Equivalent Units of Production Formula, Calculation & Example
Manufacturers can identify strengths and weaknesses by comparing the EUP for each team or process and implementing improvement strategies. Navarro started the month of June with 300,000 tons of iron ore in process in the Melting Department. Manufacturing companies use a lot of ways to figure out what their operational strategy needs to be when they make their products.
These conversion factors are often based on assumptions and estimates and may not accurately reflect the work done at each production stage. Companies calculate the cost per unit of production to know how to most accurately determine price should i hire someone to clean my house before an appraisal for the customer. Every penny counts, especially if the product that they’re selling is made in the thousands. Accurate calculations and proper application of cost metrics will allow companies to ensure that every cost is accounted for.
- The total materials costs for the period (including any beginning inventory costs) are computed and divided by the equivalent units for materials.
- The third section illustrates cost allocation between completed units and WIP units.
- As a result, the equivalent units of direct materials will always be higher than other manufacturing costs.
- These conversion factors are often based on assumptions and estimates and may not accurately reflect the work done at each production stage.
It is a crucial metric to determine the cost of goods sold and inventory value in a production environment. Equivalent Unit of Production (EUP) is a measure used in manufacturing and accounting to determine the total number of fully completed units that could have been produced from work in progress during a given period. In manufacturing, a product typically goes through multiple stages of production, and each stage may produce partially completed units of production that need further processing to become fully completed units. If overhead is applied based on labor, the process is simplified because the “percent complete” would be the same for labor and overhead. Assume that a manufacturer uses direct labor continuously in one of its production departments.
Accurate financial reporting
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 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. Thus, the equivalent units for direct materials are generally higher than for other manufacturing expenses. This report shows the costs used in the preparation of a product, including the cost per unit for materials and conversion costs, and the amount of work in process and finished goods inventory. A complete production cost report for the shaping department is illustrated in Figure 5.6.
By tracking the number of equivalent units produced, companies can compare their performance over different periods or against industry benchmarks, providing valuable insights into how well they are doing and where they can improve. The formula for calculating equivalent units of production uses the weighted-average method formula because of its simplicity. To calculate the equivalent units of production, multiply the total number of units to be produced by the percentage that has been produced. It essentially accounts for the work that has already been done in a production project.
The costs and units of the current time period are added to the costs and units of the last time period. The equivalents units of production is equal to the number of units that have been completed and transferred, plus the number of units that are currently in production. 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 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.
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. 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. For example, if management projects that the per unit cost of production should be $3, then the calculation provides them data on how to improve the process to reduce resource usage and bring the per unit cost down to projected amounts. The company is also able to split up the cost of manufacturing among departments’ completed units and the remaining work-in-progress units.
The percent complete can be different for
direct materials, direct labor or overhead. The total materials costs for the period (including any beginning inventory costs) are computed and divided by the equivalent units for materials. The total of the cost per unit for materials ($1.50) and for conversion costs ($6.90) is the total cost of each unit transferred to the testing and sorting department. The total materials costs for the period https://simple-accounting.org/ (including any beginning inventory costs) is computed and divided by the equivalent units for materials. The total of the cost per unit for material ($1.17) and for conversion costs ($2.80) is the total cost of each unit transferred to the finishing department ($3.97). When the hickory size 5A drumsticks have completed the shaping process, they are transferred to the packaging department along with the inventory costs of $29,775.
The treatment of the beginning WIP units will depend on which costing method, usually weighted average or FIFO, the business is using. The table below summarizes the movement of physical units during the accounting period. For example, suppose a manufacturer consistently produces fewer units than expected in a particular production stage. In that case, they may need to allocate more resources to that stage to improve efficiency. Once the cost per EU is calculated, the costs are allocated to the goods that were partially finished and completely finished during the period.
In this example, direct materials (logs) are 100% complete because they are added at the beginning of the process. Let’s assume for the sake of simplicity that it takes about 50 days to process logs into sheets of plywood that are then ready to move on to the finishing department where they are sanded and the edges are trimmed. The mill starts up the machines at the beginning of the month, putting in enough logs to make 1,000 sheets of plywood.
Enables cost analysis
In many production departments, units are typically transferred from the initial stage to the next stage in the process. When the units are transferred, the accumulated cost per unit is transferred along with them. Since the unit being produced includes work from all of the prior departments, the transferred-in cost is the cost of the work performed in all earlier departments. In the agricultural industry, the equivalent production units may be calculated based on the crop yield or the livestock’s weight. This approach helps measure the productivity of farms and ranches and determine agricultural product value.
In the current period, we transferred 500 units to process 2, and have 350 equivalent units in our WIP inventory. Essentially saying, that process 1 completed 850 units to completion of process 1 in this period. Units of production can be used to measure output and productivity, and they are often used in cost accounting to determine the cost of production for each unit. The production unit can vary depending on the industry or company, but it is a fundamental concept in production and manufacturing processes.
We want to make sure that we have assigned all the costs from beginning work in process and costs incurred or added this period to units completed and transferred and ending work in process inventory. The units that were completed and transferred out plus the ending inventory equal the total units to account for. The packaging department for Rock City Percussion completed 6,500 units and transferred them into finished goods inventory.
Why is equal to units in completed status?
Accountants base this concept
on the supposition that a company must incur approximately the same
amount of costs to bring 1,000 units to a 40% level of completion
as it would to complete 400 units. Overall, understanding EUP is essential for manufacturing and production businesses looking to control costs, increase efficiencies, and improve profitability. By tracking EUP, managers can make more informed decisions about allocating resources and managing inventory, ultimately leading to a more prosperous and profitable business. EUP can identify areas of the production process where capacity is underutilized or overutilized. By calculating the EUP for each production stage, manufacturers can determine whether they need to adjust their production schedule or allocate more resources to specific stages. While EUP can help analyze the cost of production, it may not always reflect the actual costs incurred by the business.
The operational strategy is a plan that includes the goals and behaviors used to accomplish the goals of a company. These measurements supply different information depending on the tool used and the intended outcome. The units that remain in the ending work-in-process inventory, however, are not complete. In other words, a unit that is 25% done is the equivalent of ¼ of a completed unit. In our next section, we will do a comparison and reconciliation of the same number of products through one process with each of the two methods. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
Manufacturers can make informed decisions about production scheduling and inventory levels by tracking the number of units in each stage of the production process. EUP considers the percentage of completion of each unit and estimates the number of fully completed units that could have been produced from work in progress based on the degree of completion of each unit. Advanced managerial accounting courses usually demonstrate the mechanics of handling the cost of spoilage within a process cost system. However, for now simply know that the cost of “normal” spoilage should be allocated to the inventory of good units, while the cost of excessive waste is charged off as a loss on the income statement.
