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By Indeed Editorial Team

Published April 20, 2021

Calculating the equivalent units of production can help a company understand how much work and money they have put into their manufacturing process. Specifically, it's a way to understand how much money, material and labor have been invested into items that are partially complete. Understanding how to calculate this can be important for accountants, small business owners and others who manage manufacturing processes. In this article, we explain what an equivalent unit of production is and how to calculate it.

Related: Operations Management: Everything You Need To Know

What are equivalent units of production?

Equivalent units of production are a concept used to understand how much money partially completed products are worth to a company. They are useful for process costing, which is the analysis of money flow within the manufacturing process.

Equivalent units describe how much work has been done on a certain number of physical items. To simply calculate equivalent units, you can multiply the number of physical items by the percentage of the work done on them. For two items that are 50% done, you would have one equivalent unit (2 x 50% = 1). When the items are completely finished, the number of equivalent units is equal to the physical items.

This simple equation, however, doesn't take into effect that the needs of the manufacturing process vary over time. For instance, most of the materials may be added to an item at the beginning of the manufacturing process, while more labor is needed later in th e process to assemble and refine. To account for this variation, accountants usually calculate equivalent units of production for three kinds of costs: materials, overhead costs and labor costs. The equivalent units of production may be different for the three kinds of costs.

Read more: What Is Process Costing? (With Example)

Why calculate equivalent units of production?

The advantage to calculating equivalent units is that you can refer to whole units rather than partially completed ones, which simplifies accounting calculations. By knowing the equivalent units of production for materials, overhead costs and labor costs, an accountant can estimate how much more money or time is required to finish those products. Calculating equivalent units of production can also help create a financial report or understand where the money in your institution is currently invested.

Related: Formula for Cost Per Unit Calculation (With Examples)

What are the ways to calculate equivalent units of production?

You can calculate equivalent units of production using the weighted average method or the first-in first-out method. The weighted average method does not take into account any inventory that might have been started in an earlier period and finished during the time period relevant to the calculations. This can make it more appropriate for a time period at the beginning of a project or year when there is no beginning inventory. The first-in first-out method does factor in this beginning inventory, so it can be used in more situations.

How to use the weighted average method

Here is the weighted average method formula:

(Number of units completed) + (units in progress x percentage of completion for this cost component) = equivalent units of production for cost component

To calculate equivalent units of production with the weighted average method, an accountant would follow these steps:

1. Find number of units completed within the time period

The accountant first finds out how many units have been finished and sent out. Since these items are 100% complete, each unit sent out is one equivalent unit of production.

Example: Small Item Production Company is calculating their process costs for the month of January. They have completed and sent out 3,000 miniature mice in January.

2. Find number of units in progress at the end of the time period

Next, the accountant finds out how many units are partially finished at the end of the time period. This number is sometimes called the ending work-in-progress inventory.

Example: Small Item Production Company started 4,000 more mini mice.

3. Find what percentage of materials, labor and overhead costs are complete for those items

The accountant finds out how much work is complete on the units in progress and converts it into a percentage if necessary.

Example: The incomplete mice have 80% of the materials added to them, but they have had only 35% of the labor and the overhead costs applied.

4. Apply formula to calculate equivalent units of production for materials, labor and overhead costs or conversion costs

The accountant can apply the formula to get the equivalent units of production for each aspect of the item's costs. Sometimes accountants combine labor and overhead costs and refer to it as the conversion cost.

Example: Small Item Production Company accountants calculate the equivalent units of production for materials like this:

3,000 mini mice completed + (4,000 mini mice in progress x 80% of materials added) = total equivalent units of production for materials

3,000 + 3,200 = 6,200 equivalent units of production for mice materials

The accountants calculate the equivalent units of production for conversion costs like this:

3,000 mini mice completed + (4,000 mini mice in progress x 35% of conversion costs complete) = total equivalent units of production for conversion costs

3,000 + 1,400 = 4,400 equivalent units of production for mice conversion costs

So the Small Item Production Company accountants report that they completed 6,200 equivalent units of production for mice materials and 4,400 equivalent units of production for conversion costs during the month of January.

Related: How to Calculate Average Inventory

How to use the first-in first-out (FIFO) method

This method is called first-in first-out because it includes information about the partially finished items at the beginning of the time period, the items first in the manufacturing process for that period, and the costs to get them finished and shipped out, so they are the first items sent out during that time period. Here is the formula for the FIFO method:

Equivalent units of production to complete beginning inventory + units started and completed during the period + equivalent units of production for items partly completed during the period = total equivalent units of production for the period

And here is the formula to calculate how many equivalent units it takes to complete the beginning inventory:

Units in beginning inventory x (100% - percentage completion of beginning inventory) = equivalent units of production to complete beginning inventory

Here are the steps to calculate equivalent units of production with the FIFO method:

1. Calculate equivalent units of production needed to complete items in beginning inventory

To calculate the equivalent units of production still required to finish the beginning inventory, the accountant figures out how many items were partially completed at the beginning of the month and how much work was done at that time. They can then calculate the equivalent units of production that were needed to finish these items.

Example: Small Item Production Company is calculating material costs for its miniature cats in January. They had 5,000 partially completed miniature cats at the beginning of January. These cats had 70% of the materials added. Small Item accountants calculate the remaining equivalent units of production like this:

5,000 cats in progress x (100% - 70% materials added) = 5,000 cats x 30% materials left to be added = 1,500 remaining material equivalent units of production

2. Find number of units completed during the time period

Next, the accountant adds the number of units completed during the time period. Each of these units is equal to one equivalent unit of production since they are done.

Example: Small Item Production Company manufactured 6,000 miniature cats from start to finish during January.

3. Find number of units started during the time period that are incomplete

This is the number of units that are partially completed at the end of the time period, or ending work-in-progress inventory.

Example: Small Item Production Company started an additional 3,000 miniature cats during January.

4. Find what percentage of work is done on units started during the time period

This may vary depending on whether you are calculating material cost, labor cost, overhead cost or conversion cost (labor and overhead cost combined).

Example: The additional 3,000 mini cats have had 40% of materials added so far.

5. Calculate equivalent units of production for ending work-in-progress inventory

To calculate this, the accountant would multiply the number of items in progress by the percentage of work done on them so far.

Example: The Small Item accountants calculate the material equivalent units of production for the 3,000 mini cats that are the ending work-in-progress inventory:

3,000 items in progress x 40% of materials added = 1,200 material equivalent units of production for the ending work-in-progress cat inventory

6. Calculate total equivalent units of production for the time period

The accountant then uses the FIFO formula to calculate the equivalent units of production for the time period by entering the values from earlier steps.

Example: The Small Item accountants calculate the cat material equivalent units of production for January like this:

1,500 equivalent units of production to finish previous cats + 6,000 cats completed in January + 1,200 equivalent units of production done on cats not yet completed = 8,700 equivalent units of production

With this calculation, the Small Item accountants see that the total cost of materials used to complete cats in January was the cost of materials for 8,700 cats.

What are equivalent units of production used for?

Once an accountant knows the equivalent units of production, they can also calculate how much it costs to finish manufacturing the inventory. They calculate these costs using the total number of items, equivalent units of production and the costs to make each item. Here is the formula to calculate the remaining costs to finish inventory:

(Total items finished and in progress x cost per item to complete) - (equivalent units of production x cost per item to complete) = remaining cost to finish inventory

Example: Small Item Production Company knows it costs $2 in materials to finish each mini mouse. They want to know how much money they will need to finish all 7,000 mini mice they started in January. They calculate the remaining cost by applying the formula:

(7,000 total mice x $2) - (6,200 equivalent units of mice production x $2) = remaining cost for materials

$14,000 - $12,400 = $1,600

Small Item Production Company has to spend $1,600 more on materials for January mice.