Final answer:
The question touches on understanding production costs using backflush costing and direct costing. Average cost and marginal cost concepts are key to analyzing cost per unit; average cost being the cost divided by the quantity and marginal cost as the additional cost for an extra unit. The profitability is then assessed by comparing these costs with pricing and revenue.
Step-by-step explanation:
A firm using backflush costing and direct costing approaches is interested in understanding their cost per unit of production. In this scenario, both average cost (AC) and marginal cost (MC) play pivotal roles. The average cost is calculated by dividing the total cost (TC) by the quantity (Q) of output produced, which is the usual method for cost per unit. For example, AC = TC/Q. Conversely, the marginal cost is the cost incurred when producing an additional unit, which means MC = ΔTC/ΔQ.
In the given example, the firm produces 10,000 units with direct materials costing $15.00 per unit and conversion costs at $7.50 per unit. To find the average cost for producing these units, we would add the cost of direct materials and conversion costs to get a per-unit total cost, then divide this by the total units.
Further, an example is provided in the context of widget production where producing two widgets has a total cost of $44, giving an average cost of $22 per widget. If the first widget costs $32.50 to make, and the second widget brings the total cost to $44, then the marginal cost of the second widget is $11.50.
- We examine the total revenues by multiplying the quantity of units sold by the price per unit.
- Then, we evaluate the total costs and compare with the revenues to ascertain whether the firm is profitable at that level of production and pricing.
- If the price is less than the average cost, the firm incurs losses, as shown in the example where producing five units at $26/unit versus a sell price of $25/unit leads to a loss of $5 in total.