Let’s take a look at Dad’s Perfect Pies Production Report for February based on the following results:

The 750 shells in production at the end of January were 60% complete as to conversion costs and 100% complete as to direct materials, so in February they will need 40% more conversion but 0% more direct materials.

The mixing department started another 3,250 shells during February, and at the end of the month, there were still 1,000 shells being mixed and prepped for baking. They were only 25% complete as to conversion but 100% of the direct materials had been added (because they are added at the beginning of the process).

According to the accounting records, direct materials transferred to the mixing department were costed at $3,575 and direct labor and factory overhead were $3,640.

Under the weighted average method, costs transferred in from last month are added to this month’s costs and distributed across all units. This is the simplest way to account for beginning inventory costs, but not always the most accurate. For example, if costs are going up, the cost of those 750 pie shells in beginning work in process inventory would be less than the cost of the 1,000 pie shells in ending inventory.

The First-in, First-out method of allocating costs assumes that the units in beginning work-in-process inventory are finished first, then transferred out, and then all the batches during the month are finished and transferred out, and then only the most recent costs are assigned to ending inventory.

Therefore, FIFO creates three groups of units to be accounted for:

• Beginning work-in-process – Units started in the prior month, completed in the current month
• Started and completed – Units started and completed in the current month
• Ending work-in-process – Units started in the current month not yet completed

Therefore, there are a few more steps in creating the Production Cost Report. However, the first step is the same as with the weighted average method.

Step 1 – Calculate units to account for

Establish the total inventory in production by adding units started into production to beginning work in process (what was left only partially finished at the end of the prior month). The company had 750 shells in process at the close of business on January 31. The beginning inventory of 750 plus the 3,250 pie shells worth of materials placed into production during the month gives us 4,000 total units to account for.

Step 2 – Calculate units accounted for

This is where equivalent units are different than the normal formula, but only for beginning inventory.

Under the FIFO method, we assume beginning inventory is finished first, before anything else is started. Last month (January) all of the direct materials were added and accounted for, so this month, there are no more direct materials to add. The EUs for this month for direct materials for beginning inventory is zero. For conversion costs, last month we added 60% of the costs to the work-in-process, and for February, we will use 40% as our factor to convert the physical units to Equivalent Units. 60% finished last month = 40% left to do this month.

For beginning inventory, the formula for EUs is:

Actual Units * (1 – % complete)

750 units * (1 – 0.60) = 750 * 0.40 = 300 EUs

This is important and an easy place to slip up. EUs for beginning inventory is the complement of last month’s ending inventory because now you are finishing them up. If the beginning work-in-process inventory is 10% done, then the factor to use to calculate EUs to finish it up this month is 90%.

Units started during the period, finished, and then transferred out are 100% complete, so the Equivalent Units and the actual physical units are the same.

Unfinished units (work-in-process) in this department have to be converted to Equivalent Units. In this case, since materials are all added at the beginning, the Equivalent Units for Direct Materials is 100% of the actual units, but the Equivalent Units for the Conversion Costs allocation is 25% of actual units or 250 EUs.

We started with 750 units that were 100% complete as to materials and 60% processed, so the beginning work-in-process EUs for direct materials is 0% of 750 and for conversion costs is 40% of 750 which is 300.

We have 4,000 total units for which to account, with 750 in process at the beginning of the month, and the last batch that is still in process at the end of the month will be 1,000 shells once it is done. On the last day of February, it was only 25% through the process, meaning that the EUs for ending inventory for direct materials was 1,000 units and for conversion costs was 25% of 1,000 units which is 250 EUs.

Because we started with 750 shells we finished and transferred out, and we started another 3,250 into the process and ended with 1,000 still in the mixing department, we see that we transferred out 3,000 shells to the baking/packaging department. With 750 started in January, the other 2,250 were started and completed in February.

Step 3 – Divide costs by equivalent units

From the accounting records, we see that total direct materials transferred to the mixing department in February were $3,575 and that direct labor and manufacturing overhead totaled $3,640.

In the weighted average method, we divided total costs by total Equivalent Units, but here is where the FIFO method is significantly different.

Because we calculated EUs based on completed units, including EUs that represent the effort it took to complete the beginning inventory, we divide ONLY costs added during the period by our Equivalent Units.

Step 4 – Allocate costs based on equivalent units

Refer to step 2 for our calculator of EUs:

Multiply the cost per equivalent unit by the number of equivalent units for each category of units accounted for.

1. Costs for beginning work-in-process come from the prior Production Report’s ending work-in-process
2. The cost to complete work-in-process is the EUs calculated in step 2 * the cost per EU from step 3

3. Work started and completed during the period = EUs * cost per EU

4. Costs allocated to ending work-in-process = EUs * cost per EU

Step 5 – Complete the production report

In circumstances where the product is flowing in batches like this, FIFO gives us a more accurate per unit cost for both beginning and ending work-in-process inventory.

Now, check your understanding of the FIFO method of computing ending and work-in-process inventory using process costing.