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Often we are asked questions about the meaning of the terms and concepts ERS
uses in describing farm production costs and returns. This
glossary is intended to provide users with a working definition of key
terms and a better understanding of how these concepts are applied in estimating
the performance of the farm production sector.
Allocated Overhead
Allocated overhead is a category of expenses recommended by the AAEA taskforce, and is similar to economic costs under the former methods. These include costs of
hired labor, opportunity cost of unpaid labor, capital recovery of machinery
and equipment, opportunity costs of land, general farm overhead, and taxes
and insurance.
Capital Recovery
After switching to the AAEA task force recommendations, the capital recovery
method for estimating asset ownership costs replaced the previous capital
replacement and nonland capital estimates. Capital recovery cost is an estimate
of the cost of replacing the capital investment in machinery and equipment
that is used up in the annual production process, plus interest that the
remaining capital could have earned in an alternative use. It is estimated
based on replacement prices paid for farm machinery in each year. An estimate
of the long-run rate of return to farm assets out of current income (10-year
moving average) is used as the interest rate in the capital recovery estimate.
The long-term realized rate of return to these specialized resources is used
in order to reflect that these resources can be used effectively only in
the agricultural sector. The major advantage of capital recovery over capital
replacement and nonland capital estimates is that it more accurately measures
the actual capital costs incurred in the production process.
Capital Replacement
Capital replacement, or economic depreciation, is the portion of
the value of machinery and equipment, in addition to repairs, that is used
up in the production of a particular commodity. It is based on the current
value of the machinery. Capital replacement may be regarded as a discretionary
expense in any particular year. It may be deferred when income is low but
ultimately must be paid to maintain the capital stock so that over the long
term, the operation remains in business.
Cash Costs
Cash costs are the out-of-pocket expenses paid in cash. These include
variable and fixed inputs such as seed, fertilizer, feed, overhead, and cash
interest payments. Cash costs depend on production practices and on quantities
and prices of inputs. The fixed cash expenses, which are difficult to attribute
directly to a specific enterprise on a farm, are allocated to each crop or
livestock enterprise based on the commodity's relative value of production.
Economic Costs
Economic costs are the full ownership costs (cash and noncash) for
operating the business. They account for all production inputs, without regard
to the ownership or equity positions of farm operators. They include both
variable and fixed cash expenses (except interest payments); capital replacement;
and imputed costs of land, unpaid labor, and capital invested in production
inputs and machinery.
General Farm Overhead
General farm overhead are the expenses for items such as farm supplies,
marketing containers, hand tools, power equipment, maintenance and repair
of farm buildings, farm utilities, and general business expenses that cannot
be directly attributed to a single farm enterprise. In the old accounting
methods, costs of general farm overhead items were allocated to each commodity
based on its value of production relative to that of other farm commodities.
After switching to the AAEA task force recommendations, costs of general
farm overhead items were allocated to each commodity based on its relative
contribution to total farm operating margin (i.e. value of production less
operating costs).
Harvest-Month Price
Harvest-month price is used to value the production for crops since
the cost-of-production accounts do not include the costs of marketing. To
use a marketing-year average price would necessitate measuring the costs
associated with storage as well as other marketing-related expenses.
Land Costs
Land is a specialized input. Its value as a production input depends on
the value of the crops or livestock that it produces, which is reflected
in rental costs. Because an alternative use for land for any one landowner
is to rent it to someone who will produce the same commodity, ERS values
land in the cost-of-production accounts at it rental value. In the old accounting
methods, the land rental rates for each crop were a composite of share and
cash rental rates. The estimated "net" land rent was the gross
rent minus real estate taxes and the value of any inputs supplied by landlords.
After switching to the AAEA task force recommendations, cash rental rates
on land producing the commodity in the local area were used to estimate the
land cost. In areas where cash rental markets were thin, share rent equivalents
were used to estimate the land cost.
Nonland Capital
Returns to nonland capital is the opportunity cost of having
capital invested in farm machinery and equipment. ERS computes this cost
using an estimate of machinery and equipment values times the sectorwide
longrun rate of return to production assets from current income. The long-term
realized rate of return to these specialized resources is used in order to
reflect that these resources can be used effectively only in the agricultural
sector.
Operating Capital
Returns to operating capital is the opportunity cost of carrying
input expenses from the time they are used until harvest (for crops) or throughout
the year (for livestock). ERS measures the return to operating capital at
the annual average rate on 6-month U.S. Treasury bills. This rate is used
as a proxy for the next best risk-free alternative use of capital.
Operating Costs
Operating costs is a category of costs that is similar to variable
costs under the former accounting methods. These include inputs such as seed, fertilizer,
feed, chemicals, and interest on operating capital; hired labor is not included
under operating costs but is considered as allocated overhead.
Residual Returns to Management and Risk
Residual returns to management and risk is the difference between
the gross value of production and total economic costs. The return to management
and risk indicates the extent to which longrun production costs are covered
by production valued at average harvest-month prices.
Taxes and Insurance
Taxes and insurance are overhead costs that are not directly attributable
to a farm enterprise, but must be paid by all enterprises. In the old accounting
methods, real estate tax cost per acre was charged on the acres used to produce
the commodity, while farm expenditures for other property taxes and insurance
were allocated to the commodity based on its value of production relative
to that of other farm commodities. Real estate taxes were included because
real estate tax costs were netted out of the land cost. After switching to
the AAEA task force recommendations, property taxes and insurance were allocated
to each commodity based on its relative contribution to total farm operating
margin (i.e. value of production less operating costs). Real estate tax costs
were excluded because they were not netted out of the land cost.
Unpaid Labor
Unpaid labor includes the opportunity costs of providing unsalaried labor.
Examples are labor provided by the farm operator and labor services provided
by partners and family members. Unpaid labor hours are measured directly
in commodity surveys. In the old accounting methods, unpaid labor was valued
annually at the hired wage rate for all agricultural employees. After switching
to the AAEA task force recommendations, unpaid labor was valued at an estimate
of the off-farm
wages paid to farm operators working off-farm.
Variable Costs
Variable costs are the out-of-pocket cash expenses paid for inputs
unique to the commodity being produced. Variable expenses depend on production
practices and on quantities and prices of inputs. These include inputs such
as seed, fertilizer, feed, chemicals, and hired labor.
For more information on ERS's current estimation methods, go to Methods.
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