Final answer:
Finding a single cost driver for variable factory overhead costs is key in cost system design. Average variable cost helps determine profitability excluding fixed costs, and the average fixed cost illustrates the benefit of increasing production to spread fixed costs over more units.
Step-by-step explanation:
Finding a single cost driver that changes in the same proportion as variable factory overhead costs is an important goal of effective cost system design. Although this can be difficult, because variable overhead comprises many different components that might not vary directly with production levels, understanding and accurately applying cost drivers is crucial for assigning variable overhead to products or services.
We calculate average variable cost (AVC) by taking variable cost and dividing by the total output at each level of output. AVC are typically portrayed as U-shaped on a graph. When a firm's AVC is lower than the market price, it signals that the firm could be earning profits, not considering fixed costs.
Considering fixed costs, also known as overhead, we understand that as production increases, the average fixed cost (AFC) decreases because the fixed cost is distributed over a larger number of units. This concept is known as "spreading the overhead". If the fixed cost is $1,000, the AFC curve would show a downward trend as output increases, illustrating the spreading effect.
Breaking down total costs into fixed cost, marginal cost, average total cost, and AVC is beneficial as each measure provides distinct insights for the firm's cost management strategies and decision-making processes.