In this article we will discuss about the calculation of work in progress using the concept of equivalent production.

Production is continuous in most of the process industries. On any given day, there may be stocks of material, and stocks of semi-finished product in each process.

Valuation of work-in-progress poses a complicated problem at the time of finalising accounts for a period.

Opening work-in-progress represents semi-finished goods at the beginning of a period. Balance of work might have been done on them to make them into finished goods in the current period. Similarly, at the end of the current period, semi-finished goods can be in process which needs some more work to complete them.

The cost of the closing work-in-progress should be credited to the process account and carried forward to the next period. During next period such cost is debited to the process. Such debit and credit for opening and closing work-in- progress will affect the cost of the completed units in both the periods.

The basic objective in relation to the work-in-progress is to ascertain the amount spent on material, labour and overheads for these incomplete goods. Accurate cost cannot be found because unit cost in processes is only an average. However, the concept of equivalent production is usually employed to tackle the problem of valuation of work-in-progress and other process outputs.

Equivalent Production:

The concept of equivalent production is the basis for spreading process costs equitably over fully completed units and the work-in-progress comprising semi-finished units.

According to I.C.M.A (London) Terminology “Equivalent units are a notional quantity of completed units substituted for an actual quantity of incomplete physical units in progress. The principle applies when operation costs are being apportioned between work-in-progress and completed output.”

For example- 150 units 40% complete are equal to 60 completed units.

Method of Computation of Equivalent Units:

a. In each process the opening work-in-progress at the beginning of the period and its degree of completion relating to material, labour and overheads should be noted.

b. The number of units introduced into the process should be recorded.

c. Any predetermined rate of normal loss and the normal loss in units should be taken into account.

d. The actual final output for the period should be noted.

e. Any abnormal loss or gain in units and its degree of completion in terms of materials, labour and overheads should be ascertained.

f. Closing work-in-progress in units and its degree of completion in terms of material, labour and overheads should be ascertained.

g. The degree of completion of the scrapped units and realisation from the sale of scrap of normal loss units should be noted.

There are two basic methods of computing equivalent production:

(1) When Degree of Completion of Work in Progress is Uniform Regarding Material, Labour and Overheads:

Note:

It is assumed that opening stock units are fully completed which implies first in first out method.

(2) When Degree of Completion of Work in Progress is not Uniform for Material, Labour and Overheads:

A detailed statement is prepared to ascertain equivalent production. Input into the process and the outputs of the process are tallied. Separate columns are opened for equivalent production of materials, labour and overheads.

The work done in the period in relation to opening stock, units completely processed, closing stock, abnormal loss, etc., are separately shown for material, labour and overheads.

Evaluation of Work, Based on Equivalent Production:

(a) A statement of cost is prepared where in the amount spent in the process on material, labour and overheads are divided with the respective equivalent units to ascertain cost per equivalent unit.

(b) A statement of evaluation is prepared. Here the cost of closing work-in-progress, abnormal loss, units completed, work completed on opening stock, etc., is computed. Equivalent units for material, labour and overheads relating to each of the above items a multiplied with the respective costs per unit. Thus, the total cost of the entire process is spread over the various items which represent the outputs of the process.

Types of Equivalent Production Problems:

I. When there is Only Closing Work in Progress without Process Losses:

Here the equivalent units for the closing work-in-progress and the units completed are added. Cost per unit is computed and the cost of work-in-progress and the completed units are ascertained separately.

II. When there is Only Closing Work in Progress, But with Process Losses:

(a) When there is Normal Loss Only:

Input and output are tallied, taking the normal loss also into account. However, for ascertainment of equivalent units, the normal loss units are ignored because the cost of normal loss in a process has to be borne by the other items of output. Scrap value from normal loss is subtracted from material cost while ascertaining cost per unit of each element.

(b) When there are Both Normal and Abnormal Losses:

Input and output in the process are tallied, taking into account all the process losses. Normal loss units are ignored while computing equivalent units. However abnormal loss units are treated as a separate item. Degree of completion of scrap is applied to the units of abnormal loss while computing equivalent units.

In the statement of evaluation, the cost of abnormal loss is also ascertained separately.

III. When there is Opening, as well as Closing Work in Progress, and Without Process Losses:

The presence of opening work-in-progress complicates the computation of equivalent production. Conversion of opening work-in-progress will vary according to the basic assumption relating to the method of work-in-progress.

The following are the three usual methods:

(a) Average Cost Method:

This method is more appropriate in industries where prices of inputs fluctuate from period to period.

The closing value of work-in-progress in the previous period has now become the value of opening work-in-progress. This cost is added to the cost of the current period and an average rate is obtained. This method results in the evening out of price fluctuations.

In the calculation of equivalent production, opening stock units are not to be shown separately. They are also included in the completed units transferred to the next process.

(b) FIFO Method:

In this method, the opening stock units which are incomplete are assumed to be finished first. Work is done on fresh units from the previous process only after completing the opening stock units.

This method is more useful when costs are relatively stable without frequent changes.

Opening work-in-progress is separately shown in the computation of equivalent production, apart from other completed units.

(c) LIFO Method:

In the last in first out method, the fresh units received from the previous process are assumed to be finished first. Then work may be done on the opening incomplete units. Closing work-in-progress will include most of the opening work-in-progress. The impact on costs is that the finished units are shown at current cost whereas the closing work-in-progress is shown at the previous periods prices represented in the cost of opening work-in-progress.

FIFO method is more popular because of its logical and sequential appeal.

IV. When there is Opening as well as Closing Work-in-Progress with Process Losses?

Here a detailed equivalent production statement is prepared showing input and output with all details. Equivalent production for opening stock, closing stock, completely finished units and abnormal loss are shown for material, labour and overheads separately.

If intermediate process account is to be prepared, distinction is made between units transferred from previous process and the materials added in the present process by showing them as material I and material II separately.