Management Accounting: Concepts And Techniques

MANAGEMENT ACCOUNTING: CONCEPTS AND TECHNIQUES
 
By Dennis Caplan
 
PART 4: DETERMINING THE COST OF INVENTORY
 
CHAPTER 14:  WORK-IN-PROCESS
 
How does a company that uses an assembly-line or batch manufacturing process determine the cost of work-in-process at period-end, when there are hundreds or thousands of units of inventory at varying stages of completion? The answer relies on theconcept of an equivalent unit. For example, four units that are each half-finished are equivalent to two complete units. Eight units that are each 25% finished are also equivalent to two complete units. In both examples, the cost accounting terminology is that there are two equivalent units in work-in-process. Similarly, if two units are 50% complete, and four units are 25% complete, there arestill two equivalent units in work-in-process. What does it mean for a unit of inventory to be 50% complete? It means that 50% of the inputs required to make the unit have been incurred.
 
In some manufacturing environments, materials enter the production process early, while labor and other inputs are incurred more evenly throughout the process. For example, an apparel manufacturer cuts all of thefabric for the batch at the beginning of the production process, while sewing operator labor is incurred more-or-less evenly from the time the fabric is cut until the garments are completed. In this situation, companies frequently calculate equivalent units separately for materials and conversion costs (labor and overhead). In fact, companies can calculate equivalent units separately for as manydifferent types of inputs as desired, breaking materials and labor into subcategories. However, the additional accuracy of the cost accounting information thus obtained seldom justifies the additional costs to track it.
 
The following nine examples illustrate how equivalent units are used to calculate the cost of work-in-process, beginning with a simple setting and progressing to morecomplicated scenarios. Each example involves a company that assembles personal computers from purchased components. As shown in some of these examples, the company’s assumption about inventory flow is relevant.
 
Example 1:
 
  | Beginning Inventory |  Activity during the week | Ending Inventory |
Units | 0 | 10 units made and shipped out (i.e., sold) | 0 |
Costs incurred | $0* |Materials:             Conversion costs: | $1,900940 |   |
 
* Throughout these examples, the box for “costs incurred—beginning inventory” reports the beginning balance in the WIP account for the week.
 
Question: What is the cost per unit for each unit made and sold?
 
Answer:
Total costs:       $1,900 + $940 = $2,840
Cost per unit:    $2,840 ÷ 10 units = $284 per unit.
 
Since there is no endinginventory, there is no work-in-process, and no equivalent unit calculations are necessary. The cost of ending inventory is zero.
 
Since 10 units were sold, the cost of goods sold is $284 x 10 = $2,840.           
 
 
Example 2: This example introduces ending work-in-process.
 
  | Beginning Inventory |  Activity during the week | EndingInventory |
Units | 0 | 10 units started, 9 unitscompleted and shipped out | 1 partially finished unit |
Costs incurred | $0 | Materials:             Conversion costs: | $1,900940 |   |
 
Question: What is the cost of goods sold? What is the cost of ending work-in-process?
 
Answer:
Unable to determine without knowing the extent to which the partially-finished unit is completed.
 
 
Example 3: Same as Example 2, but with additionalinformation about the status of ending work-in-process.
 
  | Beginning Inventory |  Activity during the week | Ending Inventory |
Units | 0 | 10 units started, 9 units completed and shipped out | 1 partially finished unit, 50% complete with respect to both materials and conversion costs |
Costs incurred | $0 | Materials:             Conversion costs: | $1,900940 |   |
 
Questions: What...