How to Calculate Equivalent Units: Weighted-Average & FIFO
Learn to accurately measure production output from partially completed goods for precise cost accounting and inventory valuation.
Process costing systems track costs in continuous production industries like food processing or chemical manufacturing. Within these systems, “equivalent units” are central to accurate cost allocation. This concept expresses partially completed units as fully completed units, representing the total work performed on all units, whether finished or in progress, translated into the number of whole, completed units. Converting incomplete units into their equivalent completed form enables businesses to allocate costs precisely and make informed decisions about pricing, production efficiency, and inventory valuation. This ensures financial reporting accurately reflects resources invested in both finished goods and work-in-process inventory.
Understanding the Core Components
Before calculating equivalent units, it is important to understand several foundational elements. “Physical units” refer to the actual count of products, encompassing both fully completed items and those in various stages of completion.
Direct materials are raw substances that become an integral part of the finished product. Their completion percentage depends on when they are introduced into the production process. Conversion costs represent the expenses incurred to transform raw materials into finished goods, encompassing direct labor and manufacturing overhead. These costs are incurred continuously, reflecting the extent of processing work applied.
Work-in-process (WIP) inventory includes all units that have entered the production process but are not yet finished. This category includes beginning WIP (units partially completed in a prior period) and ending WIP (units incomplete at the current period’s close). The “percentage of completion” estimates how much work has been performed on partially completed units for both direct materials and conversion costs.
Calculating with the Weighted-Average Method
The weighted-average method for calculating equivalent units combines the work performed on beginning work-in-process inventory with the work done in the current period. This approach averages all costs over the total equivalent units, providing a single cost per unit for both completed and partially completed products. It simplifies the calculation by not differentiating between units from prior periods and those started and completed in the current period.
To begin, identify the total units completed and transferred out of the production department during the period. These units are considered 100% complete for all cost components within that department. Next, determine the units remaining in ending work-in-process (WIP) inventory, which are partially complete.
For direct materials, calculate equivalent units by adding the units completed and transferred out to the product of ending WIP units and their percentage completion for materials. For example, if 10,000 units were completed and transferred, and 2,000 units in ending WIP are 70% complete for materials, the equivalent units for materials would be 10,000 + (2,000 0.70) = 11,400 units.
Similarly, for conversion costs, add the units completed and transferred out to the product of ending WIP units and their percentage completion for conversion costs. Using the previous example, if the 2,000 ending WIP units are 40% complete for conversion costs, the equivalent units for conversion would be 10,000 + (2,000 0.40) = 10,800 units.
Calculating with the FIFO Method
The FIFO (First-In, First-Out) method for calculating equivalent units assumes that the units in beginning work-in-process inventory are completed first, followed by units started and completed during the current period. This method focuses on the work performed only in the current period, providing a more precise tracking of costs based on their incurrence. It distinguishes between work done in the prior period and work done in the current period for beginning inventory.
First, calculate the equivalent units needed to complete the beginning work-in-process (WIP) inventory. This involves multiplying the beginning WIP units by the percentage of work remaining to be done in the current period for both direct materials and conversion costs. For instance, if 1,000 beginning WIP units were 60% complete for materials, they need an additional 40% completion, so 1,000 (1 – 0.60) = 400 equivalent units for materials are associated with completing beginning WIP in the current period.
Next, identify the units that were both started and completed during the current period. These units are 100% complete for all cost elements. For example, if 8,000 units were started and completed this period, they contribute 8,000 equivalent units for both materials and conversion costs.
Finally, calculate the equivalent units for the ending work-in-process (WIP) inventory, similar to the weighted-average method. This means multiplying the ending WIP units by their percentage completion for materials and conversion costs. If 1,500 ending WIP units are 50% complete for materials and 30% for conversion, they represent 1,500 0.50 = 750 equivalent units for materials and 1,500 0.30 = 450 equivalent units for conversion.