Equivalent production

Meaning of Equivalent Production:

This represents the production of a process in terms of completed units. In other words, it means converting the uncompleted production into its equivalent of completed units. The term equivalent unit means a notional quantity of completed units substituted for an actual quantity of incomplete physical units in progress, when the aggregate work content of the incomplete units is deemed to be equivalent to that of the substituted quantity, (e.g. 100 units of 60% completed = 60 completed units).

The principle applies when operation costs are being apportioned between work- in-progress and completed output. Thus in each process an estimate is made of the percentage completion of any work-in-progress. A production schedule and a cost schedule will then be prepared.

Procedure for Evaluation:

The procedure to be adopted under such case is as under:

(1) Find out equivalent production after taking into consideration the process losses, degree of completion of opening and/or closing stock.

(2) Find out net process cost according to elements of costs i.e., materials, labour and overheads.

(3) Ascertain cost per unit of equivalent production of each element of cost separately by dividing each element of costs by respective equivalent production units.

(4) Evaluate output finished and transferred and work-in-progress.

Problems:

The problems on equivalent production may be divided into four groups:

I. When there is only closing work-in-progress but with no process losses.

II. When there is only closing work-in-progress but with process losses.

III. When there is opening as well as closing work-in-progress with no process losses.

IV. When there is opening as well as closing work-in-progress with process losses.

These are now discussed one by one.

I. When there is Only Closing Work-in-Progress but with No Process Losses:

Under this case, the existence of process losses is ignored. Closing wrk-in-progress is converted into equivalent units on the basis of estimates as regards degree of completion of materials, labour and production overhead. After calculating the equivalent units, it is not difficult to evaluate closing work-in-progress.

Illustration 8:

Input 3,800 units; output 3,000 units; closing work-in-progress 800 units.

II. When there is Only Closing Work-in-Progress but With Process Losses:

Abnormal loss should, however, be considered as production of good units completed during the period. If units scrapped (normal) have any realisable value, the amount should be deducted from the cost of materials in the cost statement before dividing by equivalent production units. Abnormal gain will be deducted to obtain equivalent production. Special attention should be given while valuing abnormal losses or gains.

Illustration 9:

During January 2012 units were introduced into Process I. The normal loss was estimated at 5% on input. At the end of the month, 1,400 units had been produced and transferred to the next process, 460 units were uncompleted and 140 units had been scrapped.

It was estimated that uncompleted units had reached a stage in production as follows:

III. When there is Opening as Well as Closing Work-in-Progress but with No Process Losses:

Often in a continuous process there will be opening as well as closing work-in-progress which are to be converted into equivalent of completed units for apportionment of process costs. The procedure of conversion of opening work-in-progress will vary depending upon which method of valuation of work-in-progress is used.

The valuation of work-in-progress can be made in the following ways depending upon the assumptions made regarding the flow of costs:

(a) Average Cost Method,

(b) FIFO,

(c) LIFO and

(d) Weighted Average Method.

These are discussed one by one in the following pages:

(a) Average Cost Method:

According to this method opening inventory of work-in-progress and its costs are merged with production and cost of the current period respectively. An average cost per unit is determined by dividing the total cost by the total equivalent units, to ascertain the value of the units completed and units in process.

This method is useful when prices fluctuate from period to period. The closing valuation of work-in-progress in the old period is added to the cost of the new period and an average rate obtained which tends to even out price fluctuations. In calculating the equivalent production opening units will not be shown separately as units of opening work-in-progress are taken to be included in the units completed and transferred.

Illustration 10:

From the following details prepare statement of equivalent production, statement of cost, statement of evaluation and Process Account by following average cost method:

(b) FIFO Method:

According to this method, the units first entering the process are completed first after taking into consideration the percentage of work to be done and shown separately in the statement of equivalent production. Thus the units completed during a period would consist partly of units which were incomplete at the beginning of the period and partly of the units introduced during the period.

The cost of completed units is affected by the value of opening inventory which is based on the cost of previous period. This method is satisfactory when prices of raw materials and rates of direct labour and overheads are relatively stable.

Work-in-progress at the end of the period becomes the opening work-in-progress for the next period; the closing work- in-progress will be valued at costs ruling during the new period, while the opening work-in- progress will be valued at costs ruling during the old period. Thus, where costs are more or less the same in each period, this system is adequate.

Illustration 11:

From the following details, prepare statement of equivalent production, statement of cost, statement of evaluation ad Process Account by following FIFO Method.

(C) Last in First-out (LIFO) Method:

According to this method, units lastly entering in the process are first to be completed. This assumption will definitely have a different impact on the cost of completed units and closing inventory of work in progress. The completed units will be shown at their current cost and the closing inventory of work-in-progress will continue to appear at the cost of opening inventory of work-in-progress along with current cost of work in progress, if any.

Illustration 12:

From the following information relating to the month of January, 2012, calculate the equivalent production units and the value of finished production and work-in-progress using LIFO method.

(D) Weighted Average Method:

When two or more dissimilar products are manufactured in the same process, a simple average process cost may give misleading results. In such a case, a close study of production and costs of each type of product is required to be made and the relative importance of one as compared to others should be indicated in terms of points to be used as a common denominator.

In order to find out the cost of production under weighted average method, statements of weighted average production in terms of points and cost for each type of product should be prepared. The computation of weighted average process cost sheet will be easy, if due consideration to weights or points are given. It will be more clear from the following illustration:

Illustration 13:

X Co. Ltd. produces three types of products A, B and C and keeps accounts for Process I, Process II and Process III.

Following statements show the relative importance of each type of product in each process:

IV. When there is Opening as Well as Closing Work-in-Progress but with Losses:

Under this method equivalent production units regarding opening and closing work-in- progress are to be calculated with due adjustment for process losses as already discussed in the previous pages. Sometimes, particulars relating to in between process (say process B) are given.

In that case effective units will be calculated with reference to Materials-I (entering from Process A) and Materials-II (introduced in Process B). Material I will be taken as 100% complete in respect of abnormal loss/gain, finished goods and work-in-progress.

This will be more clear from the following illustrations:

ILLUSTRATION
The finished product of a factory passes though two processes. from the following production and cost data related to process 1 prepare process 1 account showing full working ( Use FIFO)

Op Stock 10K
Material 27.5 K
Labor 50K
Manuf. OH 40 K
Op Stock (25% finished)  4000 kg
Introduced in Process 1   12000 kg
Transferred to Process II   10000 Kg
Closing Stock (20% complete) 5000 kg
Normal spoilage    1000 kg ( no realisable value)


Statement of Equivalent Production

Opening Stock 4000 kg   (Equivalent Production 3000 kg) (75%)
Introduced and Completed (10000-4000)= 6000 kg (Equivalent Production 6000 kg) (100%)
Normal loss 1000 kg
Closing Stock 5000 kg ( Equivalent production 1000 kg (20%)
Total Output 4000 kg+6000kg+1000kg+5000kg=16000 kg
Equivalent Production= 3000kg+6000kg+1000kg=10000kg


Total Cost Incurred
Material 27.5 K+
Labour 50K+
Manuf. OH 40 K=117.5 K

Total Equivalent Units=10000 kg
Cost per equivalent units=Rs 11.75