Final answer:
The FIFO (First-In, First-Out) method is used for calculating the equivalent units of production in manufacturing. It helps in determining the costs of inputs required for a given output and aids in the computation of cost per equivalent unit, especially when costs fluctuate.
Step-by-step explanation:
The FIFO (First-In, First-Out) method is primarily used for calculating the equivalent units of production in a manufacturing process. When using the FIFO method, a company counts the number of units that were completed and the number of equivalent units of production for units that were partially completed at the end of an accounting period. This method focuses on the costs incurred on the equivalent units produced during the current period, excluding the cost of work done in previous periods.
Using the FIFO method aids in determining the costs of inputs a firm needs to produce a certain quantity of output, which is essential for calculating total production costs. For example, the production function may indicate that specific combinations of labor and capital (e.g., 50 units of labor and 10 units of capital) are required to produce output.
If labor and capital costs fluctuate, as in the scenario where labor costs increase from $100 to $200 per unit, a company may re-evaluate its production methods (such as choosing between 20 units of labor and 40 units of capital versus 10 units of labor and 70 units of capital) to find the most cost-effective production method that adjusts for the rising costs. This ensures that the cost per equivalent unit is computed accurately.