Unit Cost

and finance Allah shmoop What is processed Costing shmoop old

All right People like the name says process costing helps

you figure out well the cost of the process But

which process All right well here we're talking about manufacturing

process costing helps companies determine how much it'll cost them

to make each individual product they manufacture Firms use the

technique to assign the expenses related to manufacturing to each

of the units they produce The process works best in

cases of mass production Yeah lots and lots of identical

items getting made in mass production If you're carving custom

totem poles by hand while process costing won't really come

into play or help you much however much it costs

you to make that one totem pole Well that's just

what it cost you But when you're cranking out giant

patches of the same product while process costing tells you

how much money to assign to the manufacture of each

little unit Okay so you run a company that makes

the eyes that go into teddy bears You don't make

the teddy bears themselves You're actually scared of stuffed animals

Long story involving a haunted teddy He tried to kill

you as a kid although while the memory is a

little foggy but you can emotionally handle making just the

eyeballs So your company makes millions and millions of little

black buttons that you ship off to teddy bear factories

all over the world All your eyes are the same

You make 1,000,000 eyes a month The only material you

need is the plastic will Buying the plastic to make

1,000,000 eyes cost you 100 grand Meanwhile the cost of

paying your workers plus the expenses associated with running cutting

shaping and stamping machines well all that together comes to

150 grand Using advanced calculus you determine that the material

cost for the 1,000,000 eyes or 10 cents and I

the labor and machine expenses known as your conversion costs

are 15 cents and I The total cost for the

process is 25 cents and I a total of 250

grand for materials in conversion cost divided by the 1,000,000

eyes you just produced Well the simple division works because

each eye's essentially identical You can assume that each one

took an equal amount of time an equal amount of

plastic an equal amount of machine power to produce and

labor to produce the adult get labour in a single

product factory process costing doesn't provide much insight but when

there are multiple products the strategy is essential to understanding

profit margins for the various products Will you start a

second business line to sell eyes for dolls You also

have a fear of dolls because of that time your

sister locked you in her closet over night A lot

of years of therapy spent on that one Thanks Susie

Well the doll eyes and the teddy eyes used the

same plastic and the same machines and the same labour

Under the new setup you're making 750,000 eyes 500,000 doll

eyes The plastic costs you 200 grand a month The

cost of the machines and labor total 150 grand so

in total you're spending $350,000 to manufacture 1.2 5,000,000 eyes

Do the math each I cost 28 cents per I

know that right Not quite The doll eyes required twice

the plastic as the teddy eyes However they only need

2/3 of the time in the machines and only 2/3

of the labor time to create So here's where process

costing earns its keep The goal here is to take

these general costs and apply them to the specific products

Right So you're spending 200 grand a month on plastic

to make 750,000 teddy eyes and 500,000 doll eyes That's

1.2 5,000,000 eyes total including those for both dolls and

Eddie's But the doll eyes take twice as much plastic

to make throw everything into the process costing mathematical blender

and you end up with wealth 10 cents and I

for the teddy version and 20 cents and I for

the doll version So now let's do the same thing

with the other costs While 150 grand total for all

production doll eyes used 2/3 of the resource is as

the teddy eyes math blender Again we get 10 cents

for the doll eyes and 15 cents from teddy eyes

Total cost for the two products 25 cents for the

teddy eyes and 30 cents for the doll eyes So

process costing shows us that doll eyes arm or expensive

to make by a fair amount than the Eddie eyes

Full time for the annual board meeting You have money

for a marketing push and the board wants you to

recommend which product to push harder Eddie eyes or doll

eyes Well the teddy I sell for 35 cents each

and the doll I sell for 51 cents each Well

the process costing we did shows us that the teddy

product cost 25 cents to make And if they sell

for Roel 35 cents that means that there's a 10

cent gross profit on each sale Divide that 10 cent

profit by the 35 cents in revenue each one brings

in and well gross margins on those then come in

about an 29% The doll product cost 30 cents to

make with a 51 cent sales price The gross profit

on each eye is then 21 cents which means gross

margin just over 41% So the doll eyes while more

expensive to make our ah higher margin product because they

sell for so much more you recommend a marketing push

for the doll eyes information you wouldn't have had if

you didn't go through the process costing rigmarole like we

just did here It makes process costing a very useful

tool when you're mass marketing or mass producing multiple products

and yet can't say the same for the totem pole

subsidiary you're thinking about you know getting off the ground

Each totem pole there takes a different amount of time

and different amount of materials and we'll each has different

machine costs associated with its production But at least you

know when you carve out the animal faces you'll have 00:05:12.789 --> [endTime] the eyes all ready to go