These costs are then used to calculate the equivalent units and total production costs in a four-step process. An equivalent unit is a term used to describe work-in-progress inventory units at the end of a specific time period. It defines the number of completed units of a particular item that the company could have produced, given the amount of costs that were incurred during that time period for all items not yet completed. This lesson introduces the topic of equivalent units and demonstrates how to calculate this number. It also calculates per unit cost of production and illustrates a production cost report and the way in which the corresponding numbers are used by management. The processing departments often have partially complete units in ending inventory known as work in process ending inventory. In order to compute the per unit cost of a department, we need to determine the total output of that department.
To calculate the cost per equivalent unit formula, you must divide the total production costs assigned in the process by the equivalent units of production. This will give you the cost that can be allocated to each equivalent unit produced during the period. Accountants use the term equivalent units to explain how costs are segmented between items that are still in production versus items that are in completed form.
Many items are in continuous production, so without some way to calculate equivalent units, it would be difficult to determine how much money was tied up in production costs. Incomplete work must be accounted for on a regular basis so that a value can be placed on the incomplete work. Knowing how to calculate equivalent units of production is an important tool in the business and accounting world. There are two ways to calculate this metric, known as the weighted average method or the first-in, first-out method.
The production cost report for this department will indicate that it manufactured 10,300 (10,000 + 300) equivalent units of product during June. Once the equivalent units for materials and conversion are known, the cost per equivalent unit is computed in a similar manner as the units accounted for. The costs for material and conversion need to reconcile with the total beginning inventory and the costs incurred for the department during that month. For example, if there are 1,000 units in progress, and the company has only expended 40% of the processing costs on these units, then you have 400 equivalent units of production. The concept of equivalent units is used solely in process costing because you are determining the equivalent unit calculation based on a mass quantity of an item. To use the FIFO method, only the percentage of beginning parts completed during the accounting period is used, along with the production costs incurred in completing those units. You can use the same method for calculating the overhead costs and materials if you know the percentage of completion of each pricing factor.
Therefore, our total cost of units completed and transferred out to the next department is $3,000 (i.e., $1,875 + $1,125). Equivalent units are often measured separately for direct materials costs as opposed to conversion costs (i.e., direct labor and manufacturing overhead). This is done because direct materials costs are often added entirely at the beginning of the manufacturing process, whereas conversion costs are incurred more evenly throughout the process.
This formula not only applies to materials that are in continuous production, but also to labor costs and overhead costs. Because direct materials, direct labor, and manufacturing overhead typically enter the production process at different stages, equivalent units must be calculated separately for each of these production costs. When assigning a cost to equivalent units of production, you typically assign either the weighted average cost of the beginning inventory plus new purchases to the direct materials, or the cost of the oldest inventory in stock .
The 1,200 ending work in process units are 100% complete with regard to material and have 1,200 (1,200 × 100%) equivalent units for material. The 1,200 ending work in process units are only 35% complete with regard to conversion costs and represent 420 (1,200 × 35%) equivalent units. As a result, the equivalent units of direct materials will always be higher than other manufacturing costs. When a company assigns costs to an equivalent unit of production, the simplest method is by using the weighted-average cost of beginning inventory and adding new cost in additional purchases of direct materials.
Equivalent Units & The Weighted
Units completed and transferred are finished units and will always be 100% complete for equivalent unit calculations for direct materials, direct labor and overhead. For units in ending work in process, we would take the units unfinished x a percent complete. The percent complete can be different for direct materials, direct labor or overhead.
That is, we would use our information about direct materials costs and direct materials equivalent units to compute a direct materials cost per equivalent unit. And, separately, we would use our information about conversion costs and conversion cost equivalent units to compute a conversion cost per equivalent unit. Then we would use those two separate per-unit costs to calculate the costs for the units that were completed and transferred out and for the units still in ending Work-in-Process inventory. All of the materials have been added to the shaping department, but all of the conversion elements have not; the numbers of equivalent units for material costs and for conversion costs remaining in ending inventory are different. All of the units transferred to the next department must be 100% complete with regard to that department’s cost or they would not be transferred.
However, if the physical units are not 100 percent complete, the equivalent units will be less than the physical units. At the end, he determines that his 100 units are only 70 percent the way through the production process. If the closing work-in-progress is 800 units, 70% complete in all respects, the equivalent units of production of closing work-in-progress is 560 units (i.e., 800 x 70%). Thirdly, the equivalent units of production for the closing work-in-progress should be determined by considering the number of units of closing work-in-progress and the level of completed work. Partially completed units converted to the equivalent completed units; calculated by multiplying the number of physical units on hand by the percentage of completion of the physical units.
Clearly, full-time students take more classes each term and generally use more resources than part-time students. Figure 4.3 “Concept of Equivalent Units” provides an example of the equivalent unit concept in which four desks, 50 percent complete, are the equivalent of two completed desks. For example, if the opening work-in-progress is 500 units, 40% complete in all respects, then the degree of work to be performed in the current period is 60%. Once the cost per EU is calculated, the costs are allocated to the goods that were partially finished and completely finished during the period. It is a little different, however when there is a beginning and ending number of units that have been partially finished. These goods in process must have costs allocated to them along with the goods that were finished during the period. In this case, the equivalent production for opening work-in-progress in the period is 300 units (i.e., 500 x 60%).
Step Three: Determining The Cost Per Equivalent Unit
In addition to the equivalent units, it is necessary to track the units completed as well as the units remaining in ending inventory. The reconciliation involves the total of beginning inventory and units started into production. ABC International has a manufacturing line that produces large amounts of green widgets. At the end of the most recent accounting period, ABC had 1,000 green widgets still under construction. The manufacturing process for a green widget requires that all materials be sent to the shop floor at the start of the process, and then a variety of processing steps are added before the widgets are considered complete. At the end of the period, ABC had incurred 35% of the labor and manufacturing overhead costs required to complete the 1,000 green widgets.
- Mathematically, this is done by converting the partially completed units into fully completed units and then adjusting the output figure.
- Because direct materials, direct labor, and manufacturing overhead typically enter the production process at different stages, equivalent units must be calculated separately for each of these production costs.
- For the shaping department, the materials are 100% complete with regard to materials costs and 35% complete with regard to conversion costs.
- Although each department tracks the direct material it uses in its own department, all material is held in the material storeroom.
Direct material is added in stages, such as the beginning, middle, or end of the process, while conversion costs are expensed evenly over the process. Often there is a different percentage of completion for materials than there is for labor.
The computation of equivalent units under FIFO method are a little bit complex than under weighted average method. The weighted average method blends the cost and work of the current period with the cost and work of the previous period.
These parts are only half done, so they can’t be counted as finished parts, but the costs involved in making them need to be accounted for. If a report was created, it would indicate that there are 1,150 equivalent units of production.
For instance, calculating the cost of goods produced is simple if there is no beginning or endinggoods in process inventory. All of the costs incurred during the period would be allocated to the goods because they were all completed. Assume that a manufacturer uses direct labor continuously in one of its production departments. During June, the department began with no units in inventory and then started and completed 10,000 units. In addition, it started 1,000 units but they were only 30% complete at the end of June.
Acids, Bases And Equivalents
The equivalent units belonging to beginning inventory represent the work done during the current period to complete the units that were not completed in the previous period. The equivalent units belonging to ending inventory represent the work done during the current period to bring the units to a stage of partial completion. These partially completed units at the end of the current period will become the beginning work in process inventory of the next period.
Weighted Average Method Of Equivalent Units Of Production
Work-in-progress can be valued based on actual cost (i.e., an attempt may be made to find out how much materials have been used on the incomplete units and how much labor and expenses were used). The concept of an equivalent unit can be applied to determine the number of full-time equivalent students at a school. Colleges use FTES data to plan and make decisions about course offerings, staffing, and facility needs. Although having information about the number of students enrolled is helpful, headcount data do not provide an indication of whether the students are full time or part time.
If the department’s direct labor cost was $103,000 during the month, it’s June direct labor cost per equivalent unit will be $10 ($103,000 divided by 10,300 equivalent units). This means that $100,000 (10,000 X $10) of labor costs will be assigned to the finished units and $3,000 (300 equivalent units X $10 labor cost per equivalent unit) will be assigned to the 1,000 partially completed units. Thus, the equivalent units for direct materials are generally higher than for other manufacturing expenses. In process costing, the total output of a department during a particular period of time is usually termed as equivalent units of production. In our example, the equivalent units of production of department X is 5,400 units which could be used for computing per unit cost of the department. Second, the FIFO method gives full consideration to the amount of processing done during the current period on the units in beginning inventory and on the units in ending inventory. In FIFO, both beginning and ending inventories are essentially converted to an equivalent units basis.
This article explains the computation of equivalent units of production under FIFO method. The concept of equivalent units has been explained in the previous article of this chapter — equivalent units of production – weighted average method. If you have come to this article directly, we suggest you go to previous article, read and understand the concept of equivalent units and then come back to this article to continue. This report shows the costs used in the preparation of a product, including the cost per unit for materials and conversion costs, and the amount of work in process and finished goods inventory. A complete production cost report for the shaping department is illustrated in Figure 5.6.
In order to compute the total output of department X for the month, these equivalent units would be added to the units completed during the month. The department X’s total output for the month is, therefore, 5,400 units (5,000 units completed during the month + 400 equivalent units in ending work in process inventory). The company is also able to split up the cost of manufacturing among departments’ completed units and the remaining work-in-progress units. Finally, the equivalent units of production calculated via the previous three steps should be aggregated to ascertain the total output in terms of equivalent units or equivalent production.
For example, the closing stock of 200 units in a process, with 60% complete in respect of materials, wages, and overheads, is equivalent to 120 units (i.e., 200 x 60%), which are 100% complete. Companies calculate the cost per unit of production to know how to most accurately determine price for the customer. Every penny counts, especially if the product that they’re selling is made in the thousands. Accurate calculations and proper application of cost metrics will allow companies to ensure that every cost is accounted for. Plugging in the information that you have from the parts maker, there are 300 partially completed units.
It also allows managers to calculate per unit cost of production to help determine unit pricing for customers. A production cost report is a departmental report that illustrates all of the information for quick analysis by management. The weighted average method of computing equivalent units of production blends together the units and cost of current period with the units and cost of previous period.