How to Calculate Unit Costs of Production?

Unit cost of Production:

The unit cost of production is the total amount of expenses incurred by a company to produce a certain quantity of goods or services and then divide the total amount by the quantity produced.

For example, the total cost of a cement company is $30,000 to produce 10,000 units, the unit costs of production will be $3 each. ($30,000/10,000).

The total cost of production usually consists of fixed cost and variable costs and that’s why calculating the accurate unit cost of production becomes very crucial to analyze the performance of a company.

This analysis allows managers and owners to set standards and check if the company production department is working efficiently according to the set standards.

Understanding Fixed and Variable Costs:

Managing fixed and variable costs of production becomes very important as the companies looking to implement different strategies to manage their unit costs.

Variable costs mean all those production costs that remain constant per unit but change with the variation in the volume of production.

Variable costs are directly associated with the product or service and can only be incurred in case of production.

For example salaries of employees involving directly in production, cost of direct material, packaging cost, and cost of shipment or delivery.

Fixed costs are opposite to the variable costs. This means that fixed costs are not dependent on the volume of production and remains the same irrespective of the output.

Examples of fixed costs include insurance, office rent, administrative costs and salaries, overhead costs, warehouse rent, rent of production machinery, etc.

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In managerial accounting fixed costs are normally irreverent as the entity has no control over it. While their main focus is to control and minimize the variable costs of a product to maximize the profit.

Calculation of Unit Costs of Production:

For calculating unit costs of production, you need to identify the accurate figures of:

  • Total fixed costs for the period
  • Total variable costs for the period
  • The total unit produced in the period

In a manufacturing company, calculating these figures may be a little tricky but it becomes difficult in case of the service industry as it is difficult to identify a unit for services rendered.

The common formula for calculating costs of production is as follows:

Unit Costs = (Fixed Costs + Variable Costs) / Quantity Produced

Example: Company’s ABC, total fixed and variable cost of producing 2,000 units in a company are $6,000 and 10,000 respectively.

Calculate the unit production cost?

According to formula: Unit Cost = (Fixed cost + variable cost) / quantity produced

= ($6,000 + $10,000) / 2,000

= $16,000 / 2,000

Unit Cost = $8

Break-Even Analysis and Unit Cost:

The unit cost or breakeven point is the minimum amount of price at which a company should sell their product to avoid losses.

In the above example, the breakeven unit cost is $8 per unit. And revenue above this price will be the company’s profit.

For example, if a company produces and sells 2,000 units for a sale price of $10 and a per-unit cost is $8 for each unit.

The company will earn a profit of $2 ($10-$8).

Generally, companies consider different factors while determining the selling price for their products keeping in view all the fixed and variable expenses.

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