Question

Explain in layman terms "equivalent units of production" (EUP).

How does the calculation of EUP differ between the weighted-average (WA) method and the first-in-first-out (FIFO) method? Which method provides more accurate results, WA or FIFO? Defend your answer on why.

Discuss in detail how a company would determine how many work in process (WIP) accounts to maintain when process costing is employed?

Answer 1

Equivalent units of production:

When beginning and ending inventories and spoilage exist, a calculation known as equivalent units of production (EUP) must be performed to measure how much production (work) was really done during the period. EUP represents the amount of completed output that could have been produced if all the work performed during the period had been for units both started and completed. It is an adjustment for the partial effort in beginning and ending inventories and in spoilage. In other words, EUP is how many units that could have been started, fully processed, and completed with the amount of inputs (costs) used during the month. EUP is divided into the total costs to obtain the cost per equivalent unit produced. This changes the basic formula for calculating unit cost to:

Unit cost = Total department costs / EUP

The main difference between weighted average cost accounting, LIFO, and FIFO methods of accounting is the difference in which each method calculates inventory and cost of goods sold.

The weighted average cost method uses the average of the costs of the goods to assign costs. In other words, weighted average uses the formula: Total cost of items in inventory available for sale divided by total number of units available for sale.

In contrast, FIFO (first in, first out) accounting means that the costs assigned to goods are the costs for the first goods bought. In other words, the company assumes that the first goods sold are the oldest or the first goods bought. On the other hand, LIFO (last in first out) assumes that the last or latest items bought are the first items to be sold.

The costs of goods under weighted average will be between the cost levels determined by FIFO and LIFO. FIFO is preferable in times of rising prices, so that the costs recorded are low and income is higher, while LIFO is preferable in times when tax rates are high because the costs assigned will be higher and income will be lower.

Consider this example for an illustration. Let's say you are a furniture store and you purchase 200 chairs for $10 and then 300 chairs for $20, and at the end of an accounting period you have sold 100 chairs. The weighted average costs, FIFO, and LIFO costs are as follows:

Example:

200 chairs @ $10 = $2,000

300 chairs @ $20 = $6,000

Total number of chairs = 500

Weighted Average Cost:

Cost of a chair: $8,000 divided by 500 = $16/chair

Cost of Goods Sold: $16 x 100 = $1,600

Remaining Inventory: $16 x 400 = $6,400

FIFO:

Cost of Goods Sold: 100 chairs sold x $10 = $1,000

Remaining Inventory: (100 chairs x $10) + (300 chairs x $20) = $7,000

LIFO:

Cost of Goods Sold: 100 chairs sold x $20 = $2,000

Remaining Inventory: (200 chairs x $10) + (200 chairs x $20) = $6,000.