Learning Objective 4 Interpret unit costs cautiously
The preceding section concentrated on the behavior patterns of total costs in relation to volume or activity levels. But what about unit costs?
A unit cost, also called an average cost, is calculated by dividing the total cost by the related number of units produced. In many decision contexts, calculating a unit cost is essential. Consider the booking agent who has to make the decision to book Taylor Swift to play at Soldier Field. 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 reaching a decision, the booking agent also must predict the number of people who will attend. Without knowing the number of attendees, she cannot make an informed decision about the admission price she needs to charge 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 per person; if 20,000 attend, the unit cost increases to Unless the total cost is “unitized” (that is, averaged by the level of volume or activity), the $4,000,000 cost is difficult to use to make decisions. The unit cost combines the total cost and the number of people in a simple and understandable way.
Accounting systems typically report both total-cost amounts and average-cost-per-unit amounts. The units might be expressed in various ways. Examples are automobiles assembled, packages delivered, or hours worked. Consider Tennessee Products, a manufacturer of speaker systems with a plant in Memphis. Suppose that, in 2020, its first year of operations, the company incurs $40,000,000 of manufacturing costs to produce 500,000 speaker systems. Then the unit cost is $80:
If 480,000 units are sold and 20,000 units remain in ending inventory, the unit-cost concept helps managers determine total costs in the financial statements, i.e., the income statement and balance sheet, which are used to report the company’s financial results to shareholders, banks, and the government.
Cost of goods sold in the income statement, 480,000 units times 80 dollars per unit: 38,400,000 dollars
Ending inventory in the balance sheet, 20,000 units times 80 dollars per unit: 1,600,000 dollars
Total manufacturing costs of 500,000 units: 40,000,000 dollars
Unit costs are found in all areas of the value chain—for example, the unit cost of a product design, a sales visit, and a customer-service call. By summing unit costs throughout the value chain, managers can calculate the unit costs of the different products or services. Managers use this information, for example, to decide the prices they should charge, or which products they should invest more resources, such as R&D and marketing, in.