Work Units: Calculation and Use in Full Costing

We cannot calculate costs without understanding the concept of work units. In fact, a work unit is a criterion that allows us to allocate a global cost between several materials or products.

What is Full Costing?

It is a management technique that aims to calculate the cost of a product, then calculate the result of its sale (profit or loss).

According to this technique, Cost = Direct costs + Indirect costs

A direct cost is a cost that concerns only one product. An indirect cost is a cost that concerns several products.

Problem of Indirect Costs

Suppose that the total indirect costs related to procurement are equal to 6000 dollars. The company purchases two materials: 1000 kg of X and 200 kg of Y. The question is how to allocate this cost between X and Y?

We can answer like this: The allocation will be made according to the quantity. The material with the higher quantity (weight) should bear more costs. In this case, the criterion used to allocate this cost is weight.

How to do it: We look for example at the cost per kg. In this case, we say that the company bought 1200 kg (1000+200) and spent 6000 dollars. So the cost per kg will be 6000/1200 = 5 dollars. The costs borne by X will be 5*1000 = 5000 dollars and the costs of Y will be 200*5 = 1000 dollars

Here we said that the kg is the work unit.

1200 is the number of work units

5 dollars is the cost of one work unit.

How to calculate the cost of a work unit?

We calculate the cost of a work unit in the indirect cost allocation table. The procedure to follow involves 2 steps

Determine the number of work units

It is a question of counting the number of work units of the ENTIRE COMPANY.

Example 1: If the work unit is "kg purchased". If the company buys 500 kg A and 800 kg B then the number of work units is 1300.

Example 2: If the work unit is "hour of DMH". The company manufactures X and Y. X requires 1.5 hours and Y requires 3 hours. If the company manufactures 100 units of X and 200 units of Y then the number of work units is the total number of hours used by the COMPANY in this workshop i.e. 100*1.5 +200*3 = 750 h

Calculate the cost of a work unit

It is a question of dividing the total cost of the center by the number of work units

Let's take the last example: If the total cost of the workshop is 3000 dollars then the cost of a work unit will be = 3000/750 = 4 dollars

How to use work units in costs?

When we want to calculate the indirect costs related to X we do: the number of work units of X * cost of a work unit.

For our example:

the costs related to X = (100*1.5)*4 =150 *4 = 600

the costs related to Y = (200*3)*4 =600 *4 = 2400

Note that the total costs of X and Y = 3000 (600+2400) and that the product that uses more DMH has borne more costs.

Interactive Application

I propose here a cost calculation application that includes the indirect cost allocation table, purchase cost, production cost, and cost of goods sold and result. In this application, you can choose the work units to use, see their application in all tables, and see the differences.

Alpha Company manufactures plastic cars (Model G and Model P). It uses two plastic materials (MIX and DIO). You are given information about its operations during the month of March 2024.

Purchase of Materials and Stocks

Production

One hour of direct labor costs 5 dollars.

Sales

Indirect Costs:

Corrected Application

Indirect Cost Allocation Table

Explanations

Purchase Cost Table

Purchase cost of raw materials = purchase price + procurement costs (direct and indirect)

Production Cost Table

Production cost = cost of materials consumed + manufacturing costs (direct and indirect)

Cost of Goods Sold Table

Cost of goods sold = production cost of finished goods sold + distribution costs (direct and indirect)

Final Stock Table

Final stock quantity = initial stock + inputs - outputs