NAME: VIRAK

ROLLNO: 11

TITLE OF CIR: How does the weighted average method of process costing calculate the costs of goods Unit and spoilage?

SIGNATURE OF STUDENT:

How does the weighted average method of process costing calculate the costs of good unitsand spoilage?

Weighted average method of process costing while calculating the cost of good units

The weighted-average process costing method calculates cost per equivalent unit of all work done to date (regardless of the accounting period in which it was done) and assigns this cost to equivalent units completed and transferred out of the process and to equivalent units in ending work-in-process inventory. The weighted average cost is the total of all costs entering the WIP account divided by total equivalent units of work done to date. Following is the how weighted –average method is used by describing five step procedure.

Step 1: Summarize the flow of physical units. Here the physical units are calculated by adding WIP in beginning and the units through which work started during the year. And after that the units which are completed and transferred out during the period get deducted, what is remaining is the work in process for the end of the year.

Step 2: Compute Output in terms of Equivalent Units. The weighted average cost of inventory is calculated by merging together the cost of beginning inventory and the manufacturing costs of a period and dividing by the total number of units in beginning inventory and units produced during the accounting period. Following is the relationship shown in the equation below.

Equivalent units in Equivalent units of Equivalent units’ Equivalent unitsBeginning work in + work done in = completed and + in ending work inProcess current period transferred out in processCurrent period

Step 3: Summarize Total costs to Account for. Total cost includes opening WIP (Direct materials plus conversion cost plus any direct cost added during the year).

Step 4: Compute Cost per Equivalent Unit. Step 4 shows the computation of weighted- average cost per equivalent unit for direct materials and conversion costs. Weighted - average cost per equivalent unit for direct materials and conversion costs. Weighted – average cost per equivalent unit is obtained by dividing the sum of costs for beginning work in process plus costs of work done in current period by total equivalent units of work done to date.

Step 5: Assign Total Costs to Units Completed and to Units in Ending Work in Process. This takes the equivalent units completed and transferred out and equivalent units in ending work in process calculated, and assigns amount to them using the weighted – average cost per equivalent unit for direct materials and conversion costs calculated in step4.

Following is the example which shows all the five steps of weighted average costing method.

(Step 1) (Step 2)Equivalent Units

Flow of Production

Physical Units

Direct Material

Conversion Costs

Work in process, beginning 225

Started during current period 275To account for 500

Completed and transferred out during current period 400 400 400Work in process, ending 100

(100 x 100%; 100 x 50%) 100 50

Accounted for 500

Work done to date 500 450

Direct Materials: 225 physical units × 100% completed × Rs 800 per unit = Rs 180000Conversion costs: 225 physical units × 60% completed × Rs 600 per unit =Rs 81000

Total Production Costs

Direct Materials

Conversion Costs

(Step3) Work in process, beginning 261000 180000 81000

Costs added in current period 361800 198000 163800622800 378000 244800

(Step4) Costs incurred to date 378000 244800

Divide by equivalent units of work done to date 500 450Cost per equivalent unit of work done to date 756 544

(Step5) Assignment of Costs:

Completed and transferred out (400 units) 520000 (400 x Rs756)+ (400 x Rs544)Work in process, ending (100 Units) 102800 (100 x Rs756)+ (50 x Rs 544)Total costs accounted for 622800 378000 244800

Direct materials:100equivalent units x weighted average cost per equivalent unit of Rs 756 Rs 75600Conversion costs:50equivalent units x weighted – average cost per equivalent unit of Rs 544 Rs 27200 Total costs of ending work in process Rs 102800

Illustration-ProblemConsider the following data relating to a process of the month of March 2007

1800 units were in process at the beginning valued at Rs 83200 made up of Rs 38400 of material cost, Rs 24000 of labor costs and Rs 20800 of overhead expenditure.

These units where

1) 80% complete with regard to Direct materials2) 40% complete with respect to labour3) 60% complete with respect Overhead expense

12000 units of material were introduced in the process during the yearTotal material cost incurred for the process is Rs 211680Direct wages incurred where Rs 273240Overhead expenditure Rs132480There were 2400 units in the process at the end of the period

These units where

1) 75% complete with regard to direct material2) 50% complete with respect to labour3) 30% complete with regard to overhead expenses

There where no loss in proceessing

Working Note:Total input = Opening WIP Units + Units introduced

1800 units + 12000 units13800 units

Closing WIP= 2400 unitsCompleted Production=Total input – Closing WIP13800 units – 2400 units11400 units

Note: Statement of Equivalent production shown in Excel sheet

Production started and completed in the current period= Total Production/Output – Opening WIP Complete= 11400 units- 1800units= 9600 units

Note Statement of Cost shown in excel sheet.

Weighted Average method of Process Costing for calculating spoilage

The second concept of weighted average method of process costing is calculating for spoilage. Spoilage is the cost of wasted resources and defective products that cannot be recovered by rework or recycling. Spoilage is a normal part of production costs. One way to handle spoilage costs is to view them as a normal part of production. Spoilage, if material in amount, should be identified and reported, at least internally, so that managers can assess spoilage and waste as a cost to be managed and minimized. Calculations for spoiled units are made the same way as for good units, using the five-step approach described earlier. However, the number of physical units must be split between good units and spoiled units. Equivalent units are also split so that costs can be assigned to the spoiled units. The percentage of completion for spoiled units depends on when the spoilage is detected and what portion of the work has been completed for those units.

Following are the steps shown for calculating of spoilage:

Step 1: Of the five-step process is the same as described before — determine the total number of physical units.

Step 2: Now, units must be split three ways instead of two. Before, units were split between those that were completed and transferred out and those remaining in ending WIP. With spoiled units included, there is a third group of units — those that are spoiled. The number of equivalent units for each of these three groups must be calculated separately.

Step 3: Is the same as before — it consists of determining what costs are to be accounted for.

Step 4: Is the same, except now the number of equivalent units will be calculated and shown for spoiled units, and therefore the cost per EU will be different.

Step 5: Is different. Now, costs must be assigned to units completed and transferred out, ending WIP inventory and spoiled units.

Spoilage costs can be reported as a period cost and expensed right away (as part of cost of goods sold), or they can be treated as part of production costs and flow through the inventory system until product is sold.

Normal spoilage is waste that is considered to be part of the production process. It is generally counted as a normal cost of good units produced.

Abnormal spoilage is waste in excess of normal spoilage. Abnormal spoilage is usually treated as a period cost, regardless of how normal spoilage is treated.

Spoilage is usually not listed as a separate expense on financial statements. Regardless of how spoilage is reported on financial statements though, the amount and associated cost of spoilage is important information for managers to have.

Two types of Spoilage:

1) Normal Spoilage2) Abnormal Spoilage

Normal Spoilage

Normal spoilage is spoilage inherent in a particular production process. In particular, it arises even when the process is operated in an efficient manner. The costs of normal spoilage are typically included as a component of the costs of good units manufactured, because good units cannot be made without also making some units that are spoiled. There is a tradeoff between the speed of production and the normal spoilage rate. Management makes a conscious decision about how many units to produce per hour with the understanding that, at the rate decided on, a certain level of spoilage is almost unavoidable. For this reason, the cost of normal spoilage is included in the cost of the good units completed. At Nilkamal Plastics, the 400 units spoiled because of the limitations of injection molding machines and despite efficient operating conditions are considered normal spoilage. The calculations are as follows

Manufacturing cost per unit, Rs615000 ÷ 20500 units = Rs30

Manufacturing costs of good units alone, Rs30 per unit × 20000 units = Rs600000

Normal spoilage costs, Rs30 per unit × 400 units = Rs 12000

Manufacturing costs of good units completed = Rs 612000

Manufacturing cost per good unit = Rs 612000 = Rs 30.60 20000 units

Because normal spoilage is the spoilage related to the good units produced, normal spoilage rates are computed by dividing units of normal spoilage by total good units completed, not total actual units started in production. At Nilkamal Plastics, the normal spoilage rate is therefore computed as 400 ÷ 20000 = 2%.

Abnormal Spoilage

Abnormal spoilage is spoilage that is not inherent in a particular production process and would not arise under efficient operating conditions. If a firm has 100% good units as its goal, then any spoilage would be considered abnormal. At Nilkamal, the 100 units spoiled due to machine breakdowns and operator errors are abnormal spoilage. Abnormal spoilage is usually regarded as avoidable and controllable. Line operators and other plant personnel generally can decrease or eliminate abnormal spoilage by identifying the reasons for machine breakdowns, operator errors, etc., and by taking steps to prevent their recurrence. To highlight the effect of abnormal spoilage costs, companies calculate the units of abnormal spoilage and record the cost in the Loss from Abnormal Spoilage account, which appears as a separate line item in the income statement. At Nilkamal, the loss from abnormal spoilage is Rs3000 (Rs30 per unit × 100 units).

Spoilage in Process costing using weighted average method

Illustration: XYZ co manufactures computer chips for television sets. All direct materials are added at the beginning of the production process. To highlight issues that arise with normal spoilage, we assume no beginning inventory and focus only on direct material costs. The following data are available for May 2012.

Physical units

Direct Materials

1. Work in process, beginning inventory (may 1) 02. Started during may 100003. Good units completed and transferred out during May 50004. Units spoiled (all normal spoilage) 10005. Work in process, ending inventory (May 31) 40006. Direct Material cost added in May Rs 300000

Effect of recognizing Equivalent units in Spoilage for direct material cost for XYZ Co for May 2012

Approach counting spoiled Units when computing output In equivalent units

1. Costs to Account for Rs 3000002. Divide by equivalent units of output ÷ 100003. Cost per equivalent unit of output Rs 304. Assignment of costs:5. Good units completed (5000 units × Rs 30 per unit) Rs 1500006. (Add) normal spoilage (1000 units × Rs 30 per unit) Rs 300007. Total costs of good units completed and transferred out Rs 1800008. Work in process, ending (4,000 units × Rs 30 per unit) Rs 1200009. Costs accounted for Rs 300000

Spoilage is detected upon completion of the process and has zero net disposal value. An inspection point is the stage of the production process at which products are examined to determine whether they are acceptable or unacceptable units. Spoilage is typically assumed to occur at the stage of completion where inspection takes place. As a result, the spoiled units in our example are assumed to be 100% complete with respect to direct materials. In example we calculate and assign cost per unit of direct materials. Overall, XYZ co. generated 10,000 equivalent units of output: 5,000 equivalent units in good units completed (5,000 physical units 100%), 4,000 units in ending work in process (4,000 physical units 100%), and 1,000 equivalent units in normal spoilage (1,000 physical units 100%). Given total direct material costs of Rs 300000 in May, this yields an equivalent-unit cost of Rs30. The total cost of good units completed and transferred out, which includes the cost of normal spoilage, is then Rs 180000(6,000 equivalent units Rs30), while the ending work in process is assigned a cost of Rs 120000 (4,000 equivalent units Rs30). There are two noteworthy features of this approach. First, the 4,000 units in ending work in process are not assigned any of the costs of normal spoilage. This is appropriate because the units have not yet been inspected. While the units in ending work in process undoubtedly include some that will be detected as spoiled when inspected, these units will only be identified when the units are completed in the subsequent accounting period. At that time, costs of normal spoilage will be assigned to the good units completed in that period. Second, the approach used in Example delineates the cost of normal spoilage as Rs 30000. By highlighting the magnitude of this cost, the approach helps to focus management’s attention on the potential economic benefits of reducing spoilage.

Five step Procedure for process costing with spoilage

Illustration: ABC Company manufactures a recycling container in its forming department. Direct materials are added

at the beginning of the production process. Conversion costs are added evenly during the production process. Some units of this product are spoiled as a result of defects, which are detectable only upon inspection of finished units. Normally, spoiled units are 10% of the finished output of good units. That is, for every 10 good units produced, there is 1 unit of normal spoilage. Summary data for July 2012 are as follows:

Physical Units (1)

Direct Materials (2)

Conversion Costs (3)

Total Costs(2)+(3)=(4)

1. Work in process, beginning inventory (July 1

2000 Rs 15000 Rs 10000 Rs 25000

2. Degree of completion of beginning work in process

100% 60%

3. Started during July 100004. Good unit completed and transferred

out during July 8000

5. Work in process, ending inventory (July 31)

1500

6. Degree of completion of ending work in process

100% 50%

7. Total Costs added during July Rs 70000 Rs 90000 Rs160000

8. Normal spoilage as a percentage of good unit

10%

9. Degree of completion of normal spoilage

100% 100%

10. Degree of completion of abnormal spoilage

100% 100%

Step1: Summarize the flow of physical unit of output:Total Spoilage = (units in beginning WIP inventory + units started) – (goods unit completed and transferred out + units in ending WIP inventory)

= (2000 + 10000) – (8000+1500) = 2500 units

Recall that normal spoilage is 10% of good output at ABC Company. Therefore, normal spoilage 10% of the 8000 units of good output = 800 units.

Abnormal spoilage = Total spoilage - Normal spoilage = 2500 – 800 = 1700 units

Step2: Compute output in term of equivalent unit:Compute equivalent units for spoilage in the same way we compute equivalent units for good units. As illustrated previously, all spoiled units are included in the computation of output units. Because ABC’s inspection point is at the completion of production, the same amount of work will have been done on each spoiled and each completed good unit.

Step3: Summarize Total costs to Account for:The total costs to account for are all the costs debited to Work in Process.

Step4: Compute cost per equivalent unit

Step5: Assign total cost to units completed, to spoiled units, and to units in ending WIP:This step now includes computation of the cost of spoiled units and the cost of good units.

Step 3, 4, &5 shown in Excel sheet no 5/6