3 5 Process Costing FIFO Method Managerial Accounting

The EUP for the 2,000 partially completed units can be calculated to determine the cost per production unit. It requires tracking the units at each production stage and applying conversion factors to determine the equivalent number of completed units. Actual units produced is a simpler method, as it only requires tracking the number of fully completed units. EUP considers partially completed units in the production process, while actual units produced only consider fully completed units ready for sale or use. In some industries, such as mining, the output may be measured in different units, such as weight or volume.

This can take valuable time away from other tasks and require additional resources. EUP helps businesses to determine the value of their inventory at different stages of production accurately. This is important because the value of work-in-progress inventory is not the same as the value of finished goods inventory, and businesses need to know the true value of their inventory to make informed decisions. Equivalent units is a cost accounting concept that is used in process costing for cost calculations. It has no relevance from an operational perspective, nor is it useful for any other type of cost derivation other than process costing.

Navarro started the month of June with 300,000 tons of iron ore in process in the Melting Department. The units that remain in the ending work-in-process inventory, however, are not complete. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.

• Equivalent or effective units of production represent the production of a process expressed in terms of completed units.
• It can help ensure the calculation is accurate and can be used for effective decision-making.
• This helps companies to make informed decisions regarding their production processes and allocate resources efficiently.
• At the end, he determines that his 100 units are only 70 percent the way through the production process.
• The trick is to make sure you completely understand how to calculate Equivalent Units and to take the allocation of costs base on EUs step-by-step, which is what we will do in the next section.
• Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.

There is a simple formula that is used to calculate the equivalent units of production for those partially completed units. This formula not only applies to materials that are in continuous production, but also to labor costs and overhead costs. For the shaping department, the materials are \(100\%\) complete with regard to materials costs and \(35\%\) complete with regard to conversion costs. The \(7,500\) units completed and transferred out to the finishing department must be \(100\%\) complete with regard to materials and conversion, so they make up \(7,500 (7,500 × 100\%)\) units.

Time Value of Money

The parts maker’s best estimate is that these additional 300 parts are 50 percent completed. 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. 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.

This simplifies the process because the beginning inventory and current period production can be combined or “averaged” together. For example, forty units that are \(25\%\) complete would be ten (\(40 × 25\%\)) units that are totally complete. An equivalent unit of production is an expression of the amount of work done by a manufacturer on units of output that are partially completed at the end of an accounting period. Basically the fully completed units and the partially completed units are expressed in terms of fully completed units.

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. Equivalent units of production is a term applied to the work-in-process inventory at the end of an accounting period.

The concept of an equivalent unit can be applied to determine
the number of full-time equivalent students (FTES) 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 (the
headcount) is helpful, headcount data do not provide an
indication of whether the students are full time or part time. Clearly, full-time students take more classes each term and
generally use more resources than part-time students. The treatment of the beginning WIP units will depend on which costing method, usually weighted average or FIFO, the business is using. Note that, in the weighted average method, beginning work-in-process inventory is ignored.

• In industries where products are made in a single stage or where the production process is relatively simple, EUP may not provide much benefit.
• 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.
• Textbook content produced by OpenStax is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License .
• The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.
• In the next page, we will do a demonstration problem of the FIFO method for process costing.
• In the example, the cost per equivalent unit for direct materials is 10.00, cost per equivalent unit for direct labor is 4.00, and the cost per equivalent unit for manufacturing overhead is 1.50.

Often there is a different percentage of completion for materials than there is for labor. 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 cb contingent liability 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. 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.

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Accurate costing is crucial for the calculation of equivalent units of production. Companies should use an appropriate costing method, such as process or job costing, and ensure all costs are assigned to the proper production units. Companies should have clear and well-defined production processes to ensure all production units are accounted for and accurately measured. It can help minimize errors and inconsistencies in calculating equivalent production units. EUP provides a more accurate picture of production output and cost analysis, as it considers partially completed units and provides a way to compare the cost of production to the number of units completed.

Module 7: Costing Methods

The equivalent production for each department is determined, which is later used to calculate the cost per unit of each job order by apportioning their total costs on basis of equivalent units. Just to spread the total costs equitably over part finished and fully complete units the concept of equivalent units is required. The number of equivalent units is the number of equivalent fully complete units which the partly completed units represent. First, we need to know our total costs for the period (or total costs to account for) by adding beginning work in process costs to the costs incurred or added this period. Then, we compare the total to the cost assignment in step 4 for units completed and transferred and ending work in process to get total units accounted for. In this illustration, Navarro is assumed to use the weighted-average costing method (other approaches such as FIFO could be used).

In that case, it can be challenging to determine the equivalent production units for each period. Equivalent Units of Production is a more accurate method to determine whether the proposed output of the process will be able to meet or exceed that budgeted for. In production, units completed in a period is equivalent to units that got into the finished goods or work-in-progress.

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Manufacturers can make informed decisions about production scheduling and inventory levels by tracking the number of units in each stage of the production process. While EUP can help analyze the cost of production, it may not always reflect the actual costs incurred by the business. For example, EUP does not consider the cost of rework or defects, which can significantly impact the overall cost of production.

Comparison of Equivalent Units of Production to Actual Units Produced

Now you can determine the cost of the units transferred out and the cost of the units still in process in the shaping department. 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 units4 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.

Calculating Equivalent Units of Production (EUP) is a crucial process in manufacturing accounting that helps businesses accurately determine the cost of goods sold and the value of their inventory. Equivalent Unit of Production (EUP) is an essential tool in accounting, particularly in the manufacturing industry, as it helps businesses accurately measure their production output and inventory valuation. This article will define the equivalent unit of production, explain how to calculate it, discuss its importance in accounting, explore its advantages and disadvantages, and provide best practices for accurate calculation. To measure output accurately, these partially completed units must be considered in the output computation.