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And finance Allah Shmoop How can unit fixed costs mislead

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the misled Okay so you're in the wireless vibrating headset

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business This year you spent a small fortune building all

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the assembly and tuning elements you needed to crank out

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tons of those headsets Well the initial cost was big

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and the factory requires angle maintenance insurance and other costs

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of about twenty five million bucks a year The factory

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can handle production of up to a million units with

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employees working nine hour days with loaded fully allocated costs

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Buzz brain ink could produce these units for fifty dollars

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each and wholesale them to places like Costco and Walgreens

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and Wal Mart for one hundred dollars and well make

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a nice living Things were generally running at capacity when

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an order came in from China Yes it seemed like

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almost the whole country wanted these things A one time

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special order for a million units Special price Forty five

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dollars each So this is a problem How can you

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sell a product for less than it costs you to

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make that product right Like here it cost you fifty

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bucks and they want to buy him for forty five

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so you can't You can't lose money on every sale

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and I hope to make it up involving him or

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something It doesn't work that way Well at least not

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unless you live in either idiot ville or bankruptcy corner

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So you reject that huge order from China that would

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have lost you a whole bunch of money But then

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some widely manager who actually bothered to pay attention to

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this video said Hey wait a minute Does it really

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cost us fifty bucks a unit to make these things

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We have twenty five dollars of hard raw material costs

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but then we kind of arbitrarily allocated twenty five dollars

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toe Amor ties the factory's twenty five million dollars a

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year costs on the current full capacity of a million

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units a year we currently produce After all we've run

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the factory only nine hours a day Well everyone in

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the meeting becomes silent All the suits realized that the

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allocation and twenty five dollars per unit is way too

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high If the factory was going to crank out say

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two million units instead of just one well then all

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the numbers would change That is for the additional cost

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of five bucks a unit The factory could pay time

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and a half two employees running a midnight to nine

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a M shift and that would add just five million

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dollars total to the annual cost time and a half

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would be sought after by a lot of workers They

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make twenty bucks an hour is normal time so they'd

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make thirty bucks an hour for working the overnight shift

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No problem filling those jobs in the factory quickly Meanwhile

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making a second million units could lead to other good

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things that make that twenty five dollar allocation seem even

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further off the mark like being ableto ordered double the

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raw materials and have much more power with their vendor

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suppliers That is they'd probably get even more volume discounting

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than they already did under just one million units worth

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of stuff right volume purchasing If they're hard materials plastic

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and wires and bent metal things in the vibrating unit

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thing in the battery holder couldn't they get ten twenty

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thirty percent less if they were doubling the size of

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their order Yeah probably so that riel allocation of twenty

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five dollars have cost is now squishy and suspect and

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almost a company murderer Well the order from China is

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a one time thing Is it fair to lumpy in

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that one time deal with the normal operations of the

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business Could you argue that well operationally it makes sense

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to keep the allocations as they are I keep the

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twenty five dollars a unit allocation for that factory maintenance

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costs for the first million and then on the extra

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cost of human labor Well just add that extra five

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bucks a unit to the raw material costs of twenty

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five bucks a unit to get a total marginal cost

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of thirty dollars a unit for each one sold to

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China for forty five dollars Right you making fifteen dollars

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If you think about the accounting that way is it

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fair to break them up like that Since China's orders

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well probably will never happen again Maybe not the worst

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idea to break them out separately anyway Think of it

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this way You're starting a quote New unquote business for

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the China Order Your regular operations represent the old business

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The new businesses selling one year's worth of production in

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China at nice profit margins fifteen dollars a unit You're

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having toe higher up To do so you're having to

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readjust union contracts and other things to accommodate for that

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one year period If you just blended everything together for

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a company wide two million units sold well then it

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would kind of cloud the rial inputs and the rial

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margins and the rial direct costs here So if you

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think about things you almost rejected China's offer ordeal thinking

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that you'd be losing five dollars a unit in doing

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so But because someone on your staff watch this video

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you wisely accept that offer and make fifteen dollars a

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unit times a million And that's fifteen million box extra

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for your company money you'd have otherwise rejected It's totally

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fine If you want to send shmoop a percentage of

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your gains here you know we do take gratuities You're

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welcome

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