Cost Accounting (14th Edition)

TOTAL COSTS AND UNIT COSTS 35
Total Costs and Unit Costs
The preceding section concentrated on the behavior patterns of total costs in relation to
activity or volume levels. We now consider unit costs.
Unit Costs
Generally, the decision maker should think in terms of total costs rather than unit costs.
In many decision contexts, however, calculating a unit cost is essential. Consider the
booking agent who has to make the decision to book Paul McCartney to play at Shea
Stadium. She estimates the cost of the event to be $4,000,000. This knowledge is helpful
for the decision, but it is not enough.
Before a decision can be reached, the booking agent also must predict the number of
people who will attend. Without knowledge of both total cost and number of attendees,
she cannot make an informed decision on a possible admission price to recover the cost of
the event or even on whether to have the event at all. So she computes the unit cost of the
event by dividing the total cost ($4,000,000) by the expected number of people who will
attend. If 50,000 people attend, the unit cost is $80 ($4,000,000 ÷ 50,000) per person; if
20,000 attend, the unit cost increases to $200 ($4,000,000 ÷ 20,000).
Unless the total cost is “unitized” (that is, averaged with respect to the level of activity
or volume), the $4,000,000 cost is difficult to interpret. The unit cost combines the
total cost and the number of people in a handy, communicative way.
Accounting systems typically report both total-cost amounts and average-cost-perunit
amounts. A unit cost, also called an average cost, is calculated by dividing total
cost by the related number of units. The units might be expressed in various ways.
Examples are automobiles assembled, packages delivered, or hours worked. Suppose
that, in 2011, its first year of operations, $40,000,000 of manufacturing costs are
incurred to produce 500,000 speaker systems at the Memphis plant of Tennessee
Products. Then the unit cost is $80:
Learning
Objective 4
Interpret unit costs
cautiously
. . . for many decisions,
managers should
use total costs, not
unit costs
Total manufacturing costs
Number of units manufactured = $40,000,000 = $80 per unit
500,000 units
If 480,000 units are sold and 20,000 units remain in ending inventory, the unit-cost concept
helps in the determination of total costs in the income statement and balance sheet
and, hence, the financial results reported by Tennessee Products to shareholders, banks,
and the government.
Cost of goods sold in the income statement, 480,000 units * $80 per unit
$38,400,000
Ending inventory in the balance sheet, 20,000 units * $80 per unit
ƒƒ1,600,000
Total manufacturing costs of 500,000 units $40,000,000
Unit costs are found in all areas of the value chain—for example, unit cost of product
design, of sales visits, and of customer-service calls. By summing unit costs throughout the
value chain, managers calculate the unit cost of the different products or services they
deliver and determine the profitability of each product or service. Managers use this information,
for example, to decide the products in which they should invest more resources,
such as R&D and marketing, and the prices they should charge.
Use Unit Costs Cautiously
Although unit costs are regularly used in financial reports and for making product mix
and pricing decisions, managers should think in terms of total costs rather than unit
costs for many decisions. Consider the manager of the Memphis plant of Tennessee
Products. Assume the $40,000,000 in costs in 2011 consist of $10,000,000 of fixed
costs and $30,000,000 of variable costs (at $60 variable cost per speaker system produced).
Suppose the total fixed cost and the variable cost per speaker system in 2012
are expected to be unchanged from 2011. The budgeted costs for 2012 at different