Buying Out Contracts
Due to the reduced production from the hot and dry conditions, producers are concerned about being able to fulfill their commitments on forward contracts. In those situations where producers will not have enough production to meet their forward contract requirements, the cost of having to buy-out the shortfall with the grain company can be included in a producer’s AgriStability expenses.
For the expense of buying-out the contract to be considered allowable, it will need to be reasonable for the farm. The forward contract would have to be for a commodity and production amount reasonably produced by the farm.
A contract buyout can vary from company to company, but in most cases, it is the difference between the amount the producer committed to deliver, and the actual amount they must meet for the commitments of the forward contract. In some cases, there can be a penalty applied to buying out a contract and covering the increase in the price of the crop for the amount the producer is unable to deliver. These buy out costs are directly related to the cost the grain company has, to either replace the contracted grain it expected to receive from the producer or the cost to buy itself out of its future position and an administrative fee. Some grain companies are allowing some producers to defer their contract to the next crop year.
Examples of a Contract Buy-Out
The producer had a forward contract for 100 tonnes at a price of $500 per tonne. The producer only grows 50 tonnes and is short 50 tonnes to meet the commitment of their forward contract. The current price for the grain is $850 per tonne. The elevator company is also charging a $30 per tonne administration cost for buying out contracts.
To calculate the amount AgriStability will cover when the producer buys out the contract, the shortfall the producer has to cover to fulfill the contract and the expense associated with covering the shortfall will need to be identified.
- The producer is short 50 tonnes and must cover the shortfall at the original contracted price (50 tonnes x $500 = $25,000).
- The producer must also cover the price difference between the contracted price and the current values which is $350/tonne ($850-$500) (50 x $350 = $17,500).
- The producer pays the administration penalty ($30 x 50 tonnes = $1,500)
- Total cost to buy out the contract is $44,000 ($25,000 + $17,500 + $1,500)
The producer would still receive income for the 50 tonnes they are able to deliver at the contracted price = 50 x $500 = $25,000.
The $44,000 total buyout cost is the allowable expense for AgriStability. The $25,000 of income for the grain that was delivered would be considered allowable income.
Example of purchasing grain to fulfill a forward contract:
The producer had a forward contract for 100 tonnes at a price of $500 per tonne. The producer only grows 50 tonnes and is short 50 tonnes to meet the commitment of their forward contract. The producer decides to purchase grain from a neighbor to fulfil the forward contract.
To calculate the amount AgriStability will cover when the producer buys grain to fulfil the contract, the shortfall the producer has to fulfill the contract and the income and expenses associated with buying grain to cover their contract shortfall will need to be identified.
Producer is short 50 tonnes. They purchase the neighbour’s grain at current price of $850 per tonne = 50 x $850 = $42,500. The producer delivers the 100 tonnes at the contracted price of $500 per tonne and receives payment = 100 x $500 = $50,000
The $50,000 income from the forward contract is allowable income and the $42,500 expense to buy grain from the neighbour is an allowable expense for AgriStability.
In some cases, delivery on forward contracts may be deferred to the following year. For AgriStability, producers will be required to report the inventory they have on hand at the end of the fiscal year. Producers can use the contracted price to value that inventory; however, SCIC will require documentation to verify the price and tonnage which is contracted and will need the final contract information to show how the contract was fulfilled (or bought out) to accurately allocate the income and expense from the transaction.