Units are typically moved from the beginning of the process to the next stage in many production departments. The accumulated cost per unit is transferred along with the units when they are moved. The transferred-in cost represents the cost of the work completed in all previous departments because the unit being produced includes work from all of those departments.
The hickory size 5A drumsticks are transferred to the packaging department along with the $29,775 in inventory costs once the shaping process is complete. The inventory costs of $29,775 were broken down into materials costs of $8,775 and conversion costs of $21,000 in (Figure). For the packaging division, Rock City Percussion spent $2,000 on raw material inventory during the month of July. The packaging department tracks costs similarly to the shaping department, and requests raw materials from the material storeroom. For a total of $22,100 in conversion costs, the packaging department calculated direct material costs of $2,000, direct labor costs of $13,000, and applied overhead of $9,100. For this department, equivalent units are calculated, and a new cost per unit is calculated.
Cost Per Equivalent Unit (weighted average method)
Why calculate equivalent units of production?
Calculating equivalent units has the benefit of allowing you to refer to complete units rather than incomplete ones, which makes accounting calculations simpler. An accountant can estimate how much more money or time is needed to complete those products by understanding the equivalent units of production for materials, overhead costs, and labor costs. Understanding where the money in your institution is currently invested or creating a financial report can both benefit from equivalent units of production calculations.
What are equivalent units of production?
A concept called “equivalent units of production” is used to calculate the value of partially finished products to businesses. They are helpful for process costing, which examines how money moves during the production process.
Equivalent units quantify the amount of labor put into a set number of tangible objects. Simply multiply the quantity of physical items by the amount of work done on them to determine equivalent units. You would have one equivalent unit for two items that are 50% complete (2 x 50% = 1). The number of equivalent units is equal to the physical items when the items are fully finished.
However, this straightforward equation disregards the fact that the manufacturing process’s requirements change over time. For instance, the majority of the materials might be added to an item at the start of the manufacturing process, but more labor might be required for assembly and refinement later on. Accountants typically determine equivalent units of production for three types of costs: materials, overhead costs, and labor costs, to account for this variation. The equivalent units of production for each of the three types of costs may vary.
How to use the weighted average method
Here is the weighted average method formula:
Equivalent units of production for this cost component are (number of units completed) + (number of units in progress x percentage of completion for this cost component).
An accountant would carry out the following actions to determine equivalent units of production using the weighted average method:
1. Find number of units completed within the time period
The accountant first ascertains the quantity of completed and distributed units. Since these products are entirely finished, each unit that is sent out represents one unit of production.
Example: For the month of January, the Small Item Production Company is calculating its process costs. In January, they finished and distributed 3,000 miniature mice.
2. Find number of units in progress at the end of the time period
The accountant then determines how many units are only partially completed at the conclusion of the time period. This number is sometimes called the ending work-in-progress inventory.
Example: Small Item Production Company started 4,000 more mini mice.
3. Find what percentage of materials, labor and overhead costs are complete for those items
The accountant determines how much of the work on the units in progress is complete and, if necessary, converts it into a percentage.
80% of the materials have been added to the incomplete mice, but only 35% of the labor and overhead costs have been applied.
4. Apply formula to calculate equivalent units of production for materials, labor and overhead costs or conversion costs
The formula can be used by the accountant to determine the equivalent units of production for each cost element of the item. The conversion cost is a term used by accountants occasionally to combine labor and overhead costs.
The equivalent units of production for the following materials are determined by the accountants of the Small Item Production Company:
Total equivalent units of production for materials equals 3,000 mini mice finished plus (4,000 mini mice in progress x 80% of materials added)
Equivalent units of production for mice materials: 3,000 + 3,200 = 6,200
The equivalent units of production for conversion costs are determined by the accountants in the following manner:
Total equivalent units of production for conversion costs equals 3,000 mini mice completed plus (4,000 mini mice in progress x 35% of conversion costs complete)
For conversion costs, 3,000 + 1,400 = 4,400 equivalent units of production for mice.
Accordingly, the Small Item Production Company’s accountants report that during the month of January, they produced 6,200 equivalent units of mice materials and 4,400 equivalent units of conversion costs.
What are the ways to calculate equivalent units of production?
You can determine equivalent units of production using the first-in, first-out method or the weighted average method. The weighted average method disregards any inventory that might have been started in a previous period and completed during the calculation period. This can make it more suitable for a time when there is no beginning inventory at the beginning of a project or year. This initial inventory is taken into account by the first-in, first-out method, making it applicable in more circumstances.
How to use the first-in first-out (FIFO) method
The reason this approach is known as first-in-first-out is because it takes into account information about the partially finished items at the start of the time period, the items that started the manufacturing process first for that time period, and the costs to finish and ship them, making them the first items sent out during that time period. Here is the formula for the FIFO method:
Total equivalent units of production for the period equals equivalent units of production to finish the beginning inventory plus units started and finished during the period plus equivalent units of production for items partially completed during the period.
And here is the equation to determine how many equivalent units are required to finish the initial inventory:
Equivalent units of production are equal to the beginning inventory units multiplied by 100% minus the beginning inventory’s percentage completion.
The FIFO method’s steps for calculating equivalent units of production are as follows:
1. Calculate equivalent units of production needed to complete items in beginning inventory
The accountant determines how many items were partially completed at the beginning of the month and how much work was done at that time in order to determine the equivalent units of production still needed to finish the beginning inventory. The equivalent units of production required to complete these items can then be determined.
Example: In January, Small Item Production Company is estimating the cost of materials for its miniature cats. At the beginning of January, they had 5,000 miniature cats that were not yet finished. These cats had 70% of the materials added. The remaining equivalent units of production are determined by small item accountants in the following way:
1,500 remaining material equivalent units of production from 1,500 cats in progress multiplied by (100% – 70% materials added)
2. Find number of units completed during the time period
The accountant then multiplies the quantity of units finished during the time period. Since they are finished, each of these units equates to one equivalent unit of production.
An illustration is the complete production of 6,000 miniature cats by Small Item Production Company in January.
3. Find number of units started during the time period that are incomplete
The number of incomplete units, also known as the work-in-progress inventory’s final count, is shown here.
Example: In January, the Small Item Production Company started 3,000 more miniature cats.
4. Find what percentage of work is done on units started during the time period
Depending on whether you are figuring out the cost of materials, labor, overhead, or conversion (labor and overhead cost combined), this could change.
For instance, 40% of the materials for the extra 3,000 mini cats have already been added.
5. Calculate equivalent units of production for ending work-in-progress inventory
The accountant would multiply the number of items in progress by the amount of work completed on them thus far to arrive at this calculation.
Example: For the 3,000 mini cats that make up the final work-in-progress inventory, the small item accountants determine the material equivalent units of production:
1,200 material equivalent units of production for the final work-in-progress cat inventory are obtained by multiplying 3,000 items in progress by the 40% of materials added.
6. Calculate total equivalent units of production for the time period
The accountant then enters the values from earlier steps into the FIFO formula to determine the equivalent units of production for the time period.
For instance, the Small Item accountants determined the January cat material equivalent units of production as follows:
1,500 equivalent units of production were needed to complete the previous cats, 6,000 equivalent units were completed in January, and 1,200 equivalent units were completed on the unfinished cats, totaling 8,700 equivalent units of production.
The Small Item accountants determine from this calculation that 8,700 cats’ worth of materials were used to complete cats in total in January.
What are equivalent units of production used for?
An accountant can determine the cost to complete manufacturing the inventory once they have the equivalent units of production. The total number of items, equivalent units of production, and the costs to make each item are used to calculate these costs. The formula to determine the remaining costs to complete inventory is as follows:
The remaining cost to finish inventory is equal to (total items finished and in progress x cost per item to complete) – (equivalent units of production x cost per item to complete).
Example: The manufacturer of small items is aware that each mini mouse requires $2 in materials. They are curious about the amount of money needed to complete the 7,000 mini mice they began in January. They calculate the remaining cost by applying the formula:
The remaining cost for materials is equal to (7,000 total mice x $2) – (6,200 equivalent units of mice production x $2).
$14,000 – $12,400 = $1,600
The cost of materials for January mice will increase by $1,600 for the small item production company.
FAQ
How do you calculate equivalent units of production using the weighted average method?
Number of physical units minus the percentage of completion equals equivalent units. 1,500 equivalent units = 5,000 physical units are 30% complete for direct labor and overhead, while 3,000 equivalent units are 60% complete for direct materials.
What are equivalent units of production in process costing?
According to the amount of direct materials, direct labor, and manufacturing overhead costs incurred during that time for the items that weren’t yet finished, it is the approximate number of completed units of a product that a company could have produced.
How do you find the equivalent units of production using FIFO?
According to the amount of direct materials, direct labor, and manufacturing overhead costs incurred during that time for the items that weren’t yet finished, it is the approximate number of completed units of a product that a company could have produced.
