Question

What are equivalent units, how do we compute them, and why do we care?

Answer 1

Equivalent units is a cost accounting concept that is used in process costing for cost calculations. It has no relevance from an operational perspective, nor is it useful for any other type of cost derivation other than process costing.

In cost accounting, equivalent units are the units in production multiplied by the percentage of those units that are complete (100 percent) or those that are in process. That covers everything.

Say you’ve mixed enough sugar to make 800,000 units of candy. Assume that ending work in process is 25 percent complete for all components of production (material, labor, and overhead). The table below shows the computation of equivalent units.

Equivalent Units of Production
Units	Complete	Equivalent Units
Completed and transferred	800,000	100 percent	800,000
Work in process, ending	800,000	25 percent	200,000
Equivalent units			1000,000

Although 25 percent of the units are unfinished, in “equivalent unit talk” you can treat them as 200,000 completed units. Add them to the really completed units to get 1000,000 units, which represents the number of equivalent whole units you have produced. It’s a lot easier to talk about a whole unit than some whole units and some partially completed units.

The next step is to compute the cost per equivalent unit. Take the total costs of $101,800, and divide by the number of units. Remember that the total costs are the sum of the beginning inventory cost ($48,000) and the costs added during production ($53,800):

Cost per equivalent unit = total costs ÷ number of units

Cost per equivalent unit = $101,800 ÷ 1000,000

Cost per equivalent unit = $0.01018

The calculation goes to four decimal places, because when you’re making candy that sells for 20 cents per unit, and you’re producing hundreds of thousands of units, every tiny fraction of a dollar counts.