A split rule is the written statement of what each shared cost is divided by: hours, acres, head or revenue. You write it before you look at any result, to share each cost between the enterprises of the farm, its separate lines of production such as the wheat and the cow herd. A 960-acre farm in central Kansas grows winter wheat and runs a cow herd. Its $48,000 a year for the tractor and the shed lands as $28,800 on the wheat if you divide by tractor hours and $36,000 if you divide by revenue. That is a $7,200 gap with no change in the machinery. To decide which enterprise earns its keep, write the basis for each shared cost first and date it. Work out the results only after that.
Which farm costs serve more than one enterprise?
A shared cost is a bill that pays for more than one enterprise and has no invoice tied to just one of them. The example farm has four, shown in the figure below: the tractor and the shed, the interest on the operating loan, the office and the accountant, and the farm’s taxes. Together they come to $120,000 a year. Depreciation, the price paid for a machine or building spread over its years of use, is part of the first line.
Each one hides in a different place. The accountant’s fee leaves by direct debit every month. The interest sits in the bank statement among the loan payments. The tractor and the shed were paid for years ago, so no new invoice reminds anyone of them. Brazil’s national supply agency, Conab, counts the interest on loans that fund the crop or herd as a production cost, next to seed and fuel.
How large is the pile? On mixed farms in the Swiss Alps, the researchers Gazzarin and Lips of Agroscope put shared costs at 60 to 70 percent of total cost. Even before paying the family for its own labor, the share is above 50 percent. That is a mountain region with costly buildings and machines, so the share on your farm will differ. List yours: every bill that pays for more than one enterprise, with the enterprises it serves and the ones it never touches.
What should each shared cost be divided by?
By something that follows the kind of cost. The FAO handbook on farm cost of production sets this as the rule for every allocation key. It rules out two shortcuts: no land area for livestock expenses that belong to no single product, and no animal counts for crop expenses of the same kind. For a tractor used on several crops, it names the land cultivated, the hours used or the passes over each field as workable keys. Conab divides buildings by an occupancy rate, the percentage of the building’s use by a given crop.
Inside a herd the choice matters too. Aranha, Dias and Ítavo, in a 2016 paper on Brazilian cattle accounting, note that indirect costs are usually split per head, which charges a calf as much as a cow. In their worked example, per head overvalued the young, light animals. They propose the animal unit, which is 450 kilograms (about 990 pounds) of live weight. The example was done on paper with 230 animals, so only the direction of the error carries over.
For overhead with no physical link to any enterprise, such as general business expenses, the FAO says it is generally accepted to divide by each enterprise’s share of the farm’s net margin. If net margin is unavailable, it allows gross margin (revenue minus the costs that change with output) or gross receipts. The sheet of the example farm uses a physical basis on every line. For each of yours, write the basis and one sentence of why.
How much does the choice of basis move the numbers?
Enough to change the figure, and sometimes which enterprise looks like the good one. The FAO handbook works an example from the Philippines. A farm has 3.50 hectares (about 8.6 acres) in three plots and one tractor, and the question is how much of the tractor’s cost goes to a 2.00-hectare rice plot. Divide by the whole farm’s area and that plot carries 57 percent. Ask first whether the tractor worked the other plots, learn it worked only the rice, and the same plot carries 67 percent. The tractor did the same work in both sums, and the ten points moved because of a question asked before dividing.
The example farm shows the same thing in dollars. It has 640 acres of wheat and 320 of pasture, and the wheat took 150 of the tractor’s 250 hours in the year.
Which basis moves when the price moves?
Anything divided by revenue. Gazzarin and Lips reviewed the methods used to split farm costs. They find that splitting by what each enterprise earns is hardly suited to analysis, because the level of cost ends up set by market prices. They list working hours, tractor hours, area and livestock units as physical keys. A physical key that was chosen badly is wrong the same way every year, so you can find the error and fix it.
On the example farm, the wheat sold for $360,000 in year 1 and the cattle for $120,000. In year 2 the wheat price fell and the wheat sold for $240,000, while the cattle still sold for $120,000.
Public methods have changed basis too, and printed the change. The USDA’s documentation of its cost estimates shows its former method, which divided general farm overhead by each crop’s value of production, beside a later method that divides the same costs by relative gross margins. Both are in print, so a reader can see what moved. That is what makes the revenue and margin bases usable at all. Mark every cost on your sheet that you divide this way, and do not compare two years across a change as if nothing happened. The same applies to the lowest price you can take, the break-even price, whose cost line moves if the split follows revenue.
What goes on the sheet first, and how long does it take?
One afternoon, with the list of shared costs and twelve months of bank statements on the table. Make it a day when nobody is waiting for an answer about any enterprise, because the one rule is that whoever writes the basis does not work out the enterprise results first. The tractor line takes the hour meter. Two other pages in this library cover the rest. What repairs cost per machine turns the reading into a cost per hour, and running a farm as a business is the subject of the farm management section.
A split rule that turns out wrong, written and dated, can be checked and corrected; one nobody wrote down cannot.