Differenttypesofcapitalgoodsin

agricultureandtheestimationof
capitalcosts
RegionalTrainingCourseonAgriculturalCostofProductionStatistics
21 25November2016,Daejeon,RepublicofKorea

1 Capitalassets:definitions(1/2)
Capitalgoods=capitalassets=capitalinputs

Def: inputnotentirelyusedupduringoneproductionperiod:it
generatesservicesforaperiodthatgoesbeyondthecroppingorannual
productioncycle

Typicalcapitalgoods:
o Farmbuildingsandinfrastructures whereproductiontakesplace
o Machineryandequipment usedintheproductionprocess
o Animals usedinfarmoperations(tilling,harvesting,etc.)
o Animalsbreedandusedtoobtainlivestockproducts (milk,wool,
meat,skin,etc.)
o Permanentcrops suchasorchards,coffee,cacao,olives,etc.)
o Treeplantations
1 Capitalassets:definitions(2/2)

Residualcapital:inputsotherthantraditionalcapitalassetsthatcanyield
benefitsbeyondthecurrentproductionperiod

Examples:sometypesoffertilizers

Thecarryovereffect maybeamplifiedbyspecificcroppingpractices,such
ascroprotations

itisnotrecommendedtotreattheseinputsascapitalassets,because:
o Itisdifficulttoseparatethoseinputsthathaveacarryoverfromthose
thatdonot
oTheidentificationofthenatureandextentofthesecarryovereffectsis
toocomplex:theydependoncroppingpractices,typeoffertilizerused,
etc.

2 Capitalcosts:definitions
Allcostsassociatedwiththeownershipofcapital:
o Economicdepreciation (orconsumptionoffixedcapital):itrepresents
thereductionintheusefulservicelifeofcapital(duetoobsolescenceand
age)
o Opportunitycostofcapital:thereturnoncapitalhaditbeeninvestedin
thenextbestalternative
o Othercosts associatedwithcapitalownershiporuse,suchasproperty
taxes,insuranceexpenses,licenses,fees,etc.Theseshouldnotbesubject
todepreciationandgroupedintoadifferentitem

Capitaldepreciationhastobe allocatedovertheservicelifeofthecapital
asset

Costsassociatedwithrentedcapital aregenerallygroupedinaspecificcost
item(ex:rentalservices),oftenwithothernoncapitalrentalservices(labor,
etc.)
3 Measuringdepreciationcosts:firstbestapproach

Depreciationofownedcapitalgoods changeinthemarketpriceofthe
capital:

Depreciationcosts(t)=P(t) P(t1)

WhereP(t)isthecurrentmarketpriceoftheasset

Ifcurrentmarketpricesareavailableonlyforasimilarasset(pivotasset)
butnottheassetitself:

Depreciationcosts(t)=P(t).P(0)

WhereP(t)isthepercentagechangeinthemarketvalueofthepivotasset
andP(0)thepurchasepriceoftheasset

4 Measuringdepreciationcosts:alternativeapproaches(1/5)

Intheabsenceof reliablemarketpricesforcapitalassets,assumptionsonthe
assetsservicelifeandthedepreciationratehavetobemade:

Lineardepreciationschedule (orstraightlinedepreciation):

Depreciationcosts(t)=[P(0) P(T)]/T

WhereTistheusefulservicelifeoftheassetandP(T)itspriceattheendofits
servicelife(salvagevalue)
o Advantages:easytoimplement,easilyunderstandablebyanalysts
o Drawbacks:theassetisdepreciatedateachperiodofafixedamount,
whichisunrealistic=>underestimationofdepreciationatthebeginningof
theperiod,overestimationattheend
4 Measuringdepreciationcosts:alternativeapproaches(2/5)

NonLineardepreciationschedule

=>Depreciationcosts(t)=P(0).f(t)

Wheref(.)isanonlinearfunctionoftimeandf(t)=1toensurefull
depreciation
o Advantages:morerealisticdepreciationschedule,reduceddata
requirements(onlythepurchasepriceoftheassetisrequired)
o Drawbacks:howtodeterminethedepreciationschedule/choosef(.)?

4 Measuringdepreciationcosts:alternativeapproaches(3/5)

Decliningbalanceapproach:afixedrateisappliedtothecurrentvalue
ofthedepreciatedasset

Depreciationcosts(t)=.P(t)

WhereP(t)=P(t1)*(1 )==P(0)*(1 )**T

o Advantages:morerealisticdepreciationschedule,reduceddata
requirements(onlythepurchasepriceoftheassetisrequired)

o Drawbacks:theassetneverdepreciatestozero;methodbest
limitedtothosecapitalassetswithalongservicelife
4 Measuringdepreciationcosts:alternativeapproaches(4/5)

Decliningbalanceapproach:example

4 Measuringdepreciationcosts:alternativeapproaches(5/5)

Methodsdeterminingcapitalcostsastheamountthatneedstobe
provisionedeachyear bythefarmer:Annuity,Costrecoveryapproach,etc.
o Thesemethodsaredescribedinthepresentationonpreproduction
costs
o Advantages:consistentfromaneconomicpointofview
o Drawbacks:complexity

Methodsbasedonthecostofpurchasingacapitalservice:
o Assumesthatthepriceoftheserviceprovidercoversthecostofusing
hisowncapital
o Assumesthatsuchrentalcostsareavailableandrepresentative
5 Measuringdepreciationcosts:measurementissues

Fullydepreciatedassetsthatkeepbeingused
o Systematic betweentheeffectiveandtheoreticalservicelifeofan
assetshouldleadtoarevisionoftheparameters
o Theeffectiveservicelifeisoftenprolonged,mostlyindeveloping
countries,throughrepairwork>ifthesearesubstantial,theyshouldbe
accountedforasaninvestmentandanewassetcreated(e.g.engine
change)

Lackofreliability/availabilityofmarketvalues

Farmandhouseholduseofcapitalhavetobedistinguished:
o Small/mediumfarmswhichuseassetssuchasvehiclesorbuildings
fortheirfarmingactivityaswellasforprivatepurposes
o Onlythesharerelativetofarmusehastobeaccountedforas
depreciationcostsforthefarm

6 Theopportunitycostofcapital:definitions

OpportunityCostofCapital(OCC)=expectedreturnonthecapital invested
inthefarmoperationifithadbeeninvestedinthenextbestalternative

OCCprovidesameasureoftheprofitabilityoffarminvestmentsrelativeto
othersectors:itisrelevantforanalyticalandpolicypurposes,lesssoforthe
farmersthemselves

Thepurchaseofcapitalassetsisaninvestment.Improvementworksthat
leadtoanincreaseintheservicecapacityand/orservicelifeoftheasset,such
aslandterracing,wells,enginechange,etc.arealsoaninvestment

Interestpaymentsassociatedwiththepurchaseofcapitalassetsshouldbe
accountedforasafinancialcost forthefarminaseparatecostcategory
6 Theopportunitycostofcapital:measurement

FirstBestApproach:
OCC(t)=Marketvalueoftheassets(t)*(1+r)
Whereristherateofreturnoncapitalinthenextbestalternative
o Intheory,rshoulddependontheinvestmentpossibilitiesinthe
region,thesizeoftheinvestment,etc.

o Inpractice,risdifficulttodetermine:itvariesacrossregion/localities,
timeandpreferences!Itsdeterminationishighlysubjectiveand
thereforepronetocriticisms

AlternativeApproach:ifregion/areaspecificrateofreturnareabsent,
longtermgovernmentbondratesaregenerallyused

7 Rentedcapital(1/2):mainissues

Widespreadpracticeindevelopingcountries becauseofthedifficultyto
financethepurchaseofcapitalassets

Rentalpriceoftenincludesservicesassociatedwiththecapitalasset
(machineoperator,fuel,inputs,etc.):thisleadstoallocationquestions

Therentingofcapitalservicesmaynotnecessarilyinvolveamonetary
transaction:

o Exchangeofotherservices>valueattheopportunitycost

o Shareoftheharvest/production>valueattheproducerpriceforthe
commodity
7 Rentedcapital(2/2):accountingoptions
Groupingrentalcostsunderaspecificitem,suchasrentedservicesorcustom
services:
o Simplestoption,butleadstounderestimationofcapitalcostsforfarmerswho
rent
o Comparabilityisaffectedwhencomparingcostitemsbetweenthosewhorent
vs.thosewhodonot
o Butthecomparisonoftotalcostsinformsontherelativeprofitabilityofeach
option(rentingvs.owning),allthingsequal
o Recommendedapproachfromnationalaccountsperspective:appropriately
measurestransactionsbetweenbranches

Allocaterentalcoststoeachcostitem:
o Ensurescomparability
o Complexity:howtoseparatelabor,inputs,etc.fromthecostoftheasset?
o Doublecounting:implicitcapitalcostsincludedintherentalprice=>agiven
assetcanbedepreciatedtwice(inthenrentalcompanysaccountsaswellasin
thefarmersaccounts)=>overestimationofcapitalcostsattheaggregatelevel

8 References

AAEATaskForceonCommodityCostsandReturns (2000).Commodity
CostsandReturnsEstimationHandbook.UnitedStatesDepartmentof
Agriculture:Ames,Iowa,USA.

GlobalStrategytoImproveAgriculturalandRuralStatistics (2016),
HandbookonAgriculturalCostofProductionStatistics,Handbookand
Guidelines,pp.6066.FAO:Rome.