Question

The manager of the manufacturing unit of a company is responsible for the costs of the manufacturing unit. The president is in the process of deciding whether to evaluate the manager of the manufacturing unit by the average cost per unit or the variable cost per unit. Quality and timely delivery would be used in conjunction with the cost measure to reward the manager.

a. What problems are associated with using the average cost per unit as a performance measure?
b. What problems are associated with using the variable cost per unit as a performance measure?

Answer 1

AC Problems : Incurred even at 0 output level, much varying & deviant from cash flows

VC Problems : Doesn't include fixed cost, incomplete expenditure, incomplete financial (accounting) statements.

Step-by-step explanation:

Average Cost is the cost per unit off output.

Problems with AC as a performance measure :

• It includes all (fixed & variable cost) average. So, including fixed cost, it is not zero even at zero output level.
• It's variance analysis during production & cost phases is very complicated.
• It's result are deviant as evident from cash flows.

Variable Cost is the cost incurred on variable factors of production.

Problems with VC as a performance measure :

• It doesn't include fixed cost. So, it is not a correct measure of complete total expenditure.
• Fixed costs are huge. No financial inclusion of them makes accounting information unreliable (for legal purposes)