process-costing systems

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

8Process-Costing

Systems

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Learning Objective 1

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Production environment Homogenous units Mass produced Automated Continuous flow

Process Costing

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Costing procedureCosts are recorded

for a department.Department costs are

assigned equally to units produced.

Production environment Homogenous units Mass produced Automated Continuous flow

Process Costing

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To determinebalance sheet

inventory

To evaluateproductionefficiency

To evaluateproducts

To helpset prices

How are unitcosts used?

Why Process Costing Is Useful

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DirectMaterials

Type of Product Cost

Dol

lar A

mou

nt

DirectLabor

ManufacturingOverhead

Direct labor costsare usually smallin comparison to

other productcosts in process

cost systems.(high level of automation)

Process Costing – The Cost Inputs

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So, direct labor and manufacturing overhead are oftencombined into one product cost called conversion.

DirectMaterials

Type of Product Cost

Dol

lar A

mou

nt ConversionDirect labor costsare usually smallin comparison to

other productcosts in process

cost systems.(high level of automation)

Process Costing – Conversion Costs

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Job costing Costs accumulated by the

job. Work in process has a job

cost record for each job. Many unique, high cost

jobs. Jobs built to customer

order.

Process costing Costs accumulated by

department or process. Work in process has a

production report for each batch of products.

A few identical, low cost products.

Units continuously produced for inventory in automated process.

Comparing Job Costingand Process Costing

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Work in process contains individual

jobs in a job cost system.

Direct Materials

FinishedGoods

Cost of GoodsSold

Direct Labor

ManufacturingOverhead

Jobs


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FinishedGoods

Cost of GoodsSold

Products

Work in process contains homogenous products in a process

cost system.

Direct Labor& Overhead

(Conversion)

Direct Materials


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Same objective: determine the cost of products

Same Inventory accounts: raw materials, work in process, and finished goods

Same overhead assignment method:predetermined rate times actual activity





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No beginning or endingWork in Process Inventory

Common when a company issuccessful at just-in-time production

Department With No Beginning or Ending WIP Inventory

Cost perunit = Manufacturing costs for a period

Units produced for the period

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Spirit Beverages produces a sport drink. During October, the Blending Department had the following manufacturing costs:

Spirit started and completed 8,000 four-bottle packages during October. Spirit had no beginning work in process inventory.

Compute the manufacturing unit costs for October.

Direct materials $16,000Conversion costs 5,600 Total costs to be assigned $21,600

Department With No Beginning or Ending WIP Inventory

Direct materials $16,000 ÷ 8,000 units = 2.00$ Conversion costs 5,600 ÷ 8,000 units = 0.70$ Mfg. cost per completed unit $21,600 ÷ 8,000 units = 2.70$

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Department With Ending WIP Inventory




No beginning Work in Process Inventory

Ending Work in Process Inventory consistsof incomplete units at the end of the period.

We must now deal with the conceptof equivalent units.

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Equivalent units is a concept expressing partially complete units as a smaller number

of fully complete units.

Cost perequivalent

unit

= Manufacturing costs for a periodEquivalent units for the period

We must now deal with the conceptof equivalent units.


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+ =So, 10,000 units 70 percent complete

are equivalent to 7,000 complete units.

Two one-half filled cups areequivalent to one full cup.

Equivalent Units Example

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Let’s look at the five-step process for assigning costs to units produced, followed

by an example using the five steps.

Assigning Costs to Products

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Summarize the flow of physical units (number of units completed and number of units remaining in process).

Compute the number of equivalent units produced. Summarize the total costs to be accounted for

(costs in beginning work in process inventory and the costs incurred in the current period).

Compute costs per equivalent unit. Assign unit costs from to units completed and to

units in ending work-in-process inventory.

Assigning Costs to Products –The Five-step Process

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Spirit incurred the following manufacturing costs in October (same data as before):

Spirit started 8,000 units and completed 6,000 units in October. Spirit had no beginning work in process inventory. All direct

materials had been added to each unit still in process, but only 20 percent of conversion costs had been incurred for the 2,000

units still in process.Complete the five-step process to assign

costs to units produced in October.

Direct materials $16,000Conversion costs 5,600 Total costs to be assigned $21,600


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Department With Ending WIP Inventory – Equivalent Units

Step 1 Step 2Physical Equivalent Units

Flow of Units in October Units Material ConversionUnits to account for Beginning work in process inventory 0 Units started this period 8,000 Total units to account for 8,000

Units accounted for Completed and transferred out 6,000 ? ? Ending work in process inventory 2,000 ? ? Total units accounted for 8,000 ? ?

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Units accounted for Completed and transferred out 6,000 6,000 6,000 Ending work in process inventory 2,000 ? ? Total units accounted for 8,000 ? ?

Units completed and transferred are 100%complete for both material and conversion.


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Units accounted for Completed and transferred out 6,000 6,000 6,000 Ending work in process inventory 2,000 2,000 ? Total units accounted for 8,000 8,000 ?

All material had been added to units remaining in process.


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Units accounted for Completed and transferred out 6,000 6,000 6,000 Ending work in process inventory 2,000 2,000 400 Total units accounted for 8,000 8,000 6,400

20% of 2,000 units


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Department With Ending WIP Inventory – Assigning Costs

Flow of Costs in October Material Conversion TotalCosts to account for (Step 3) Costs in beginning work in process inventory $ 0 $ 0 $ 0 Current period costs 16,000 5,600 21,600 Total costs to account for 16,000$ 5,600$ 21,600$

Equivalent Units 8,000 6,400 Costs per equivalent unit (Step 4) ? ? ?

Costs accounted for (Step 5) Costs transferred ? ? ? Cost of ending work in process inventory ? ? ? Total costs accounted for ? ? ?

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Equivalent Units 8,000 6,400 Costs per equivalent unit (Step 4) 2.00$ 0.875$ 2.875$

Costs accounted for (Step 5) Costs transferred ? ? ? Cost of ending work in process inventory ? ? ? Total costs accounted for ? ? ?

$16,000 ÷ 8,000 equivalent units



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Costs accounted for (Step 5) Costs transferred 12,000$ 5,250$ 17,250$ Cost of ending work in process inventory ? ? ? Total costs accounted for ? ? ?

6,000 equivalent units @ $2.00



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Costs accounted for (Step 5) Costs transferred 12,000$ 5,250$ 17,250$ Cost of ending work in process inventory 4,000 350 4,350 Total costs accounted for 16,000$ 5,600$ 21,600$


400 equivalent units @ $0.875


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Primary question to be answered:Which units were completed first

during the period?(How you answer this question will affect the Total EU for the period.)

Department with Beginning & Ending WIP Inventory

When there is Beginning WIP, the determination of equivalent units

becomes somewhat more complicated.

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Weighted Average vs. FIFO

Weighted-Average

All units and costs are considered

together to determine average cost per EU,

regardless of whether the costs were incurred last

period or currently.

FIFOCosts are accounted for by layer. Cost per EU for this period is computed separately from the Cost per EU

for last period.


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Weighted-Average

All units and costs are considered

together to determine average cost per EU,

regardless of whether the costs were incurred last

period or currently.

Weighted-Average is the most

commonly used

method.

Weighted Average vs. FIFO


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Let’s revisit Spirit in Decemberwhere we have a beginning

inventory from the previous month.

Assigning Costs UsingWeighted-Average Costing

The weighted average method . . . Makes no distinction between work done in the prior period

and work done in the current period. Blends together units and costs in beginning inventory with

units and costs in the current period.

The FIFO method is covered in Appendix A.

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Spirit had the following cost andunit data for December:

Complete the five-step process to assign costs to unitscompleted and to units left in process for December.

Percentage Complete Total CostsUnits Materials Conversion Materials Conversion

Beginning WIP inventory 2,000 40% 80% 2,000$ 1,000$ Costs incurred in Dec. 20,000 7,000 Units Started in Dec. 12,000 Units completed 10,000 100% 100%Ending WIP inventory 4,000 25% 60%

Beginning and Ending InventoryWeighted-Average Costing

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First let’s look at a flow chart showing the blending of units in beginning work in process inventory with units started

during the month.


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Beginning Inventory2,000 units

12,000 unitsstarted

EndingInventory

4,000 units

14,000 units 10,000 unitscompleted

Now let’s examine the five-step process.


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Flow of Units in December Units Material ConversionUnits to account for Beginning work in process inventory 2,000 Units started this period 12,000 Total units to account for 14,000

Units accounted for Completed and transferred out 10,000 ? ? Ending work in process inventory 4,000 ? ? Total units accounted for 14,000 ? ?


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Units accounted for Completed and transferred out 10,000 10,000 10,000 Ending work in process inventory 4,000 ? ? Total units accounted for 14,000 ? ?



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Units accounted for Completed and transferred out 10,000 10,000 10,000 Ending work in process inventory 4,000 1,000 2,400 Total units accounted for 14,000 11,000 12,400

25% of 4,000 units 60% of 4,000 units


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Flow of Costs in December Material Conversion TotalCosts to account for (Step 3) Costs in beginning work in process inventory 2,000$ 1,000$ 3,000$ Current period costs 20,000 7,000 27,000 Total costs to account for 22,000$ 8,000$ 30,000$

Equivalent units 11,000 12,400 Costs per equivalent unit (Step 4) ? ? ?

Costs accounted for (Step 5) Costs assigned to units transferred ? ? ? Cost of ending work in process inventory ? ? ? Total costs accounted for ? ? ?


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Equivalent units 11,000 12,400 Costs per equivalent unit (Step 4) 2.00$ 0.6452$ 2.6452$

Costs accounted for (Step 5) Costs assigned to units transferred ? ? ? Cost of ending work in process inventory ? ? ? Total costs accounted for ? ? ?




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Costs accounted for (Step 5) Costs assigned to units transferred 20,000$ 6,452$ 26,452$ Cost of ending work in process inventory ? ? ? Total costs accounted for ? ? ?




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Costs accounted for (Step 5) Costs assigned to units transferred 20,000$ 6,452$ 26,452$ Cost of ending work in process inventory 2,000 1,548 3,548 Total costs accounted for 22,000$ 8,000$ 30,000$




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Costs Transferred infrom Prior Departments Multiple departments in a process result in units and

costs that are transferred from a prior department to the current department.

These transferred-in costs are treated exactly like a direct material that is added at the beginning of a production process.

Let’s revisit Spirit. with the addition of transferred-in units and costs. We will use the December information and the weighted-average method.

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Complete the five-step process for Spirit to assign costs tounits completed and to units left in process for December.

Costs Transferred infrom Prior Departments

Percentage CompleteFlow of units in December Units Materials Conversion Trans-inBeginning WIP inventory 2,000 40% 80% 100%Transferred-in during Dec. 12,000 Units completed 10,000 100% 100% 100%Ending WIP inventory 4,000 25% 60% 100%

Total CostsFlow of costs in December Units Materials Conversion Trans-inCosts incurred in Dec. 20,000$ 7,000$ 52,000$ Beginning WIP inventory 2,000 2,000 1,000 5,000 Transferred-in during Dec. 12,000 Units completed 10,000 Ending WIP inventory 4,000

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Flow of Units in December Units Material Conversion Trans-inUnits to account for Beginning WIP inventory 2,000 Units transferred in during Dec. 12,000 Total units to account for 14,000

Units accounted for Completed and transferred out 10,000 ? ? ? Ending WIP inventory 4,000 ? ? ? Total units accounted for 14,000 ? ? ?

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Units accounted for Completed and transferred out 10,000 10,000 10,000 10,000 Ending WIP inventory 4,000 ? ? ? Total units accounted for 14,000 ? ? ?


100% complete for material,conversion, and transferred-in units.

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Units accounted for Completed and transferred out 10,000 10,000 10,000 10,000 Ending WIP inventory 4,000 1,000 2,400 4,000 Total units accounted for 14,000 11,000 12,400 14,000


25% of 4,000 units 60% of 4,000 units

Transferred-in units are 100% complete

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Flow of Costs in December Material Conversion Trans-in TotalCosts to account for (Step 3) Costs in beginning WIP inventory 2,000$ 1,000$ 5,000$ 8,000$ Current period costs 20,000 7,000 52,000 79,000 Total costs to account for 22,000$ 8,000$ 57,000$ 87,000$

Equivalent units 11,000 12,400 14,000 Costs per equivalent unit (Step 4) ? ? ? ?

Costs accounted for (Step 5) Costs assigned to units transferred ? ? ? ? Cost of ending WIP inventory ? ? ? ? Total costs accounted for ? ? ? ?

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Equivalent units 11,000 12,400 14,000 Costs per equivalent unit (Step 4) 2.00$ 0.6452$ 4.0714$ 6.7166$

Costs accounted for (Step 5) Costs assigned to units transferred ? ? ? ? Cost of ending WIP inventory ? ? ? ? Total costs accounted for ? ? ? ?





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Costs accounted for (Step 5) Costs assigned to units transferred 20,000$ 6,452$ 40,714$ 67,166$ Cost of ending WIP inventory ? ? ? ? Total costs accounted for ? ? ? ?





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Costs accounted for (Step 5) Costs assigned to units transferred 20,000$ 6,452$ 40,714$ 67,166$ Cost of ending WIP inventory 2,000 1,548 16,286 19,834 Total costs accounted for 22,000$ 8,000$ 57,000$ 87,000$





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Accounting for Spoilage CostsSpoilage represents the amount of resources that go

into the process, but DO NOT result in finished product.

Managers face key problems related to spoilage:

1. Identifying whether it exists.

2. Determining whether it can be eliminated.

3. Deciding whether eliminating it is worthwhile.

4. Determining the cost of spoilage.

The 5-step approach discussed earlier canbe modified by including spoilage

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Accounting for Spoilage Costs

Abnormal spoilage is the result of unusual operating problems.Abnormal spoilage is in addition to normal spoilage,

and is recorded as a loss of the period.

Normal spoilage occurs as a part of the regular operationsof an efficient process.

We will illustrate the spoilage using the December data forSpirit Beverages, but without the transferred-in costs.

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Percentage Complete Total CostsUnits Materials Conversion Materials Conversion

Beginning WIP inventory 2,000 40% 80% 2,000$ 1,000$ Costs incurred in Dec. 20,000 7,000 Units Started in Dec. 12,000 Units completed 10,000 100% 100%Spoiled units 500 20% 50%Ending WIP inventory 3,500 25% 60%

Spoilage is found at an inspection when 20% of the materialhas been added and the conversion is 50% complete.

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Beginning Inventory2,000 units

12,000 unitsstarted

Spoilage

500 units

14,000 units 10,000 unitscompleted


Complete the five-step process to assign costs to unitscompleted and to units left in process for December.

EndingInventory

3,500 units

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Units accounted for Completed and transferred out 10,000 ? ? Spoiled units 500 ? ? Ending work in process inventory 3,500 ? ? Total units accounted for 14,000 ? ?

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Units accounted for Completed and transferred out 10,000 10,000 10,000 Spoiled units 500 ? ? Ending work in process inventory 3,500 ? ? Total units accounted for 14,000 ? ?



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Units accounted for Completed and transferred out 10,000 10,000 10,000 Spoiled units 500 100 250 Ending work in process inventory 3,500 ? ? Total units accounted for 14,000 ? ?


20% of 500 units 50% of 500 units

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Units accounted for Completed and transferred out 10,000 10,000 10,000 Spoiled units 500 100 250 Ending work in process inventory 3,500 875 2,100 Total units accounted for 14,000 10,975 12,350

25% of 3,500 units 60% of 3,500 units


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Equivalent units 10,975 12,350 Costs per equivalent unit (Step 4) ? ? ?

Costs accounted for (Step 5) Costs assigned to units transferred ? ? ? Spoiled units ? ? ? Cost of ending work in process inventory ? ? ? Total costs accounted for ? ? ?

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Costs accounted for (Step 5) Costs assigned to units transferred ? ? ? Spoiled units ? ? ? Cost of ending work in process inventory ? ? ? Total costs accounted for ? ? ?

$22,000 ÷ 10,975 equivalent units$8,000 ÷ 12,350 equivalent units


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Costs accounted for (Step 5) Costs assigned to units transferred 20,046$ 6,478$ 26,524$ Spoiled units ? ? ? Cost of ending work in process inventory ? ? ? Total costs accounted for ? ? ?

10,000 equivalent units @ $2.004610,000 equivalent units @ $0.6478


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Costs accounted for (Step 5) Costs assigned to units transferred 20,046$ 6,478$ 26,524$ Spoiled units 200 162 362 Cost of ending work in process inventory ? ? ? Total costs accounted for ? ? ?

100 equivalent units @ $2.0046250 equivalent units @ $0.6478


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Costs accounted for (Step 5) Costs assigned to units transferred 20,046$ 6,478$ 26,524$ Spoiled units 200 162 362 Cost of ending work in process inventory 1,754 1,360 3,114 Total costs accounted for 22,000$ 8,000$ 30,000$

875 equivalent units @ $2.00462,100 equivalent units @ $0.6478


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Let’s conclude our discussion of process costing by

examining the cost flows in a two- department process, A and B. We will use T-accounts and

start with materials.

Process Cost Flows

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•Other Overhead

Factory Overhead

WIP Dept. A•Direct

Materials

•Direct Materials

WIP Dept. B

•Purchases •DirectMaterials

Materials Inventory

Process Cost Flows

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•Other Overhead

Factory Overhead

•Indirect Materials


Materials

•Direct Materials

WIP Dept. B


•PurchasesMaterials Inventory

•DirectMaterials

Process Cost Flows

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Next let’s add labor and manufacturing overhead

to the process cost flows. Are you with me?

Process Cost Flows

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•Other Overhead

Factory Overhead

Wages Payable

•IndirectLabor


Materials

•Direct Materials

WIP Dept. B

•Indirect Labor


Process Cost Flows

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•Other Overhead

Factory Overhead•OverheadApplied to

Work inProcess

Wages Payable

•DirectLabor

•IndirectLabor


Materials•Conversion

•Direct Materials

•Conversion

WIP Dept. B

•Indirect Labor


Process Cost Flows

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Next let’s transfer work from Department A to

Department B. Are you ready?

Process Cost Flows

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•Transferred to Dept. B

•Transferred from Dept. A


Materials•Conversion

•Direct Materials

•Conversion

WIP Dept. B

Process Cost Flows

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Now let’s complete the goods in Department B and

sell them. Still with me?

Process Cost Flows

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Finished Goods•Cost of Goods

Mfd.

•Cost of Goods

Mfd.

Cost of Goods Sold

WIP Dept. B•Direct

Materials•Conversion•Transferred from Dept. A

Process Cost Flows

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Finished Goods

•Cost of GoodsSold

•Cost of Goods

Mfd.

•Cost of GoodsSold

•Cost of Goods

Mfd.

Cost of Goods Sold

WIP Dept. B•Direct

Materials•Conversion•Transferred from Dept. A

Process Cost Flows

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8-81

Cost Assignment to Products Using FIFO

The weighted-average inventory method mixes previous period costs with those of the present period.

FIFO assumes that units in the beginning inventory were completed.

Count production in this period only when calculating equivalent units.

This allows managers to identify and manage current period costs.

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Comparing Weighted-Average and FIFO Costing Methods

Using FIFO to isolate current period costs is useful when the beginning inventory balance is very large.

Otherwise, the smaller the beginning inventory balance, the closer the unit cost results under both methods.

Though either method is acceptable for external reporting, separating the costs with FIFO is preferable.

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Operation Costing A hybrid of job-order and process

costing. Applied to production activities:

with repetitive operations (so conversion costs do not change).

when different materials may be used (so materials costs could change).

Examples: Fabrics used in shirt manufacturing Engines used in similar cycle bodies

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End of Chapter 8

process-costing systems

Documents

process cost systems

process costingcosts

automated process

process inventorycommon

job cost system

job cost record

high cost jobs

beginning work