Average total cost is the aggregate of all costs incurred to produce a batch, divided by the number of units produced. The outcome includes a combination of all fixed costs and variable costs incurred to produce the units, and so is considered the most comprehensive costing compilation for a production run. The formula is:
(Total fixed costs + Total variable costs) / Number of units produced = Average total cost
The concept is useful for setting long-term pricing, where the price at which units are offered for sale (net of discounts) must exceed the average total cost. Any lower price point does not allow a business to generate a profit over the long term.
A problem with this concept is that, as production volumes increase, the incremental cost to produce a unit declines, so the cost of the last unit produced may be much lower than the cost of the first unit produced. This disparity is hidden in the average total cost calculation.