What are Equivalent Units of Production?
Definition: Equivalent units of production are the sum of the units completed during a given accounting period together with the unfinished units that have been expressed as finished units. Simply stated, equivalent units of production are the units in production represented as a factor of the completeness of the production process during that particular accounting period.
Indeed, process accounting may not amount to much from the operational perspective of the business but it matters in process costing. Specifically, process costing helps the management to make sense of what happens to direct materials that go into production at the beginning of the accounting period. Process costing helps the management to explain the behavior of the production process at the end of a given accounting period from the perspectives of direct materials used.
When computing the equivalent units of production, accountants take note of two things. First, all the units that have been completed and shipped out of the factory are considered 100% finished. Second, accountants assign a level of completeness to the units that are still in production at the end of the accounting period in question. Therefore, a unit could be 10% complete or even 90% complete at the end of the accounting period.
In accounting, there is the need to capture the every aspect of the production process to ensure that the management of the business has a pulse on the trend of costs. This is the primary objective of process accounting. Process accounting uses the concept of equivalent units of production to capture all manners of costs, including the costs of unfinished units.
How to Compute Equivalent Units of Production
Every organization dealing in production of goods has an inventory account the work in progress. Keeping track of the work in progress is crucial for the organization given that it has to account for each penny deployed during the production process. The process costing system helps to quantify all the activities that take place during an accounting period.
Indeed, each department of a production company has work-in-progress inventory account and completed units account. To determine how costs flow through each account in a given accounting period, it is imperative for the accountant to determine the unit cost of the products that each department is transferring out of the account that tracks the number of units that are yet to be completed. To start the process off, the accountant has to determine the equivalent units of production first.
Usually, accountants assume that all the units that are registered in the work-in-progress inventory account are completed just partially. However, these units must be converted in equivalent fully completed units before computing the equivalent units of production for that accounting period.
Equivalent Units of Production Formula
To compute the equivalent units formula, you simply multiply the actual units by the level (percentage) of completion i.e.
Equivalent units = number of actual units x percentage of completion
Equivalent Units Example Calculation
Company Theta produces power generators for the low-end market. During the month ended 31 December 2019, Company Theta had completed 980 generators and shipped them to the warehouse. However, company records show that there 412 generators that were still inproduction by the close of the month. Furthermore, the company had incurred 75% of the cost of direct materials while producing the 412 generators. Company Theta’s accountant wants to compute the unit cost of products at the end of December 2019.
Step 1: Find the equivalent units of production in the work-in-progress inventory account.
Equivalent units of production = 412 x 75/100 = 309.
Step 2: Find the equivalent units of production in the completed account
Equivalent units = 980 x 100/100 =980
The total equivalent units of production at the end of December 2019 were 980 + 309 = 1,289.
Assume that the department spent $51,560 as total cost of production at the end of the month, the accountant can easily compute the unit cost of production by dividing the total cost of production by the equivalent units of production i.e.
Unit cost of production = Total Cost of Production for the Accounting Period ÷ Equivalent Units of Production
= 51,560 ÷ 1,289 = $40.