Question

Scenario: Davis Skaros has recently been promoted to production manager. The company uses process costing. He has just started to receive various managerial reports, including the production cost report you prepared. It showed his department had 2,000 equivalent units in ending inventory. His department has had a history of not keeping enough inventory on hand to meet demand. He has come to you, very angry, and wants to know why you credited him with only 2,000 units when he saw on his production line at the end of the month 4,000 units.

Prepare a maximum 300-word response and explain to Mr. Skaros why his production cost report showed only 2,000 equivalent units in ending inventory. In accounting terms, explain to him the concept of equivalent units versus the physical units on the production floor.

Answer 1

Concept of equivalent units versus physical units:-

Physical units are units produced at the end of the required repotred date. Number of physical units are all the units which were produced by the production department and even units which are partly processed are also counted as completed units from production department. That means the total number of units in closing inventory contains, finished goods, partly processed goods and goods which are in primary stage of production also. All these goods are counted as one completed unit.

But whereas in equivalent production units, only completed units at each are taken as one unit. Units which are partly processed are counted based on percentage of completion or the amount of costs incurred for partly producing units.

So, if for the products for which only 20% of work was completed then this type of 5 partly produced products will be taken into one completed unit.

For example:- If in case of a partly completed product, only direct marerials and labour are incurred and next process of incurring overheads and other packing expenses are not incurred then the cost of the partly completed products shall be shown only for the directly material and labour incurred.

If for 100 units of production

Direct material $5 per unit and labour $5 per unit other over heads $5 per unit and for packing $5 per unit.

Total cost of production per unit = $20

And if 50 units were produced completely and 50 were processed only upto direct material and labout

Equivalent units of production :-

Completed = 50 × $20 = $1000 = 50 units

Partly completed = 50 × $10 (5+5) =$ 500

= 500 ÷ $20 = 25 units

Therefore total equivalent number of units are equal to ( 50 + 25) = 75 units

We can also calculate in percentage of calculation method i.e

(5+5)÷20 = 50% of completion for partly completed units.

So, 50 units × 50% = 25 units and 50 completed units which totals 75 equivalent units produced.

And in the given case, may be 1000 units were completed fully and for 3000 units only 1/3 rd processing was completed so, 1000 completed units + 1000 units (3,000×1/3) partly completed units totalled 2000 equivalent units.

The same should be explained to Davis as acreason for difference in physical units and equivalent units of production.