John Smith, president of Furman Enterprises, remembers from his first accounting course that to calculate unit...
John Smith, president of Furman Enterprises, remembers from his first accounting course that to calculate unit cost you divide total cost by the number of units produced. In reviewing a recent production report, he noticed that fixed overhead per unit was higher than he expected. He has ordered the production department to increase production in the coming months by 15% so that the overhead costs are spread over more units, which will lower the unit cost. He believes that this action will result in a higher gross margin per unit and increase the company's profitability. He brings his idea to you, the production manager. Do you think his suggestion is a good one? Why or why not?
Homework Answers
The suggestion provided by John is ideal as in simple costing terms, fixed overhead variable with change in number of units. (For example a fixed overhead of 1,00,000 spread over 10,000 units is a cost of 10/unit whereas if the same is spread over 20,000 units the cost decreases to 5/unit. Hence fixed overhead is variable in terms of change in units.
Also, with an increase in units produced, the total contribution earned (selling price per unit - variable cost per unit) also increases, thus increasing the profitability and gross margins per unit.
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