxable years 
beginning after December 31, 1962. 

To be able to deduct patronage refunds 
from gross income in computing its Federal 
income tax liability, the farmer cooperative's 
patronage refunds must meet three strict 
requirements: (1) The refund must meet the 
definition of a "patronage dividend" as set 
forth in Subchapter T added to the Internal 
Revenue Code of 1954 by the Revenue Act of 
1962 (see definition below). (2) The refund 
must be paid in cash, property, or "qualified 
written notices of allocation." (3) The refund 
must be paid within 8| months following the 
close of the cooperative's fiscal year 
(5, pp. 27-29). 

Subchapter T defines a patronage dividend 
(refund) as the amount paid to a patron: 

1. On the basis of quantity or value of 
business done with or for the patron. 

2. Under an obligation which existed at the 
time the patron transacted his business 
with the organization. 

3. As determined by reference to the net 
earnings of the organization from busi- 
ness done through or for patrons 
(5, p. 11). 

The key differences between patronage re- 
funds of a cooperative and dividends of a 
corporation may be summed up briefly. In a 
cooperative, patronage refunds are not left to 
the discretion of a board of directors. Bylaws 
and other legal documents usually obligate 
the cooperative to make patronage refunds 
and outline the steps to be followed in return- 
ing to patrons that part (or all) of the net 
savings on the basis of business transacted 
with the association. 

In corporations other than cooperatives, 
stockholders have left to the board of direc- 
tors power of controlling dividend policy. The 
board determines whether dividends on stock 
should be paid, as well as the nature and the 
amount of dividends. If declared, dividends 
are distributed to the stockholders in pro- 
portion to the number of shares held by them, 
and not on the basis of business transacted 
with the corporation. While patronage refunds 
are paid from current net savings, dividends 
on stock may be paid from accumulated earn- 
ings of more than 1 year. 

A cooperative corporation returns net sav- 
ings to patrons in proportion to the amount 
of business each transacts with it. The re- 
sulting refunds are expressed in a variety 
of ways — cents per bushel, cents per hundred- 
weight, cents per pound, dollars per ton, 
percentage of sales, and so on — depending 
upon the activities engaged in by the co- 

As used in this report, the term "paLxv...-ge 
refunds (or patronage dividends)" refers to 
amounts allocated to patrons based on their 
volume of business with the cooperative. 
These allocations, made at the end of a fiscal 
year or other fixed period, represent net 
amounts remaining after meeting all operating 
overhead and maintenance costs and expenses. 
Such refunds are made in (1) cash or (2) non- 
cash forms, such as capital stock, revolving 
fund certificates, letters of advice, and 
the like, or both ways. They are also 
made by crediting patrons' equity accounts 
without giving written notices of such allo- 

Some cooperatives pay refunds at final settlement; 
others consider all payments to patrons (advances 
and final settlement) as patronage refunds. 

Pooling and Elements of 
Patronage Refunds 

To this point the definition of patronage 
refunds seems quite clear. Occasionally, how- 
ever, the issue becomes a little cloudy, when 
there is pooling. Officials of two large market- 
ing cooperatives reported that their associa- 
tions operated on a pooling basis and, there- 
fore, made no patronage refunds. These 
officials did not consider that their associations 
were participating in any form of patronage 
refund plan for the following reasons: (1) The 
associations acquired capital by making per 
unit capital retains instead of relying on 

retention of net savings, and (2) the associa- 
tions did not make per unit deductions to 
cover costs of handling or grading products, 
or to meet other operating expenses. 

Pooling, per se, however, does not preclude 
the payment of patronage refunds. For ex- 
ample, one marketing cooperative studied 
operated a pool — running simultaneously with 
its fiscal year, which ends March 31 — and 
also made patronage refunds. The organization 
did not "buy" any products from its members. 
Products were consigned to the association 
and then graded and sold on a pooled basis. 
When the grower shipped his product to the 
association, he authorized the association 
to deduct I cent a pound as a capital retain 
from his advance payment, and a per unit 
hauling and grading charge that varied with 
the size of his shipment. 

During the operation of the pool, more than 
$1 million was advanced to growers. The 
amount advanced was determined by reference 
to the market price of the products sold and 
the expected price of the unsold products. 
At the close of the pool, the cooperative re- 
funded net savings of $20,000 to growers on a 
patronage basis. The following tabulation indi- 
cates how the patronage refunds were deter- 

Pool Operating Statement for Year 
Ended March 31, 1965 

Sales $1,500,000 

Value of products marketed: 

Beginning inventory $77,000 

Advances (or payments) to 

growers i 1,400.000 

Products available for sale . 1,477,000 

Less ending inventory 47,000 

Value of products marketed 1,430,000 

Gross savings on sales 70,000 

Other operating revenue: 

Per-unit handling charges . . 100,000 
Per-unit grading charges, , . 50,000 


Gross savings on operations $220,000 

Operating expenses 200,000 

Net savings 20,000 

* Includes f>er unit capital retain certificates issued 
to growers by the cooperative. 

The tabulation shows that pooling coopera- 
tives making per unit capital retains may 
also make patronage refunds.^ In the case 
illustrated, the refunds resulted largely from 
unused per unit operating retains. What then 
of the two associations that operated pools 
and had no patronage refunds? These two 
associations said that they strictly limited per 
unit deductions to capital retains. Both made 
an advance (or advances) to patrons upon re- 
ceipt of product. At the close of their pools, 
each cooperative determined the excess of 
receipts over the sum of expenses and previous 
advances to patrons, and made a final payment 
or settlement to producers. 

The question here is: Under what circum- 
stances is a final settlement made by a pooling 
cooperative not a patronage refund? We must 
conclude tentatively that it is not a patronage 
refund if the final settlement did, in fact, 
serve to bring the farmer's payment up to or 
near the estimated "going rate or price for 
products delivered." 

Some pooling cooperatives regard all pay- 
ments (advances and final settlement) made to 
the patron as a patronage refund. This concept 
his merit in associations that pool sales 
proceeds. Such pooling of sales proceeds 
is a natural consequence when cooperatives 
guarantee a market for all products shipped 
by patrons. To provide such a market, the 
association usually sells some products at a 
much lower value than others (for example, 
in processed form rather than fresh). 

Since sales proceeds under such a marketing 
program represent a blended or pooled price 
to patrons, the market price for raw products 
at time of delivery, in many instances, is 
indeterminate. Therefore, total payments to 
patrons may be considered patronage payments 
or refunds after deducting all expenses con- 
nected with marketing and with processing 
the raw products. 

However, if the initial advance or advances 
reflected the current market value and the 
final settlement returned savings realized 
from efficient operations above current 

^ For a discussion of the essential features and tax 
treatment of capital retains, see Per-Unit Capital 
Retains (6). 

market value, such final settlement would be 
a patronage refund as here defined. At times 
the final settlement may contain elements of 
both capital retains (as evidenced by per unit 
retain certificates, fixed without reference to 
net earnings) and patronage refunds. 

For these two pooling cooperatives, did the 
advances made during their operation and 
prior to their final payment represent the 
estimated or actual market price? According 
to the bylaws of one, title passed to that 
cooperative upon receipt of product. Thus the 
advance appears to be the same as the price 
paid to the producer for the product. There- 
fore, any final settlement after operating ex- 
penses and advances have been deducted, 
seems to qualify as a patronage refund. In- 
formation obtained about the final settlement 
of the second pooling cooperative was not 

sufficient for estimating whether it repre- 
sented savings over and above the market 
value of the products delivered. 

For cooperatives that pool sales proceeds, 
we have two concepts of patronage refunds: 
(I) Where the market value of raw products 
can be determined, the final settlement is 
the patronage refund, if it returns savings 
realized from efficient operations above the 
current market value; and (2) where the 
market value of raw products is indeterminate, 
total payments received by patrons for prod- 
ucts marketed may be considered as the 
patronage refund. 

However, before we consider the problems 
encountered among the 18 associations, let us 
first discuss the fundamental factors im- 
mediately prerequisite to the computation of 
patronage refunds. 


In a study of patronage refunds, the as- 
sociation's written instruments prescribing 
distribution of savings become an important 
source of information. Not only do these writ- 
ten agreements show the cooperative's com- 
mitment regarding refunds; but they also, in 
most cases, set forth other deductions from 
net savings which affect the amount available 
for patronage refunds. 

Officials of the 18 associations were asked. 
Was allocation or distribution of patronage 
refunds provided for in a written obligation 
contained in your cooperative's organization 
papers? Fifteen replied that it was. Of the 
three cooperatives having no such written 
obligation, one was undergoing a corporate 
reorganization. The other two were marketing 
products on a pooling basis, as we have dis- 
cussed, and considered patronage refunds ir- 
relevant to their type of operations. 

Where does such a written obligation usually 
appear? All 15 cooperatives indicated that it 
is included in their bylaws. (One association 
signified its membership agreement also men- 
tioned refunds.) Typical examples of the way 

the bylaws were worded regarding refunds 

are as follows: 

Example 1. In order to induce patronage 
and to assure that this cooperative op- 
erates on a nonprofit basis for its mem- 
bers, the association is obligated to 
account for its net savings to all members 
on a patronage basis. At the end of each 
fiscal year, net savings shall be appor- 
tioned and refunded to member patrons 
in cash, revolving fund certificates, or 
by credits to their accounts in the capital 
ledger. That part of net savings derived 
from business with nonmember patrons 
shall be retained by the association as 
unallocated surplus. If the cooperative 
suffers a net loss in any year, such loss 
shall first be charged against unallocated 
surplus until it is exhausted, and then 
against the capital ledger accounts. 

Example 2. This association shall be 
operated on a nonprofit cooperative basis 
for the mutual benefit of its members and 
patrons, and all net savings or margins, 
not needed for payment of dividends on 

capital stock, or repairment of a loss, 
shall be distributed each year as patronage 
refunds. Such refunds shall be made in 
cash, certificates of ownership, capital 
stock or by crediting patrons' accounts; 
and shall be at all times the property of 
the patrons and not the property or sav- 
ings of this cooperative. 
The question was asked, "Did your asso- 
ciation show an overall net savings for your 
last fiscal year?" Fourteen of the 16 associa- 
tions paying refunds reported that they had 
a net savings. Table 2 shows total net savings 
realized by the 14 cooperatives and deductions 
made before arriving at the amount paid to 
patrons on a patronage basis. Altogether, 
three-fourths of their net savings were dis- 
tributed as patronage refunds. About 70 per- 
cent were paid in cash and 30 percent in 
noncash forms, such as capital stock and 
revolving fund certificates. Ways of distribut- 
ing refunds are covered in greater detail 
in the section "Procedures Used in Distribut- 
ing Refunds." 

Table 2. — Disposition of net savings made by 14 
cooperatives for fiscal years ending in 1964 
and 1965 




Total net margins 

or savings 



Less: Dividends 

paid on 








savings . . . 



Federal and 

State in- 

come taxes . 



Total de- 

ductions . 



Total amount paid 

to patrons on a 

patronage basis . . 



was paid as dividends on capital stock. Often 
this was capital stock that had been issued 
as patronage refunds in prior years. Un- 
allocated retained savings or "free surplus" 
accounted for 24 percent. Income taxes took 
the other 20 percent. The third deduction, 
for income taxes, resulted almost entirely 
from the other two. The net savings realized 
were not vested in members or in all patrons 
either currently or upon dissolution but were 
distributed as dividends on capital stock or 
retained as free or unallocated surplus. Thus 
they are taxable at the cooperative level. ^ 
The only patronage refunds which are taxable, 
as pointed out on page 5, are those not qualify- 
ing under existing legislation. Only one as- 
sociation reported nonqualifying patronage 
refunds and paid income tax on this amount. 

Some may ask, "Why do cooperatives retain 
any unallocated savings, if they operate at 
cost?" Several reasons account for this: 
(1) Cooperatives may follow the policy of 
paying patronage refunds to members only, 
with savings resulting from nonmember busi- 
ness retained in the cooperative for capital 
purposes. (2) Small refunds — for example, 
less than $1 — may not be returned to patrons 
because of the high cost of making such re- 
funds in relation to their value. (3) Some 
State laws may require cooperatives to main- 
tain reserves of a certain amount as additional 
security to creditors, and some cooperatives 
have construed this to mean unallocated re- 
serves. (4) Sometimes a cooperative may 
allow itself to drift away from the operation- 
at-cost principle. 

Referring to this latter situation, Gardner 

The extent to which patronage refund 
amounts may be diverted to so called free 
surplus or to higher returns on capital 
reduces the amount of financial benefits 
to be shared in proportion to the use of 
an association's services. To direct funds 

The other fourth of the net savings was 
accounted for in three ways. Fifty-six percent 

4 Net savings distributed as dividends on capital 
stock were not taxable to 5 of the associations because 
of their qualification under Section 521 of the Internal 
Revenue Code, This point is discussed further on 
p. 20 of this report. 

in this manner would conflict directly with 
the cooperative concept because its effect 
would be to bolster the investment aspects 
of an association by increasing their sig- 
nificance from the standpoint of rates of 
returns (2, p. 11). 

The 14 associations used 6 different com- 
binations of methods to distribute their net 
savings during fiscal 1964-65. Table 3 illus- 
trates the combinations of methods and per- 
centages involved. 

Two of the cooperatives had not distributed 
any net savings as patronage refunds since 
1959. Two had a policy of distributing all net 
savings as patronage refunds. Two others 
(nonstock cooperatives) distributed all mem- 
ber savings as patronage refunds, but retained 
nonmember savings as unallocated surplus on 
which income tax was paid. 

One association distributed all net savings 
(after income tax) as patronage refunds. It 
paid refunds by crediting patrons' equity ac- 
counts without giving written notices of such 
allocations. This method of paying refunds 
does not meet the "qualified written notice 
of allocation" requirement contained in Sub- 
chapter T of the Revenue Act of 1962. Thus, its 
refunds were not qualified and had to be taken 
into account in figuring taxable income, s 

Another cooperative distributed all net sav- 
ings as patronage refunds after paying divi- 
dends on capital stock. The income tax resulted 
from a small amount of refunds, placed in 
contingency reserve, on which patrons re- 
ceived no written notification. In six others, 
as shown in table 3, patronage refunds were 
paid after making the other types of distribu- 

Table 3, — Combination of methods used in distributing net savings by 14 cooperatives 

during fiscal year 1964-65 


of distribution 



Federal and 




Capital stock 


income taxes 

net savings 
































Determining net savings of each individual 
transaction would be highly impractical for 
most farmer cooperatives because of the size 
and complexity of their operations. For this 
reason, many cooperatives figure a rate of 
refund by dividing savings to be distributed 
as patronage refunds by the total volume of 
patronage — measured, generally, in either 
physical units (bushels, tons, pounds, etc.) 

or dollars. This rate is then used as the 
factor in determining the amount of each 
patron's refund. As long as all transactions 
between cooperative and patrons result in 
approximately similar savings, this method 
is an equitable one. 

® The meaning of qualified and nonqualified patronage 
refunds is discussed on p. 18 of this report. 


However, as cooperatives expand their op- 
erations — for example, when a farm supply 
cooperative adds marketing facilities, or vice 
versa, or when a dairy bargaining cooperative 
diversifies its activities to include egg mar- 
keting — the equitability of patronage refund 
distribution methods is usually improved by 
using accounting procedures that enable the 
cooperative to determine net savings on a 
divisional, departmental, or product basis. 
By using such procedures, net savings or net 
losses are obtained from as nearly homo- 
geneous a group of products as is practicable 
and reasonable from a business standpoint. 
Separate refund rates are then computed for 
distributing net savings from each operational 
unit to patrons on a patronage basis. 

Information obtained from officials of 16 
cooperatives revealed that all had subdivided 
their operations to some extent. « Twelve of 
the 16 cooperatives operated both marketing 
and farm supply divisions; the other 4 operated 
departments strictly within either marketing 
or farm supplies. 

In this study we grouped methods of com- 
puting patronage refunds into four major 
classifications: (1) On a total business basis; 
(2) on a divisional basis; (3) on a departmental 
basis; and (4) a combination of methods. 

On a Total Business Basis 

When patronage refunds are computed on a 
total business basis, one rate of refund is 
computed for net savings, regardless of types 
of products handled or the number of depart- 
ments or divisions within the association. 
This rate is determined by dividing the net 
savings to be distributed by the total dollar 
volume of business. If refunds are distributed 
to members only, the volume of member 
business is used as the basis for computing 
refunds. However, if refunds are distributed 
to members and nonmembers, then total busi- 
ness volume is the basis. 

The obvious advantages of the total business 
method of computing patronage refunds are 


As mentioned on p. 6, 2 cooperatives interviewed 
for the study did not regard patronage refunds as ap- 
plicable to their type of pooling operation. 

the simplicity with which such refunds can be 
determined, the relatively small amount of 
bookkeeping necessary, and the minimizing 
of the problem of how to handle losses be- 
tween divisions or departments. 

On the other hand, the total business method 
has obvious deficiencies. Unless patrons of 
both marketing and farm supply divisions are 
virtually the same, one rate of refund may 
reflect an inequitable distribution of savings. 
In general, refund rates would seem more 
representative, and thus more equitable, when 
closely related to a product or a homogeneous 
group of products than to dissimilar items that 
may produce margins of greater variability. 

Four of the 16 cooperatives computed pa- 
tronage refunds on the total business basis. 
These four — dealing primarily in dairy, grain, 
livestock, and wool — were all chiefly market- 
ing associations. Although they figured the 
refunds on the total business basis, all had 
divided their operations to some extent. 

Cooperative A. Cooperative A operated two 
divisions: one in wool marketing, the other a 
small supply division. Savings from each of 
these divisions were combined into one fund. 
To compute the patronage refunds, this total 
was divided by the total pounds of grease wool 
shipped by all patrons. The result was a per 
pound rate of refund. The association reasoned 
that the added expense of computing refunds 
by divisions was unnecessary in its case be- 
cause the supply sales were relatively small 
and the patrons of both divisions were sub- 
stantially the same. 

Cooperative B. When this association com- 
puted patronage refunds, its savings came 
from cattle, hog, and sheep departments and 
were combined in one fund. The association 
then divided this fund by the total commissions 
paid by all patrons, resulting in a single rate 
of refund per $ 1 of commissions (or market- 
ing charges collected). 

Cooperative C . Cooperative C had two di- 
visions, with five departments in its marketing 
division. . .butter, condensed milk, dry milk 
powder, and whole milk and cream. In the 
supply division, there was no departmentali- 
zation because of product similarity and rela- 
tively small turnover in inventory. This as- 
sociation used departmentalization in its 



As our Nation's cooperatives expand and diversify operations, computation and distribution of patronage refunds 
become more of a problem. Regionals compute refund rates either on a total business, divisional, or depart- 
mental basis, or use a combination of these methods. 

« > 


FARMER OWNfo Sl^^JKl"^^^ 

Generally, refund rates seem more equitable when closely related to a product or homo- 
geneous grouping of products. Many regional cooperatives obtain equitability by com- 
puting patronage refunds on a departmental basis. 


marketing division as a management tool to 
determine efficiency of operation, but did not 
use it in computing refunds. The association 
computed only one rate of refund in deter- 
mining the amount of patronage refund to be 
returned to each patron. This rate was based 
on the pounds of raw whole milk (both Grade A 
and manufacturing grade) marketed by the 
association for its patrons, as follows: 

Net savings = $215,700 - 
Total lbs. of 369,468,725 
raw whole milk 
marketed by 

5.838112 cents per 
rate of 

Cooperative D. This association maintained 
separate accounting for its farmer members 
(Class A) and its cooperative association 
members (Class B). Savings to be distributed 
from the marketing and retail supply business 
with Class A patrons were placed in one fund. 
The association then divided this amount by 
their total dollars of purchases and sales in 
computing the cents-per-dollar rate of refund. 
Likewise, savings from the wholesale business 
with Class B patrons were not distributed on 
a departmental basis but were combined into 
one fund. This was then divided by their total 
volume of business to determine the cents- 
per-dollar refund rate to be used in distribut- 
ing these savings to Class B members. 

The use of different rates of refund for 
different classes of members, as illustrated 
by Cooperative D, occurs not only in those 
associations using the total business method 
to compute refunds, but also in those using the 
divisional and departmental methods. Such 
a procedure improves the equitability of re- 
fund distributions when these different rates 
reflect actual differences in costs of services. 

On a Divisional Basis 

A division is a separation of operations by 
major functions such as marketing or farm 
supply. Two or more rates of refund are 
computed depending upon the number of divi- 
sions within the cooperative. 

Three of the 16 cooperatives figured their 
patronage refunds on a divisional basis. Coop- 
erative "G" was mainly a farm supply asso- 
ciation but also had a marketing division. 
Cooperative "E" was mainly a marketing 
(cottonseed) cooperative, with minor farm 
supply. The other association — Cooperative 
"F" — was about equally divided between mar- 
keting and farm supply operations. 

Cooperatives E and F. In computing pa- 
tronage refunds. Cooperatives E and F used 
essentially the same method of figuring one 
refund rate for each division based on its 
net savings and patronage. For example, in 
Cooperative E, patronage refunds came from 
two sources: Savings from handling farm 
supplies and commissions from tobacco 
marketing. Total patronage refunds in 1965 
amounted to $15,000 and were paid in cash. 
Farm supply savings counted for $9,000, and 
unused (or net) commissions from the sale of 
tobacco made up the balance. 

The cooperative used one refund rate (5 
percent of sales) to distribute the $9,000 of 
farm supply savings. Likewise, in returning 
to patrons the $6,000 saving from marketing, 
it used one rate of refund (25 percent of the 
selling charges on tobacco). As indicated by 
the single refund rate in each division, no 
further departmentalization of accounting was 
used in computing patronage refunds. The only 
product marketed was tobacco; and because of 
the relatively small supply sales, management 
considered it unnecessary to extend depart- 
mentalization to the product level. 

The question members need to realize in 
determining patronage refund policy in this 
instance is: Assuming greater equity could 
be obtained by determining net savings by prod- 
ucts, would it be worth the additional expense 
of maintaining more detailed records? 

Cooperative G . Cooperative G was pri- 
marily engaged in handling farm supplies with 
90 percent of its 1964-65 business in this 
area. Its departmentalization extended to the 
product or commodity level in the supply 
division, with a manager in charge of each 
of the six departments — feed, fertilizer, pe- 
troleum, hardware, seed, and agricultural 
chemicals. In the marketing division there 
was no departmentalization. Notwithstanding 


VVhen a single commodity is marketed, such as the livestock shown above, and returns from farm supply 
sales are small, management will often use the total business method of returning net savings to farmers. 
The expense of more departmentalized record-keeping could well outweigh any improvement in equity. 

the departmentalization of its farm supply 
division, management used the two functional 
divisions as bases for computing patronage 
refunds. According to management officials 
interviewed, net savings were figured for each 
of the six farm supply departments by allocating 
overhead costs on a sales basis. This was done 
to provide directors with a measurement of 
the performance of each of the departments. In 
the judgment of management, the association 
would have to install an expensive cost ac- 
counting system to be able to prorate true 
overhead costs to each of these departments. 
Without such a system, the association's man- 
agement believed it would not achieve greater 
equitability by figuring separate patronage 
refunds for each of the six departments. 

On a Departmental Basis 

A department is the separation of opera- 
tions within a division. For example, the farm 

supply division may have such departments 
as fertilizer, mixed feed, and petroleum. 
When refunds are figured on a departmental 
basis, a cooperative may compute one rate of 
refund for each of the departments within a 
division and the refunds are then made to the 
patrons of the respective departments. Each 
rate is arrived at by dividing the net savings 
of the department by the total business volume 
of that department. If refunds are paid only to 
members, however, nonmember business vol- 
ume is excluded when computing the refund 

There is further breakdown possible within 
a department. For example, in a single grain 
department, there may be as many sections 
as there are types of grain marketed — wheat, 
oats, corn, barley, etc. When such sections 
exist, patronage refunds may be figured on 
an intradepartmental basis by (a) computing 
separate rates of refund for each type of prod- 
uct, or (b) grouping similar products together 


and making one rate of refund. Thus a co- 
operative may compute the rate of refund 
on the basis of net savings resulting from 
either (a) or (b). As in the other methods, if 
refunds are paid only to members, nonmember 
business is excluded from total business 
volumes used in computation. 

Of the 16 associations, 6 computed their 
patronage refunds on the departmental basis. 
This was the most widely used method among 
the cooperatives interviewed. Three of these 
associations were primarily marketing; two 
had large business volumes in both marketing 
and farm supply; and one handled only farm 
supplies. Commodities handled included dairy 
products, eggs, soybeans, small grains, and 
all types of farm supplies. 

Cooperative H. Cooperative H maintained 
seven departments, organized within three 
major divisions as follows: 


1, Marketing ^=-1^ 

2. Manufacturing =:z~ 

3. Farm supply _. 
sales - 


-1. Wholesale (grain and beans) 

-2. Retail (grain and beans) 

-3. Egg 

-4. Plant food 

■5. Feed 

-6. Wholesale 

-7. Retail . , 

The cooperative determined the net results 
of each department's operations and then used 
the resulting net savings or losses as the 
basis for computing patronage refunds. Table 
4 illustrates this procedure and shows how 
departmental losses were absorbed by other 
departments with savings. The method used 
in determining the amount of loss to be ab- 
sorbed by each department with savings was 
to multiply the total loss ($12,000) by that 
department's percentage of total savings. 

For example, in table 4 the first depart- 
ment listed (wholesale farm supplies) ac- 
counted for 28 percent of total net savings 
distributed as patronage refunds. Therefore, 
it was charged with 28 percent ($3,360) of 
the total loss which resulted in a $80,640 
patronage refund paid to patrons of this 
department. Obviously no patronage refunds 
were paid by the two net loss departments. 
The manager commented that members were 
completely satisfied with this method of com- 
puting patronage refunds. It incorporates the 
essential factors that provide for equity in a 
diversified cooperative: (1) Grouping of simi- 
lar products or functions by departments; and 
(2) using the net results of these departments 
as the bases for computing refunds. 

Cooperative I. This marketing cooperative 
processed and marketed soybeans, operated 
an egg marketing department, and sold mixed 

Table 4. — Computing patronage refunds by departments, for year ended August 31, 1965 


Net savings 





Net losses 




Wholesale farm supplies . 
Retail farm supplies. . . . 
Plant food manufacturing. 
Feed manufacturing . , . , 

Egg marketing. . , 

Retail marketing 

Wholesale marketing . . . 















( 804) 











After dividends on capital stock. Federal income taxes, and unallocated retained savings. 


feeds and seeds. It maintained separate ac- 
counting for its six departments: Soybeans 
purchased; soybean meal; feed ingredients; 
mixed feed sales; seed; and eggs. It computed 
separate rates of refund for each of these 
departments, except eggs. The cooperative's 
policy was to pay patronage refunds to mem- 
bers only; because patrons selling to the egg 
department were nonmembers, the coopera- 
tive did not pay patronage refunds to these 
patrons. In the feed ingredients, mixed feed 
sales, and seed departments, it transacted 
business with other regional cooperatives 
as well as with member locals. Separate 
accounting was maintained for the business 
transacted with the locals and regionals in 
these departments. Separate rates of refund 
were computed for distribution to local co- 
operatives based on the savings resulting from 
local transactions. Separate rates of refund 
were also computed and paid to regional as- 
sociations based on the savings resulting from 
regional transactions. 

Cooperative J . Cooperative J^was a large- 
scale farm supply cooperative maintaining 3 
departments — petroleum, feed, and plant 
food — sectionized into 24 products or product 
groupings. Within each of these three depart- 
ments, net savings were determined by sec- 
tions composed of (1) a single kind of product 
(for example, paint) or (2) a group of similar 
products (for example, livestock equipment). 
As table 5 indicates, of the 24 sections within 
the 3 departments, 22 paid patronage refunds. 
The other two — protein ingredients and pot- 
ash — incurred net losses and paid no refunds. 
We did not determine how the association 
handled these losses in computing patronage 
refunds. This large regional had a net savings 
of nearly $8,000,000 in 1965. Seventy-five 
percent of this amount — $5,950,000 — was re- 
turned to its member farmer cooperatives 
as patronage refunds. Table 5 illustrates the 
elaborate system of departmentalization main- 
tained by this association and how it related 
directly to the computation of patronage 

Cooperatives K, L, and M . Cooperatives K, 
L, and M computed and distributed patronage 
refunds on a departmental basis. Their 
methods did not differ in any appreciable 

way from those explained for Cooperatives 
H, I, and J. 

Combination of Methods 

An association with two or more divisions 
may compute its refund rate on a divisional 
basis for marketing, but use a departmental 
basis for its farm supplies. Or, an association 
with both marketing and farm supply divisions 
may compute its patronage refunds on a 
departmental basis, but use a total business 
basis for distributing its nonpatronage income 
as patronage refunds. Cooperatives N, O, and 
P used various combinations of methods to 
compute patronage refunds. 

Cooperative N. Cooperative N, an asso- 
ciation with both marketing and farm supply 
divisions, allocated net savings within the 
farm supply division to each product depart- 
ment on the basis of gross margins of each 
of the products. It computed rates of refund 
for each of the products showing a savings. 
We did not determine how it handled losses. 
In the marketing division, however, it com- 
puted only one rate of refund. This was on the 
basis of a physical unit, usually bushels. 

According to the manager of Cooperative N, 
this combination of methods used in computing 
patronage refunds was the most equitable and 
practicable policy for his association because 
products marketed produced similar gross 
margins. In the farm supply division, however, 
the great variety of products handled neces- 
sitated greater departmentalization because 
of the wide range of gross margins established 
for the various products handled. 

Cooperatives O and P . Cooperatives O and 
P based patronage refunds on a departmental 
system, with one notable exception. Depart- 
mental lines were not observed necessarily 
in distributing nonpatronage income. Coopera- 
tive O, for example, derived nearly 60 percent 
of its 1964 patronage refund, $500,000, from 
incidental income or nonoperational sources 
not directly related to the association's mar- 
keting or purchasing activities. This "non- 
patronage income" came from the sale of 
stock investments and liquidation of a sub- 
sidiary. It was allocated to patrons of the 
years during which these investments were 


Table 5. — Departmentalization based on a product or grouping of similar products to obtain 
equitability in computing patronage refunds for year ended June 30, 1965 


Business volume on 
which a patronage 
refund was based 



refund ^ 





1,000 gallons 
or tons 



Gasoline , 








Burner fuels & dieselex 


L P Gas „ 

Lubricants , ,,, 




Paint , 


Appliances , 


Total petroleum department 





Mixed feed 









Complete swine feeds 


Protein ingredients 

Animal health , 


Specialty products 


Livestock equipment 


Steel products 


Total feed department 





Mixed fertilizer 














Ammonium nitrate 


Solution 41, other solutions and 30-10-0. . . . 


Rock phosphate 




Farm chemicals 


Seed „ 



Total plant food department 





Total patronage refunds 





^ Computed by dividing each section's patronage refund dollars (net savings of section after 
deductions for capital stock dividends, income taxes and unallocated retained savings) by its 
volume of business measured in dollars, gallons, or tons. 

held. Farmer cooperatives, such as this one, 
that qualify under Section 521 of the Internal 
Revenue Code, may, in addition to other de- 
ductions permitted by the Code, deduct income 
from nonpatronage sources provided the 
amounts in question are handled in accordance 
with Subchapter T. 

Equitability in the computation of such re- 
funds is required since Income Tax Regulations 
prescribe that: 

In order that the deduction for amounts 
paid with respect to income derived from 
business done with or for the United States 
or any of its agencies or from sources 


other than patronage may be applicable, it 
is necessary that the amount sought to be 
deducted be allocated on a patronage basis 
in proportion, insofar as is practicable ', 

to the amount of business done by or 
for patrons during the period to which 
such income is attributable (1, p. 36,683). 


Not only do cooperatives use different meth- 
ods in computing patronage refunds; but they 
also follow different procedures in distributing 
these refunds. Cooperatives generally dis- 
tribute patronage refunds in the form of cash, 
written notices of allocation, or book credits 
without written notification to patrons. Table 6 
indicates the different types of distribution used 
by 12 of the 18 cooperatives in paying refunds.* 

Table 6. — Media used by 12 cooperatives in paying 
patronage refunds for their last fiscal year ending 
in either 1964 or 1965 












Qualified written notices of 


Common stock 





Preferred stock . 


Letters of advice 


Certificates of various kinds. 



Book credits without written 

notice of allocation to patrons. 



Total patronage refunds . , 



^ Many authorities consider the phrase "insofar as 
is practicable" of vital importance. A tax analyst, 
associated with one of the large regional cooperatives 
included in this study, gives the following example: 
"Technically any gain realized on the sale of a truck 
held for 4 years would belong to the patrons of those 
4 years. However, the current thinking is that allo- 
cating a small amount of income (say S200) to patrons 
of 4 years would not be practical. Therefore, the $200 
can be treated as part of the net savings for the current 
years and allocated to the patrons of that year," 

8 Table 6 is based upon information received from 
12 cooperatives, since the remaining 6 cooperatives 
studied either (1) did not recognize patronage refunds 
in their type of operations, (2) incurred net losses for 
the period studied, or (3) did not distribute patronage 
refunds during the period in question. 

As indicated in table 6, the cooperatives 
paid out as cash slightly more than 70 percent 
of all patronage refunds. Such cash refunds 
were not taxable to the cooperatives but were 
taxable to patrons for the year in which they 
received them. Tne cooperatives retained 
about 30 percent of the refunds for capital. 

Table 6 further shows that all (except for 
one-tenth of 1 percent) of the noncash refunds 
were qualified written notices of allocation. 
Just what are "written notices of allocation" 
and what does "qualified" imply? 

1. Written notices of allocation are any 
capital stock, revolving fund certificates, cer- 
tificates of indebtedness, or other written 
notices, which disclose to the patron the stated 
dollar amount allocated to him by the coopera- 
tive as a patronage refund. 

2. For a written notice of allocation to be 
qualified, and therefore not taxable to the co- 
operative, 20 percent or more of the patronage 
refund must have been paid in cash with the 
patron consenting to include the noncash por- 
tion of the patronage refund in his gross in- 
come for the year in which he received such 
noncash refund. 

Common and preferred stock accounted for 
about three-fourths of the value of noncash 
refunds. Letters of advice, and certificates 
of various kinds, made up the balance. Two 
associations made patronage refunds in the 
form of book credits without written notice 
of allocation to patrons. In referring to book 
credits, one of the cooperatives used the term 
"Patrons' reserve" in the net worth section of 
its balance sheet. Only about 1 percent of its 
1964 patronage refund was allocated as book 
credits which would not be revolved to patrons 
in cash, until the reserve is liquidated at some 
future date or the association dissolves. The 
reason for allocating this reserve on a patron- 
age basis instead of retaining it as a free (or 
unallocated) reserve was to insure equitability 
in any future distribution of this amount. 


The other association distributed all of its 
1965 net savings (less income tax) in the 
form of book credits without written notices 
of allocation to patrons, as shown in the 
following tabulation: 

Total net savings for year ending, 

March 31, 1965 $ 20,746 

Less: Federal income tax 3,957 

Total patronage refunds in form of 

book credits without written notice 

of allocation to patrons 16,789 

We asked the association's manager why 
this cooperative did not qualify its refunds. 
He was positive in his belief that many of the 
patrons would not consent to include in their 
income the noncash portion of a patronage 
refund. He believed that if refunds were 
qualified the number of patrons marketing 
through this association would substantially 

Noncash Refunds and Patron 

Procedures used by 12 cooperatives in 
getting patrons' consent to include the non- 
cash portion of patronage refunds in their 
tax returns are shown in the following tabu- 

Number of 
Procedure cooperatives 

Bylaw consent \ , 11 

Individual patron's written consent. , , . . 3 
Consent by qualified check ^ 3 

Cooperative has a bylaw which provides that 
membership constitutes consent. 

2 Patron endorses and cashes, on or before a 
specified date, a check which has imprinted on it that 
such action constitutes consent, which represents at 
least 20 percent of total refund. 

Cooperatives not reporting use of these 
procedures to get patrons' consent were the 
2 pooling associations, the 3 cooperatives 
that paid all patronage refunds strictly in 
cash, and the 1 association making all pa- 
tronage refunds as book credits. Many of the 
cooperatives studied followed more than 1 

procedure. Thus the total number of coopera- 
tives in the tabulation exceeds 12 because 4 
cooperatives listed more than 1 procedure. 
Bylaw consent, of course, can be used only 
for members. For nonmember patrons, the 
cooperatives used either individual written 
consent, consent by qualified check, or both. 

The tabulation shows that 11 of the 12 as- 
sociations used bylaw consent. Usually, the 
cooperative's bylaw was worded somewhat 
as follows: 

Each person who hereafter applies for 
and is accepted to membership in this co- 
operative, and each member of this coop- 
erative on the effective date of this bylaw, 
who continues as a member after such 
date shall, by such act alone, consent that 
the amount of any distributions with re- 
spect to his patronage. . .which are made 
in written notices of allocation and which 
are received by him from the cooperative, 
will be taken into account by him at their 
stated dollar amounts. . .in the taxable year 
in which such written notices of alloca- 
tion are received by him. 

The one cooperative that did not use bylaw 
consent depended upon consent by qualified 
check for both member and nonmember pa- 
trons. One large regional used all three con- 
sent procedures. For nonmembers, one pro- 
cedure was to obtain individual written consent 
at the time of the transaction. If this was not 
possible, consent by qualified check was used 
at the time of the refund. By using all three 
methods, this regional obtained 100 percent 
agreement from patrons for the last 2 years, 
1964 and 1965. 

Treatment of Small Refunds 

Regarding the treatment of patronage re- 
funds under a certain size, the question was 
asked, "Are small refunds paid or allocated 
to patrons if less than a certain amount?" 
Nine cooperatives replied yes; seven, no. 

Of those saying no, all had adopted a policy 
of paying no refunds to patrons if the amount 
was less than $1. In one case, however, if the 
patron was a nonmember eligible for member- 
ship, the less-than-$l refund was placed in a 


"stock trust account" to be applied to the pur- 
chase of one share of $1 par value common 
stock whereby the patron automatically became 
a member patron. Management officials of 
three associations interviewed indicated that 
special treatment was given to refunds of less 
than $5. One cooperative paid refunds falling 
in this size category entirely in cash. The 
other two associations made these refunds 
solely in written notices of allocation. 

Section 521 Cooperatives 

Of the 16 cooperatives operating on a pa- 
tronage refund basis, 9 met requirements set 
forth in Section 521 of the Internal Revenue 
Code. They held "letters of exemption" from 
the Commissioner of Internal Revenue. One 
requirement for cooperatives qualified under 
Section 521 is that members and nonmembers 
be treated in the same manner in regard to 
patronage refunds. However, there was un- 
certainty among some association officials 
interviewed as to the exact meaning of this 
requirement. Some wondered what is meant 
by treatment ". . .in the same manner." One 
cooperative interpreted this requirement to 
mean that "all patrons receive the same rate 
of refund within each commodity department." 

Section 521, as amended, permits exceptions 
to the identical treatment of patrons in the 
following situations: 

1. No cash has to be paid as patronage re- 
funds to patrons who do not consent to 
include noncash refunds in their own tax 

2. Refunds between $1 and $5 may be paid 
solely in written notices of allocation. 

3. Refunds of less than $1 need not be paid 
at all. The cooperative pays taxes on 
these amounts so retained. 

4. Smaller amounts of dividends or interest 
may be paid on nonqualified allocations 
to nonconsenters than is paid on qualified 
allocations to consenters. 

Seven associations did not meet Section 521 
requirements. These cooperatives followed a 
policy of making patronage refunds only to 
members. They did not maintain patronage 
records for nonmember business. In such 
cooperatives, members benefit from savings 
resulting from transactions with nonmembers. 
The unallocated reserves also absorb losses 
from this type of business when they occur. 

In computing taxable income, both types of 
associations — those which qualify under Sec- 
tion 521 and those which do not — may exclude 
qualified patronage refunds from gross income. 
Major differences are: (1) Cooperatives qual-' 
ifying under Section 521 may deduct dividends 
paid on capital stock. Other cooperatives may 
not deduct these dividends. (2) Cooperatives 
qualifying under Section 521 may deduct non- 
patronage income allocated to patrons; other 
cooperatives may not. 


Cooperative management officials were 
asked to list problems. Most of the problems 
reported related either directly or indirectly 
to matters of equitability. Problems ranged 
from handling divisional and departmental 
losses to recording and distributing small 
refunds. Among these 18 regionals we found 
misunderstanding resulting from a lack of 
generally accepted definitions of such terms 
as "nonpatronage income," "patronage re- 
fund," "final settlement," and "net savings." 

Treatment of divisional and departmental 
losses were listed by five associations as 
areas needing further research if cooperatives 
are to develop the most effective patronage 
refund policies. Some of the decisions facing 
these associations were: How do we treat a 
loss in our marketing division when the pur- 
chasing division operated at a margin? Should 
margins from farm supply absorb marketing 
losses? Is such action equitable if patrons of 
both divisions are virtually the same? If they 


are not? Is it more equitable to incorporate 
separately the various divisions of a co- 

In a similar vein, questions of equity arise 
when the loss of one department is charged 
against the earnings of another department 
within the same division. Does this unfairly 
subsidize the operations of certain patrons? 
Should the loss be collected directly from 
patrons of the department incurring it? 

How to handle nonpatronage income was 
given as another area of concern. If certain 
property owned by the association is sold, 
how should this nonpatronage income be dis- 
tributed; As patronage refunds on the basis 
of current patronage? Or as patronage refunds 
over an extended period? 

The treatment of the large vs. the small 
patron again brought up questions of equita- 
bility vs. equality. Are quantity discounts to 
large producers equitable? If discounts are 
too large or too small, are certain patrons 
subsidizing others? 

The problem of recording and distributing 
small patronage refunds was offering a real 
challenge to many associations at the local 
level. Here the question of equal treatment 
of all types of patrons had to be weighed 
against the problem of keeping costly and 
time-consuming records. 

Other problem areas included determining 
proper rates of depreciation and handling 
noncash refunds. Can accelerated deprecia- 
tion rates — that is, writing an asset off in 
10 years when it may have an estimated life 
of 15 or 20 years — be justified? Should pa- 
trons who do not agree to include noncash 
refunds as income (nonconsenting patrons) 
be treated the same as consenting patrons? 

^* ^^ ^ ^ ^ ^ ^ ^ ^ 

Patronage refunds are widely accepted by 
patrons as a measure of cooperative success. 
There is, however, a growing complexity in 
patronage refund procedures — stemming from 
expansion and diversification of cooperative 
activities — which presents possibilities for 
misunderstanding unless members are fully 
informed. Thus, through the patronage refund 
system, cooperatives have an excellent edu- 





Cl^Gs B coiEnon stock 

-icralvlng fund certi:ficates 









Enlightened cooperative management will take time 
to explain how patronage refunds are computed and 
distributed. Members and other patrons leave with 
a much better knowledge of how their association 

cational vehicle for explaining their operating 
methods and policies to members and patrons. 

This report is the forerunner of more ex- 
tensive FCS research into methods and pro- 
cedures farmer cooperatives use in making 
patronage refunds. Its purpose is to supply 
information and insight into current policies 
followed by cooperatives in distributing net 
savings to patrons on a patronage basis. In 
examining these patronage refund policies 
and procedures, this preliminary report has 
raised many questions. It has attempted to 
achieve a workable definition of patronage 
refunds meaningful to both marketing and 
farm supply cooperatives. 

It has also considered briefly the agree- 
ments setting forth refund obligations, other 
deductions from net savings that take pre- 
cedence over patronage refunds, how such 


refunds are figured, and the importance of As a result of this report and data obtained 

division of operations in achieving equity in from mail questionnaires, FCS will evaluate 

refund computation and distribution. This re- further the equitability of present patronage 

port, in addition, has touched on the various refund methods and procedures and will make 

problems about patronage refunds which con- recommendations for improvement where nec- 

cerned the cooperative officials interviewed. essary. 


(1) Commerce Clearing House, Inc. 

1965. Income Tax Regulations. Final and Proposed Under Internal Revenue Code. Vol. 2. 

Washington, D.C. Aug. 

(2) Gardner, Kelsey B. 

1963. What Are Patronage Refunds? U.S. Farmer Cooperative Serv., Inform 34. Feb. 

(3) Hulbert, L. S. 

1958. Legal Phases of Farmer Cooperatives. Revised and extended by Raymond J. 
Mischler. U.S. Farmer Cooperative Serv., FCS Bui. 10. Jan. 

(4) Knapp, Joseph G. 

1963. Farmers in Business. Amer. Inst. Coop., Washington, D.C. 

(5) Mischler, Raymond J., and Volkin, David. 

1962. How the Revenue Act of 1962 Affects Farmer Cooperatives. U.S. Farmer Coopera- 
tive Serv., Gen. Rpt. 105. Oct. 

(6) Neely, D. Morrison, and Volkin, David. 

1966. Per-Unit Capital Retains — Tax Treatmentby Cooperatives and Patrons. U.S. Farmer 

Cooperative Serv., Inform 51. Jan. 

(7) Packel, Israel. 

1956. The Law of Cooperatives. 3d ed. Matthew Bender and Co., Inc., N.Y. 

(8) Swanson, Bruce L. 

1965. Statistics of Farmer Cooperatives. U.S. Farmer Cooperative Serv., Gen. Rpt. 
128. July. 

(9) U.S. Farmer Cooperative Service. 

1958. Three Principles of Agricultural Cooperation. U.S. Farmer Cooperative Serv., Ed. 
Cir. 13. Nov. 





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Farmer Cooperatives in the United States, FCS Bulletin 1. 

Managing Farmer Cooperatives, Educational Circular 17. Kelsey B. Gardner. 

Improving Management of Farmer Cooperatives, General Report 120. Milton L. Manuel. 

Financial Structure of Regional Farmer Cooperatives, General Report 133. Nelda Griffin. 

Financial Structure of Regional Farm Supply Cooperatives, General Report 124. Nelda 

Per-Unlt Capital Retains — Tax Treatment by Cooperatives and Patrons, Information 51. 
D. Morrison Neely and David Volkin. 

How the Revenue Act of 1962 Affects Farmer Cooperatives, General Report 105. Ray- 
mond J. Mischler and David Volkin. 

Handling Net Margins Under the New Tax Law, Information 39. Raymond J. Mischler. 

Revolving Fund Method of Financing Farmer Cooperatives, General Report 41. Helim H. 
Hulbert, Nelda Griffin, and Kelsey B. Gardner. 

How Adjustable Revolving Fund Capital Plan Works, General Report 111. Nelda Griffin. 

Methods of Financing Farmer Cooperatives, General Report 32. Helim H. Hulbert, 
Nelda Griffin, and Kelsey B. Gardner. 

Sample Legal Documents for New Cooperatives, Educational Circular 19. 

A copy of each of these publications may be obtained upon request while a supply is 
available from — 

Farmer Cooperative Service 

U.S. Department of Agriculture 

Washington, D.C. 20250