Unit product cost is the total cost of a production run, divided by the number of units produced. It is useful to delve into the concept in more detail, to understand how costs are accumulated.
A business commonly manufactures similar products in batches that may include hundreds or thousands of units per batch. Costs are accumulated for each of these batches and summarized into a cost pool, which is then divided by the number of units produced to arrive at the unit product cost. The usual contents of this cost pool are the total direct material and direct labor costs of a batch, as well as a factory overhead allocation.
For example, a business produces 1,000 green widgets. The company's cost accountant determines that the business spent $12,000 on direct material costs, $2,000 on direct labor costs, and incurred $8,000 of factory overhead costs to complete the batch of widgets. When divided by the 1,000 units produced, this sum total of $22,000 of costs results in a unit product cost of $22/each.
While the preceding description may make it appear that the calculation of the unit product cost is simple, there are a number of variations on the concept that make it more difficult to calculate. Consider the following:
- Abnormal costs. If a business incurs abnormally high production expenses in certain periods, consider not including them in the unit product cost calculation. Otherwise, the unit cost will appear unusually high just in the period when the extra expense was incurred, and also does not reflect the long-term cost of producing the units in question.
- Overhead inclusions. Only manufacturing overhead costs should be included in the overhead costs that are allocated to individual product units. Unrelated administrative costs should be rigorously excluded.
- Purpose of information. If the reason why a unit product cost is being derived is to determine the lowest price at which to sell a product, then the calculation should not contain an allocation of overhead, and perhaps not even a charge for direct labor costs. In many situations, the only direct cost associated with a product is its direct material cost. Conversely, if the intent is to use the information to derive a long-term price that will absorb all costs incurred, then overhead should certainly be included in the calculation.