Interactions with Work Package

In considering costs involved in agricultural production, Abbott and Makeham (1980) identified five main farm costs. These are:

· Variable Costs

· Overhead (fixed) Costs

· Financial Costs

· Capital Costs, and

· Personal Costs

3.2.1 Variable Costs

Variable Costs are expenses which vary in size positively with variation in output level. Variable Cost rises and falls with output and is zero when the farmer is not producing. It is therefore sometimes called direct cost.

Variable costs include: The raw materials, the cost of direct labour, the running expenses of fixed capital such as fuel, ordinary repairs and routine maintenance, insurance on crops and animals.

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Variables costs are directly associated with the level of intensity of each activity, but may also determine the yield or level of output of the activity. For instance, the amounts and kinds of fertilizer, seed and cultivation in a crop enterprise, largely determines the crop yield.

Similarly, in an animal enterprise, the level and type of feed and medicines used have a major effect on the productivity of any given type of animal. Therefore, for a farmer to obtain high output on the farm, requires that he must be ready to spend much money on variable cost items.

The reason for identifying the variable costs of a farm business is to give the farmer an idea of the size of the change in terms of cost which will occur if he expands or contracts one or more of the enterprises.

Knowing the likely variable costs and gross income, the farmer is in the position to make a quicker decision of the merit or otherwise of making a change in the enterprise.

3.2.2 Overhead (Fixed) Costs

Overhead cost is also known as fixed cost. Fixed costs are costs which do not vary with the level of output. In other words, fixed cost is the same regardless of the level of production. Apart from being fixed, another characteristic of fixed cost is that it must be incurred even when no output is yet forthcoming. Thus, a businessman must erect a factory, office buildings and hire staffs even before the factory starts production.

Abbott and Makeham (1980) identified three types of overhead costs to include: total overhead, operating and activity costs.

i. Total Overhead Costs

These include the following: essential living expenses of the farmer, wages and food for permanent workers, loan interest and repayments, replacement of capital items such as plants, machinery, buildings, all taxes, repairs to water supply, insurance on employees, travel and other business expenses.

The main advantages of farmer knowing the level of total overhead costs are that: They are unavoidable costs which must be met every year. Secondly, it is used to show the gross margin which must be achieved for all farm activities in the planting season. Lastly, the total gross margin is normally the only source other than additional borrowing from which the overhead cost can be met.

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ii. Operating Overhead Costs

According to Abbott and Makeham (1980), operating overhead costs are used in calculating the true profit in an accounting sense. They are overheads associated with the annual business operations of the farm.

The main component of operating costs include: Operator‟s allowance, depreciation of capital items such as buildings and machines, wages of permanent workers, taxes but not income tax, repairs of water supply, roads, buildings and structures, insurance on buildings, plant, fixed structures, etc, telephone and business expenses.

iii. Activity Overhead Costs

These are costs which will not be incurred if the business is terminated.

Examples of such costs include: depreciation on equipment used. Costs under this category are regarded as partly fixed and partly variable.

Even though they are classified as fixed costs, the amount to be fixed is determined by the level of operation or use of the equipment.

3.2.3 Finance Costs

These covers the annual interests paid on borrowed money and the repayment made on loans where hired purchases are made. These types of costs are associated with loan repayment and insurance costs lumped together in one sum.

3.2.4 Capital Costs

These costs are usually associated with costs incurred in the process of providing capital assets used in farm production. Examples of these costs include costs on capital project like building, machinery, land purchase, land clearing, water supply, extra livestock and planting of palm trees, rubber, and cocoa or fruit trees.

3.2.5 Personal Costs

Purchased food, clothing, medical expenses, school fees, and family traveling costs are considered as personal costs.

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In some cases, some of these items are directly related to the level of output of the farm. For example, an ill or undernourished farmer is not likely to have a high work output and money spent on food or medicine is likely to have a direct effect on total farm output. The minimum total living or personal costs of the farm are normally included in the total overhead. When budgeting for family farm, they are one of the most important and unavoidable items in the total farm costs.

3.3 Average and Marginal Costs