Variable Cost Per Unit Definition
Variable cost per unit refers to the cost of production of each unit produced in the company which changes when the volume of the output or the level of the activity changes in the organization and these are not the committed costsCommitted CostsCommitted Costs are fixed, budgeted, or confirmed payments to be made in the future to vendors for goods or services to be taken, which are necessary for the smooth flow of the business and whose absence may disrupt the main operations of the business, potentially having a significant impact on the company. of the company as they occur only in case there is the production in the company.
Variable Cost Per Unit Formula
The formula for the calculation of the Variable Cost Per Unit is as follows
- Total Variable Expenses = Total variable expenses refers to all those costs incurred by the company during the period total of which change when the volume of the output or the activity changes in the company where the change in the variable expenses will be in the proportion of the difference in the output of the company. Some common variable cost includes the cost of the raw material, cost of the direct labor or the casual labor, fuel expenses, packaging expenses, etc.
- The Output of the Company = Output refers to the total number of the units produced by the company during the period under consideration.
Example of Variable Cost Per Unit
The following is the example of a variable cost per unit.
X ltd. has the business of manufacturing and selling readymade garments in the market. During September 2019, it incurred some of the expenses which are given below. Also, during the same month, it produced 10,000 units of the goods. Mr. X now wants to know the variable cost per unit for September 2019.
Transactions during the month are as follows:
- Direct material CostDirect Material CostDirect Material Cost is the total cost incurred by the company in purchasing the raw material along with the cost of other components including packaging, freight and storage costs, taxes, etc. that are related directly to the manufacturing and production of various products of the company. for the month: $ 1,000,000
- Direct labor costDirect Labor CostDirect labor costs refer to the total cost incurred by the company for paying the wages and other benefits to its employees against the task performed by them, which are straight away related to the manufacturing of the products or provision of the services. for the month: $ 500,000
- Paid the rent for the whole year, amounting to $ 48,000.
- Paid for the packing expenses required in September amounting $ 20,000
- Other direct manufacturing overheadManufacturing OverheadManufacturing Overhead is the total of all the indirect costs involved in manufacturing a product like Property Tax on the production premise, Remunerations of maintenance personnel, Rent of the manufacturing building, etc. for the month amounts to $ 100,000
- Insurance Expenses for the whole year paid in September amounting to $ 24,000.
Calculate the variable cost per unit for September.
Calculation of Total Variable Expenses using below formula is as follows,
Total Variable Expenses = Direct Material Cost + Direct Labor Cost + Packing Expenses + Other Direct Manufacturing Overhead
- = $ 1,000,000+ $ 500,000 + $ 20,000 + $ 100,000
- Total Variable Expenses = $ 1,620,000
Output of the company = 10,000 units
Calculation of Variable Cost Per Unit
- = $ 1,620,000 / 10,000
- = $ 162
Thus for September 2019, the variable cost per unitCost Per UnitCost per unit is defined as the amount of money spent by a corporation over a period of time to produce a single unit of a specific product or service, and it takes into account two components in its calculation: variable and fixed costs. It aids in determining the selling price of the company's product or services. of the company comes to $162.
- Direct material expenses change with change in the level of production and thus will be considered as a variable cost.
- Direct labor expenses change with change in the level of production and thus will be considered as a variable cost.
- The company pays rent amount in advance for the whole year, so it is the fixed expense and will not be a part of the variable cost.
- Packing expenses changes with change in the level of production and thus will be considered as a variable cost.
- Other direct manufacturing overhead changes with change in the level of production, and thus will be considered as a variable cost.
- Insurance expenseInsurance ExpenseInsurance Expense, also called Insurance Premium, is the amount a Company pays to obtain an insurance contract for covering their risk from any unexpected catastrophe. You can calculate it as a fixed percentage of the sum insured & it is paid at a daily pre-specified period. is paid by the company in advance for the whole year, so it is a fixed expense and will not part of the variable cost.
The different advantages are as follows:
- It helps the company in knowing that what will be it’s the per-unit cost of production and hence helps in the calculation of the contribution per unitContribution Per UnitUnit Contribution Margin is the amount you get after removing the variable costs related to the sale of a unit from its total sales. It measures the contribution of a specific product to the Company’s overall profit. and break-even analysisBreak-even AnalysisBreak-even analysis refers to the identifying of the point where the revenue of the company starts exceeding its total cost i.e., the point when the project or company under consideration will start generating the profits by the way of studying the relationship between the revenue of the company, its fixed cost, and the variable cost. of the company.
- With the calculation of the variable cost per unit, top management gets more defined data, which will help them for the decision making that may be required in the future for expanding the business.
- With the help of the variable cost per unit, management will be able to know that what is the minimum price that the company is required to offer to its new customer in case it gets bulk order by considering the fixed costFixed CostFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity. as the sunk costSunk CostSunk costs are all costs incurred by the firm in the past with no hope of recovery in the future and are not considered while making any decisions since these costs will not change regardless of the decision's outcome. as it will be incurred in case even if there is no production in the company.
The disadvantage is as follows:
- In case the company is not able to segregate the expenses into variable and fixed cost correctly, or in case any error occurs in such bifurcation. The variable cost per unit cannot be calculated correctly.
The different vital points are as follows:
- To calculate the variable cost per unit, the company requires two components, which include total variable expenses incurred during the period and the total level of production of the company.
- A company which is having a relatively high variable cost will be able to estimate the profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. per unit more accurately.
Thus the variable cost per unit is a cost per unit incurred by the company, which changes with the change in the level of production in the company. To calculate the variable cost per unit, the company requires two components, which include total variable expenses incurred during the period and the total level of production of the company.
It helps in the calculation of the contribution per unit and break-even analysis of the company, which will help the management of the company for the decision-making process that may be required in the future for expanding the business and approval of the new orders.
This article has been a guide to Variable Cost Per Unit and its definition. Here we discuss how to calculate variable cost per unit using its formula, along with an example, advantages and disadvantages. You can learn more from the following articles –