Understanding Cost Elements of a Business: Calculation, Break-Even Point, and Diminishing Returns

In this document we will discuss about Understanding Cost Elements of a Business and below are the summary points of this document:- Calculation of cost elements: fixed cost, variable cost, average variable cost, average total cost, average fixed cost, and marginal cost. Break-even point: Minimum output cost or average total cost is $61.39 at a quantity of 90 units. Diminishing returns: Higher unit output leads to higher variable costs and affects average total cost.

Running head: COST ELEMENTS OF A BUSINESS
Cost elements of a business
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1COST ELEMENTS OF A BUSINESS
Table of Contents
Question 1..................................................................................................................................2
Question 2..................................................................................................................................3
Question 3..................................................................................................................................3
Reference....................................................................................................................................5

2COST ELEMENTS OF A BUSINESS
Question 1
When total costs (TC) are known –
(a) Fixed cost (FC) = Total cost – Variable costs
(b) Variable cost (VC) = Total cost – Fixed cost
Calculation of variable cost – variable cost is the cost that varies in the proportion with the
services or volume of goods produced by the business. It is calculated through multiplying
the total output quantity by variable cost per output unit (Kaplan & Atkinson, 2015). For
example, if variable cost per unit is $ 10 and total output unit is 20 unit, variable cost = $ 10 *
20 = $ 200. However, if the unit increases to 25, variable cost = $ 10 * 25 = $ 250.
(c) Average variable cost (AVC) = Variable cost / quantity
Calculation of average variable cost – AVC is computed though dividing total variable cost
(TVC) by number of output units (Lew, Pacana & Kulpa, 2017). For example, if TVC = $
200 and the number of output units are 20, AVC = $ 200 / 20 = $ 10 per unit.
(d) Average total cost (ATC) = Total costs / quantity
Calculation of ATC = total cost (TC) is the sum of total variable cost and total fixed cost.
ATC is computed through dividing TC by number of output units or quantity (Kaplan &
Atkinson, 2015). For example, if TC is $ 1000 and number of output units are $ 50, ATC = $
1000 / 50 = $ 20.
(e) Average fixed cost (AFC) = Fixed cost / quantity
Calculation of AFC – AFC is computed though dividing total fixed cost (TFC) by number of
output units (Lew, Pacana & Kulpa, 2017). For example, if TFC = $ 2000 and the number of
output units are 20, AFC = $ 2000 / 20 = $ 100 per unit.

3COST ELEMENTS OF A BUSINESS
(f) Marginal cost (MC) = Difference in total cost / difference in quantity output
Computation of MC – MC is decrease or increase in the total cost of production if the output
is increased by 1 more unit (Medudula, Sagar & Gandhi, 2016). For example, if difference in
the total cost is $ 5000 and difference in output units is 1000 unit, MC = $ 5,000 / 1000 = $ 4.
Question 2
Question 3
Based on above computation table minimum output cost or the average total cost is $
61.39 at the quantity of 90 units. This is also regarded as the break-even point.
Answer 4
(a) ATC for producing 10th Gizmo is $ 20, however, ATC of producing 11th Gizmo is $
22

4COST ELEMENTS OF A BUSINESS
In the given scenario, effect of diminishing returns will be used. If the unit of output is
larger, it will require larger amount of the variable input for producing large number of
output. Hence, it will lead to higher variable cost amount. Average total cost is equal to total
of average fixed cost and average fixed cost (Greco, Grimaldi & Cricelli, 2016).
(b) ATC for producing 10th Gizmo is $ 20, however, ATC of producing 11th Gizmo is $
18
In this scenario, effect of spreading will be used. Reason behind this is if the output
unit is larger, the fixed cost will be spread over larger quantity. It will lead to lowering of the
average fixed cost. Average total cost is equal to total of average fixed cost and average
fixed cost (Greco, Grimaldi & Cricelli, 2016).

5COST ELEMENTS OF A BUSINESS
Reference
Greco, M., Grimaldi, M., & Cricelli, L. (2016). An analysis of the open innovation effect on
firm performance. European Management Journal, 34(5), 501-516.
Kaplan, R. S., & Atkinson, A. A. (2015). Advanced management accounting. PHI Learning.
Lew, G., Pacana, A., & Kulpa, W. (2017). The concept of customer cost accounting. Journal
of Business and Retail Management Research, 11(3).
Medudula, M. K., Sagar, M., & Gandhi, R. P. (2016). Costing and Pricing Mechanism of
Telecom Services. In Telecom Management in Emerging Economies (pp. 119-149).
Springer, New Delhi.