In this article we will discuss about:- 1. Meaning of Equivalent Production 2. Valuation of Work-in-Progress 3. Procedure for Accounting of Equivalent Production 4. Methods for the Valuation of Opening Work-in-Progress 5. Adjustment of Treatment of Normal Loss, Abnormal Loss and Abnormal Gain in Computation of Equivalent Production.
In a process industry, production is on a continuous basis. As a result, in variably, there will be some work-in-progress (i.e., partly-finished units) in each process at the end of accounting period. When there is work-in-progress in any process, naturally, there arises the problem of valuation of the work-in-progress. To facilitate the valuation of work-in-progress, a technique known as ‘Equivalent Production’ has been developed. Under this technique, the units of work-in-progress are converted into equivalent fully finished units, and then valued as equivalent fully finished units.
The term ‘Equivalent Production’ has been defined by Wheldon as, “the production of a process in terms of completed units”.
From the above definition, it is clear that equivalent production is the conversion of work-in-progress units into equivalent finished units. This is done by the following formula:
Equivalent Completed Units –
For example – if there are 50 units in work-in-progress and those are estimated to 80% complete then their equivalent production is –
Valuation of work-in-progress can be made on the basis of any one of the following:
1. On Actual Cost Basis:
An attempt may be made to find out how much material has been used upon the finished units and how much amount of labour and expenses has been spent on them. In other words, aggregate of the cost of material, labour and overhead in respect of work-in-progress is the value of work-in-progress.
2. On Equivalent Production Basis:
Under this method, work-in-progress units are converted into equivalent finished units. For example – in a process 1,000 units were introduced out of which till the accounting period 600 units are completed and out of 400 units 60% are completed,
i.e. (400 × 60)/100 = 240 units will be considered as equivalent units and total completed units will be 840 units (i.e., 600 + 240).
The following accounting processes are adopted in respect of equivalent production:
Equivalent production represents the production of a process in terms of completed units. In other words, it means converting the in-completed production into its equivalent of completed units.
To find out equivalent unit following statement is prepared:
(1) Completed output, units of abnormal wastage, units of closing Work-in-progress and units of abnormal effectives are deemed to be 100% complete as regards materials transferred from preceding process, if further materials have been introduced into the process and degree of completion as regards material is given.
(2) For convenience materials consumed in the process may be divided into two parts, viz., Material A representing material transferred from previous process and Material B showing further materials added in the process.
(3) Units of normal wastages are charged to costs, hence in respect of them equivalent production is never computed.
(4) Units of abnormal wastages should be considered to be 100% complete if nothing is mentioned in the question about their degree of completion.
(5) Units of abnormal effectives are considered to be 100% complete for each element.
(6) Total units of input should be equal to total of units completed plus units of normal wastage plus units of closing Work-in-progress plus units of abnormal wastage or minus units of abnormal effectives.
After preparing equivalent production, cost per unit of material, labour and overheads is ascertained. For this total expense is divided by equivalent production of material, labour and overhead.
This can be shown as under:
Only sale proceeds of normal wastage should be deducted. It will be deducted from material A, if used otherwise from material B.
After ascertaining per unit production cost of material, labour and overheads, to obtain total cost of produced units, units of abnormal wastage and at the end of period unfinished units and units of abnormal effectives, a statement of apportionment of cost is prepared in the following manner –
Lastly, Process Account is prepared by general method.
Generally two methods are used for the valuation of opening Work-in-progress they are:
(1) First-in-First-out Method (FIFO Method),
(2) Average Cost Method
(1) FIFO Method:
Where FIFO method is used, the opening Work-in-progress unit must be first converted into finished units after considering the extent of work to be done on them. This must be shown separately in the statement of equivalent production units. The inventory costs brought forward from the past period is not added to the current costs.
When opening units of Work-in-progress are given and degree of completion is also given but method of valuation of Work-in-progress is not given, valuation of Work-in-progress should be made on the basis of FIFO method.
(2) Average Cost Method:
Under this method, the stage of completion of opening Work-in-progress is not considered. In the equivalent production computation, the opening Work-in-progress units are not shown separately, but are included in the total units completed and transferred to next process. The value of opening Work-in-progress is added to the costs incurred in the current accounting period, and the total cost is divided by the total units completed in order to arrive at the average cost of equivalent units.
Adjustment of Treatment of Normal Loss, Abnormal Loss and Abnormal Gain in Computation of Equivalent Production:
1. Treatment of Normal Loss:
In case of normal loss, nothing should be added as equivalent production. However, realisable value of normal loss is subtracted from the cost of material so as to ascertain the net material cost. The net material cost becomes the basis of calculating the normal cost per unit in the statement of cost.
2. Treatment of Abnormal Loss:
Abnormal loss should be considered as production of good units completed during the period. Abnormal loss, thus, is added to equivalent production with due consideration to its degree of completion. Unless the degree pf completion is specified, it may be assumed that abnormal loss units are 100% complete in respect of all elements of cost.
3. Treatment of Abnormal Gain:
Units of abnormal gain are represented by good finished production. Units of abnormal gain are subtracted to obtain equivalent production. It should be kept in mind that stage of completion of units of abnormal gain should be taken at 100% in respect of all elements of cost.