If you recall, the concept of process costing is that the production is continuous. The input (material, labour, and overheads) is continuously being added into the process and output is continuously being produced. In process costing, the production process is divided into artificial batches (also known as processes). Then, the cost of each process is calculated conveniently.
There is one problem with this method that needs to be addressed and that is the concept of work-in-progress. At the end of one process, some units are fully completed whereas some units are partly completed. These partly finished units are known as work-in-progress (WIP) units and this closing WIP becomes the opening WIP for the next accounting period. In this article, we are going to consider closing work in progress.
Equivalent Units (EU)
Now, if we charge the full cost to these partly finished units, would it be fair? Of course not! To address this problem, the concept of Equivalent Units (EU) was developed. This states that the products that are partly finished can be regarded as an equivalent proportion of fully completed units.
Let us understand this with the help of an example. Consider 1,000 units were input into a particular process and at the end of that process, 900 fully completed units and 100 units that are 50% complete were produced. This 50% is called the degree of completion which shows the percentage completion of work-in-progress units. The 100 units in work-in-progress which have a degree of completion of 50% can be regarded as equivalent to 50 fully completed units. Thus 100 units 50% complete are considered as 50 equivalent units.
Work-in-progress units can have different degrees of completion with regards to material, labour and overheads. Mostly, all the products are 100% complete concerning material cost since it is input at the start of a process. So, the work-in-progress units are only incomplete due to labour and overheads.
(Note for students: The examiner can also combine labour and overheads and just state the degree of completion of Conversion Cost (sum of labour and overheads).
Calculating Cost of Finished Output and Work-in-Progress
There are four steps to calculate the process cost involving closing work-in-progress units. These are:
- Calculate the equivalent units concerning each cost category (Material, labour, and overheads).
- Calculate the cost per equivalent unit.
- Allocate the cost per equivalent unit to Finished units.
- Allocate the cost per equivalent unit to WIP units.
Let us explain each step with the help of an example.
Example – Process costing with closing work in progress (WIP)
1,000 units were input into a particular process. 800 fully complete units were produced, and 200 units were in work-in-progress. The WIP progress units are 100% complete concerning material cost. The following information is available: