Equivalent Units Transcript
Costing Methods > Process Costing > Equivalent Units
Unlike job costing, where we know the total cost of partially completed jobs at the end of the period, process costing isn't as easy to figure out. This is because are partially completed products aren't at the same percentage of completion at the end of the period, like they are in job costing. Some products may be in the sorting or breaking process, while others are in refining or conching. Finally, some may be in wrapping and packaging.
Trying to determine the value of ending WIP inventory can be rather challenging since the products are at different stages in the production process. The fact is we know the cost of a fully completed product but we don't easily know the cost for a 42% completed product. And let's add a layer of difficulty to that. We don't easily know the cost of a product that is 81% complete for direct materials but only 58% complete for conversion costs.
So in order to deal with this complexity, I want to introduce the concept of equivalent units. Equivalent units represent the amount of work done during a period in terms of fully completed units.
A very simple example would be if I have 100 units that are 50% complete, that's the equivalent to 50 units that are 100% complete. And remember I know the cost of fully completed units, so I can apply the product cost times the 50 equivalent units to determine the cost of the hundred partially completed units.
Calculating equivalent units is an important part of process costing so let's do one more example.
Suppose you have a work study job at the college and the college president asked you to compute the cost of instruction per fulltime equivalent student. The college vice president for finance provides you with the following information. The total cost of instruction is eight million dollars. The college has 1000 fulltime students and 5000 part-time students, so what is the average cost of instruction per fulltime equivalent student?
To determine this there's one more piece of information we need. We need to know, on average, how many classes part-time student take.
Let's assume they take three classes, so that would be 60% of the courseload of fulltime students. Now we can figure out the average cost of instruction per fulltime equivalent student.
1000 fulltime students take 100% of a full load.
5000 part-time students take 60% of a fulltime load.
So we multiply the 1000 students times 100% which equals 1000 students, right? 1000 fulltime students is the equivalent of 1000 fulltime students, that's pretty obvious.
Then we multiply 5000 students times and 60% which equals 3000 students so 5000 part-time students is the equivalent of 3000 fulltime students.
Thus, the fulltime equivalent of students is 4000.
Finally, we divide the eight million dollars of costs by the 4000 equivalent students and you can report to your college president that the average cost of instruction, per fulltime equivalent student, is $2000.
And that concludes this short video on understanding some of the complex issues of process costing and specifically how to calculate equivalent units.