cost per unit

There are two major costing methods used for creating income statements in managerial accounting: absorption costing and variable costing. These two methods vary based on the way that fixed overhead is applied to the product cost. Product cost includes direct materials, direct labor, and overhead. These are the costs that are included in cost of goods sold and inventory. Only these costs can be included in inventory.

Make more money now! Try our JOB search.

Absorption Costing

Absorption costing is what you probably think of when you think of product costing. Since the beginning of your managerial accounting course, you have been told that product cost consists of direct materials, direct labor, and overhead. Since we have introduced cost behavior into the course, we know that overhead can be either variable or fixed (direct materials and direct labor are variable costs).

Under absorption costing, we are going to take into account all of the variable product costs and absorb the fixed overhead into the cost of the product.

Let’s look at an example.

Here is some basic cost information for a business. What information is important when we are calculating product cost using absorption costing?

Direct materials, direct labor, variable overhead, and fixed overhead should all be included in the cost of the product using absorption costing. Direct materials, direct labor, and variable overhead are already expressed in per unit figures but fixed overhead is not. We must allocate the fixed overhead to each of the units.

There are two figures we are given: units produced and units sold. Which do you think we should use? You want to make sure that fixed overhead is allocated to all of the units. Therefore, you should use units produced. Using units produced will allow overhead to be allocated to all of the units, those that were sold and those that are still remaining in inventory.

Allocate overhead by dividing the fixed overhead by the number of units. This will give us fixed overhead per unit.

Fixed overhead per unit = $48,000/10,000 units

Fixed overhead per unit = $4.80 per unit

NOTE: Fixed overhead per unit will only be $4.80 per unit when 10,000 units are produced. This is not a variable rate. The rate is not constant. If the company AB2produced 20,000 units, the rate would be $2.40 ($48,000/20,000). This rate will fluctuate as production changes.

With the fixed overhead now expressed as a per unit figure, we can add it to the direct materials, direct labor, and variable overhead to calculate the absorption cost per unit. Under absorption costing, the cost per unit is $48.80.

Absorption costing is required by GAAP and must be used on the external financial statements.

Variable Costing

Variable costing is just another form of product costing. As the name implies, only variable product costs are used to calculate the cost per unit of a product. Therefore, we will not include any of the fixed overhead in the cost of the product. AB3

It might be tempting to include variable selling cost because it is also a variable cost, but remember that selling cost is a period cost and is expensed when incurred. Only include product costs in the calculation: direct materials, direct labor, and variable overhead. Notice that the product cost is lower because no fixed overhead is included.

In the next post, we will look at the traditional (absorption) income statement and the contribution margin (variable) income statement.

Share This:


Related pages


why assets have debit balanceweighted average periodic inventory methodgross pay vs net pay definitionexamples of accounting journal entriesallowance for doubtful debts definitionaccounts payable debitpurchases returns and allowanceshow to record accrued revenuepremium bonds calculatorwithholding tax entryreconciling items in bank reconciliationdesired profit formulanett pay calculatorfifo cost methodpayroll ledger samplefifo cost of ending inventory2014 ss wage basehow to prepare journal entries in accountingdifferentiate between wholesaler and retailercalculate gp percentagehow to calculate unit variable costwhat are federal withholdingsis manufacturing overhead a fixed coststraight line amortization formulasamples of income statementsanalyzing and recording transactionshow to calculate operating profit margin ratiofree payroll tax calculator 2014calculation of retained earnings on balance sheetunemployment taxes withheldcomputer depreciation calculatorwhat is beginning inventorypreparing journal entries examplescost of goods sold calculation formulaprior period adjustment journal entrydiscount allowed income statementhow to calculate variable costingcalculating cost of goods manufacturedcalculate lifostraight line method of amortization calculatorexamples of unearned revenuetwo methods of accounting for uncollectible accounts are theaccrued salaries journal entry2014 fica wage basecash discount examplecosting and cost accountingaccumulated depreciation debit or creditmanufacturing overhead cost applied to work in processpresent value calculator with paymentsnote receivable journal entrybad debt expense calculatorformula of accumulated depreciationjournal entries for accrued expenseswhat are examples of current liabilitieshow to calculate total variable costscost of finished goods manufactured formulatypes of unearned incomeperpetual inventory meaningdepreciated book valueunpaid salaries adjusting entrybonds payable journal entryformula for direct materials usedadjusting entry for inventoryoverheads business definitionpayroll tax calculator 2015calculating wipdeferred revenue journal entriesannuity tables calculatordifference between ordinary annuity and annuity duewhen are adjusting entries preparedhow to calculate salvage value of an assetbanking reconciliation definitiondiscount annuity formulavariable cost per unit calculationdiscount received journal entrythe calculation of depreciation using the declining-balance methoddebit unearned revenuemanagerial accounting income statement