EQUIVALENT UNITS: WHAT THEY ARE FOR, CALCULATION AND EXAMPLES - DUDAS - 2024

The equivalent units of production correspond to the number of completed units of an article which in theory could have produced a company, given the percentage amount incurred direct materials, direct labor and manufacturing overhead during this period for items not yet completed.

In other words, if there are 100 units in process but only 40% of the processing costs have been spent on them, then it is considered that there are 40 equivalent units of production. These units are generally declared or calculated separately.

This separation occurs like this: on the one hand, direct materials; and on the other, all other manufacturing expenses. This is because direct materials are commonly added at the beginning of the production process, while the other costs are incurred gradually as the materials are integrated into the production process.

Therefore, the equivalent units for direct materials are generally higher than for other manufacturing expenses.

What are they for?

The equivalent unit is a cost accounting concept used to calculate process costs. Applies to work-in-process inventory at the end of an accounting period.

It has no relevance from an operational perspective. It is also not useful for any other type of cost derivation other than process costing.

When goods are produced in a continuous process, how do you distribute the costs between work in process and finished products? Accountants have come up with the concept of the equivalent unit, a physical unit expressed in terms of a finished unit.

For example, ten units in process that are 30% finished equals three equivalent units of finished product. None of the ten units is finished, it is simply said that the equivalent amount of work necessary to complete three units has been done.

An equivalent unit of production is an indication of the amount of work performed by manufacturers who have partially finished units available at the end of an accounting period.

Results presentation

Equivalent units will be found in production cost reports for manufacturers' producing departments that use a process cost system.

Cost ledgers likely present cost calculations per equivalent unit of production under two cost flow assumptions: weighted average and FIFO.

How are they calculated?

Equivalent units are calculated by multiplying the number of physical units available by the units' completion percentage. If the physical drives are 100% complete, the equivalent drives will be the same as the physical drives.

However, if the physical drives are not 100% complete, the equivalent drives will be less than the physical drives.

For example, if four physical units of product are 50% complete at the end of the period, an equivalent of two units has been completed

(2 equivalent units = 4 physical units × 50%). The formula used to calculate equivalent units is as follows:

Equivalent units = number of physical units × percentage of completion

Basically, fully completed units and partially completed units are both expressed in terms of fully completed units.

Direct Materials Cost Allocation

When you assign a cost to equivalent units of production for direct materials, you typically assign the weighted average cost of the opening inventory plus new purchases, or the cost of the oldest inventory in stock (known as the FIFO method).

The simpler of the two methods is the weighted average method. The FIFO method is more accurate, but the additional calculations required do not represent a good cost-benefit trade-off.

Using the FIFO method is only considered when costs vary substantially from period to period so that management can see trends in costs.

Evaluation

Evaluating 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 necessary to complete the process within that department.

This type of evaluation should be repeated for direct labor and overhead. If indirect costs are applied based on labor, the process is simplified because the "percent complete" would be the same for labor and overhead.

However, if indirect costs are applied on another basis (such as machine hours), then the equivalence units would need to be determined separately, for labor and for overhead.

Examples

Here is a diagram of the concept of equivalent units. By examining the diagram, you can think of the amount of water in the glasses as costs that the company has already incurred.

First example

Suppose a manufacturer uses direct labor continuously in one of its production departments. During June the department started with no units in inventory, and started and ended 10,000 units.

It also started an additional 1000 units that were 30% complete at the end of June. This department is likely to declare that it manufactured 10,300 (10,000 + 300) equivalent units of product during June.

If the department's direct labor cost was $ 103,000 for the month, the 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 allocated to completed units and $ 3000 (300 x $ 10) will be allocated to partially completed units.

Second example

ABC International has a manufacturing line that produces large quantities of green boxes. At the end of the most recent accounting period, ABC had 1,000 green boxes still in production.

The green box manufacturing process requires all materials to be shipped to the shop at the start of the process. A variety of processing steps are then added before the boxes are deemed finished.

At the end of the period, ABC had incurred 35% of the overall labor and manufacturing costs required to complete the 1,000 green boxes.

Consequently, there were 1000 equivalent units for materials and 350 equivalent units for direct labor and manufacturing overhead.

References

1. Steven Bragg (2017). Equivalent units of production. Accounting Tools. Taken from: accountingtools.com.
2. Harold Averkamp (2018). What is an equivalent unit of production? Accounting Coach. Taken from: accountingcoach.com.
3. Principles of Accounting (2018). Equivalent Units. Taken from: principlesofaccounting.com.
4. Lumen (2018). 3.2 Equivalent Units (Weighted Average). Chapter 3: Process Cost System. Taken from: courses.lumenlearning.com.
5. Kenneth Boyd (2018). HOW TO COMPUTE EQUIVALENT UNITS IN COST ACCOUNTING. Dummies. Taken from: dummies.com.