Manufacturing cost element responsible for the fluctuating costs
The manufacturing cost element which is responsible for the fluctuating costs in the production of TC-1 is the manufacturing overhead. This is because manufacturing overhead is an indirect cost which remains fixed regardless of the number of batches of TC-1 produced. Thus, the more the number of batches produced, the lower the per unit manufacturing overhead cost due to the principle of economies of scale (Anton, 2006). This causes the total cost of production to decrease as the number of batches produced increases. This fact is supported by the per unit production cost of the company which decreases with an increase in the number of batches produced over the four-quarter period. The direct costs increase with the number of batches produced and, therefore, they do not affect the unit cost (Nokes, 2009).
Manufacturing overhead refers to those costs which are not directly related to the production of a certain product. This means that these costs cannot be directly traced to the finished product. However, these costs are necessary to facilitate production. Examples of manufacturing overhead includes the costs of electricity, heating, water, staff costs, rent, etc. Allocation of manufacturing overhead to individual products is done through the most relevant base such as direct labor hours, direct machine hours, floor area, direct material usage, etc.
Unlike manufacturing overhead, direct costs which include direct labor and direct material costs can be directly traced to the final product. Allocating these costs to the final product is, therefore, easy.
Solution to the problem of fluctuating unit cost
To solve the problem of fluctuating unit cost, the management of C3-40 Pine Company should standardize the number of batches of TC-1 produced in each quarter. This will ensure that the manufacturing overhead cost incurred in each quarter is the same which will lead to uniform unit production cost. To arrive and the most optimal number of batches will require the company’s management to determine the production level of TC-1 at which the total cost of production is the lowest. This figure can be arrived at using the Economic Batch Quantity (EBQ) model which helps to establish the quantity of units that can be produced at the lowest average cost (Clinton, 2006).
By standardizing the number of units 0f TC-1 produced in each quarter, the company will be able to smooth out the unit production costs which will ensure that this cost remains the same from quarter to quarter. The firm should do this by first determining the most economical number of units of TC-1 that it should produce in order to take advantage of economies of scale. Producing below or above this level would cause the company to incur higher average costs than when producing at the optimal level.
To apply the EBQ model will require the company to estimate the annual demand of its products. This is a difficult exercise which requires the use of estimates. The company can use historical sales data to estimate the annual demand of TC-1.
Restatement of the quarterly data
|Per unit cost||Quarter|
|Direct materials||$100,000/5000= $20||$220,000/11,000=$20||$80,000/4000=$20||$200,000/10,000=$20|
Assuming that 10 batches are the most economical number of units to produce, the restated quarterly data on TC-1 production would be as follows:
|Production in batches||10||10||10||10|
|Unit cost (per batch)||$44,500||$44,500||$44,500||$44,500|
Anton, B. (2006). Management Accounting – Approaches, Techniques, and Management Processess. New York: Thomas Reuters.
Clinton, B. (2006). Cost Management. New York: Thomas Reuters.
Nokes, S. (2009). Taking Control of Costs. London: Prentice Hall.