Average Total Cost Formula Step By Step Calculation

Formula to Calculate Average Total Cost

It is straightforward, and it is calculated by dividing the total cost of production by the number of goods produced.

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However, the total cost is comprised of fixed cost and variable cost of production. Mathematically,

Total Cost of Production = Total Fixed Cost + Total Variable Cost

It can also be calculated by adding up average fixed costAverage Fixed CostAverage Fixed Cost refers to the company’s fixed production expenses per unit of goods produced. Fixed costs are costs that do not vary with the amount of output produced by the company and are independent of the number of goods or services produced by the business.read more and average variable cost. This average total cost equation is represented as follows-

where,

Average fixed cost = Total fixed cost/ Quantity of units producedAverage variable costAverage Variable CostAverage Variable Cost refers to the cost that directly varies with the output incurred on each unit of goods or services. It is evaluated by dividing the total variable cost incurred during the period by the number of units produced.read more = Total variable cost/ Quantity of units produced

Calculation of Average Total Cost (Step by Step)

Examples

Example #1

Let us consider an example where the total fixed cost of production of a company stood at $1,000, and the variable cost of production is $4 per unit. Now, let us do the calculation of the average total cost when the quantity of production is:

Firstly, the fixed cost of production is collected from the profit and loss accountProfit And Loss AccountThe Profit & Loss account, also known as the Income statement, is a financial statement that summarizes an organization’s revenue and costs incurred during the financial period and is indicative of the company’s financial performance by showing whether the company made a profit or incurred losses during that period.read more. A few examples of the fixed cost of production are depreciation cost, rent expense, selling expenseSelling ExpenseThe amount of money spent by the sales department on selling a product is referred to as selling expenses. This includes expenses incurred on advertising, distribution and marketing. Because it is indirectly related to the production and delivery of goods and services, it is classified as an indirect cost.read moreThe amount of money spent by the sales department on selling a product is referred to as selling expenses. This includes expenses incurred on advertising, distribution and marketing. Because it is indirectly related to the production and delivery of goods and services, it is classified as an indirect cost.read moreThe amount of money spent by the sales department on selling a product is referred to as selling expenses. This includes expenses incurred on advertising, distribution and marketing. Because it is indirectly related to the production and delivery of goods and services, it is classified as an indirect cost.read more, etc. Next, the variable cost of production is also collected from the profit and loss account. A few examples of the variable cost of production are raw material cost, labor costLabor CostCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.read more, etc. Next, the total cost of production is calculated by summing up the total fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more and total variable cost. Total Cost of Production = Total Fixed Cost + Total Variable Cost Now, the quantity of units that has been produced has to be determined. Finally, the average total cost of production is calculated by dividing the total cost of production calculated in step 3 by the number of units produced determined in step 4. Average Total Cost = Total Cost of Production / Quantity of Units Produced
1,000 units1,500 units3,000 units

In the below template, we have done the calculation of the Total Cost of Production using the given data.

So the total cost of production at 1,000 units will be calculated as:

So from the above calculation, the Total Cost of Production for 1000 units will be:

= $1,000 + $4 * 1,000

Now, at 1,000 units, it will be calculated as:

= $5,000 / 1,000

Total Cost of Production for 1500 units

= $1,000 + $4 * 1,500

So, for 15000 units it will be –

$7,000 / 1,500

Total Cost of Production for 3000 units

= $1,000 + $4 * 3,000

So, for 3000 units, it will be –

= $13,000 / 3,000

In this case, it can be seen that the average total cost decreases with the increase in the production quantity, which is the major inference from the above cost analysis.

Example #2

Let us consider another example where the total fixed cost of production of a company stood at $1,500 while the variable cost of production per unit varies with production quantity. Now, let us calculate the average total cost when:

Variable cost is $5.00 per unit from 0-500 unitsVariable cost is $7.50 per unit from 501-1,000 unitsAnd variable cost is $9.00 per unit from 1,001-1,500 units

Therefore,

Total cost of production at 500 units = Total fixed cost + Total variable cost

= $1,500 + $5 * 500

For 500 units, it will be = $4,000 / 500

Again,

Total cost of production at 1,000 units = Total fixed cost + Total variable cost

= $1,500 + $5 * 500 + $7.5 * 500

At 1,000 units = $7,750 / 1,000

Total cost of production at 1,500 units = Total fixed cost + Total variable cost

= $1,500 + $5 * 500 + $7.5 * 500 + $9 * 500

At 1,500 units = $12,250 / 1,500

In this case, it can be seen that the average total cost initially decreases with the increase in the production quantity till 1,000 units. But then the trend reverses beyond that production level due to an increase in the average variable cost. The detailed excel calculation is presented in tabular format in the later section.

Average Total Cost Calculator

You can use the following Calculator.

Use and Relevance

It is vital to understand the concept of average total cost since it helps a production manager to figure out till what level the production can be increased profitably. Usually, the total fixed cost doesn’t change, and as such, the change in average total cost is primarily driven by the change in average variable cost.

In cases where the average total cost breaches the permissible limit, then the production manager should either halt the incremental production or try to negotiate the variable cost.

Example of Average Total Cost (with Excel template)

The following table gives a detailed calculation of the case discussed in example 2 and shows how the average total cost varies with the change in quantity produced. Here, it reverses trend after a certain point, which indicates that at that level of production, the cost of production starts to increase after the initial phase of moderation.

In the below given excel template, we have used the equation to find the Average Total Cost for certain units produced.

So the Average Total Cost Calculation will be:-

The below-given graph shows the Average Total Cost of the Company.

Formula to Calculate Average Total Cost#

Calculation of Average Total Cost (Step by Step)#

Examples#

Example #1#

Example #2#

Average Total Cost Calculator#

Use and Relevance#

Example of Average Total Cost (with Excel template)#

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