Equivalent units of production is an important concept in cost accounting, especially for companies that manufacture products through multiple processes. It allows manufacturers to accurately track production output and allocate costs even when some units are not yet complete. In this comprehensive guide I’ll explain what equivalent units of production are why they matter, and walk through the step-by-step process for calculating them.
What Are Equivalent Units of Production?
Equivalent units of production refer to the number of fully completed units that could have been produced given the manufacturing work done during a period. It bridges the gap between the actual units produced and units that are partially complete, known as work-in-progress (WIP).
For example say at the end of a period, there are 500 units completed and transferred out to finished goods. But there are also 200 units of closing WIP that are 60% complete in terms of materials labor, and overhead. The equivalent units of production would be
- 500 completed units
- 200 x 60% = 120 equivalent units for the partial WIP
- Total equivalent units = 620
So the equivalent units provide a common measure of output that accounts for both finished goods and partial WIP. This allows manufacturers to accurately track production volume and allocate costs.
Why Calculate Equivalent Units?
There are several key reasons manufacturers need to calculate equivalent units rather than relying just on the actual completed units:
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Incorporate WIP – Since WIP units are not fully complete, they need to be converted into equivalent complete units to measure total output. Ignoring partial WIP would underestimate production.
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Precise inventory valuation – Equivalent units allow manufacturers to accurately value ending WIP inventory based on the completion level rather than guessing at costs. This improves balance sheet accuracy.
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Optimize efficiency – Tracking equivalent unit trends over time helps identify production bottlenecks and opportunities for process improvements. This leads to better utilization of resources.
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Accurate costing – Equivalent units ensure costs are allocated properly between completed units and WIP. This prevents over- or under-costing finished goods.
4 Steps to Calculate Equivalent Units
Calculating equivalent units involves four key steps:
Step 1: Equivalent Units of Beginning WIP
- Identify number of units and completion % of beginning WIP.
- Multiply beginning WIP units by % complete to get equivalent units.
For example, if there were 400 units in beginning WIP that were 50% complete, the equivalent units would be 400 x 50% = 200
Step 2: Units Started and Completed
- Subtract ending WIP units from total units added to production during the period.
For example, if 800 units were added but ending WIP is 200 units, then 600 units were started and completed.
Step 3: Equivalent Units of Ending WIP
- Identify number of units and completion % of ending WIP.
- Multiply ending WIP units by % complete to get equivalent units.
For example, if ending WIP is 300 units that are 60% complete, the equivalent units are 300 x 60% = 180.
Step 4: Sum Equivalent Units
- Add together the equivalent units from Steps 1-3 to get total equivalent production for the period.
This provides the most accurate measure of total output expressed in fully completed unit terms.
Example of Calculating Equivalent Units
Let’s walk through an example to illustrate how to calculate equivalent units of production:
A manufacturing company has the following information for Department A in January:
- Units in beginning WIP: 500 units, 100% complete for materials, 40% complete for conversion costs
- Units started during January: 11,000 units
- Units transferred out to finished goods: 10,500 units
- Units in ending WIP: 800 units; 90% complete for materials, 60% complete for conversion costs
Step 1) Equivalent units of beginning WIP:
- Materials – 500 units (100% complete, so equal to units)
- Conversion costs – 500 x 40% = 200 equivalent units
Step 2) Units started and completed:
- 11,000 units were started
- 10,500 units were transferred out
- So 11,000 – 10,500 = 500 units were started and completed
Step 3) Equivalent units of ending WIP:
- Materials – 800 x 90% = 720 equivalent units
- Conversion costs – 800 x 60% = 480 equivalent units
Step 4) Sum all equivalent units:
| Category | Equivalent Units |
|---|---|
| Beginning WIP – Materials | 500 |
| Beginning WIP – Conversion | 200 |
| Started & Completed | 500 |
| Ending WIP – Materials | 720 |
| Ending WIP – Conversion | 480 |
| Total Equivalent Units | 2,400 |
So the total equivalent units of production for Department A in January is 2,400 units. This provides a precise measure of output incorporating both finished goods and partial WIP.
When to Calculate Equivalent Units
Companies using process costing systems should calculate equivalent units each time ending WIP inventory exists. Typically this is done each:
- Accounting period – Monthly, quarterly, annually
- Production run or process cycle
- Anytime an accurate measure of production is needed
Updating equivalent units each period provides visibility into ongoing production efficiency and progress.
Automating the Calculation
While equivalent units can be calculated manually or in a spreadsheet, companies can also use cost accounting software to automate the calculation. This eliminates manual errors and saves significant time for the accounting team. The software seamlessly pulls in beginning and ending WIP data andcompletion percentages to output the equivalent unit figures.
Additionally, the software can generate equivalent unit reports by department or product line. This makes it easy to identify areas for improvement. As production scales, automating equivalent units becomes a must.
Key Takeaways
- Equivalent units of production convert partial WIP into equivalent completed units to measure total output.
- This allows for accurate cost allocation, inventory valuation, and identifying production efficiencies.
- Companies using process costing should calculate equivalent units each period.
- The calculation involves four steps:
- Equivalent units of beginning WIP
- Units started and completed
- Equivalent units of ending WIP
- Sum total equivalent units
- Automating the calculation via cost accounting software saves time and improves accuracy.
Understanding how to properly calculate equivalent units is critical for process manufacturers. By following the steps outlined, manufacturers can reap the many benefits this metric provides for optimizing operations and costs.
3 Determining Equivalent Units
- Understand the concept of an equivalent unit.
Question: The beginning of this chapter describes process costing and the flow of costs through accounts used in a process costing system. The challenge is determining the unit cost of products being transferred out of each departmental work-in-process inventory account. We start the process of determining unit cost information with an important concept, the concept of equivalent units. What are equivalent units, and how are equivalent units calculated?
Answer: Units of product in work-in-process inventory are assumed to be partially completed; otherwise, the units would not be in work-in-process inventory. Process costing requires partially completed units in ending work-in-process inventory to be converted to the equivalent completed units (called equivalent units). Equivalent unitsPartially 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. are calculated by multiplying the number of physical (or actual) units on hand by the percentage of completion of the units. If the physical units are 100 percent complete, equivalent units will be the same as the physical units. However, if the physical units are not 100 percent complete, the equivalent units will be less than the physical units.
For example, if four physical units of product are 50 percent complete at the end of the period, an equivalent of two units has been completed (2 equivalent units = 4 physical units × 50 percent). The formula used to calculate equivalent units is as follows:
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.
Question: With the concept of equivalent units now in hand, we can calculate equivalent units for the three product costs—direct materials, direct labor, and manufacturing overhead. Why do we calculate equivalent units separately for direct materials, direct labor, and manufacturing overhead?
Answer: Equivalent units in work in process are often different for direct materials, direct labor, and manufacturing overhead because these three components of production may enter the process at varying stages. For example, in the Assembly department at Desk Products, Inc., direct materials enter production early in the process while direct labor and overhead are used throughout the process. (Imagine asking workers to assemble desks without materials!) Thus equivalent units must be calculated for each of the three production costs. (Note that direct labor and manufacturing overhead are sometimes combined in a category called conversion costs, which assumes both are added to the process at the same time. In this text, we keep direct labor and manufacturing overhead separate.) The next section presents how we use the equivalent unit concept for product costing purposes. Be sure you understand the concept of equivalent units before moving on.
How to Calculate Equivalent Units
How do you calculate equivalent units of production?
Equivalent units of production = Actual number of units in manufacturing process x Percentage of work completed 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.
Why is equivalent units of production important?
Equivalent units of production is an important idea because companies use it to calculate production costs, as well as in reporting production costs after production has been completed. To calculate the equivalent units of production, simply multiply the total number of units to be produced by the percentage that has been produced. For example:
What is equivalent units of production (eup) in cost accounting?
Equivalent units of production (EUP) in cost accounting is a measure used in process costing to determine the total number of fully completed units that could have been produced from work in progress during a given period. EUPs bring clarity and precision to the messy world of multi-stage manufacturing, optimizing costs, inventory, and production.
How to calculate equivalent units of production using a weighted average?
To calculate equivalent units of production using a weighted average, the important step is to combine the equivalent units of work completed in the current period with the equivalent units of work in process from the previous period.
