SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

12 Months Ended

Oct. 31, 2011

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

The Company owns and operates a 50 million gallon ethanol plant near Heron Lake, Minnesota with ethanol distribution throughout the continental United States.  In addition, the Company produces and sells distillers grains with solubles as co-products of ethanol production.  The Company was formed on April 12, 2001 to have an indefinite life. The Company converted the plant from being coal fuel to natural gas fuel in November 2011.

Principles of Consolidation

The financial statements include the accounts of Heron Lake BioEnergy, LLC and its wholly owned subsidiaries, Lakefield Farmers Elevator, LLC and HLBE Pipeline Company, LLC, collectively, the “Company.”  HLBE Pipeline Company, LLC owns 73% of Agrinatural Gas, LLC (Agrinatural); the remaining 27% is included in the consolidated financial statements as a noncontrolling interest.  All significant intercompany balances and transactions are eliminated in consolidation.

Fiscal Reporting Period

The Company’s fiscal year end for reporting financial operations is October 31.

Accounting Estimates

Management uses estimates and assumptions in preparing these financial statements in accordance with generally accepted accounting principles.  Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses.  The Company uses estimates and assumptions in accounting for significant matters including, among others, the carrying value and useful lives of property and equipment, analysis of impairment on long-lived assets, contingencies and valuation of forward purchase contract commitments and inventory.  The Company periodically reviews estimates and assumptions, and the effects of revisions are reflected in the period in which the revision is made. Actual results could differ from those estimates.

Noncontrolling Interest

Amounts recorded as noncontrolling interest relate to the net investment by an unrelated party in Agrinatural. Income and losses are allocated to the members of Agrinatural based on their respective percentage of membership units held. Agrinatural will provide natural gas to the plant with a specified price per MMBTU for an initial term of 10 years, with two renewal options for five year periods.

Revenue Recognition

Revenue from sales is recorded when title transfers to the customer, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists, and the sales price is fixed and determinable.  The title transfers when the product is loaded into the railcar or truck, the customer takes ownership and assumes risk of loss.

In accordance with the Company’s agreements for the marketing and sale of ethanol and related products, marketing fees and commissions due to the marketers are deducted from the gross sales price as earned. These fees and commissions are recorded net of revenues as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products. Shipping costs incurred by the Company in the sale of ethanol are not specifically identifiable and as a result, are recorded based on the net selling price reported to the Company from the marketer. Shipping costs incurred by the Company in the sale of ethanol related products are included in cost of goods sold.

Cash and Equivalents

The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash and equivalents.

The Company maintains its accounts at five financial institutions.  At times throughout the year, the Company’s cash balances may exceed amounts insured by the Federal Deposit Insurance Corporation and the Securities Investor Protection Corporation.  The Company does not believe it is exposed to any significant credit risk on cash and equivalents.

Restricted Cash

The Company is periodically required to maintain cash balances at its broker related to derivative instrument positions, as part of a loan agreement.

Restricted Certificates of Deposit

The Company maintains restricted certificates of deposit as part of its grain dealer’s license.

Accounts Receivable

Credit terms are extended to customers in the normal course of business.  The Company performs ongoing credit evaluations of its customers’ financial condition and, generally, requires no collateral.

Accounts receivable are recorded at estimated net realizable value.  Accounts are considered past due if payment is not made on a timely basis in accordance with the Company’s credit terms.  Accounts considered uncollectible are written off.  The Company’s estimate of the allowance for doubtful accounts is based on historical experience, its evaluation of the current status of receivables, and unusual circumstances, if any.  At October 31, 2011 and 2010, the Company was of the belief that such accounts would be collectable and thus an allowance was not considered necessary.

Inventory

Inventory consists of raw materials, work in process, finished goods, supplies, and other grain inventory.  Raw materials are stated at the lower of cost or market on a first-in, first-out (FIFO) basis.  Work in process and finished goods, which consists of ethanol and distillers grains produced, if any, is stated at the lower of average cost or market.  Other grain inventory, which consists of agricultural commodities, is valued at market value (net realizable value).  Other grain inventory is readily convertible to cash because of its commodity characteristics, widely available markets and international pricing mechanisms.  Other grain inventory is also freely traded, has quoted market prices, may be sold without significant further processing, and has predictable and insignificant disposal costs.

Derivative Instruments

From time to time, the Company enters into derivative transactions to protect gross margins from potentially adverse effects of market and price volatility in future periods.  In order to reduce the risks caused by market fluctuations, the Company hedges a portion of its anticipated corn and natural gas purchases, and ethanol sales by entering into options and futures contracts.  These contracts are used with the intention to fix the purchase price of anticipated requirements for corn and natural gas in the Company’s ethanol production activities and the related sales price of ethanol produced.  The fair value of these contracts is based on quoted prices in active exchange-traded or over-the-counter market conditions.

The Company generally does not designate these derivative instruments as hedges for accounting purposes and derivative positions are recorded on the balance sheet at their fair market value, with changes in fair value caused from marking these instruments to market, recognized in current period earnings or losses on a monthly basis.  While the Company does not designate the derivative instruments that it enters into as hedging instruments because of the administrative costs associated with the related accounting, the Company believes that the derivative instruments represent an economic hedge.

In order for a derivative to qualify as a hedge, specific criteria must be met and appropriate documentation maintained.  If the derivative does qualify as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will be either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings.  Gains and losses from derivatives that do not qualify as hedges, or are undesignated, must be recognized immediately in earnings.

The Company evaluates its contracts to determine whether the contracts are derivatives.  Certain contracts that literally meet the definition of a derivative may be exempted as “normal purchases or normal sales.”  Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business.  Certain corn, ethanol and distillers grains contracts that meet the requirement of normal purchases or sales are documented as normal and exempted from the accounting and reporting requirements, and therefore, are not marked to market in our financial statements.

Other Intangibles

Other intangibles are stated at cost and include road improvements located near the plant in which the Company has a beneficial interest in but does not own the road.  The Company amortizes the assets over the economic useful life of 15 years.

Property and Equipment

Property and equipment are recorded at cost.  Depreciation is provided over an estimated useful life by use of the straight-line deprecation method.  Maintenance and repairs are expensed as incurred; major improvements and betterments are capitalized.  Construction in progress is comprised of costs related to the construction of the ethanol plant facilities.  Interest is capitalized during the construction period.  Depreciable useful lives are as follows:

Land improvements	15 Years
Plant building and equipment	7 - 40 Years
Vehicles and equipment	5 - 7 Years
Office buildings and equipment	3 - 40 Years

The Company has construction in progress at October 31, 2011 of approximately $4,133,000 related to the construction of the natural gas equipment and connection to the plant.  The construction was completed in fiscal 2012 related to the conversion from coal.  The Company had approximately $500,000 remaining on construction in progress at October 31, 2011.

Long-Lived Assets

The Company reviews property and equipment and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  Circumstances which could trigger a review include, but are not limited to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition of construction of the asset; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the assets; and current expectation that the asset will more likely than not be sold or disposed significantly before the end of its estimated useful life.  If circumstances require a long-lived asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset. If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.

The Company’s ethanol production facilities, has an installed capacity of 50 million gallons per year.  The carrying value of these facilities at October 31, 2011 was approximately $88.6 million. In accordance with the Company’s policy for evaluating impairment of long-lived assets described above, management has evaluated the recoverability of the facilities based on projected future cash flows from operations over the facilities’ estimated useful lives. Management has determined that the projected future undiscounted cash flows from operations of these facilities exceed their carrying value at October 31, 2011; therefore, no impairment loss was indicated or recognized. In determining the projected future undiscounted cash flows, the Company has made significant assumptions concerning the future viability of the ethanol industry, the future price of corn in relation to the future price of ethanol and the overall demand in relation to production and supply capacity.  Given the uncertainties in the ethanol industry, should management be required to adjust the carrying value of the facilities at some future point in time, the adjustment could be significant and could significantly impact the Company’s financial position and results of operations.  No adjustment has been made to these financial statements for this uncertainty.

Deferred Loan Costs

Costs associated with the issuance of the debt discussed in Note 9 and 10 were recorded as deferred loan costs, net of accumulated amortization.  Loan costs are amortized to operations over the term of the related debt using the effective interest method.  During fiscal 2009, the Company expensed the remaining unamortized loan costs totaling approximately $445,000 associated with this debt when it was classified as current.

Deferred Offering Costs

The Company defers the costs incurred to raise equity financing until that financing occurs. At such time that the issuance of new equity occurs, these costs will be netted against the proceeds received.

Fair Value of Financial Instruments

On November 1, 2008, the Company adopted guidance for accounting for fair value measurements of financial assets and financial liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis. On November 1, 2009, the Company adopted guidance for fair value measurement related to nonfinancial items that are recognized and disclosed at fair value in the financial statements on a nonrecurring basis. The guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements).

The three levels of the fair value hierarchy are as follows:

·Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

·     Level 2 includes:

1.Quoted prices in active markets for similar assets or liabilities.

2.Quoted prices in markets that are observable for the asset or liability either directly or indirectly, for substantially the full term of the asset or liability.

3.Inputs that derived primarily from or corroborated by observable market date by correlation or other means.

·Level 3 inputs are unobservable inputs for the asset or liability.

The level in the fair value hierarchy within which a fair measurement in its entirety falls is based on the lowest level input that is significant to the fair value measurement in its entirety.

Except for those assets and liabilities which are required by authoritative accounting guidance to be recorded at fair value in our balance sheets, the Company has elected not to record any other assets or liabilities at fair value. No events occurred during the years ended October 31, 2011 or 2010 that required adjustment to the recognized balances of assets or liabilities, which are recorded at fair value on a nonrecurring basis.

The carrying value of cash and equivalents, restricted cash, restricted certificates of deposit, accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short maturity of these instruments. The fair value of long-term debt has been estimated using discounted cash flow analysis based upon the Company’s current incremental borrowing rates for similar types of financing arrangements. The fair value of outstanding debt will fluctuate with changes in applicable interest rates. Fair value will exceed carrying value when the current market interest rate is lower than the interest rate at which the debt was originally issued. The fair value of a company’s debt is a measure of its current value under present market conditions. It does not impact the financial statements under current accounting rules. The Company believes the carrying amount of the revolving term loan and line of credit approximates the fair value.

The Company estimates the fair value of debt based on the difference between the market interest rate and the stated interest rate of the debt.  The carrying amount and the fair value of long-term debt are as follows:

	Carrying Amount		Fair Value
Long-term debt at October 31, 2011	$	51,417,525	$	51,417,525
Long-term debt at October 31, 2010	$	54,899,287	$	52,885,420

Income Taxes

The Company is treated as a partnership for federal and state income tax purposes and generally does not incur income taxes. Instead, its earnings and losses are included in the income tax returns of the members.  Therefore, no provision or liability for federal or state income taxes has been included in these financial statements.  Differences between financial statement basis of assets and tax basis of assets is related to capitalization and amortization of organization and start-up costs for tax purposes, whereas these costs are expensed for financial statement purposes. In addition, the Company uses the alternative depreciation system (ADS) for tax depreciation instead of the straight-line method that is used for book depreciation, which also causes temporary differences.  The Company’s tax year end is December 31.  Primarily due to the partnership tax status, the Company does not have any significant tax uncertainties that would require disclosure.  The Company recognizes and measures tax benefits when realization of the benefits is uncertain under a two-step approach.  The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%.  Primarily due to the Company’s tax status as a partnership, the adoption of this guidance had no material impact on the Company’s financial condition or results of operations.

The Company files income tax returns in the U.S. federal and Minnesota state jurisdictions.  The Company is no longer subject to U.S. federal and state income tax examinations by tax authorities for years before 2008.

Net Income (Loss) per Unit

Basic net income (loss) per unit is computed by dividing net income (loss) by the weighted average number of members’ units outstanding during the period.  Diluted net income or loss per unit is computed by dividing net income (loss) by the weighted average number of members’ units and members’ unit equivalents outstanding during the period. There were no member unit equivalents outstanding during the periods presented; accordingly, for all periods presented, the calculations of the Company’s basic and diluted net income (loss) per unit are the same.

Environmental Liabilities

The Company’s operations are subject to environmental laws and regulations adopted by various governmental entities in the jurisdiction in which it operates.  These laws require the Company to investigate and remediate the effects of the release or disposal of materials at its location.  Accordingly, the Company has adopted policies, practices, and procedures in the areas of pollution control, occupational health, and the production, handling, storage and use of hazardous materials to prevent material environmental or other damage, and to limit the financial liability, which could result from such events.  Environmental liabilities are recorded when the liability is probable and the costs can be reasonably estimated.

Reclassifications

The Company made reclassifications to certain fees received in the Consolidated Statement of Operations for the 2010 and 2009 to conform to classifications for 2011. The Company also made reclassifications for certain restricted cash amounts to be included with restricted certificates of deposit in the Consolidated Balance Sheet as of October 31, 2010 to conform to classifications at October 31, 2011.  These reclassifications had no effect on members’ equity or net income as previously presented.  The change related to restricted certificates of deposit increased operating cash flows by $400,000 and increased cash used in financing activities.