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Cost Accounting: How Can Unit Fixed Costs Mislead the Misled? 3 Views


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How can unit fixed costs mislead the misled? Unit fixed costs can be misleading because the fixed cost per unit decreases as production increases; using unit fixed costs can make companies believe that their fixed costs are higher than they actually are, so they have to charge more for their goods to compensate.

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Transcript

00:00

And finance Allah Shmoop How can unit fixed costs mislead

00:06

the misled Okay so you're in the wireless vibrating headset

00:12

business This year you spent a small fortune building all

00:15

the assembly and tuning elements you needed to crank out

00:18

tons of those headsets Well the initial cost was big

00:22

and the factory requires angle maintenance insurance and other costs

00:25

of about twenty five million bucks a year The factory

00:27

can handle production of up to a million units with

00:30

employees working nine hour days with loaded fully allocated costs

00:34

Buzz brain ink could produce these units for fifty dollars

00:38

each and wholesale them to places like Costco and Walgreens

00:42

and Wal Mart for one hundred dollars and well make

00:44

a nice living Things were generally running at capacity when

00:47

an order came in from China Yes it seemed like

00:50

almost the whole country wanted these things A one time

00:54

special order for a million units Special price Forty five

00:57

dollars each So this is a problem How can you

01:02

sell a product for less than it costs you to

01:04

make that product right Like here it cost you fifty

01:07

bucks and they want to buy him for forty five

01:09

so you can't You can't lose money on every sale

01:12

and I hope to make it up involving him or

01:14

something It doesn't work that way Well at least not

01:16

unless you live in either idiot ville or bankruptcy corner

01:19

So you reject that huge order from China that would

01:22

have lost you a whole bunch of money But then

01:24

some widely manager who actually bothered to pay attention to

01:27

this video said Hey wait a minute Does it really

01:31

cost us fifty bucks a unit to make these things

01:34

We have twenty five dollars of hard raw material costs

01:37

but then we kind of arbitrarily allocated twenty five dollars

01:41

toe Amor ties the factory's twenty five million dollars a

01:44

year costs on the current full capacity of a million

01:48

units a year we currently produce After all we've run

01:51

the factory only nine hours a day Well everyone in

01:55

the meeting becomes silent All the suits realized that the

01:57

allocation and twenty five dollars per unit is way too

02:00

high If the factory was going to crank out say

02:03

two million units instead of just one well then all

02:06

the numbers would change That is for the additional cost

02:09

of five bucks a unit The factory could pay time

02:11

and a half two employees running a midnight to nine

02:14

a M shift and that would add just five million

02:17

dollars total to the annual cost time and a half

02:20

would be sought after by a lot of workers They

02:22

make twenty bucks an hour is normal time so they'd

02:24

make thirty bucks an hour for working the overnight shift

02:27

No problem filling those jobs in the factory quickly Meanwhile

02:31

making a second million units could lead to other good

02:34

things that make that twenty five dollar allocation seem even

02:37

further off the mark like being ableto ordered double the

02:40

raw materials and have much more power with their vendor

02:43

suppliers That is they'd probably get even more volume discounting

02:47

than they already did under just one million units worth

02:50

of stuff right volume purchasing If they're hard materials plastic

02:54

and wires and bent metal things in the vibrating unit

02:57

thing in the battery holder couldn't they get ten twenty

02:59

thirty percent less if they were doubling the size of

03:02

their order Yeah probably so that riel allocation of twenty

03:04

five dollars have cost is now squishy and suspect and

03:08

almost a company murderer Well the order from China is

03:11

a one time thing Is it fair to lumpy in

03:13

that one time deal with the normal operations of the

03:16

business Could you argue that well operationally it makes sense

03:19

to keep the allocations as they are I keep the

03:22

twenty five dollars a unit allocation for that factory maintenance

03:25

costs for the first million and then on the extra

03:27

cost of human labor Well just add that extra five

03:30

bucks a unit to the raw material costs of twenty

03:33

five bucks a unit to get a total marginal cost

03:36

of thirty dollars a unit for each one sold to

03:38

China for forty five dollars Right you making fifteen dollars

03:41

If you think about the accounting that way is it

03:43

fair to break them up like that Since China's orders

03:46

well probably will never happen again Maybe not the worst

03:49

idea to break them out separately anyway Think of it

03:51

this way You're starting a quote New unquote business for

03:54

the China Order Your regular operations represent the old business

03:59

The new businesses selling one year's worth of production in

04:02

China at nice profit margins fifteen dollars a unit You're

04:05

having toe higher up To do so you're having to

04:07

readjust union contracts and other things to accommodate for that

04:11

one year period If you just blended everything together for

04:14

a company wide two million units sold well then it

04:16

would kind of cloud the rial inputs and the rial

04:19

margins and the rial direct costs here So if you

04:22

think about things you almost rejected China's offer ordeal thinking

04:25

that you'd be losing five dollars a unit in doing

04:28

so But because someone on your staff watch this video

04:31

you wisely accept that offer and make fifteen dollars a

04:34

unit times a million And that's fifteen million box extra

04:37

for your company money you'd have otherwise rejected It's totally

04:41

fine If you want to send shmoop a percentage of

04:42

your gains here you know we do take gratuities You're

04:45

welcome

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