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I'm Larry Walther, this is principlesofaccounting.com,
Chapter 20 and we're looking at Process Costing and Activity-Based Costing.
In this specific module we're going to consider the concepts of equivalent units.
In the previous module we talked about the general characteristics of process
costing, now we're going to get in to the nuts and bolts of process costing.
And that begins by understanding the concept of equivalent units, and
how we're going to determine the cost per equivalent unit.
And so, an equivalent unit is an abstract concept.
It's simply a physical unit expressed in terms of a finished unit.
For example, if we have 10 units in process that are 30% complete,
we can simply say that, that process relates to or
equates to 3 equivalent units of output, 30% of 10.
None of the 10 units is complete, it's simply that the equivalent amount of work
necessary to complete 3 units is said to be performed.
Now, recognize that equivalent units is not necessarily the same across
all factors of production, we have material, labor and overhead.
For example, we might be only 80% complete with respect to materials and
only 60% complete with respect to labor and overhead.
So we would have more equivalent units of material in
process than we would equivalent units of conversion cost and process.
And that's perfectly fine, perfectly logical, but
it will cause us to adapt our calculations to reflect that fact.
Of course, if overhead is applied based on labor, the process is simplified.
As I've assumed here, that if we're 60% complete with respect to labor I've
also assumed we're 60% complete with respect to overhead
as labor is the application base I've assumed in this example.
Now, the textbook has an example for Navarro Steel and
I'm simply following along with that illustration.
The first stage in Navarro's production process is the Melting Department.
And so, Navarro, I'm assuming, started month with 300,000 tons of ore in process,
during the month they added an additional 600,000 tons into process
thus there's 900,000 total units that must be reconciled or accounted for.
I'm assuming 650,000 tons were transferred on
to the next department leaving 250,000 in process at the end.
So we can then look at a unit reconciliation.
And this is the beginning point to get our arms around the total
units that are involved in a particular process during a particular period.
And so here are the 900,000 tons that we need to explain or
reconcile or determine the disposition of.
And we know that 650,000 tons were transferred out, and we verified that
250,000 were still in process at the end of the month in the melting department.
So that 900,000 to 900,000, that reconciliation is highly important.
Of course, it's possible that the total units that went in
are not equal to the units that went out and remain in process.
We may have evaporation or spillage or spoilage or waste or scrap of some type.
If that’s normal in the production process, we allow for that.
In other words, in our reconciliation, we would say, well,
we had 600,000 units transferred out,
250,000 units still in process and 50,000 simply evaporated, if that were the case.
We would then take the total cost and assign it to the good units.
We're not going to assign costs to the normal spoilage,
the cost that relates to that simply gets pooled in and
applied to the units that are actually making their way toward finished goods.
Now, that's for normal spoilage.
Abnormal spoilage or excessive waste we might go ahead and track costs for
those units, assign costs for those units and reconcile those amounts
as lost components and report that as such in the income statement.
Now, as with any inventory method, and process costing is an inventory costing
method, we need to adopt a cost flow assumption.
I'm going to use weighted-average illustration in this particular case.
We could do this is an alternative process called FIFO costing.
We need to do it one way or
the other, so let's look at this under the average costing method.
And we're going to average together the cost associated with beginning inventory
and current period production.
And so the left hand side of the slide, this is the schedule we just developed.
The reconciliation of the units that existed, we've already seen,
we've explained how the 900,000 units went into production and
where they ended at the end of the month.
Also, I'm adding an additional fact here, the ending work in process status,
the materials are 50% injected into the process and
the conversion cost and labor and overhead is 40% complete.
So we're fractually complete with respect to the ending working process, and here's
how this works out, the 650,000 units that were completed and transferred to the next
department, then 100% complete with respect to material, labor and overhead.
But the ending work in process, 250,000 tons being 50 percent complete with
respect to materials gives us the 125,000 equivalent units of materials,
and 40% of the 250,000 gives us the 100,000 units of conversion costs.
That means then for the month our equivalent units calculations need
to be based upon 775,000 tons of direct materials, and
conversion relates to the labor and
overhead necessary to convert 750,000 equivalent units of finished process.
And that information is vital as we go forward calculating the cost
per equivalent unit.
And so another schedule here and some more facts.
Our beginning work in process contained 2,122,500 and
an additional 7,365,000 was added into
process during the month distributed between material, labor and overhead.
So, we got a total cost to account for,
the actual cost sign is $9,487,500, broken down between material,
labor and overhead and now here's where the equivalent unit comes into play.
We'll divide each of those cost pools by the equivalent units related to that
cost pool, to come up with the cost per equivalent unit,
very simply, our materials, average cost is $9.00 a ton.
Our conversion cost, average is $3.35 a ton.
Our total cost for one complete equivalent unit of output is $12.35.
And so this is the calculation of the cost per equivalent unit.
These numbers will become essential and vital as we go forward,and in fact,
we'll incorporate this part of this schedule into our final
cost of production report, that we'll see in a subsequent module.
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