Cost per unit
Cost per unit denote the costs that can be allocated to an allocation object. Companies determine, unit costs within cost unit accounting. Besides cost centre accounting and cost type accounting, this is the third and last subsystem of the accounting system. While cost type accounting collects the absolute amount and the value of the costs incurred by the company for the consumed resources, in cost centre accounting these costs are allocated to the individual cost centres in the company. In cost unit accounting it is ultimately determined the amount of resources consumed by a company in relation to the goods or services produced by the company and this resulting value represents the cost per unit (Taschner, Charifzadeh 2020, p. 73).
Benefits of using cost per unit
The unit costs, which are determined within the framework of a cost accounting system, are available to the management as a basis for decisions. Furthermore, they serve as a supporting instrument for the planning and controlling activities of the management or the controlling department with regard to the business activity or parts thereof (Vanderbeck 2010, p. 4).
Here, unit costs are used to generate important information for decision-making in the following areas (Vanderbeck 2010, p. 4; Taschner, Charifzadeh 2020, p. 73):
- Information on the level of the cost per unit of a product is an essential decision-making tool in determining the selling price of the product. It should be high enough to cover all of the costs that are incurred by the allocation object. For example, the unit price is compared with the manufacturing costs of the product, but also with marketing and administration costs. At the same time, the owners of the company are usually expected to make a reasonable profit on the product, which must also be taken into account in setting the price.
- Therefore for management the interest in the cost per unit results from the fact that it is possible to derive the profit per unit produced or per service by equating the unit costs with the unit revenues. It enables management to carry out analyses of the profitability of products and services and furthermore, this information can be used in the decision-making process to optimally allocate scarce resources according to profitability.
- Detailed unit cost information is also needed when facing competition in the market. In the market, companies compete on product prices. By using detailed unit cost information, you can analyse how you gain a price advantage over your competitor. In this way, a decision can be made about which measures need to be taken. On the one hand, an optimisation of the cost structure may be necessary, or a reduction of the sales price may solve the problem, whereby a mixture of both approaches is also possible. The goal is to ensure that the sale of the product or service generates a profit.
- In some companies or industries, it is common to submit bids for contracts. In this case, the cost per unit is essential information to determine a profitable and competitive offer price.
Determination of cost per unit
The general calculation of unit costs is carried out by means of an average calculation, which is why the term average cost is also used. As shown in the following formula, an absolute total cost amount is divided by the number of corresponding allocation objects. This makes it possible to calculate specific unit costs along the entire value chain, such as the unit production costs, the unit labour costs or also the unit costs in customer service, etc (Bhimani et al. 2015, p. 37).
Formula::
Example 1::
As the previous formula and example illustrate in business practice, the majority of companies use absorption costing (also known as full cost accounting) when applying unit cost accounting. This approach is based on adding the fixed costs proportionally to the allocated objects in plus the variable unit costs in order to obtain the costs per unit. However, it should be noted that the total costs, which consist of the sum of the cost units, are the same as the total costs from cost accounting. Otherwise, this absorption costing approach could in some cases lead to erroneous decision outcomes between several alternatives. This can be avoided if the fixed costs used are allocated on the basis of the allocation objects of the corresponding alternatives (Schuster 2021, p. 21).
Example 2:
In the following examples, two alternatives are compared with each other. Two products are used in each scenario. Product 1 has variable unit costs of 200 € per unit, while product 2 has variable unit costs of 300 € per unit. The fixed costs are assumed to be 220,000 €. The two scenarios differ in the number of units of the two products. In scenario 1, 400 units of product 1 and 100 units of product 2 are planned. Scenario 2 assumes 200 units for product 1 and product 2.
| Variable cost | Product 1: 200 € * 400 units = 80,000 €
Product 2: 300 € * 100 units = 30,000 € 80,000 € + 30,000 € = 110,000 € |
| Fixed cost | 220,000 € |
| Total Cost | 330,000 € |
In scenario 1, one would assume a total cost of 330,000 € in the period. To switch to the unit cost level, we need the allocation percentage of the fixed costs. This is 220,000 €/110,000 € = 2 (200 %) for scenario 1.
| Product 1 | 200 € + 200 € * 2 = 600 € per unit |
| Product 2 | 300 € + 300 € * 2 = 900 € per unit |
| Total Cost on basis of unit cost | 600 € * 400 unit + 900 € * 100 unit = 330,000 € |
| Variable cost | Product 1: 200 € * 200 units = 40,000 €
Product 2: 300 € * 200 units = 60,000 € 40,000 € + 60,000 € = 100,000 € |
| Fixed cost | 220,000 € |
| Total Cost | 320,000 € |
In scenario 2, one would assume a total cost of 320,000 € in the period. To switch to the unit cost level and we need the allocation percentage of the fixed costs again, otherwise cost allocations are no longer neutralised. This is 220,000 € /110,000 € = 2 (200 %) for scenario 2.
| Product 1 | 200 € + 200 € * 2.2 = 640 € per unit |
| Product 2 | 300 € + 300 € * 2.2 = 960 € per unit |
| Total Cost on basis of unit cost | 640 € * 200 unit + 960 € * 200 unit = 320,000 € |
Scenario 2 generates lower costs and is therefore preferable from this point of view. In both scenarios, the total costs of the period and the total costs are the same and have therefore been calculated correctly and can therefore be used as a decision criterion (Schuster 2021, pp. 21-22).
Criticism of a cost per unit calculation
The previous example 2 illustrates that when using absorption costing in unit cost accounting, a possible source of error would be that the unit costs of the products were calculated in scenario 1 and then the same unit costs were also applied in the calculation of scenario 2. In this case, the total costs of the period in scenario 2 would no longer correspond to the total costs on the basis of the unit costs and would be therefore determined incorrectly. A further point of criticism can be found in the fact that the exclusive consideration of costs per unit takes place on a full cost basis. Because the costs contain a proportional distribution of fixed costs, costs are taken into account in the cost per unit that are incurred independently of product decisions. This fact could distort any make-or-buy decisions and the advantageousness of these could only be determined in periodic accounting and not in the unit cost accounting (Schuster 2021, p. 22).
Examples of Cost per unit
- Direct Labor Costs: These are the total wages paid to all the employees who are directly involved in the production process. This figure is divided by the total number of units produced to determine the cost per unit of direct labor.
- Direct Material Costs: These are the costs associated with the raw materials used in the production process. This figure is divided by the total number of units produced to determine the cost per unit of direct materials.
- Overhead Costs: These are the costs associated with the indirect costs of production such as rent, utilities, and other general and administrative costs. This figure is divided by the total number of units produced to determine the cost per unit of overhead.
- Fixed Costs: These are the costs that are incurred regardless of the production volume. This figure is divided by the total number of units produced to determine the cost per unit of fixed costs.
- Variable Costs: These are the costs that vary with the production volume. This figure is divided by the total number of units produced to determine the cost per unit of variable costs.
Limitations of Cost per unit
One of the limitations of cost per unit is that it does not take into account the external costs incurred by a company. * Firstly, it does not account for the impact of external factors such as inflation, changes in currency exchange rates, taxes and tariffs, and changes in the cost of raw materials. * Secondly, it does not factor in the opportunity costs associated with production, such as the cost of producing a product that could have been produced at a lower cost elsewhere. * Thirdly, it does not take into account the cost of maintaining or replacing machinery and equipment, which can add significantly to the cost of production. * Finally, it does not account for the costs associated with research and development, marketing, and other investments in the company’s future. Therefore, cost per unit does not provide a comprehensive picture of the company’s costs.
One of the other approaches related to Cost per unit is the Activity-Based Costing (ABC) method. This method focuses on identifying activities that consume resources and calculating the amount of resources used for each activity. By doing so, the cost per unit of each activity can be determined, providing a more accurate picture of the costs incurred by the company. Other approaches include Target Costing, Standard Costing, Marginal Costing, and Process Costing.
The Activity-Based Costing method is a type of cost accounting that assigns costs to activities and then to the products or services that use those activities. It helps in understanding the cost of activities and the cost of products or services. Target Costing is a method used to determine the cost of a product or service based on the target price, which is set by the customer or market requirements. Standard Costing is a method used to determine the cost of a product or service by using predetermined costs for each activity. Marginal Costing, on the other hand, is a method used to determine the cost of a product or service based on the costs of the materials, labour and overhead used in the production process. Lastly, Process Costing is a method used to determine the cost of a product or service based on the costs of each activity within a production process.
In summary, Cost per unit is a method used to determine the cost of a product or service by allocating the costs of resources used to the goods or services produced. Other approaches related to Cost per unit include Activity-Based Costing, Target Costing, Standard Costing, Marginal Costing, and Process Costing.
| Cost per unit — recommended articles |
| Standard price — Differential costing — Direct costing — Cost oriented pricing — Segment margin — Differential cost — Weighted average method — ABC method — Cost model |
References
- Bhimani, A., Horngren, C. T., Datar, S. M., Rajan M. (2015). Management and cost accounting. Harlow, England, New York: Pearson (Always learning).
- Schuster, P., Heinemann, M., Cleary, P. (2021). Management accounting. Cham, Switzerland: Springer (Springer texts in business and economics).
- Taschner, A.; Charifzadeh, M. (2020). Management accounting in supply chains. Wiesbaden, Germany: Springer Gabler.
- Vanderbeck, E. J. (2010). Principles of cost accounting. 15th ed. Mason OH: South-Western Cengage Learning.
Author: Martin Friesen
