Separate Equivalent Units for Direct Materials and Conversion Costs

Equivalent units are often measured separately for direct materials costs as opposed to conversion costs (i.e., direct labor and manufacturing overhead). This is done because direct materials costs are often added entirely (or mostly) at the beginning of the manufacturing process, whereas conversion costs are incurred more evenly throughout the process.

EXAMPLE: Choice Chocolate Company is a chocolate bar manufacturer. In the production process, each bar of chocolate passes through three departments: mixing, molding, and packaging. The molding department doesn’t add any direct materials to the process. (In contrast, the mixing department adds materials such as cocoa butter, sugar, milk, etc.) So every single unit of production in the molding department’s inventory will be considered 100%-complete with respect to direct materials (because the department has no further DM costs to add to any unit). But the units will each have varying levels of completeness with respect to conversion costs.

When measuring equivalent units separately for direct materials costs and conversion costs, the overall process works exactly the same as we discussed in the book, except that in steps 2-5 each calculation is performed separately for direct materials and conversion costs instead of everything being lumped together into one calculation.

EXAMPLE: During the month of January, Choice Chocolate Company’s molding department completed 1,500 physical units and transferred them to the packaging department. At the end of the month, the molding department had 1,000 physical units in Work-in-Process inventory. Those Work-in-Process units are estimated to be 100% complete with respect to direct materials and 30% complete with respect to conversion costs.

From this point, the remaining steps of process costing would be followed just as discussed in the book, but with separate calculations for direct materials and conversion costs. That is, we would use our information about direct materials costs and direct materials equivalent units to compute a direct materials cost per equivalent unit. And, separately, we would use our information about conversion costs and conversion cost equivalent units to compute a conversion cost per equivalent unit. Then we would use those two separate per-unit costs to calculate the costs for the units that were completed and transferred out and for the units still in ending Work-in-Process inventory.

EXAMPLE: Let’s assume that, in steps 3 and 4 of process costing, the molding department calculates direct materials cost of $1.25 per equivalent unit and conversion costs of $0.75 per equivalent unit. How would the department know how much to reflect as the ending WIP balance and the amount transferred to the next department?

To calculate ending Work-in-Process, we see that there are 1,000 direct materials equivalent units at a cost of $1.25 per equivalent unit, giving us a cost of $1,250. And we see that there are 300 conversion cost equivalent units at a cost of $0.75 per equivalent unit, giving us a cost of $225. Therefore, our total ending Work-in-Process balance is $1,475 (i.e., $1,250 + $225).

That is, total costs in end WIP:
(1,000 x $1.25) + (300 x $0.75) = $1,475

To calculate the amount transferred to the next department, we see that there are 1,500 direct materials equivalent units at a cost of $1.25 per unit, giving us a cost of $1,875. And we see that there are 1,500 conversion cost equivalent units at a cost of $0.75 per unit, giving us a cost of $1,125. Therefore, our total cost of units completed and transferred out to the next department is $3,000 (i.e., $1,875 + $1,125).

That is, total cost of units completed and transferred out:
(1,500 x $1.25) + (1,500 x $0.75) = $3,000