Benefits of Unit Cost Analysis

I worked for Monsanto in the Agricultural Division as a young accounting assistant. I was transferred from corporate to agricultural, entering a whole new world. At that time, the agricultural division was the most profitable part of the organization. What made it a new world for me was that there were no computers within this accounting department.

My first responsibility was to compose the domestic gross profit statement. I asked where to find the computer so I could begin setting up the spreadsheet. My boss laughed and handed me a columnar pad with thirteen columns and a calculator.

Each month, I used a 20-pound report for each product and transferred the respective product's gross sales, freight, quantity sold, and cost-related expenses onto my paper. I calculated the sales and cost units by product, compiled all the information, and generated a gross profit statement. During this process, I needed to explain why any sales or cost unit deviated from the budget by $.005.

I realized I was the computer. In this accounting environment, the belief was that computers are good, but people are more intelligent. A spreadsheet can't tell you why. To know why, you must understand the nature and components of unit cost.

A unit cost reflects the costs incurred to produce, store, and sell one unit of a particular product. Unit costs include:

· Fixed costs - depreciation, monthly rents, organizational cost allocations, and any cost incurred, whether or not production occurs; and
· Variable costs - labor, materials, electricity, any cost that increases or decreases depending on the output produced.

Total cost/total output equals unit cost. Total cost and total output are typically derived from a budget or forecast and can change on an annual, quarterly, or monthly basis. The static unit cost is a "best guess" based on past results, used to analyze the variance between the static unit cost and the actual unit cost. This variance analysis creates awareness of input costs, planned output, and planned productivity.

Input costs refer to the products and services used to produce output. Examples of variances are:
· Increase/decrease in the cost of material,
· Increase/decrease in freight in,
· Loss of vendor discounts,
· Missed vendor discounts.

Planned output is the estimated number of units. Examples of variances are:
· Material shortages,
· decrease in available labor,
· Equipment breakdown,
· Raw materials spillage,
· production for a customer who later canceled the order,
· Over-production based on incorrect scheduling,
· Overtime required due to unscheduled production,
· Overtime required due to a labor shortage,
· Increase/decrease in labor benefits,
· Increase in hourly wage.

Planned productivity refers to the number of units produced by current employees. Examples of variances are:
· Acquisition of new machinery that is less labor-intensive,
· Improvements in the production process.

A change in fixed costs can also contribute to the variance. For example,
· Change in fixed cost allocations,
· Increase/decrease in support staff costs,
· Change in monthly depreciation or rents.

Unit cost variance analysis can reveal these changes. Sometimes, poor communication results in an over- or understated standard cost unit. These variances also alert management to changes that can be addressed quickly before the end of the next monthly cycle, such as negotiating discounts with vendors or identifying new suppliers to provide materials at a lower cost. A monthly cost variance analysis completed within the short closing cycle can increase profit and efficiency.