In this article we will discuss about how to do the valuation of work-in-progress.
CIMA defines Equivalent Units as “a notional quantity of completed units substituted for an actual quantity of incomplete physical units in progress, when the aggregate work content of the incomplete units is deemed to be equivalent to that of the substituted quantity of completed units e.g., 150 units 50 per cent complete = 75 equivalent units”.
Equivalent completed units = Actual number of units in the process of manufacture x Percentage of work completed.
In the process industries there is likely to be partly completed units at the end of the accounting period which will be carried to the next accounting period. It is also called ‘closing’ and ‘opening work-in-progress’. This work-in-progress in the process causes difficulty in ascertainment of cost of each unit of fully completed unit.
To compute the realistic cost of completed products and incomplete products, the concept of ‘equivalent production’ is used to ascertain the unit cost. Equivalent production represents the production of a process in terms of completed units. To apportion costs fairly and proportionately, units of production must be converted into the equivalent of completed units i.e. into equivalent units of production.
It is the expression of physical units in terms of charges of work applied. When work carried out in the process includes work done on incomplete units also, equivalent production is ascertained by preparing a statement of equivalent production.
Valuation of WIP When Only Closing WIP Exists:
The cost of completed units is unaffected if the opening inventory does not exist. The average cost of the current year’s production will be absorbed into equivalent completed units.
Valuation of WIP when Opening and Closing WIP Exists:
In reality, there is both opening and closing work-in-progress and in such cases, the equivalent production is calculated using the following three methods:
(1) FIFO method,
(2) LIFO method, and
(3) Average cost method.
1. FIFO Method:
Under FIFO method, the costs are apportioned assuming that units already in the process are finished first and it distinguished between units completed that are in the opening work-in-progress and those started and completed in the period.
The main effect of FIFO is that opening work-in- progress costs are brought forward incurred at the previous period’s price levels, i.e. ‘first in’ is the ‘first out’ in that it is charged wholly to output. Hence, closing work-in-progress is valued at current period’s cost.
2. LIFO Method:
Under LIFO method units last entering the process are to be completed first. The completed units will be shown at their current cost and the closing work-in-progress will continue to appear at cost of the opening inventory of work-in-progress along with current cost of work-in-progress if any.
3. Average Cost Method:
Under this method, average unit cost is ascertained taking the total value of opening WIP value plus costs incurred during the current accounting period. The effect of this is that both WIP and completed units are valued at average unit cost. Under this method, it is assumed that value of opening WIP is merged with the units introduced in the current period and can no longer be identified separately.
In this method, the opening stock values, which are at the previous period’s price levels, are added to the current costs to provide an overall average cost per equivalent unit. No distinction is, therefore, made between units in progress at the start of the period and those added during the period.
There is no separation between units brought forward and completed and units commenced and finished during the period under review. Closing stocks, if any, would be valued on this average, and not at the costs ‘exclusive’ to these units deemed to be introduced during the period.
This means that the previous period’s cost (contained in the opening WIP valuation) influence the closing WIP valuation which is carried forward to the next period. It is for this reason that it is sometimes argued that the average cost method makes the comparison of performance between periods more difficult than when the FIFO method is used.
ABC Ltd. process its products in three processes viz., I, II and III. Process II receives units from Process I and after carrying out work on the unit transfers them to Process III.
For the month ending 31st March, 2009, the relevant data were as follows:
Opening WIP 2,000 units (25% complete) valued at Rs. 25,000.
8,000 units received from Process I valued at Rs. 43,000.
8,400 units were transferred to Process III.
Closing WIP 1,600 units (50% complete).
The costs for the period were Rs. 1,65,800 and no units were scrapped.
You are required to prepare Process II account using:
(i) Weighted average cost method,
(ii) FIFO method.
(i) Weighted Average Cost Method:
Process II – Statement of Equivalent Production
Steps in Valuation of Equivalent Units:
The basic steps involved in Process Costing for valuation equivalent units are as follows:
(1) Trace the physical flow of units so that units input to the production process are reconciled with units output or in process at the end of the period.
(2) Convert the physical units determined in (1) above into equivalent units of production for each factor of production i.e., materials, labour, overheads etc.
(3) Calculate the total costs for each factor for the period.
(4) Divide the total costs by equivalent units to establish a cost per equivalent unit.
(5) Multiply equivalent units by cost per equivalent unit to ascertain the cost of finished production and work-in-progress. Reconcile these values with the total costs for the period as calculated in (3) above.
From the following details prepare statement of equivalent production, statement of cost and find the value of:
(a) Output transferred, and
(b) Closing work-in-progress.
Opening work-in-progress: 2,000 units
Materials (100% complete): Rs. 7,500
Labour (60% complete): Rs. 3,000
Overhead (60% complete): Rs. 1,500
Units introduced into this process: 8,000 units
There are 2,000 units in process and the stage of completion is estimated to be:
Material 100%, Labour 50%, Overhead 50%, 8,000 units are transferred to next process.
The process costs for the period are: Materials Rs. 1,00,000, Labour Rs. 78,000, Overheads Rs. 39,000.