A board’s choice must take into account the business units of the cooperative. Consider a cooperative that has one line of business, which is buying milk from its members and manufacturing it into liquid milk and some butter or cheese products for consumer consumption. Member are vertically aligned with the cooperative in one way through milk from their cows. The cooperative is using one raw material product, milk, to create several types of products. As such, it is reasonable to assume that the cooperative agrees to pool all of the income derived from the sale of these products into one patronage pool. All dairy producers share equally, despite the fact that milk from different members might have different end uses. This is equitable from the members’ perspective because the overall operation of the plant has similar costs of processing the raw material product into different end uses. Each member thus participates equally because of the similar costs of manufacturing the milk into processed products.
The physical unit of raw material, pounds of milk, is easy to measure, and the cooperative would link the patronage refund with the quantity of milk each member sold to the cooperative.
Many cooperatives have just one line of business and it is relatively easy to treat each member equitably by pooling income from all products into one patronage pool and, thus, into one level of allocation. Some cooperatives, however, particularly in the farm supply business, have multiple lines of business including supply of products such as crop nutrients, crop protectants, animal nutrition, refined fuels and related energy products, and various services associated with agronomy, grain and oilseeds, and energy.
Each of these products and services has differing costs and net margins, and there are different risk profiles associated with each product based on the tools available to the cooperative. In addition, not every member needs or purchases all of these products and services, and many supply cooperatives also market a members’ feed grains and oilseeds. It thus makes sense to create multiple patronage pools in order to be equitable with each member in allocating income from that line of business to the member
In this example, the physical units are different. Crop nutrients are sold and measured in tons, crop protectants and refined fuels are measured in gallons or liters, and grain and oilseeds might be measured in bushels or tons. Furthermore, services are often bundled with the sale of the product. A cooperative might have one price for nitrogen fertilizer and application services and a different price for the purchase of that fertilizer alone. All of these products likely have different costs and different net margins per physical unit, and there is likely sharing of variable costs such as labor and fixed costs such as management. A members’ participation in the benefits from each product may thus be difficult to determine. Some products may not have physical units such as a farm equipment tires or credit (in the case of a financial services cooperative). In such a case, the board would typically create a patronage pool based on total value rather than physical units, and patronage allocated to the member could be linked with the members’ proportion of the total value of these types of products. The board may elect to allocate some of the income derived from members’ patronage into unallocated equity. In doing so, the cooperative must pay corporate taxes on that income. This choice is not common, but may be used if the board decides it needs that equity on its balance sheet.
In summary, the board of directors, based on input from management, makes a decision on the distribution of income. In doing so, it has several choices on handling patronage-sourced and non-patronage sourced income. Virtually all cooperatives choose to pay corporate taxes on the non-patronage sourced income and retain it as unallocated equity. On patronage-sourced income, the board decides how many patronage pools to operate and how to distribute income from those pools to members. These choices can be thought of as dividing the income into corporate taxes, patronage refunds, and retention as unallocated equity. The board should do what is in the best interest of the member which is to maximize the after-tax income available as patronage refunds. Operationally, what boards tend to do is retain the non-patronage sourced income as unallocated equity by paying corporate taxes upon it and distribute the patronage-sourced income as patronage refunds.