When allocating costs, companies must determine the number of units produced during a period. However, it becomes more complicated when some units haven’t finished manufacturing. Therefore, companies use equivalent units of production to solve the issue.
What are Equivalent Units of Production?
Equivalent units of production (EUP) is a concept used in managerial accounting to assess the progress of production processes, particularly in manufacturing settings where production occurs in stages. It involves converting partially completed units into the equivalent number of completely manufactured units for cost allocation and inventory valuation.
The EUP calculation considers the percentage of completion for units in process at the end of an accounting period, factoring in direct materials, direct labour, and overhead costs. This method provides a more accurate representation of the work done during the period, facilitating better cost management and decision-making.
How to calculate Equivalent Units of Production?
Equivalent units of production gauge the progression of manufacturing processes and allocate costs accurately. This calculation involves determining the number of units partially completed at the end of a period and converting them into equivalent fully completed units for cost allocation. Calculating equivalent units is essential for evaluating production efficiency, identifying areas for improvement, and making informed decisions about resource allocation and pricing strategies.
Companies must assess the units started and completed during a period to calculate equivalent units of production. Then, they must identify units in ending inventory and calculate equivalent units for direct materials and conversion costs (including direct labour and overhead). By summarizing the equivalent units for each cost category, companies obtain a total that reflects the work completed during the period.
What is the formula for Equivalent Units of Production?
Typically, companies use the weighted average method to calculate the equivalent units of production. They can measure this value of each cost component. For example, the formula for the equivalent units of production for direct materials is as follows.
Equivalent units for direct materials = Units completed + (Units in ending inventory × Percentage of completion for direct materials)
Similarly, the equivalent unit formula for conversion costs is as follows.
Equivalent units for conversion costs = Units completed + (Units in ending inventory × Percentage of completion for conversion costs)
Therefore, the equivalent units of production may differ based on the component a company uses to calculate it.
Example
Red Co. manufactures bicycles and uses the following data for January. The units started and completed during the month were 1,500 units. On the other hand, units in ending inventory were 300. Red Co. determines the percentage of conversion costs completion for those units as 80%. Based on this information, the company calculates its equivalent units of production as follows.
Equivalent units for conversion costs = Units completed + (Units in ending inventory × Percentage of completion for conversion costs)
Equivalent units for conversion costs =1,500 units+(300 units x 80%)
Equivalent units for conversion costs = 1,740 units
Conclusion
Equivalent units of production estimate the completed number of units based on their completion level. It does not reflect the actual closing inventory ready to sell. However, it provides a base to calculate how many units a company may consider completed for various calculations. Companies can gauge this value for various cost components, for example, direct material or conversion costs.
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