1. 2011 Pork Management Conference
June 16, 2011
Nashville, TN
Bron J. Scherer, CPA & Dan Sohre, Protein Sources, LLP, Mapleton, MN
2. Bron J. Scherer, CPA
◦ Partner, Protein Sources, LLP, Mapleton, MN
◦ (507) 649-1903, brons@charter.net
Dan D. Sohre
◦ Partner, Protein Sources, LLP, Mapleton, MN
◦ (507) 420-5141, dsohre@proteinsources.com
3. Background & history-our risk management
“evolution”
Accounting and Reporting Challenges
Mechanics of Risk Management Accounting
Relevance of the “Matching” Principle
Management Reporting & Interpretation
Not a “FASB/ASC” Accounting Principles Class!!
4. 2003-Our “turning point” in Risk
Management
End of “cost matrix” packer marketing
contracts
◦ Little, if any, forward thinking risk management
undertaken
◦ Simply receive physical revenues/pay physical costs
◦ May have been “ledger” balances
5. Had to become self-reliant
Commenced relationship with CIH
Our business philosophy and values in sync
CIH had substantial livestock experience (rare)
Commenced Risk Management Strategies
◦ Lean Hogs
◦ Feed inputs (Corn, SBM)
6. Began gradually
◦ Studied LH futures trading histories
◦ Historical (in percentiles)swine industry margins
◦ Numerous organizational meetings
◦ Weekly conference calls to:
Review existing positions
Consider changes in market conditions
Review affect of USDA reports
Review changes in business, production, if any
For “cooperatives”, develop methodology for “sharing” risk
management gains and losses
Established fee structure for professional services
Tested strategies on our own pigs first
7. Lack of understanding of risk management
strategies
◦ How do futures work?
◦ The effect of basis
◦ Use of futures spreads to mitigate basis risk
◦ Understanding options
Particularly costs
Opportunities
Mitigating net option premium
“Rolling” strategies at different price levels to future
periods
9. Broker Account Activity
◦ Meaningfulness of statements
◦ Regulatory reports (not much thought given to
usefulness)
◦ Transaction Reporting (monthly vs. daily)
◦ Position Reporting (lacks logical groupings)
◦ Options and futures net “P&L’s”-not GAAP
10. Cash in flow/outflow vs. “economic” results
Margin account deposits and withdrawals
Psychological burden on owner/managers
Excess/deficit cash balance in broker accounts
Investment in Option Premium
Don’t forget about the fees
Settlement of margin calls, day or days subsequent
Developing the relationship/confidence with lenders
11. Review of Daily (Broker) Statements
◦ Sort transactions by commodity, by date
◦ Summarize fees by commodity for futures
◦ P&L gains and losses
Close out futures transactions
Reverse/exercised/expired option positions
Summarize commodity transactions by type
Roll-forward each brokerage account, monthly
Utilize summary info from daily statements
Essentially treat as a “cash” account
May have reconciling items (DIT’s, period end issues)
12. Roll-forward Option Premium outstanding
◦ Option premium expended/credits
◦ Gains and losses on options reversed/liquidated
◦ Use brokerage and option premium roll-forwards
as support for monthly journal entries (first batch)
Cash flow recorded previously
Schedules of outstanding option premium
By strategy, beginning and end of month
Schedules of gains and losses, by transaction
13. We’re not done yet!
Review all realized gain and loss applicability
to current period
What’s going on with the physical activity
What was the intent of the strategy now
realized?
Determine if realized gains/losses need to be
deferred to future periods
One of the biggest obstacles to risk
management understanding…”Cash” vs.
period of physical activity
14. Adjust gains/losses for deferred items
◦ New deferred items
◦ Reversal of prior period deferred items,
now recognized
15. The "Matching" Principle
A typical hog "bear" spread
June/July Spread
Date Month Buy/Sell Price
9/15/2011 June S $85.90
July B $84.15
Spread
Differential $1.75
11/2/2011 June B $84.15 $1.75
July S $86.27 $2.12
Spread
Differential ($2.12) $3.87
June Gain/CWT = $1.75
July Gain/CWT = $2.12
Total Gain/CWT = $3.87
Deferred gain = $1,548.00 (per contract)
16. The "Matching" Principle
A typical corn-"3 way" Feed Input strategy
May 2011 Corn Contracts
Date Market Strike Put/Call Buy/Sell Price Dollars
11/1/2010 $5.96 $6.10 C B $0.61 $3,050.00
$4.80 P S ($0.11) ($550.00)
$7.80 C S ($0.20) ($1,000.00)
$0.30 $1,500.00
1/24/2011 $6.66 $4.80 P B $0.02 $100.00 ($450.00)
2/28/2011 $7.31 $6.10 C S ($1.16) ($5,800.00) ($2,750.00)
$6.50 C B $0.84 $4,200.00
3/15/2011 $6.36 $7.80 C B $0.04 $200.00 ($800.00)
4/4/2011 $7.60 $6.50 C S ($1.00) ($5,000.00) ($800.00)
($4,800.00) ($4,800.00)proof
1/24/2011Defer $450 gain to April/May
2/28/2011Defer $2,750 gain to April/May
3/15/2011Defer $800 gain to April/May
4/4/2011$800 gain recognized, transaction complete & recognized
17. Executive Summary-Monthly
◦ Balance Sheet Items (Financial Position)
◦ P&L Activity-
Fees
Futures
Options
Other costs
Schedule of all deferred gains (losses)
Liquidating value from Brokerage system
18. Bank Reporting Critical
◦ Need to know that you know
◦ In concert with your Broker’s web site
◦ Margin sensitivity analysis
◦ No SPECULATION
19. Recording of unrealized gains and
losses at balance sheet date
◦ To inventories (current assets)
◦ To equity section
20. Mark To Market Adjustment
Close Unrealized Mark to
Date Month Buy/Sell Contracts Sale Price Price Gain/(loss) Market
12/31/201
0 June Sell 1 $93.05 $93.05 $0.00 $0.00
1/31/2011 June $93.05 $100.95 ($3,160.00) $3,160.00
2/28/2011 June $93.05 $100.20 ($2,860.00) $2,860.00
3/31/2011 June $93.05 $103.87 ($4,328.00) $4,328.00
4/29/2011 June $93.05 $95.22 ($868.00) $868.00
Unrealized gain or loss will be exactly offset by the mark to market adjustment unless there
has been a change in basis.