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«JOINT COSTS, GENERAL FARM OVERHEAD, AND RIGHTS TO PRODUCE JOINT COSTS Definitions Joint production costs have been defined in the economic literature ...»

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CHAPTER 9

JOINT COSTS, GENERAL FARM OVERHEAD,

AND RIGHTS TO PRODUCE

JOINT COSTS

Definitions

Joint production costs have been defined in the economic literature as costs that "are incurred on

groups of products rather than on individual and separate ones” (Hopkins and Taylor: 404). At least three different situations give rise to joint costs. These include (1) expenses incurred in the production of joint products (defined as technically interdependent commodities arising from a joint technology), (2) expenses for inputs that affect the production of more than one enterprise (independent but organizationally related commodities) even if the production technologies are non-joint, and (3) outlays for production inputs that are either purchased for the farm as a whole or are used for the entire set of production activities undertaken by the farm. The second category is best exemplified by the allocation of capital inputs (and/or their services) or fixed expendable inputs to different enterprises. For example, the total amount of fertilizer applied by the firm is usually divided among several different crops. Or the total number of tractor hours is divided between crop and livestock operations. The third category is usually referred to as general farm or business overhead and typically includes items for which it is difficult or impossible to determine the impact of the input on either output or cost for a specific enterprise. For example, it is difficult to determine the impact of buying a new set of Allen wrenches on the average corn yield per acre or the impact of attending pesticide applicator training on cucumber gross returns. Each of the three situations may give rise to joint costs that occur either as direct costs or as indirect costs. Direct costs are defined as those costs that can normally be associated with a specific enterprise though not necessarily with individual products generated by the enterprise. Indirect costs are those costs which may apply to several enterprises or production cycles. Some inputs such as fertilizer or lime, which are normally viewed as direct costs to a given enterprise, may have an intertemporal or residual carry-over dimension that may affect the production of multiple enterprises. Individual expendable and capital inputs may fall in either or both of the direct and indirect cost categories.

Overview of Issues The three situations identified above involve the sharing of resources either among various enterprises or among unique products generated by a single enterprise. As has been well documented in the literature, the allocation of shared resources and their associated costs among products makes the process of developing a separate cost estimate for individual products highly complicated (Gilliam; Boulding). In fact, Hopkins and Taylor wrote in their 1935 treatise on “Cost of Production in Agriculture” that "The nature of joint costs...dooms any effort at their apportionment” (Hopkins and Taylor: 404). Nevertheless, a variety of computational methods has been used to allocate joint costs in order to provide cost and return (CAR) estimates for specific products. These estimates may be needed for use in a variety of purposes ranging from farm management to applied commodity program analyses.

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PRODUCTION COSTS FOR JOINT TECHNOLOGIES AND ALLOCATED COSTS

OF PRODUCTION FOR NON-JOINT TECHNOLOGIES

Enterprises were defined in Chapter 2 as any coherent portion of the general input-output structure of the farm business that can be separated out and analyzed as a distinct entity. The purpose of defining enterprises is to allow analysis of that enterprise. The most common enterprise definitions involve one output and the inputs used to produce that output as is the case with non-joint technologies. Note, however, that the multiple outputs produced with a given technology may be spatially or intertemporally differentiated forms of the same product rather than distinct outputs. Such outputs must usually be handled in a joint product framework rather than as non-joint products and the input allocation methods used must account for these spatial and time differences. Enterprise CAR estimates allow a static analysis of that enterprise for a point in time that involves one production period. Because of this static analysis, an enterprise CAR estimate will only be valid if the enterprise is in a stable or nongrowth mode. Crop enterprises should not reflect levels of fertilizer application which tend to "warehouse" nutrients, nor should they reflect resource "mining." Livestock enterprises should show a culling rate that only will maintain herd size and not reflect growth or entrenchment.

In the case of non-joint technologies, inputs and their associated costs are tied directly to an individual enterprise and may not require any procedure for allocation. The most common problems arise with inputs that are purchased on a whole-farm basis and where records are not available on allocations of these inputs to individual operations. Common examples of allocated inputs include family labor, machine time, multipurpose buildings, and sometimes fertilizer or agricultural chemicals. It is important in estimating these costs that the sum of the allocated costs add up to the total costs for the whole farm or operation.





Even when the technology is inherently joint, as in the case of corn and soybeans in rotation, it is often possible to accurately allocate specific inputs to one crop or the other as would be the case with seed.

However, those production inputs that affect multiple enterprises in a complex way should be allocated to the appropriate enterprise according to the marginal factor costs associated with each respective enterprise. The allocation of fertilizer expense in the case of a corn-soybean rotation is a good example of where the allocation is not completely straightforward. The allocation of pasture costs to a calf and to a cull cow is rather arbitrary and in determining the cost of feed used to maintain a ewe for one year, the allocation of costs between the production of wool and the production of a feeder lamb is ludicrous.

Costs that require allocation to more than one enterprise due to residual or secondary value (intertemporally) to the second enterprise can include both expendable inputs and certain capital or durable inputs. Expendable inputs should be used in an enterprise at the level required by that enterprise to maintain the specified level of production. Any amount of unused input which results in a residual benefit to a second enterprise should be reflected as a cost to that second enterprise and a reduction of cost to the first enterprise.

Again, enterprise CAR estimates should reflect only sustaining levels of input use.

Two situations exist in terms of the benefits of an input to more than one enterprise. The first is where full expected benefits have accrued to the first enterprise but residual benefits will also accrue to the second enterprise. An example would be planting alfalfa on land which will be followed by a nitrogen-using crop that benefits from the nitrogen-fixing characteristics of alfalfa. The second is where both enterprises benefit from

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use of the input, but this use is not mainly associated with one enterprise. An example would be fencing that exists between a pasture used for cattle and a wheat field from which cattle are to be restricted.

In the first situation there is an advantage to the crop that follows alfalfa but only to the point at which the additional nutrients available are mined by the following crop. That residual value will disappear if not used by the second crop. The appropriate value to be used for the residual benefit (in this case nitrogen) is the opportunity cost of acquiring that benefit from the next best available means of obtaining it.

In the second situation both enterprises benefit from the input and its cost should be allocated based on the value to each enterprise. In the example, there is no question that both enterprises benefit, but the benefit to the wheat decreases if it were not next to the pasture, and in a totally wheat area, the value could become negative due to the need to maintain fence areas where they would not be otherwise necessary.

Jointly used inputs can be allocated to separate enterprises by several methods. The allocation process can be based on use as determined by acres, hours, dollars, times over, number of units, or some other appropriate measure of use. Values should reflect the marginal factor cost of the input to that particular enterprise. The cost can be based on either opportunity cost or market cost methods. Opportunity cost should reflect the value of that portion of the input used by the enterprise in its "next best" use. Market cost should reflect the value of the portion of the input used if the input were purchased for use on the market.

Allocating the costs of such expendable cost items as fertilizer, chemicals, fuel, lubricants, and repairs for machinery can be accomplished fairly directly based on the use of these inputs by the individual enterprises.

Allocation of costs such as depreciation of equipment or land rent also can be done using procedures that have been generally accepted such as hours of use or acres planted, though there may need to be some "fine-tuning" of these processes. For some assets it is difficult to develop an acceptable allocation procedure—for example, fencing between oats and bermuda pasture grazed by cattle. Are the cattle being kept in the bermuda pasture or are they being kept out of the oats? Each situation needs to be analyzed according to the area. If it is generally a pasture area, then the cost of the additional fencing for the oats should be charged to the oats, but if the area is generally tilled, then the charge for the additional fencing should be charged to the bermuda pasture. In other words, the generally accepted practices of the area must be considered in allocating such costs.

In summary, most production costs for non-joint technologies can be allocated to an enterprise, if the enterprise is considered to be in a sustaining position. This reduces the effect of warehousing or mining by the enterprise. If inputs are applied for use by a second enterprise, the marginal factor cost of the input should be charged to that second enterprise and not to the first enterprise. Machinery and equipment inputs have welldefined processes (i.e., acre-trips, machine hours, etc.) for the allocation of their costs across enterprises.

The Task Force recommends that costs of production for joint technologies be estimated for the technology as a whole allowing for multiple outputs in the enterprise definition.

In cases where there is a need to estimate costs for individual outputs such as for corn and soybeans in rotation, the Task Force recommends that costs be allocated on an objective basis involving information on input allocations and input levels that neither warehouse or mine inputs.

9-3 Chapter 9. Joint Costs, General Farm Overhead, and Rights to Produce In the case of non-joint technologies, the Task Force recommends that the costs of inputs be allocated based on objective data on individual enterprise use. The Task Force recommends the use of data on land allocations, hours of use, acre-trips, pounds applied, etc., to determine these allocations. If objective data on the allocation of inputs between enterprises is not available, the costs of these inputs should be excluded, should remain unallocated, or in rare instances allocated following the guidelines pertaining to general farm overhead expenses.

GENERAL FARM OVERHEAD EXPENSES

General overhead costs associated with operating a business are usually incurred at the total farm level, across all enterprises, although in some instances these costs can be assigned to groups of products. Examples include liability insurance, subscriptions and dues, accounting and legal fees, shop tools, equipment storage, road maintenance, and so forth. Allocation of these shared costs to individual enterprises is often difficult or impossible in anything but an arbitrary manner. Managers, however, often must make decisions on individual enterprises, based on CARs for producing those enterprises. In such situations, it may become necessary to use some procedure that allocates overhead costs across the appropriate enterprises. Several methods have been developed that are somewhat effective in this task. These methods are based on information from surveys or from mathematically described algorithms that approximate their impact on the enterprises.

A wide variety of methods are used in practice to account for and allocate overhead expenses.

Evidence suggests that approximately 75% of the CAR estimates prepared by economists at land grant universities include an estimate of property taxes on land or equipment, and approximately 90% include charges for property insurance. Almost without exception, an opportunity interest on operating capital is included. Only about one-half of the states include business overhead costs such as office expenses or attorney fees in their CAR estimates (Klonsky, 1992: 150). The United States Department of Agriculture (USDA) includes an estimate of taxes and insurance on machinery and real estate used in production as well as an estimate of general farm overhead expenses. The USDA's general overhead cost category includes expenses to purchase such items as general farm utilities (as opposed to utility expenses for practices such as drying or irrigation that are attributable to a specific enterprise), farm shop and office equipment, supplies, drainage, accounting and legal fees, road and fence maintenance, business travel, dues, and membership fees. The USDA also includes interest expenses incurred on both operating loans and loans secured by real estate.



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