Chapter 5 LO 4 — Explain and Compute Equivalent Units and Total Cost of Production in a Subsequent Processing Stage
In many production departments, units are typically transferred from the initial stage to the next stage in the process. When the units are transferred, the accumulated cost per unit is transferred along with them. Since the unit being produced includes work from all of the prior departments, the transferred-in cost is the cost of the work performed in all earlier departments.
When the hickory size 5A drumsticks have completed the shaping process, they are transferred to the packaging department along with the inventory costs of $29,775. The inventory costs of $29,775 were calculated above. During the month of July, Rock City Percussion purchased raw material inventory of $2,000 for the packaging department. The packaging department, like the shaping department, tracks its costs and requisitions the raw material from the material storeroom. The packaging department has computed direct material costs of $2,000, direct labor costs of $13,000, and applied overhead of $9,100, for a total of $22,100 in conversion costs. Also, since the packaging department had 750 units in beginning work in process on July 1, the costs associated with these units are provided in the table below. (The $4,160 of conversion costs in beginning work in process include $700 of direct labor cost and $3,460 of factory overhead cost.) Equivalent units need to be computed for this department, as well as the cost per unit.
Packaging Department Costs for July:
Just as we needed 4 steps for the shaping department in order to determine how much the cost of units completed were and how much the cost of units in ending work in process were, we use the same 4 steps for the packaging department.
Step One: Reconcile Physical Units
In the initial manufacturing department, there can be beginning (work in process) inventory, and units that are started into production during the accounting period. In subsequent departments, instead of starting new units, units are transferred in from the prior department, but the accounting process is the same. Returning to the example, Rock City Percussion had a beginning inventory of 750 units in the packaging department. When the 7,500 sticks are transferred into the packaging department from the shaping department, the total number of units to account for in the reconciliation is 8,250, which is the total of the beginning WIP and the units transferred in:
The reconciliation of units to account for works the same way for each department. The units that were completed and transferred out plus the ending inventory equal the total units accounted for. The packaging department for Rock City Percussion completed 6,500 units and transferred them into finished goods inventory. Since the total number of units that must be accounted for is 8,250 and no units were lost to spoilage, the number of units in the packaging department’s ending inventory must be 1,750. The total of the 6,500 units completed and transferred out and the 1,750 units in ending inventory equal the 8,250 units in the packaging department.
Step Two: Calculate the Equivalent Units of Production
The only direct material added in the packaging department for the 5A sticks is packaging. The packaging materials are added at the beginning of the process, so all the materials have been added before the units are transferred out, but all of the conversion elements have not. As a result, the number of equivalent units for material costs and for conversion costs remaining in ending inventory is different for the packaging department. As you’ve learned, all of the units transferred to the next department must be 100% complete with regard to the preceding department’s cost, or they would not be transferred. The process cost system must calculate the equivalent units of production for units completed (with respect to materials and conversion) and for ending WIP with respect to materials and conversion.
For the packaging department, the units are 100% complete with regard to materials costs and 40% complete with regard to conversion costs. The 6,500 units completed and transferred out to the packaging department must be 100% complete with regard to materials and conversion, so they make up 6,500 (6,500 × 100%) units. The 1,750 ending WIP units are 100% complete with regard to material and have 1,750 (1,750 × 100%) equivalent units for material. The 1,750 ending WIP units are only 40% complete with regard to conversion costs and represent 700 (1,750 × 40%) equivalent units.
Step Three: Calculate total costs to account for and cost per equivalent unit
Once the equivalent units for materials and conversion are known for the packaging department, the cost per equivalent unit is computed in a manner similar to the calculation for the units accounted for. The costs for material and conversion need to reconcile with the department’s beginning inventory plus the costs incurred for the department during that month.
The total materials costs for the period (including any beginning inventory costs) are computed and divided by the equivalent units for materials. The same process is then completed for the total conversion costs. The total of the cost per unit for costs transferred in from the shaping department ($3.90), for materials ($0.44), and for conversion costs ($3.65) is the total cost of each unit in the packaging department.
Step Four: Calculate cost of units completed/transferred and cost of units in ending work in process
Now you can determine the cost of the units transferred out and the cost of the units still in process (ending WIP) in the packaging department. For the goods transferred out, you can simply take the number of units transferred out (6,500) times the total cost per equivalent unit ($7.99) because all items transferred to the next department are complete with respect to transferred-in, materials, and conversion costs. But the ending WIP value is determined by multiplying the work in process equivalent units for each cost type by the cost per equivalent unit for the cost type. The table below shows the calculations and for the sake of consistency, the same steps are used for both units completed/transferred out and units in ending work in process.
This information for the packaging department is accumulated in the Rock City Percussion Company production cost report provided below. The complete report will show the four steps for both the shaping and packaging departments.
A final note:
Keep in mind that the whole purpose of the 4 steps (the production cost report) is to take all the costs of a production department and split the costs between the units completed and the ones partway done at the end of the accounting period. It’s a lot of work for two numbers!
KEY TAKEWAYS
Key Concepts and Summary
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- Process costing has a work in process inventory account for each department.
- Equivalent units of production for materials may differ from the equivalent units for conversion costs.
- The total units to account for is the number of units in the beginning work in process inventory plus the number of units started into production; this total also represents the sum of the number of units completed and the number of units in the ending work in process inventory.
- The cost per equivalent unit for materials is the total of the material costs for the beginning work in process inventory and the total of material costs incurred during the period.
- The cost per equivalent unit for conversion costs is the total of the conversion costs for the beginning work in process inventory and the total of conversion costs incurred during the period.
- The cost of units transferred to the next department is the number of units transferred times the total of the cost per equivalent unit of material plus the cost per equivalent unit for conversion costs.
Glossary
- production cost report
- shows the costs used in the preparation of a product, including the cost per unit for materials and conversion costs and the amount of work in process and finished goods inventory
- spoilage
- any units that are not fit for sale due to breakage or other imperfections
