Equivalent units of production represent a way to measure the value of partially completed products in factories. This is needed in accounting so that the value of goods in hand and their costs can be allocated to a particular accounting period. Accountants need to do this when the production of items continues over the end of a period. These partially built pieces have used resources such as materials and labour and so it would not be possible to calculate unit costs without including these unfinished goods. An accounting formula determines what proportion of a completed item each partially finished item represents. There are two methods to calculate this figure. One is called the weighted average method; the other is called the "first in, first out" method, or FIFO.”
- Skill level:
Examine the work in process at the period end and estimate to what percent they are completed. Make this an average figure across all items. The percentage needs to be expressed as two figures. One represents the amount of raw materials contained in the unfinished items, while the other is the amount of effort that went into that state.
Calculate the equivalent units of production in terms of material costs (call that K) by reducing the number of partially finished goods (X) by the finished percentage (Y). So the equivalent units of production are K = (X/Y) * 100 for material costs.
Calculate the equivalent units of production in terms of work completed to work out unit labour costs. Divide the number of partially completed items (X) by the percentage of work done (Z). The formula for this figure is (X/Z) * 100.
Add the equivalent units of production to the total number of units completed in the period. This method includes partially completed work at the beginning of the period in with the figure of goods completed in the period.
Weighted average method
Decide the proportion of materials and the amount of work expended on all the unfinished products. Also, count the unfinished products. These figures should be compiled at the end of each month, so you should have on record the quantity, percentage of materials and percentage of work for the last period end. The state at the last period end is also the opening state for this period.
Calculate the amount of materials and labour needed to complete the partially completed goods at the beginning of the period. This is done by taking a count of the goods (A), estimating the percentage of materials in those goods (B) and the amount of labour expended to get them to that state (C). For material usage, the equivalent units of production for the opening status (K) are K = (A(100 – B)) * 100. The formula for the equivalent units of production for labour costs at opening (L) is L = (A(100 – C))* 100.
Calculate the equivalent units of production in terms of work completed at month end to work out material costs and unit labour costs. Divide the number of partially completed items (X) by the percentage of materials used (Y) to get the closing equivalent units of production in terms of materials (M). Divide the closing amount of unfinished goods by the percentage of work done (Z) to get completed labour costs (N). The formula for equivalent units of production in terms of materials is M= (X/Y) * 100 and the formula for equivalent units of production in terms of labour is N= (X/Z) * 100.
Add the completion effort and material requirements of goods that were partially finished at the beginning of the period to the percentage of parts and labour invested in partially figured goods at period end to get the total equivalent units of production. Equivalent units of production in terms of materials is K + M and equivalent units of production in terms of labour is L + N.
Reduce the total number of units completed in that period by the number of units partially completed at opening. Add the total equivalent units of production to this figure.
The first-in-first-out method
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