Determining Poultry Indemnity Values

By Stephen L. Ott, Agricultural Economist and Emergency Management Compensation Specialist, USDA's APHIS and Kirsti Bergmeier, Agricultural Economist, Disaster Assessment/Analysis Section, Agriculture and Agri-food Canada - This paper explores the process used to determine value in an industry where market prices are not always observable.
calendar icon 19 September 2005
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Determining Poultry Indemnity Values - By Stephen L. Ott, Agricultural Economist and Emergency Management Compensation Specialist, USDA's APHIS and Kirsti Bergmeier, Agricultural Economist, Disaster Assessment/Analysis Section, Agriculture and Agri-food Canada - This paper explores the process used to determine value in an industry where market prices are not always observable.

Examples and Lessons Learned from Poultry Disease Outbreaks in Canada and the United States

Avian influenza disease outbreaks in both Canada and the United States resulted in the depopulation of several million birds. Both countries have laws and regulations stating that owners will receive indemnity from the government to compensate for assets taken or destroyed. Government economists from both countries were charged with the task of determining value upon which indemnity was based.

In the United States and Canada, whenever the federal government orders the destruction of animals for the public good, the federal government through laws and regulation is required to compensate the owner at the fair market value of the animal taken1. However, the laws and regulations don’t state how the fair market value is to be arrived at; therefore, it has been left up to government economists to determine these values.

In the past, many of the animals ordered destroyed were either cattle or swine and as these animals were sold in public markets, a federal official could simply check with local livestock auctions to determine what similar quality animals were being sold for. Today livestock markets are becoming fewer with many animals going from birth to slaughter without ever having to pass through a public market system. Consequently, sometimes the first price observed is the carcass’s wholesale price and this is especially true in the highly integrated North American poultry industry.

Due to Avian Influenza outbreaks in Canada and in the United States and the subsequent depopulations of poultry flocks, economists from both federal governments were called upon to provide valuation for depopulated birds upon which the indemnity payments could be based. The first step to valuing a depopulated bird is to look for known market values for live birds. If this value cannot be found, the carcass value can be used minus processing costs to determine the live bird value.

It is only in the absence of a market price that economists must extrapolate a value that can either be based upon an Income Appraisal Approach or a Costs of Production Approach. Either method, if using the same data should give the same end value for a live bird. The purpose of this paper is to explain how an appraised fair market value can be determined theoretically in the absence of market prices and how economic theory was turned into practice within poultry disease outbreaks in the United States and Canada.

Determining Fair Market Value When Market Prices Are Unavailable

There are two basic types of commercial birds that must be evaluated during any avian disease outbreak: meat birds and breeder birds (including table egg layers). Each can be evaluated using one of two economically accepted methods, the Income Appraisal Approach or the Cost-of-Production Approach. A key to determining the market value with either method is the calculation of input costs and one way to calculate these costs is through an enterprise budget.

An enterprise budget can be created to calculate the costs for a fixed period of time i.e. one year or for some types of poultry, one production cycle. The first step in developing an enterprise budget is to determine the unit of analysis; often a single animal, a breeding set or if the animals are small, a group of animals. The second step is to determine those costs directly connected with the unit of analysis. The cost of variable inputs such as feed, fuel, and hired labor can be expressed as the purchase price (dollars) per animal unit. Fixed cash inputs such as insurance and taxes are expressed as the actual cost divided by the total animal unit(s) while costs for fixed assets i.e. land, buildings, and machinery, first have their costs annualized and then divided by the number of animals units. Fixed costs are annualized either through depreciation or annual capital recovery charges (ACRC) (Boehlje and Eidman, p 143).

ACRC is usually preferred to normal depreciation as ACRC includes a charge for the opportunity costs associated with the funds that are tied up in the asset. Finally, the enterprise budget needs to account for the opportunity costs associated with any capital invested, unpaid labor and management services provided by owner or other non-arms length family members. The capital invested should include all of the monies spent on variable and fixed cash inputs plus the value of any fixed assets2. For unpaid labor and management a wage rate should be charged that is equivalent to what the owner/manager could earn in other similar business activities.

The Cost-of-Production Approach for asset valuation is an extension of enterprise budgeting. It assumes that in the long-run, producers will not produce an item unless they can recover all costs associated with its production. Thus, the value of an item is, at a minimum, equal to all costs associated with its production. Such an evaluation system can be attractive for agricultural commodities where large supplies of the commodity in the market place can result in time periods where a commodity’s price is less than its production costs.

For meat birds, the Cost-of-Production Approach represents a viable valuation option. After a bird is hatched, it is fed and housed and as it ages it increases in value until it reaches its maximum value at slaughter, age six or seven weeks. Since with each day of life, costs are incurred, daily variable input costs and daily allocated fixed costs can be used to determine the animals’ value on a daily basis. A simpler approach is to take the total costs at slaughter and the cost of a day old chick and assume a linear relationship between the two for determining a daily value.

For breeder birds (and table egg layers) using the Cost-of-Production Approach to value a bird is only appropriate up to the beginning of lay. Like meat birds, breeder birds increase in value from a day old chick to the beginning of lay, approximately 26 weeks of age; therefore costs associated with raising the birds to beginning of lay are reflective of their value. However, once egg production starts there is a divergence between costs and value. The value of a breeder bird is a direct function of the number of fertilized eggs expected to be laid and thus expected meat bird production.

Once fertilized egg production starts the value of breeder birds begin to decline until salvage (spent) value is reached, approximately 40 weeks after egg production starts. Over this time period, costs are continuing to occur so the total cost of production is greatest at the end of lay. Consequently, with the Cost-of-Production Approach for breeder birds, only costs up to start of lay are used. Similar to meat birds, the daily or weekly value of breeder birds can be assumed to be a linear increase in value from the cost of day-old chicks to total costs at beginning of lay. Once egg laying starts, value depreciates linearly from beginning of lay to spent hen value at end of lay.

During periods of profitability, commodities will be worth more than their cost of production and producers will want government appraised fair market values to reflect this. Therefore, another way to determine fair market value is through the Income Approach. Basically, the Income Approach starts with the known market price of an item in a specific form and then subtracts production costs between the marketable form and the form desired for valuation or during an outbreak the form being destroyed. A key assumption to the Income Approach is that the market price is greater than production costs; if not then an asset could have a negative worth.

The Income Approach is especially appropriate for assets which have future income potential, such as breeder birds and milk cows. In these situations the value of the asset is equal to its income stream minus the costs associated with producing the income stream3. While such a method may seem simple, in reality it can become quite complex. Using meat birds as an example, the bird’s income stream is the price received by the processing plant for the carcass. Plant processing costs are then subtracted to obtain the live bird value, with adjustments being made for condemned/rejected birds. Production costs associated with raising the bird are subtracted to produce day-old chick value, with adjustments being made for mortality losses. Subtracting hatchery costs, with adjustments for hatchability rates, results in a value for a fertilized egg. The value of a fertilized egg can be used to determine the income stream for breeding birds.

Further complicating the valuation process using the Income Approach is the allocation of net revenue (gross revenue minus total costs). The net revenue associated with producing chicken products should be allocated among the different production and processing phases. This can be done by either using an allocation percentage provided by the poultry company or an allocation based upon a percentage of total cost that each production/processing phase represents. Allocating all net revenue to a single production/processing phase would generate a valuation that would represent an upper bound of the worth of the assets in that particular phase.

Valuation of immature breeding stock differs between the Income Approach and the Cost-of-Production Approach. With the Cost-of-Production Approach immature breeding stock have a very low value since they have few input costs. In contrast, the Income Approach calculates an income stream at beginning of reproduction (beginning of lay) and then subtracts the production costs associated with raising the breeding animal to the reproduction phase. Assuming positive net revenues, the Income Approach will result in a higher valuation for a day old animal than the Cost-of-Production Approach.

Further Information

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Source: Animal and Plant Health Inspection Service - July 2005

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