Cost: Meaning, Types and Importance


Cost: Meaning, Types and Importance

Meaning of Agricultural Cost

Agricultural cost according to Ibitoye and Idoko (2009) is referred to as the value of agricultural output. That is, it is the expenses incurred by farmers in the process of producing a farm product such as yam, maize, eggs, goats etc. It is also known as expenses incurred in producing a particular amount f product in a particular period. Hence one can talk of the cost of producing 10 tons of yam in a season or 100 litres of milk per week or 100 crates of eggs per month.

Cost of production can also be referred to as accounting cost, cost of materials used in the production process such as labour costs, feed costs, fertilizer costs, maintenance and repair costs, selling and administrative costs, depreciation costs, taxes and interest payment on money borrowed.

Agricultural economist view costs of production as embracing a considerable alternative costs or opportunity costs. For instance, if a farmer produces only commodity A and no B, the cost of producing A is the accounting cost plus the forgone return on B known as economic costs.

Types of Cost

In considering costs involved in agricultural production, Abbot and Makeham (1980) identified five main farm costs. These are variable costs, overhead costs, financial costs, capital costs and personal costs

1. Variable Costs

These costs are also known as direct costs. They are the costs which vary as the size and level of output of farm activities varies. For example, if the area under maize production is increased by 50%, then seed, fertilizer, labour inputs etc will also increase but may not be necessarily at the same rate. It is even possible for input like labour not to be affected by this increase. Some farm production may have direct influence on some of their variable costs. For example, if you double the cattle numbers, variable costs such as feed and veterinary fees will also double.

Variable costs are directly associated with the level of intensity of each activity. In a crop production activities for example, crop yield can be influenced by the amount of money invested on variable costs like fertilizer, seeds, weeding etc.

It is essential for farmers to identify the variable costs of his activities on the farm such as to give him an idea of the size of the change in cost which will occur if he expands or contract one or more of his farm activities. His knowledge of variable costs and probably the gross income will guide the farmer in making decision on the merit of making the change on those activities.

Examples of farm variable costs include: seed, fertilizer, animal feed, agro-chemicals, livestock, seasonal labour, electricity bill, fuel and oil, machines maintenance and repairs etc.

2. Overhead Costs

Overhead cost is also known as fixed cost of production. These costs do not vary with the level of output, which means that they may be incurred even when production is not undertaking. Thus a small increase or decrease in the area of crop or number of farm animals is not likely going to affect the overhead costs of the farm. Examples of farm overhead costs include: depreciation of plant and equipment, interest on loan, rental payments for machinery, wages and salaries of permanent staff, land maintenance and rent etc.

Overhead costs can be either of the following types:

Total Overhead Costs.

Operational Costs or Activity Overheads.

The total overhead costs are the unavoidable costs which must be met every year.

The total gross margin is normally the only source other than borrowing, from which the overhead cost can be met.

The essential components of total overhead costs include the followings: living expenses of the farmer, wages for permanent staff, loan interest and repayments, taxes, general repairs, insurance premium, replacement of capital items such as plants, machinery, building etc, travel and other business expenses.

The operational costs are used in calculating the true profit in accounting sense. They are overheads associated with annual operational expenses of the farm. Therefore, such overhead expenses like repayment of loans, living expenses, interest on loans and income tax are normally excluded in operational costs.

All other costs considered under total overhead costs are part of operational costs.

Some of the costs include: wages of permanent workers, depreciation charges, operator’s allowance, general repairs, insurance charges, telephone and other business expenses.

The third type of overhead cost is the Activity Overheads. This type of overheads are those costs which would not be incurred if the business operation was terminated. Such cost includes depreciation charges on equipment.

3. Finance Costs

These costs are associated with loan repayment and insurance costs and interest paid on loan.

4. Capital Costs

These costs are usually associated with costs incurred in the process of providing capital assets used in farm production. Examples of capital costs include costs on land clearing, land purchase, machinery, building, and plantation and livestock establishment.

5. Personal Costs

The living or personal costs of the farmer are normally included in the total overhead costs. Personal costs are one of the most important and unavoidable items in the total farm overheads. Personal costs on the farm include costs of food items, clothing, medical expenses, school fees, costs of traveling etc. some of these personal costs items are directly related to the level of output of the farmer.


Importance of Cost in Agricultural Production

One of the major motives of any farmer is profit maximization. Profit is obtained by subtracting total cost from total revenue (π = TR - TC). It is important therefore, for farmers to understand the nature and structure of production costs and how they affect the decision making process.

Understanding of cost functions also help farmers to determine the most profitable level of production as well as the level of output in which production process depends. Cost functions also help to determine the least cost combination (cost minimization) that will determine maximum profit.

Cost functions also help the farmer to determine how much variable factor to be employed in combination with fixed factors in the production of an output for maximum benefit.


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