Why do we use equivalent units

The problem of work-in-progress in the process industries is a significant one. In continuous processes, there is work-in-progress at the beginning and end of a period, as well as a degree of completion of closing work-in-progress.

Work-in-progress can be valued based on actual cost i. Equivalent or effective units of production represent the production of a process expressed in terms of completed units. To measure output accurately, these partially completed units must be considered in the output computation. Mathematically, this is done by converting the partially completed units into fully completed units and then adjusting the output figure. First, the equivalent production of opening work-in-progress should be determined by taking into account the degree of work to be performed in the current period.

In this case, the equivalent production for opening work-in-progress in the period is units i. To assess the equivalent units of production requires careful reasoning about the amount of direct material injected into production for each department, relative to the total amount of direct material that will ultimately be needed to complete the process within that department.

This type of assessment must be repeated for direct labor and overhead. However, if overhead were applied on some other basis like machine hours then a separate determination of equivalency would be needed for labor and for overhead the illustrations within this chapter will assume overhead is applied based on labor. To better understand equivalent units, focus on an example for Navarro Steel. To begin, one needs to identify the total units that are to be considered, no matter their stage of completion at the beginning and end of the month.

Navarro started the month of June with , tons of iron ore in process in the Melting Department. During June, an additional , tons were introduced into the melting vats. This means , total units must be reconciled. The quantity schedule provides this reconciliation. The reason is that many processes may involve scrap, waste, or spoilage e. Waste and spoilage would be added as a third component needed to balance the lower portion of the quantity schedule column.

Advanced managerial accounting courses usually demonstrate the mechanics of handling the cost of spoilage within a process cost system. Once the total units have been reconciled, the equivalent units are computed. The correct manipulation of the data will depend on the inventory method in use. In this illustration, Navarro is assumed to use the weighted-average costing method other approaches such as FIFO could be used.

Thus, the , units that were completed are counted as , equivalent units of output no matter their physical origin from beginning inventory or otherwise. However, the units in ending work in process require more thoughtful consideration.

The following schedule shows how the total units are translated into equivalent units:. The result is the weighted-average cost per equivalent unit for each factor of production. The individual cost factors can be combined to identify conversion cost and overall cost per equivalent unit. Necessary cookies are absolutely essential for the website to function properly. These cookies ensure basic functionalities and security features of the website, anonymously.

The June production data for Department B is:. In Department B, the ending units may be in different stages of completion regarding the materials, labor, and overhead costs. Assume that Department B adds all materials at the beginning of the production process. Accountants often assume that units are at the same stage of completion for both labor and overhead. Accountants call the combined labor and overhead costs conversion costs.

Conversion costs are those costs incurred to convert raw materials into the final product meaning, direct labor and overhead. The equivalent units for materials, labor and overhead often referred to as Conversion Costs would be calculated as:. Total equivalent units for each cost element materials, conversion cost is calculated as:. These goods in process must have costs allocated to them along with the goods that were finished during the period.

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.