Costing unit

What it means

A costing unit is the specific output for which a business calculates costs. It may be one product, one hour of service, a tonne of material, a kilometre of transport, a single job or a month of bookkeeping for one client. Price and margin are then set by reference to that unit.

The choice of unit determines how precisely a business knows what each product costs. A bakery can cost a single roll, a kilogram of dough or a whole batch, and each choice leads to different conclusions about which products are profitable and which merely take up capacity.

The unit should be measurable, understandable to both sales and operations, and match the way the business sells. If a service is billed by the hour, it makes sense to cost an hour; if it is sold as a fixed-fee package, costing of the whole package is needed.

How it works in practice

First, direct costs such as materials and labour, which can be measured precisely, are assigned to the unit. Overheads are then allocated using an allocation base, for example hours worked or machine time.

The structure of unit cost is set out in a costing formula: direct materials, direct wages, other direct costs, production overheads, administrative and selling overheads, and profit. For services the formula is simpler, but the principle is the same.

With several products it helps to record costs by cost centre and then pass them on to units. This shows, for example, whether custom work is more expensive than the price list implies and where it would pay to adjust the price or the process.

What to watch out for

A unit that is too coarse distorts results. If a firm uses only an average cost per hour for all services, demanding jobs look cheap and simple ones expensive. Where effort varies widely, activity-based costing is worth considering.

Unit cost changes with volume because fixed costs are spread over more or fewer units. Costing at full capacity can lead to prices that are too low in slower months, so volume must also be taken into account when calculating the break-even point.