Disproportionate Allocation of Indirect Costs at Individual-Farm Level Using Maximum Entropy

Markus Lips

doi:10.3390/e19090453

Abstract

This paper addresses the allocation of indirect or joint costs among farm enterprises, and elaborates two maximum entropy models, the basic CoreModel and the InequalityModel, which additionally includes inequality restrictions in order to incorporate knowledge from production technology. Representing the indirect costing approach, both models address the individual-farm level and use standard costs from farm-management literature as allocation bases. They provide a disproportionate allocation, with the distinctive feature that enterprises with large allocation bases face stronger adjustments than enterprises with small ones, approximating indirect costing with reality. Based on crop-farm observations from the Swiss Farm Accountancy Data Network (FADN), including up to 36 observations per enterprise, both models are compared with a proportional allocation as reference base. The mean differences of the enterprise’s allocated labour inputs and machinery costs are in a range of up to ±35% and ±20% for the CoreModel and InequalityModel, respectively. We conclude that the choice of allocation methods has a strong influence on the resulting indirect costs. Furthermore, the application of inequality restrictions is a precondition to make the merits of the maximum entropy principle accessible for the allocation of indirect costs.

Highlights

The total cost of production— called full cost, unit cost, or average cost—is a key item of information for managers for several reasons
The mean value of labour input indicates that far more labour is used than suggested by the standard costs from the farm-management literature (α = 2.52)
This paper elaborates on two maximum entropy applications—CoreModel and InequalityModel—for the allocation of indirect costs among enterprises at individual-farm level, using standard costs from farm-management literature as allocation bases

Summary

Introduction

The total cost of production— called full cost, unit cost, or average cost—is a key item of information for managers for several reasons. Profitability is determined by examining the difference between output price and the total cost of production. Total cost of production is a useful base for the benchmarking of companies or farms, as is the case for dairy farms in the International Farm Comparison Network (IFCN [1]). Total cost of production should be known at decision level—i.e., enterprise level, called “production branches” or “activities”. Given that most Swiss farms have several enterprises (e.g., Wheat, Potatoes or Grassland), two components—direct and indirect costs—need to be distinguished. While direct or variable costs such as seeds or pesticides are available at an enterprise level for farms of the

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Conclusion