The document discusses unit costs, which are the total expenditures incurred by a company to produce, store, and sell one unit of a product or service, encompassing both fixed and variable costs. It contrasts traditional unit-costing methods, including direct-material, direct-labor-hour, and direct-labor-cost methods, with activity-based costing (ABC), which allocates costs based on specific activities associated with production. The document details the steps involved in ABC, including identifying activities, calculating total costs, and determining unit costs while highlighting the importance of understanding fixed and variable costs.

2. Submitted to
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3. UNIT COST
• A UNIT COST IS THE TOTAL EXPENDITURE INCURRED BY A COMPANY TO
PRODUCE, STORE AND SELL ONE UNIT OF A PARTICULAR PRODUCT OR
SERVICE. UNIT COSTS INCLUDE ALL FIXED COSTS, OR OVERHEAD COSTS, AND
ALL VARIABLE COSTS, OR DIRECT MATERIAL COSTS AND DIRECT LABOR
COSTS, INVOLVED IN PRODUCTION

4. DETERMINING UNIT COST
• THERE ARE TWO BASIC WAYS TO DETERMINE UNIT COST
1. TRADITIONAL UNIT-COSTING METHODS
2. ACTIVITY-BASED COSTING

5. TRADITIONAL UNIT-COSTING METHODS
• THE TRADITIONAL COSTING SYSTEM IS AN ACCOUNTING METHOD THAT IS
USED TO PREDICT PROFITS. THIS METHOD USES CAUSE-AND-EFFECT
TECHNIQUES AND TAKES INTO ACCOUNT DIRECT AND INDIRECT COSTS AND
EXPENSES IN A BUSINESS.

6. TRADITIONAL UNIT-COSTING METHODS
• THERE ARE THREE BASIC WAYS TO TRADITIONAL UNIT-COSTING METHODS
1. DIRECT-MATERIAL-COST METHOD
2. DIRECT-LABOR-HOUR METHOD
3. DIRECT-LABOR-COST METHOD

7. If Gizmo Corporation produced 2,730 widgets and
5,690 fubars, the total direct material and total direct
labor costs would exactly match the cost of goods
sold statement. Using the overhead costs from
Gizmo Corporation's cost of goods sold statement
and profit and loss statement, the total overhead

8. DIRECT-MATERIAL-COST METHOD
• THE DIRECT-MATERIAL-COST METHOD
ASSUMES THAT OVERHEAD SHOULD BE
ALLOCATED IN PROPORTION TO THE
COST OF THE DIRECT MATERIAL SPENT
ON THE PRODUCT. THE DIRECT-
MATERIAL-COST FORMULA IS AS
FOLLOWS:
The total direct-material cost from Gizmo
Corporation's cost of goods sold
statement in is $1,411,000, so their
direct-material-cost-rate would be as
follows:

10. This overhead rate can now be factored
in with the direct costs for each product
to determine the unit cost. The unit cost
for widgets using the direct-material-cost
method is as follows:

11. DIRECT-MATERIAL-COST METHOD
• THE DIRECT-LABOR-HOUR METHOD
ASSUMES THAT OVERHEAD SHOULD BE
ALLOCATED IN PROPORTION TO THE
NUMBER OF DIRECT LABOR HOURS
SPENT ON THE PRODUCT. THE DIRECT-
LABOR-HOUR FORMULA IS AS
FOLLOWS:
Knowing that Gizmo Corporation
produced 2,730 widgets and 5,690
fubars, the total number of direct labor
hours is 59,170.

12. The unit cost for widgets using the direct-
labor-hour method is as follows:

13. DIRECT-LABOR-COST METHOD
• THE DIRECT-LABOR-COST METHOD
ASSUMES THAT OVERHEAD SHOULD BE
ALLOCATED IN PROPORTION TO THE
COST OF THE DIRECT LABOR SPENT
ON THE PRODUCT. THE FORMULA IS AS
FOLLOWS:
The total direct-labor cost from Gizmo
Corporation's cost of goods sold
statement is $1,832,000, so their direct-
labor-cost-rate is as follows:

14. The unit cost for widgets using the direct-
labor-cost method is as follows:

15. Below table shows a summary of the unit costs for widgets and
fubars under the three traditional overhead cost-allocation methods.

16. ACTIVITY-BASED COSTING
• THE TRADITIONAL COSTING METHODS GATHER
ALL THE OVERHEAD COSTS INTO A SINGLE,
RATHER LARGE POOL AND THEN ALLOCATE
THAT POOL ACROSS THE COMPANY'S
PRODUCTS AND SERVICES. THIS IS SHOWN
PICTORIALLY IN FIGURE 15.7. NATURALLY, MANY
OF THE COSTS IN THE OVERHEAD POOL ARE
DRIVEN BY FACTORS THAT ARE COMPLETELY
DIFFERENT FROM THE TRADITIONAL BASIS OF
ALLOCATION (DIRECT MATERIAL COST, DIRECT
LABOR HOURS, DIRECT LABOR COST). THE
COMPUTED OVERHEAD RATE ENDS UP BEING
AN AVERAGE LOAD.

17. ACTIVITY-BASED COSTING
• STEP 1: IDENTIFY THE ACTIVITIES
ABC STARTS WITH A LIST OF ALL THE
ACTIVITIES (BOTH DIRECT AND INDIRECT)
ASSOCIATED WITH ALL THE PRODUCTS AND
SERVICES. SOME ACTIVITIES MAY BE SPECIFIC
TO A SINGLE PRODUCT OR SERVICE, AND
OTHERS MAY APPLY TO ALL PRODUCTS AND
SERVICES. THE IMPORTANT THING IS TO
CAPTURE EVERY RELEVANT ACTIVITY THAT
CONTRIBUTES TO UNIT COST. TABLE 15.3
SHOWS AN EXAMPLE SET OF ACTIVITIES FOR
THE PENCIL AND SHARPENER FACTORY.

18. ACTIVITY-BASED COSTING
• STEP 2: DETERMINE TOTAL COST FOR
EACH ACTIVITY
• THE NEXT STEP IS TO DETERMINE THE TOTAL
COST FOR EACH ACTIVITY OVER SOME RELEVANT
STUDY PERIOD. THE STUDY PERIOD MAY BE A
QUARTER, OR A YEAR, OR ANYTHING, AS LONG AS
ALL ACTIVITIES USE THIS SAME TIME PERIOD. THE
COSTS CAN EITHER BE ESTIMATED OR
EXTRACTED FROM THE COMPANY'S ACCOUNTING
SYSTEM. THE TOTAL COST NEEDS TO INCLUDE ALL
DIRECT MATERIAL, DIRECT LABOR, AND
OVERHEAD ASSOCIATED WITH THAT ACTIVITY.
TABLE 15.4 SHOWS AN EXAMPLE OF TOTAL COSTS
FOR THE ACTIVITIES IN THE PENCIL AND
SHARPENER FACTORY.

19. ACTIVITY-BASED COSTING
• STEP 3: DEFINE A MEASURE AND
QUANTITY FOR EACH ACTIVITY
THERE NEEDS TO BE A MEASURE FOR
COUNTING HOW MANY TIMES EACH ACTIVITY
HAPPENS OVER THE COURSE OF THE STUDY
PERIOD. THE MEASURE NEED NOT BE 100%
ACCURATE, BUT IT SHOULD REPRESENT THE
PRIMARY MEANS OF COUNTING HOW MANY
TIMES THAT ACTIVITY TAKES PLACE OVER THAT
PERIOD OF TIME. EITHER ESTIMATE OR COUNT
THE NUMBER OF TIMES EACH ACTIVITY IS
PERFORMED OVER THE STUDY PERIOD. TABLE
15.5 SHOWS AN EXAMPLE SET OF
MEASUREMENTS AND QUANTITIES FOR THE
PENCIL AND SHARPENER FACTORY.

20. ACTIVITY-BASED COSTING
• STEP 4: CALCULATE AVERAGE
COST PER OUTPUT FOR EACH
ACTIVITY
• THE NEXT STEP IS TO DIVIDE THE TOTAL
COST FOR EACH ACTIVITY BY ITS
QUANTITY TO CALCULATE THE AVERAGE
COST PER OCCURRENCE. TABLE 15.6
SHOWS THE AVERAGE COST FOR EACH
ACTIVITY IN THE PENCIL AND SHARPENER
FACTORY.

21. ACTIVITY-BASED COSTING
• STEP 5: SPECIFY ACTIVITY
QUANTITIES FOR EACH PRODUCT
NEXT SPECIFY THE AVERAGE NUMBER OF
TIMES EACH ACTIVITY HAPPENS DURING
THE COURSE OF PRODUCING ONE UNIT OF
EACH PRODUCT OR SERVICE. THE ACTIVITY
MAY HAPPEN ZERO TIMES FOR A PRODUCT
IF THAT ACTIVITY DOESN'T HAVE ANY
EFFECT ON THAT PRODUCT—PRESSING
GRAPHITE CORES AND PAINTING APPLY TO
PENCILS, NOT SHARPENERS. TABLE 15.7
SHOWS THE ACTIVITY QUANTITIES AT THE
PENCIL AND SHARPENER FACTORY.

22. ACTIVITY-BASED COSTING
• STEP 6: CALCULATE UNIT COSTS
THE FINAL STEP IN ABC IS TO SUM THE
AVERAGE ACTIVITY COSTS TIMES THE ACTIVITY
QUANTITIES FOR A GIVEN PRODUCT. THE
FORMULA IS AS FOLLOWS:
• THIS GIVES THE TOTAL UNIT COST FOR THAT
PRODUCT. TABLE 15.8 SHOWS THE
CALCULATED ACTIVITY COSTS FOR PENCILS
AND SHARPENERS, AND THE TOTAL UNIT
COST IS SHOWN AT THE BOTTOM OF THE
TABLE.

23. CAUTIONS ON USING UNIT COSTS
It might seem reasonable to use unit costs to calculate total costs for any arbitrary production rate. If
the unit cost for a batch of pencils is $102.03 and 1,000 batches were produced, wouldn't the total cost
have to be $102,030? Unfortunately it's not that simple. In addition to direct costs and indirect costs,
another categorization of costs are variable costs and fixed costs:
o Variable costs are costs that are proportional to the rate of production— If you produce twice
as many pencils in one month as the last, the variable costs will be twice as much in the second
month. Raw materials are a variable cost because they are proportional to production rate.
o Fixed costs aren't affected by the rate of production— Even if the factory didn't produce a single
pencil or sharpener, the "capacity for production" has costs. The company still has to pay rent on the
factory and office space, interest on loans, property taxes, etc. These are good examples of fixed
costs.