Disproportionate Allocation of Indirect Costs at Individual-Farm Level Using Maximum Entropy

This paper addresses the allocation of indirect or joint costs among farm enterprises, and elaborates two maximum entropy models, the basic CoreModel and the InequalityModel, which additionally includes inequality restrictions in order to incorporate knowledge from production technology. Representing the indirect costing approach, both models address the individual-farm level and use standard costs from farm-management literature as allocation bases. They provide a disproportionate allocation, with the distinctive feature that enterprises with large allocation bases face stronger adjustments than enterprises with small ones, approximating indirect costing with reality. Based on crop-farm observations from the Swiss Farm Accountancy Data Network (FADN), including up to 36 observations per enterprise, both models are compared with a proportional allocation as reference base. The mean differences of the enterprise’s allocated labour inputs and machinery costs are in a range of up to ±35% and ±20% for the CoreModel and InequalityModel, respectively. We conclude that the choice of allocation methods has a strong influence on the resulting indirect costs. Furthermore, the application of inequality restrictions is a precondition to make the merits of the maximum entropy principle accessible for the allocation of indirect costs.