Kevin has edited encyclopedias, taught history, and has an MA in Islamic law/finance. He has since founded his own financial advice firm, Newton Analytical.
Have a bunch of units that are only half-finished at the end of the accounting period? Then chances are you're going to want to know more about the weighted-average method of finding equivalent units of production.
Companies rarely finish one unit of production before they start another. And they don't just work to a certain point and then go home for the rest of the month. Instead, companies are always working on production, and there are units of production that may or may not be complete when the time comes for a company to perform its accounting. So what's a company to do? Does it just ignore the incomplete units? In that case, there would be a problem. It would look like some months were especially productive for the company, when there were actually just lots of units that were half-done from the month prior, and some months that look, well, wasted in comparison. Needless to say, neither would be fun for a manager to have to explain time and time again.
Luckily, there is a solution. By using the weighted-average method of equivalent units of production, managers can include units that have already entered production in their activity reports. In other words, they can more easily show just how much work was actually done.
How to Use It
Finding the number of equivalent units by using the weighted-average method of production is pretty straightforward. First of all, take the number of units that are still in production at the end of a period. Then multiply that number by the percentage that those units are from being complete. In cases where units are at different points of completion, simply use the average progress of those units. This gives you the number of equivalent units. This process is known as conversion. As you see it, it is effectively a measure of how many units you could have completed had you focused solely on finished units and not on continuous production.
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Let's use an example to see how this works. Let's say that you managed a widget manufacturing company. In a given month you completed 10,000 widgets, but you still have 2,000 widgets under production. Remember when it comes time to fill out any paperwork, like the cost reconciliation report that justifies your expenses, that those 10,000 completed widgets are considered goods transferred out because they have moved on to a different department. Anyway, back to those partial widgets. While each widget is at a different stage of completion, on average they are 50% done. To find the equivalent units, we multiply 50% by 2,000 widgets still under production. In doing so, we get 1,000 equivalent units of widgets.
But how do we use this number? Surely we can't sell half widgets, now can we? No, unfortunately we can't. However, it can make our accounting paperwork make much more sense. Remember that I said that the cost reconciliation report uses those 10,000 widgets as goods transferred out? What I didn't mention yet is that it also asks for the cost of inventory of equivalent goods. After all, that's considered an asset. To find the cost of inventory of equivalent goods, multiply the cost of a finished unit by the number of equivalent goods. Note that these costs especially include the cost of labor and overhead.
In this lesson we learned how to use the weighted-average method of equivalent goods to help us reconcile the realities of production to accounting paperwork. Remember that the way to find the number of equivalent goods is to multiply the number of units still under production by their percentage towards completion. This process is called conversion. Also bear in mind that completed goods are goods transferred out, and that both these and equivalent goods have a role to play on the cost reconciliation report that justifies expenses.
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