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5.4 An equivalent unit is a measure of the amount of production inputs that are
applied to physical units in the production process. In process costing, costs
are assigned to equivalent units rather than physical units. The concept of
equivalent units can be ignored when there are no work-in-process
inventories or when the work-in-process inventory levels are stable over
time. For example, there will be no need to record work-in-process
inventory in businesses where the completion of the production process
coincides with the end of the accounting period. These businesses are likely
to include beverage producers where the production line is shut down (and
cleaned) at the end of each day and frozen foods manufacturers where
goods must be completed and frozen at the end of processing. The stability
of work-in-process inventory levels over time will be influenced by the
stability in the supply of inputs and in the demand for the finished goods.
The processing of motor vehicle registrations may be an example of a
production process associated with stable levels of work in process
inventory.
5.5 Exhibit 5.3 uses the weighted average method to calculate unit costs. In this
method of process costing the direct material costs incurred in this period
are added to the cost of direct materials in the opening work in process.
This total direct material cost is then divided by the number of equivalent
units to which those costs relate. In this Exhibit the direct material costs in
the opening inventory plus the direct material costs that are added during
the period total $560 000. The equivalent units of direct materials from the
opening inventory and those started during the period are 400 000. The
direct material cost per equivalent unit is therefore $(560 000/400 000) or
$1.40. Using the same approach for the conversion costs: the conversion
costs in the opening inventory plus the conversion costs incurred in the
current period total $146 150. The equivalent units of conversion in the
opening inventory plus the conversion effort for the current period total 395
000 equivalent units. The conversion cost per equivalent unit is therefore
$(146 150/395 000) or $0.37. The total cost per equivalent unit is therefore
$1.77, calculated as follows:
5.6 The cost of goods transferred out is calculated as the number of physical
units multiplied by the total equivalent cost per unit. The total cost of work
in process is calculated by taking into account the number of equivalent
units remaining for both direct material and conversion cost and
multiplying these units by the respective cost per equivalent units.
5.7 The difference between the two methods relates to the calculation of the
relevant total equivalent units for the period.
Under the weighted average method, the equivalent units of activity for the
month relate to the closing work in process inventory and the units
completed and transferred out. Thus, in Exhibit 5.2, the total EUs for direct
material are 400 000 and for conversion cost are 395 000.
Under the FIFO method, the equivalent units of activity in the beginning
work in process inventory are subtracted from the total equivalent units for
the period to arrive at the new equivalent units of activity for the current
period. In Exhibit 5.7, the total EUs that were calculated in Exhibit 5.2
using the weighted average cost method are reduced by the EUs of inputs
received by 20 000 physical units in the opening WIP, to arrive at 380 000
EUs of direct material and 393 000 EUs of conversion cost.
The result is that under the weighted average method the total costs for
opening work in process inventory plus the cost of resources consumed this
period are averaged over all work that they relate to, both that performed in
the previous period and that performed on the current period. Using FIFO
we work out the cost per unit only for the work performed in the current
period by dividing the cost of resources consumed in this period by the
measure of work performed in this period. We then work out the equivalent
units of activity required to finish off the units in the opening inventory and
add the cost of that activity to the opening inventory costs. We separately
cost the units both started and finished in this period and also the closing
inventory.
5.8 The name first-in-first-out, or FIFO, is used as it assumes that the units
transferred to finished goods inventory at any time are those that were
started earliest and the units remaining in the work in process inventory at
5.9 Under the weighted average cost method the total equivalent cost per unit is
the total of the average of the cost per equivalent unit for the opening work
in process and the units commenced during the month for the two inputs to
production. In Exhibit 5.3, the average cost per EU for direct material is
$1.40 and for conversion cost is $0.37.
For FIFO it is assumed that the old units are completed before new units are
commenced. Thus, to calculate the total cost per equivalent unit, the units in
opening work in process are first subtracted from the total of the units
completed and the closing work in process units to give the equivalent units
that relate to new production. A cost per equivalent unit is then calculated
for each input to production, based on costs incurred in the current period.
In Exhibit 5.8 the cost per EU for material is $1.33 and for conversion cost
is $0.36. These costs relate to the new production that commenced during
the period.
Under both methods there is a matching of the costs of resources consumed
with the activity performed in the consumption of those resources. Using
the weighted average method the resource costs and activity relate to the
current period plus those from the previous period that are in the opening
inventory. Using FIFO, the cost per equivalent unit relates only to the
resource costs and activity in the current period.
5.10 The production report for the WAC method is much simpler than that for
the FIFO method as the closing work in process and goods completed are
costed using a single equivalent cost per unit for each input to production.
Under the FIFO method the closing work in process is costed using the cost
per equivalent unit of the most recent production for each input to
production. The cost of completed goods is a combination of the costs of
5.11 Under the weighted average method, the cost of the beginning work in
process inventory is added to the cost incurred during the current period in
order to determine the weighted average cost per equivalent unit. Under the
FIFO method, the cost of the beginning work in process inventory is not
added to the cost of the current period to determine cost per EU. Rather, the
cost of the beginning work in process inventory is assumed to be completed
first and then new production units are commenced. The costs of opening
WIP are kept separate from the costs of the current period. The cost per
equivalent unit is then used to calculate the cost of finishing off the opening
WIP during the current period.
5.12 Estimating the cost of spoilage highlights the cost of wasted resources,
which may focus the attention of management.
Normal spoilage is considered to be a normal aspect of the production
process. It is relatively constant, statistically predictable, and unavoidable
without incurring excessive costs to improve the production process. As a
consequence, it is considered to be a normal cost in the production of the
good units that emerge from the process and can be included in the cost of
good units completed and transferred out. Abnormal spoilage is that level
of spoiled units outside the normally acceptable range, caused by factors
not normally encountered. By isolating the cost of abnormal spoilage,
managements attention is drawn to a matter that needs to be investigated. It
should be treated as a period cost and expensed in the current period.
5.13 Using the weighted average method it does not matter which units are
spoiled. When using FIFO it is necessary to identify how many spoiled
units are from those in process at the beginning of the period, and how
many of the units started this period are spoiled. In practice it is very
difficult to separately account for spoilage between the two different
categories of production.
5.14 Operation costing is a hybrid product costing system that is used when
conversion activities are very similar across product lines, but the direct
materials differ. This is often the case in batch manufacturing operations.
Conversion costs are accumulated by department, and process costing
methods are used to assign these costs to products. Different products may
go through some, or all, of the processes. Direct material costs are
5.15 The wine producers should use process costing when they are producing
single product line or different wine products on different production lines.
On the other hand, the wine producers should use operation costing when
the wines are produced in batches utilising some repetitive processes but
basically different processes and different grape varieties for different type
of wines.
5.16 The essential element in any answer to this question is that the students
demonstrate an understanding of job costing, process costing and hybrid
systems. An example could be canning, where the food that is canned
changes but the canning process remains the same. There may even be
different preparation processes for different foods.
5.19 There are many processes in service firms and service departments, and
where these processes are repetitive process costing is as suitable as when
the products are goods. Examples include processing cheques in banks,
processing claims in an insurance company, cleaning rooms in a hotel and
checking in passengers at an airport.
* These two lines in the table are used only for the FIFO method (requirements
1 and 2 in the exercise).
2 FIFO method:
Direct Conversio Total
material n
Work in process, 1 June These costs are not $490 000
included in the unit cost
calculation
Costs incurred during $850 000 $1 380 2 230 000
June 000
Total costs to account for 2 720 000
Equivalent units 8 500 2 000
Costs per equivalent unit $100 $690 $790
Check:
Cost of goods completed 423 117
and transferred out
Cost of closing work in 46 009
Copyright 2015 McGraw-Hill Education (Australia) Pty Ltd
IRM t/a Langfield-Smith, Thorne, Smith, Hilton Management Accounting 7e
14
process
Total costs accounted for $469 126*
* There is a rounding error as many items were rounded up
Direct Conversio
material n
Total equivalent units (weighted 60 000 52 000
average)
Less: Units completed and (50 000) (50 000)
transferred out
Equivalent units and ending work 10 000 2 000
in process
2 When the weighted average method of process costing is used, the good
units transferred out, spoiled units and closing WIP are all costed at the
same rate per EU, which is the weighted average of the cost of opening
WIP and current costs. If the FIFO method is used, it would be necessary to
identify whether the spoiled units were from the previous period or the
current period. In most process cost industries this would be extremely
difficult, if not impossible.
Accumulated
by process
Accumulated
by batch
[Check:
Costs incurred = $50 000 + 4000 x $10 + 4000 x $7
+ 1000 x $1 = $119 000
Costs transferred to Finished Goods = $81 000 + $38
000 = $119 000]
Conversion:
number of cost per
equivalent equivalent .......................................... 2 000 $3.00 6 000
units of
unit of
direct material direct material
Conversion:
number of cost per
equivalent equivalent .......................................... 7 000 $2.74 19 180
units of unit of
direct material direct material
* difference of $180 due to rounding error with cost per EU of conversion cost
which is more accurately 2.73684211
Direct material:
Conversion:
Check: Cost of goods completed and transferred out ................ $1 900 500
Cost of 31 May work in process inventory ....................... 891 200
Total costs accounted for................................................... $2 791 700
2 Goods completed during April cost $1 872 000 (24 000 units $78), as the
following calculations show:
Percentage of Equivalent units
completion
Physica with respect to Direct Conversi
l units conversion material on
Direct
materi Conversi
al on Total
Work in process, 1 April $18 $9 000 $27
000 000
Costs incurred during April 64 45 000 109
500 500
Total costs to account for $82 $54 000 $136
500 500
Equivalent units 1 000 900
Cost per equivalent unit $82.50 $60.00 $142.5
0
b
Work in process, 1 July, = total equivalent units, direct material
units a. new equivalent
Total units
unitsto
accomplished
account for in July;
direct material
= 120 000 80 000
= 40 000 units
c
Units started during July = units completed and transferred out work
in process, August 1 + work in process, 31
July
= 70 000 40 000 + 50 000
= 80 000 units
d
Total equivalent units = units completed and transferred out + work
direct material* in process units, 31 July
e
Total equivalent units, = units completed and transferred out +
conversion (work in process units 31 July degree of
completion)
= 70 000 + (50 000 40%)
= 90 000 units
f
New equivalent units: = total equivalent units: conversion (work
conversion in process units, 1 July degree of
completion)
g
Cost incurred during July, = total costs incurred during July cost
conversion incurred during July, direct material
= $2 986 800 $1 224 000
= $1 762 800
i
Work in process, 1 July, = work in process, 1 July, total cost work
conversion in process 1 July, direct material
= $880 000 $608 000
= $272 000
j
Cost per equivalent unit, = cost incurred during July: direct material
direct material new equivalent units in July: direct
material
= $1 224 000 80 000
= $15.30
k
Cost per equivalent unit: = conversion costs during July new
conversion equivalent units: conversion
= $1 762 800 78 000
= $22.60
l
Total cost per equivalent = cost per equivalent unit: direct material
unit and cost per equivalent unit conversion
= $15.30 + $22.60
= $37.90
m, n, o, p: refer to the
following production report.
Costs incurred to produce units that were both started and completed during
July:
number total cost per
of equivalent 30 000 $37.901 137 000
units unit
Conversion:
number of
equivalent conversion cost 20 000 $22.60 452 000
units of
per equivalent unit
conversion
Units started and completed during July: 70 000 units completed and
transferred out minus 40 000 units in the 1 July work in process inventory.
Total costs to account for $172 500 $100 400 $272 900
7 If the FIFO method had been used, in the production report the new
equivalent units accomplished for the current month would need to be
calculated by reducing the total equivalent units by the number of
equivalent units in the opening WIP inventory. Also we would usually need
to make an assumption as to whether the spoiled units were started in the
previous period or in the current period. In this example, as the opening
WIP is at the 60% completion stage we know that these are all good units.
Spoiled units are detected at the 25% stage, so that means that the spoiled
units all came from units started in the current month.
1 Conversion costs per unit, Department A, $268 000/20 000 units = $13.40
2 Conversion costs per unit, Department B, = $90 000/9 000 = $10 per unit
3 $35.90
4 $53.90
5 $76.20
2 Product cost
Non- Reflectiv
Ceralam reflective e
sheets sold Ceralam Ceralam Total
after rolling housings housings costs
Direct material:
Ceralam sheets $480 000 $200 $120 $800 000
000 000
Chemical dip 30 000 30 000
Conversion costs:
Rolling 450 000a 187 112 750 000
500a 500a
Moulding 175 105 280 000
000b 000b
Punching 200 120 320 000
000c 000c
Dipping _______ ______ 112 112
__ 500d 500
Total cost $930 000 $762 $600 $2 292
500 000 500
Units manufactured 12 000 5 000 3 000
Unit cost $77 50 $152.5 $200.00
0
a
Number of units rolling cost per unit ($37.50)
b
Number of units moulding cost per unit ($35.00)
c
Number of units punching cost per unit ($40.00)
3 Journal entries:
Work in process inventory: Rolling $1 550
000
Raw material inventory $800
000*
Applied conversion costs 750 000
* $800 000 = direct-material cost for Ceralam sheets
$750 000 = conversion cost in rolling operation
Product cost assuming direct material used in dipping was $45 000:
Non- Reflectiv
Ceralam reflective e
sheets sold Ceralam Ceralam Total
after rolling housings housings costs
Direct material:
Ceralam sheets $480 000 $200 $120 $800 000
000 000
Chemical dip 45 000 45 000
Conversion costs:
Rolling 540 000a 225 135 900 000
000a 000a
Moulding 210 126 336 000
000b 000b
a
Number of units rolling cost per unit ($45)
b
Number of units moulding cost per unit ($42)
c
Number of units punching cost per unit ($48)
d
Number of units dipping cost per unit ($45)
1 Cutting
Direct material $90 000
Direct labour 37 500
Overhead 4 050 ($45 000/15 000 hours
1350 hours)
$131 550
Sewing
Direct material $7 500
Direct labour 90 000
Overhead 28 800 ($24 000/3 000 hours
3600 hours)
$126 300
Total product costs = $131 550 + 126 300 = $257 850
Production units = 7500
Product cost per unit = $34.38
3 The work in process accounts are useful control devices to monitor the total
cost in each department. Also, despite the companys policy there may
occasionally be months where work in process is unavoidable.
Cost per
Equivalent equivalent
Input units unit Cost
Transferred in 3 500 $5.00 = $17
500
Direct material 3 500 $1.00 = 3 500
Conversion 3 500 $3.00 = 4 200
40%
Total cost of 31
May $25
work in process 200
inventory
Conversion:
number of cost per
equivalent equivalent ...............................................
units of unit of
conversion conversion
160 $7.00 = 1 120
2 The cost of manufacturing the belt is $13 per unit, which is different to the
$11.50 used for planning purposes. Using the incorrect cost the profit
margin would be overstated. If management were to use the incorrect cost
then it could result in wrong decisions.
Cost of goods completed and transferred out of the Grading Department during
November:
Cost of 1 November work in process inventory
0
Cost incurred to produce units that were both started and completed during
November
total cost per
(number of units) 36 000 $9.78 $352 080
equivalent unit
Cost incurred to produce units that were both started and completed during
November:
number
total cost per
of equivalent unit 34 000* $12.18 414 120
units
Conversion:
number of equivalent conversion cost
1000 $2.40 2 400
units of conversion per equivalent unit
Due to Home and Garden Products Ltds movement toward JIT inventory and
production methods, there is no work in process inventory in the Grading
Department on November 1. Therefore, the process costing calculations are
identical for this department under the FIFO and weighted average methods.
Thus, the solution given for the preceding problem, for the Grading Department,
is also valid for this problem. The cost of goods completed and transferred out
of the Grading Department in November is $352 080.