Example of the Cost per UnitĪBC Company has total variable costs of $50,000 and total fixed costs of $30,000 in May, which it incurred while producing 10,000 widgets. The cost per unit should decline as the number of units produced increases, primarily because the total fixed costs will be spread over a larger number of units (subject to the step costing issue noted above). (Total fixed costs + Total variable costs) ÷ Total units produced Within these restrictions, then, the cost per unit calculation is: This is a prudent choice when the need for increased capacity is not clear. Depending on the size of the step cost increase, a manager may want to leave capacity where it is and instead outsource additional production, thereby avoiding the additional fixed cost. When a step cost is incurred, the total fixed cost will now incorporate the new step cost, which will increase the cost per unit. Examples of step costs are adding a new production facility or production equipment, adding a forklift, or adding a second or third shift.
Fixed costs, such as building rent, should remain unchanged no matter how many units are produced, though they can increase as the result of additional capacity being needed (known as a step cost, where the cost suddenly steps up to a higher level once a specific unit volume is reached). Variable costs, such as direct materials, vary roughly in proportion to the number of units produced, though this cost should decline somewhat as unit volumes increase, due to greater volume discounts. The cost per unit is derived from the variable costs and fixed costs incurred by a production process, divided by the number of units produced. Cost per unit information is needed in order to set prices high enough to generate a profit.
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