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System Design—Process Costing Learning Objectives LO1. Record the flow of materials, labor, and overhead through a process costing system. LO2. Compute the equivalent units of production using the weighted-average method. LO3. Prepare a quantity schedule using the weighted-average method. LO4. Compute the costs per equivalent unit using the weighted-average method. LO5. Prepare a cost reconciliation using the weighted-average method. LO6. (Appendix 4A) Compute the equivalent units of production using the FIFO method. LO7. (Appendix 4A) Prepare a quantity schedule using the FIFO method. LO8. (Appendix 4A) Compute the costs per equivalent unit using the FIFO method. LO9. (Appendix 4A) Prepare a cost reconciliation using the FIFO method. New in this Edition • Additional simple exercises have been created. Chapter Overview A. Job-Order Costing vs. Process Costing. Process costing is used in industries that produce homogenous products such as bricks, flour, and cement on a continuous basis. 1. Similarities between job-order and process costing. Job-order and process costing

systems share some characteristics: a. Both systems have the same basic purpose—to assign material, labor, and overhead

cost to products. b. Both systems use the same basic manufacturing accounts: Manufacturing Overhead,

Raw Materials, Work In Process, and Finished Goods. c. The flow of costs through the manufacturing accounts is basically the same.

2. Differences between job-order and process costing. The differences between job-order

and process costing occur because the flow of units in a process costing system is more or less continuous and the units are essentially indistinguishable from one another. Under process costing: a. A single homogenous product is produced on a continuous basis over a long period of

time. This differs from job-order costing in which many different products may be produced in a single period.

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b. Costs in process costing are accumulated by department, rather than by individual job. c. The department production report is the key document in process costing, showing the

accumulation and disposition of cost. In job-order costing, the job-cost sheet is the key document.

B. Overview of Process Costing. (Exercises 4-1 and 4-10.) Manufacturing costs are accumulated in processing departments in a process costing system. A processing department is any location in the organization where work is performed on a product and where materials, labor, and overhead costs are added to the product. Processing departments should also have two other features. First, the activity performed in the processing department should be essentially the same for all units that pass through the department. Second, the output of the department should be homogeneous. In process costing, the average cost of processing units for a period is assigned to each unit passing through the department. Two process costing methods are illustrated in the text—the weighted-average method and the FIFO method. While the FIFO method provides more current cost data for decision-making and performance evaluation purposes, it is more difficult for students to grasp. For that reason, the FIFO method is covered in an appendix. C. Equivalent Units of Product. (Exercises 4-2, 4-11, 4-13, and 4-17.) In order to calculate the average cost per unit, the total number of units must be determined. Partially completed units pose a difficulty that is overcome using the concept of equivalent units. Equivalent units are the equivalent, in terms of completed units, of partially completed units. The formula for computing equivalent units is:

Number ofEquivalent Percentagepartially completedunits completionunits= ×

Equivalent units are the number of complete, whole units one could obtain from the materials and effort contained in partially completed units. Under the weighted-average method, the equivalent units for a particular cost category (e.g., materials or conversion cost) is computed by adding together the number of units completed and transferred out to the next department during the period and the equivalent units in the ending work in process inventory in the department.

Units transferred toEquivalent Equivalent unitsunits of the next department in ending work in

or to finished goods process inventoryproduction= +

D. Production Report. The purpose of a production report is to summarize all of the activity that takes place in a department's work in process account for a period. A production report consists of three parts:

• A quantity schedule and a computation of equivalent units. • A computation of costs per equivalent unit. • A reconciliation of all cost flows into and out of the department during the period.

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E. Production Report: Weighted-Average Method. (Exercise 4-13 followed by Exercise 4-14.) Emphasize that the weighted-average method does not attempt to separate units in the beginning inventory from units started during the current period. Costs and units from beginning inventory are blended together with costs and units from the current period. 1. Quantity Schedule and Equivalent Units. (Exercises 4-2, 4-4, and 4-11.) The first step in

preparing a production report is to prepare a quantity schedule, which shows the physical flow of units through the department. This schedule allows managers to see at glance how many units moved through the department during the period. Using the quantity schedule, the equivalent units can be easily computed.

2. Costs per Equivalent Unit. (Exercises 4-6 and 4-13.) The second step in preparing a

production report is to calculate the costs per equivalent unit. The cost per equivalent unit is computed for a particular cost category (i.e., materials, labor, overhead, or conversion) by dividing its total cost by its total equivalent units. Note that under the weighted-average method the costs include both the costs already in beginning inventory as well as the costs added by the department during the current period.

3. Cost Reconciliation. (Exercise 4-7.) The third step in preparing a production report is to

prepare a cost reconciliation. The purpose of a cost reconciliation is to show how the costs from beginning work in process inventory and costs that have been added during the period are accounted for. a. Costs come into the department from units in beginning inventory, from material,

labor, and overhead costs that are added during the period, and from any units that might have been transferred in from a prior department.

b. A department's costs are accounted for by showing the costs that are transferred out to

the next department (or to finished goods) and by specifying the costs that remain in the ending work in process inventory.

F. Operation Costing. The costing systems discussed in Chapters 3 and 4 represent the two ends of a continuum. On one end is job-order costing and on the other is process costing. Between the two extremes, there are many “hybrid” systems. Operation costing is an example of such a hybrid system. It is used in situations where products have some common as well as individual characteristics. TVs, for example, have some common characteristics in that all models must be assembled and tested following the same basic steps. However, each model has different components with different costs. The costs of the components (materials) would be charged to a batch of a particular model individually, as in job-order costing, but the conversion costs may be assigned using process costing. G. FIFO Method (Appendix 4A). (Exercise 4-15 followed by Exercise 4-16.) The FIFO method segregates the units and costs in the beginning inventory from the units and costs of the current period. 1. Quantity Schedule. (Exercises 4-5 and 4-12.) The quantity schedule prepared under the

FIFO method is identical to that prepared under the weighted-average method, except that the “units transferred out” are separated into those units that came from beginning inventory and those units that were started and completed this period.

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2. Equivalent Units. (Exercises 4-3 and 4-12.) The FIFO method differs from the weighted-average method for computation of equivalent units in two ways. a. First, under the FIFO method the “units transferred out” figure is split between units

completed from the beginning inventory and units started and completed during the current period.

b. Second, the equivalent units refers to just the equivalent units for the work performed

during the current period. The equivalent units under the FIFO method consist of three amounts: the work needed to complete the units in the beginning inventory; the work expended on the units started and completed during the current period; and the work expended on partially completed units in the ending inventory.

c. This method is called the FIFO method because it assumes that the units in beginning

inventory are completed and transferred out before any new units are started. The costs of beginning inventory are segregated from costs added during the period.

d. The only difference in the equivalent unit calculations between the two methods is that

the equivalent units in beginning inventory are included in the weighted-average method. Under the weighted-average method the costs already in beginning inventory will be added to the costs incurred during the period to arrive at unit costs. To be consistent we must add the equivalent units already in beginning inventory to the equivalent units for the work performed during the current period.

3. Costs per Equivalent Unit. (Exercise 4-8.) In computing costs per equivalent unit, costs

associated with the beginning work in process inventory are ignored. It is assumed that the units in beginning inventory are completed and transferred to the next department before any new units are worked on. Providing that more units are transferred out than were in beginning inventory, all of the costs associated with beginning inventory will be transferred to the next department.

4. Cost Reconciliation. (Exercises 4-9 and 4-16.) As with the weighted-average method, the

purpose of a cost reconciliation is to show how the costs have been charged to a department during a period and to show how these costs are accounted for. a. The “Costs to be accounted for” section of the report is the same as for the weighted-

average method. b. The “Cost accounted for” section differs from the weighted-average method in that

four layers of cost are involved. These layers are (1) the cost in the beginning inventory, (2) the cost required to complete the units in the beginning inventory, (3) the cost of units started and completed during the current period, and (4) the cost of the ending work in process inventory.

H. Evaluation of Weighted-Average and FIFO (Appendix 4A). The weighted-average method is simpler to learn and apply than the FIFO method, but the FIFO method is generally considered to be superior for cost control. The reason is that the FIFO method helps to isolate current performance by segregating current costs from prior period costs. The weighted-average method mixes the costs of the current period with the costs of prior periods.

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Assignment Materials

Assignment Topic Level of

Difficulty Suggested

Time Exercise 4-1 Process costing journal entries........................................................ Basic 20 min. Exercise 4-2 Computation of equivalent units—WAC........................................ Basic 10 min. Exercise 4-3 (Appendix 4A) Computation of equivalent units—FIFO ............... Basic 10 min. Exercise 4-4 Preparation of quantity schedule—WAC ....................................... Basic 15 min. Exercise 4-5 (Appendix 4A) Preparation of quantity schedule—FIFO............... Basic 15 min. Exercise 4-6 Cost per equivalent unit—WAC..................................................... Basic 15 min. Exercise 4-7 Cost reconciliation—WAC............................................................. Basic 20 min. Exercise 4-8 (Appendix 4A) Cost per equivalent unit—FIFO ............................ Basic 10 min. Exercise 4-9 (Appendix 4A) Cost reconciliation—FIFO .................................... Basic 45 min. Exercise 4-10 Process costing journal entries........................................................ Basic 10 min. Exercise 4-11 Quantity schedule and equivalent units—WAC ............................. Basic 15 min. Exercise 4-12 (Appendix 4A) Quantity schedule and equivalent units—FIFO..... Basic 15 min. Exercise 4-13 Equivalent units and cost per equivalent unit—WAC .................... Basic 20 min. Exercise 4-14 Cost reconciliation—WAC [assign after Exercise 4-13] ................ Basic 15 min. Exercise 4-15 (Appendix 4A) Quantity schedule; equivalent units; cost per

equivalent unit—FIFO ............................................................... Basic 20 min. Exercise 4-16 (Appendix 4A) Cost reconciliation—FIFO [assign after

Exercise 4-15] ............................................................................ Basic 20 min. Exercise 4-17 Quantity schedule; equivalent units, and cost per equivalent

unit—WAC ................................................................................ Basic 20 min. Exercise 4-18 (Appendix 4A) Quantity schedule; equivalent units, and cost

per equivalent unit—FIFO......................................................... Basic 20 min. Problem 4-19 Step-by-step production report—WAC .......................................... Basic 45 min. Problem 4-20 (Appendix 4A) Step-by-step production report—FIFO.................. Basic 45 min. Problem 4-21 Production report—WAC ............................................................... Basic 45 min. Problem 4-22 (Appendix 4A) Production report—FIFO....................................... Basic 45 min. Problem 4-23 Analysis of Work in Process T-account—WAC ............................ Medium 45 min. Problem 4-24 (Appendix 4A) Analysis of Work in Process T-account—FIFO.... Medium 45 min. Problem 4-25 Interpreting a production report—WAC......................................... Medium 30 min. Problem 4-26 Comprehensive process costing problem—WAC .......................... Difficult 90 min. Problem 4-27 Equivalent units; costing of inventories; journal entries—WAC ... Difficult 60 min. Problem 4-28 Comprehensive process costing problem—WAC .......................... Difficult 90 min. Case 4-29 Ethics and the manager; understanding the impact of

percentage completion on profit—WAC ................................... Difficult 90 min. Case 4-30 Production report of second department—WAC............................ Difficult 45 min. Case 4-31 (Appendix 4A) Production report of second department—FIFO ... Difficult 60 min. Essential Problems: Problem 4-19, Problem 4-21 Supplementary Problems: Problem 4-23, Problem 4-25, Problem 4-26, Problem 4-27, Problem

4-28, Case 4-29, Case 4-30 Appendix 4A Essential Problems: Problem 4-20, Problem 4-22 Appendix 4A Supplementary Problems: Problem 4-24, Case 4-31 Linked problems and exercises: Exercise 4-14 should be assigned in conjunction with Exercise 4-13

Exercise 4-16 should be assigned in conjunction with Exercise 4-15

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Chapter 4 Lecture Notes

Helpful Hint: Before beginning the lecture, show students the fourth segment from the first tape of the McGraw-Hill/Irwin Managerial/Cost Accounting video library. This segment introduces students to many of the concepts discussed in chapter 4. The lecture notes reinforce the concepts introduced in the video.

Chapter theme: Managers need to assign costs to products to facilitate external financial reporting and internal decision making. This chapter illustrates an absorption costing approach to calculating product costs known as process costing.

I. Comparison of job-order and process costing

A. Similarities between job-order and process costing

i. Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product costs.

ii. Both systems use the same manufacturing accounts,

including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods.

iii. The flow of costs through the manufacturing

accounts is basically the same in both systems.

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B. Differences between job-order and process costing

i. Process costing is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs are worked each period.

ii. Process costing systems accumulate costs by

department. Job-order costing systems accumulate costs by individual jobs.

iii. Process costing systems use department

production reports to accumulate costs. Job-order costing systems use job cost sheets to accumulate costs.

iv. Process costing systems compute unit costs by

department. Job-order costing systems compute unit costs by job.

Quick Check − process vs. job-order costing “In Business Insights” Some companies use a hybrid approach to calculating product costs that combines elements of process and job-order costing. For example: “A Hybrid Approach” (page 147)

• Some hospital pharmacies may use process costing to develop the cost of formulating the base solution for parenterals (that is, drugs delivered by injection or through the blood stream).

• Job-order costing can be used to accumulate the additional costs incurred to create specific parenteral solutions.

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• The additional costs include the ingredients added to the base solution and the time spent by the pharmacist to prepare a specific prescribed solution.

II. A perspective of process cost flows

A. Processing departments − Any location in an organization where materials, labor or overhead are added to the product.

i. The activities performed in a processing

department are performed uniformly on all units of production. Furthermore, the output of a processing department must be homogeneous.

ii. Processing departments can be organized

sequentially or in parallel.

1. Sequential processing means that units flow in a sequence from one department to another.

2. Parallel processing is used, where after a point, some units go through different processing departments than others.

a. For example, a petroleum refinery separates crude oil into intermediate products that go through separate processes to become end products such as gasoline, jet fuel, and heating oil.

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B. The flow of materials, labor, and overhead costs

i. The flow of costs through the manufacturing

accounts is basically the same for process and job-order costing.

1. Direct material, direct labor and

manufacturing overhead are added to Work in Process. When work in process is completed the costs are transferred to Finished Goods. When finished goods are sold, the costs are transferred to Cost of Goods Sold.

ii. Nonetheless, there is a key fundamental

difference between process and job-order costing systems.

1. Job-order costing systems trace and apply

manufacturing costs to jobs. a. One Work in Process account is often

used to accumulate costs for all jobs. The individual job cost sheets serve as a subsidiary ledger.

2. Process costing systems trace and apply manufacturing costs to departments.

a. A separate Work in Process account is maintained for each processing department.

iii. T-account and journal entry views of process

cost flows (For purposes of this example, assume there are two processing departments − A and B).

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Helpful Hint: Explain that the journal entries for job-order and process costing are similar, with the exception of the specific Work in Process account for each department under process costing.

1. The flow of raw material costs.

a. In T-account form: i. Direct material costs are debited

to the appropriate departmental Work in Process account depending upon where the materials were added to the production process. The Raw Materials account is credited for the corresponding amounts.

b. In journal entry form: i. Debit the respective departmental

Work in Process accounts. Credit Raw Materials.

2. The flow of labor costs. a. In T-account form:

i. Direct labor costs are debited to the appropriate departmental Work in Process account depending upon where the labor was added to the production process. Salaries and Wages Payable is credited for the corresponding amounts.

b. In journal entry form: i. Debit the respective departmental

Work in Processes accounts. Credit Salaries and Wages Payable.

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3. The flow of manufacturing overhead costs.

a. In T-account form: i. Manufacturing overhead costs

are debited to the respective departmental Work in Process accounts. Manufacturing Overhead is credited by the corresponding amounts.

1. Predetermined overhead rates are usually used to apply overhead to the departments.

b. In journal entry form: i. Debit the appropriate

departmental Work in Process accounts. Credit Manufacturing Overhead.

4. The flow of manufacturing costs for partially completed units transferred from Department A to Department B:

a. In T-account form: i. The cost of direct materials,

direct labor and manufacturing overhead assigned to partially completed units from Department A is debited to Department B and credited to Department A.

ii. The transferred-in costs from Department A are added to the manufacturing costs incurred in Department B.

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b. In journal entry form: i. Debit Work in Process −

Department B and credit Work in Process − Department A.

5. The flow of manufacturing costs from the final processing department to finished goods.

a. In T-account form: i. Debit Finished Goods and credit

Work in Process − Department B for the amount of the cost of goods manufactured.

b. In journal entry form: i. Debit Finished Goods and credit

Work in Process − Department B.

6. The flow of manufacturing costs from Finished Goods to Cost of Goods Sold.

a. In T-account form: i. Debit Cost of Goods Sold and

credit Finished Goods. b. In journal entry form:

i. Debit Cost of Goods Sold and credit Finished Goods.

III. Equivalent units of production

A. Equivalent units − are defined as the product of the number of partially completed units and the percentage completion of those units.

i. Equivalent units need to be calculated because a

department usually has some partially completed units in its beginning and ending inventory. These

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partially completed units complicate the determination of a department’s output for a given period and the unit cost that should be assigned to that output.

Helpful Hint: Explain that equivalent units simply restate the ending work in process inventory as if it were comprised of a smaller number of fully completed units.

ii. Equivalent units − the basic idea.

1. Two half completed products are equivalent

to one complete product. 2. 10,000 units 70% complete are equivalent to

7,000 equivalent units.

Quick Check − calculating equivalent units iii. Equivalent units can be calculated two ways.

1. The FIFO method is covered in the

appendix. 2. The weighted-average method is included

within the main portion of the chapter and it is covered next.

B. The weighted-average method of calculating

equivalent units and the cost per equivalent unit

i. Characteristics of the weighted-average method:

1. This method makes no distinction between work done in the prior and current periods.

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2. This method blends together units and costs from the prior and current periods.

ii. Treatment of direct labor

1. Direct labor costs are often small in

comparison to the other product costs in process cost systems.

2. Therefore, direct labor and manufacturing overhead are often combined into one classification of product cost called conversion costs. The forthcoming example combines these costs.

iii. An example of the weighted-average method

1. Assume that Smith Company reported activity for June as shown on this slide.

2. The first step in calculating the equivalent units is to identify the units completed and transferred out of Department A in June (5,400 units).

3. The second step is to identify the equivalent units of production in ending work in process with respect to materials for the month (540 units) and adding this to the 5,400 units from step one.

4. The third step is to identify the equivalent units of production in ending work in process with respect to conversion for the month (270 units) and adding this to the 5,400 units from step one.

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Helpful Hint: Explain that there will most likely be differences in the equivalent unit calculations between material and conversion costs, as materials are usually added at the beginning of production, while conversion costs are added during the period.

5. The equivalent units of production equals

the units completed and transferred out (5,400 units) plus the equivalent units remaining in work in process (540 units for materials and 270 units for conversion).

6. A different visual depiction of the equivalent units calculation for materials is shown on this slide.

7. A different visual depiction of the equivalent units calculation for conversion is shown on this slide.

Helpful Hint: The treatment of beginning inventory under the weighted-average method often puzzles students, since work done in the prior periods is included in the equivalent units. Explain that this is called the weighted-average method precisely because it averages together beginning inventory and work performed in the current period. Costs and units are treated consistently. Both the equivalent units and the costs that go into the unit cost calculations under the weighted-average method include amounts already in beginning inventory.

IV. Production report − weighted-average method

A. There are three sections in a production report:

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i. The quantity schedule shows the flow of units through the department and a computation of equivalent units.

ii. The costs per equivalent unit section shows the

computation of costs per equivalent unit.

iii. The cost reconciliation section shows the reconciliation of all cost flows into and out of the department during the period.

Helpful Hint: Explain that a production report indicates where units and costs came from (beginning work in process and additional units and costs) and where these units and costs end up (finished goods and ending work in process).

B. An example of a production report

i. Assume that Double Diamond Skis uses the weighted-average method of process costing to determine unit costs in its Shaping and Milling Department.

ii. Assume the following facts as shown on this slide.

iii. The first step is to prepare the quantity schedule

and compute the equivalent units.

1. Calculate the units to be accounted for (5,200 units) and the allocation of those units between “completed and transferred”

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(4,800 units) and ending work in process (400 units).

2. Calculate the equivalent units in ending work in process with respect to materials (160 units) and add these units to the units completed and transferred (4800 units) to obtain total equivalent units with respect to materials for the period (4,960 units).

3. Calculate the equivalent units in ending work in process with respect to conversion (100 units) and add these units to the units completed and transferred (4800 units) to obtain the total equivalent units with respect to conversion for the period (4,900 units).

iv. The second step is to calculate the cost per

equivalent unit.

1. Generally speaking, the cost per equivalent unit is calculated by dividing the costs for the period by the equivalent units of production for the period.

2. Calculate the total material and conversion costs to be accounted for during the period by summing the costs added during the period ($368,600 for materials and $350,900 for conversion) and the costs in beginning work in process ($9,600 for materials and $5,575 for conversion).

3. Calculate the cost per equivalent unit for materials ($76.25).

4. Calculate the cost per equivalent unit for conversion ($72.75), and the total cost per equivalent unit ($149.00).

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v. The third step is to prepare a cost reconciliation. 1. Enter the number of units completed and

transferred out during the period (4,800 units) as well as the equivalent units of materials and conversion in the ending work in process (160 units for materials and 100 units for conversion).

2. Multiply the number of units completed and transferred out (4,800 units) by the total cost per equivalent unit ($149) to obtain the cost of units transferred out during the period ($715,200).

3. Multiply the number of equivalent units in ending work in process with respect to materials (160 units) by the material cost per equivalent unit ($76.25) to obtain the total material cost in ending work in process ($12,200).

4. Multiply the number of equivalent units in ending work in process with respect to conversion (100 units) by the conversion cost per equivalent unit ($72.75) to obtain the total conversion cost in ending work in process ($7,275).

5. Sum all costs included in the reconciliation to obtain total cost accounted for ($734,675).

V. Operation costing

A. Operation costing is a hybrid of job-order and process

costing because it possesses attributes of both approaches.

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i. Operation costing is commonly used when batches of many different products pass through the same processing departments.

1. For example, similar to job-order costing, a

shoe manufacturer may charge each batch of shoes for its own specific material costs (e.g., shoes made with expensive leather would be charged accordingly, as would shoes made with inexpensive synthetic materials).

2. Similar to process costing, the shoe manufacturer may accumulate the labor and overhead costs by department and assign the same conversion cost per unit to each shoe regardless of the shoe style.

VI. Appendix 4A: FIFO method (slide 54: title slide)

A. FIFO vs. weighted-average method

i. The FIFO method (generally considered more

accurate than the weighted-average method) differs from the weighted-average method in two ways:

1. The computation of equivalent units 2. The way in which the costs of beginning

inventory are treated in the cost reconciliation report.

B. Equivalent units − FIFO method

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i. Let’s revisit the Smith Company example that was used to illustrate the weighted-average method.

1. Assume the following activity, as shown on

the slide, is reported in Department A for the month of June.

2. The first step is to determine the number of units completed and transferred out of Department A in June (5,400 units).

3. The second step is to add the equivalent units of production in ending work in process inventory (540 units for materials and 270 units for conversion) to the units completed and transferred out.

4. The third step is to subtract the equivalent units in beginning work in process inventory (120 units for materials and 60 units for conversion) from the sum of the units completed and transferred out and the equivalent units in ending work in process inventory.

a. This calculation results in 5,820 and 5,610 equivalent units of materials and conversion, respectively.

5. A different visual depiction of the calculation of equivalent units with respect to materials is as follows.

6. A different visual depiction of the calculation of equivalent units with respect to conversion is as follows.

C. Comparing equivalent units of production under the

weighted-average and FIFO methods

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i. The equivalent units in beginning inventory are subtracted from the equivalent units of production per the weighted-average method to obtain the equivalent units of production under the FIFO method. This can be illustrated using the Smith Company example as follows:

1. The equivalent units of material produced

per the weighted-average method (5,940 units) minus the equivalent units of material in beginning inventory (120 units) equals the equivalent units of production per the FIFO method (5,820 units).

2. The equivalent units of conversion per the weighted-average method (5,670 units) minus the equivalent units of conversion in beginning inventory (60 units) equals the equivalent units of production per the FIFO method (5,610 units).

Helpful Hint: The only difference in the equivalent unit calculations between the weighted-average and FIFO methods is that the equivalent units in beginning inventory are included in the weighted-average method. Emphasize again that under the weighted-average method the costs already in beginning inventory will be added to the costs incurred during the period to arrive at unit costs. To be consistent, equivalent units already in beginning inventory must be added to the equivalent units for work performed during the period.

D. The production report − FIFO method

i. Let’s revisit the Double Diamond Skis example that

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Assume the following activity, as shown on the slide, is reported in the Shaping and Milling Department for the month of May.

1. The first step is to prepare a quantity

schedule and to compute the equivalent units.

a. First, calculate the total units to be accounted for (5,200 units). This is the sum of the units in beginning work in process (200 units) and the units started into production during the period (5,000 units).

b. Second, calculate the equivalent units of material and conversion that were transferred from beginning work in process to the next department (90 units for materials and 140 units for conversion).

c. Third, calculate the number of units started and completed during the month (4,600 units).

d. Fourth, calculate the equivalent units of material and conversion that are in ending work in process inventory (160 units for materials and 100 units for conversion).

e. Fifth, calculate the total equivalent units for materials (4,850 units) and conversion (4,840 units).

2. The second step is to compute the cost per equivalent unit.

a. First, calculate the costs to be accounted for during the period ($734,675). Notice, the costs of

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beginning work in process ($15,175) are not broken down by material and conversion components.

b. Second, divide the costs added to the department for materials ($368,600) by the equivalent units of production (4,850 units) to obtain the cost per equivalent unit for materials ($76.00).

c. Third, divide the conversion costs added to the department ($350,900) by the equivalent units of production (4,840 units) to obtain the conversion cost per equivalent unit ($72.50).

d. Fourth, add the material and conversion costs per equivalent unit to obtain the total cost per equivalent unit ($148.50).

3. The third step is to prepare a cost reconciliation.

a. First, calculate the total cost from beginning inventory transferred to the next department ($32,165).

i. This includes the costs in beginning inventory ($15,175) plus the costs incurred to complete the unfinished equivalent units in beginning inventory ($6,840 for materials and $10,150 for conversion).

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b. Second, calculate the cost of units started and completed during the period ($683,100).

c. Third, calculate the costs in ending work in process inventory ($12,160 for materials and $7,250 for conversion).

d. The sum of these three numbers ($734,675) should agree with the total costs to be accounted for in the “Costs per Equivalent Unit” portion of the production report ($734,675).

Helpful Hint: Remind students that the only difference between the FIFO and weighted-average approaches is the treatment of units in beginning inventory and the costs of beginning inventory. In essence, the weighted-average approach simply combines the units in beginning inventory and the costs of beginning inventory with all other units and all costs incurred during the period. The FIFO method segregates the beginning inventory. Providing that the number of units transferred out is at least as large as the number of units in beginning inventory, the costs already in beginning inventory are simply transferred out under the FIFO method.

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Chapter 4 Transparency Masters

TM 4-1

© The McGraw-Hill Companies, Inc., 2006. All rights reserved.

AGENDA: PROCESS COSTING

1. Differences between job-order and process costing.

2. Overview of cost flows in process costing.

3. The concept of equivalent (whole) units for partially completed units.

4. Overview of the weighted-average method for determining costs.

5. Departmental production report using the weighted-average method.

a. Quantity schedule and computation of equivalent units.

b. Computation of costs per equivalent unit.

c. Cost reconciliation: assigning costs to units transferred out and to ending work in process inventory.

6. (Appendix) FIFO method production report.

7. (Appendix) Comparison of weighted-average and FIFO methods.

TM 4-2


DIFFERENCES BETWEEN JOB-ORDER AND PROCESS COSTING

(Exhibit 4-1)

TM 4-3


SEQUENTIAL PROCESSING DEPARTMENTS (Exhibit 4-2)

TM 4-4


T-ACCOUNT MODEL OF PROCESS COSTING FLOWS (Exhibit 4-3)

TM 4-5


OVERVIEW OF PROCESS COSTING

A. In process costing, costs are accumulated in processing departments.

B. A separate departmental production report is compiled for each processing department. This report provides the details of how costs are assigned to units that pass through the department.

C. Costs to be accounted for in each processing department consist of:

1) Costs of the beginning work in process inventory in the department.

2) Costs added during the period.

a. Costs of units transferred in from a preceding department.

b. Costs added in the department itself.

Materials + Labor + Overhead

Conversion Costs

D. Costs are accounted for by assigning them to:

1) Ending work in process inventory in the department.

2) Units transferred out to the next department (or to finished goods).

TM 4-6


OVERVIEW OF PROCESS COSTING (continued)

E. In process costing, each unit is assigned the average cost of units processed through the department.

F. Two things must be known to compute the average cost per unit in a department:

1) The total cost.

2) The total number of units processed.

G. Partially completed units are converted to equivalent (whole) units.

For example, 200 units in ending inventory are 25% complete with respect to conversion costs.

Equivalent Number of partially Percentage = × units completed units completion

= 200 × 50% = 50 EUs

H. The two common methods of computing average costs per unit are the weighted-average method and the FIFO method. The FIFO method is discussed in Appendix 4A.

TM 4-7


WEIGHTED-AVERAGE METHOD

• The weighted-average method averages together the beginning work in process inventories with the units started during the current period.

• For each category of cost in each processing department the following calculations are made:

Costs to be Costs of Costs addedaccounted = beginning WIP + during the

for inventory current period

Equivalent Units Equivalent unitsunits of = transferred + of ending WIP

production out inventory

Units transferred out of the department are 100% complete with respect to the work done in the department.

Costs to be accounted forCost per = EU Equivalent units of production

Costs of units Units Cost = ×transferred out transferred out per EU

Costs of units in Equivalent units of Cost = × ending WIP inventory ending WIP inventory per EU

TM 4-8


WEIGHTED-AVERAGE METHOD (cont’d)

EXAMPLE: Halsey Company makes small sailboats. During the most recent month, the following activity was recorded in the Hull Fabrication Department for conversion costs.

Work in process, beginning (80% complete) ... 15,000 units Units started into production ......................... 180,000 units Units transferred out..................................... 175,000 units Work in process, ending (30% complete) ....... 20,000 units Conversion Costs: Work in process, beginning............................ $24,000 Conversion costs incurred during the month ... $338,000

Costs to be Costs of Costs addedaccounted = beginning WIP + during the

for inventory current period

= $24,0000 + $338,000 = $362,000

Equivalent Units Equivalent unitsunits of = transferred + of ending WIP

production out inventory

=175,000 + (20,000 × 30%) = 181,000

Costs to be accounted forCost per EU =

Equivalent units of production

$362,000= = $2 per EU

181,000 EU

Costs of units Units Cost = ×transferred out transferred out per EU

= 175,000 × $2 = $350,000

Costs of units in Equivalent units of Cost = ×ending WIP inventory ending WIP inventory per EU

= (20,000 × 30%) × $2 = $12,000

TM 4-9


PRODUCTION REPORT

The production report summarizes all of the activity and cost flows in a department.

The production report has three separate, but highly interrelated, parts:

1. A quantity schedule with equivalent units.

2. Computation of costs per equivalent unit.

3. A reconciliation of all cost flows into and out of the department during the period.

EXAMPLE: The following data are for the first processing department at Midwest Refining, a company that reclaims petroleum products from used motor oil.

Units Materials Conversion Work in process, beginning:

Units in process .......................... 10,000 Percentage completion................ 60% 50% Cost of beginning inventory ......... $4,300 $7,600

Units started into production .......... 190,000 Costs added in the department

during the current period ............ $74,100 $140,400 Units completed and transferred..... 180,000 Work in process, ending:

Units in process .......................... 20,000 Percentage completion................ 80% 25%

TM 4-10


QUANTITY SCHEDULE AND EQUIVALENT UNITS: WEIGHTED-AVERAGE METHOD

• The quantity schedule accounts for the physical flow of units through a department for a period.

• The equivalent units are also shown for the units transferred out of the department and for ending work in process inventory.

Quantity Schedule

Units to be accounted for: Work in process, beginning .... 10,000 Started into production .......... 190,000

Total units to be accounted for . 200,000 Equivalent Units (EU) Materials ConversionUnits accounted for as follows:

Units transferred out ............. 180,000 180,000 180,000Work in process, ending*....... 20,000 16,000 5,000

Total units accounted for.......... 200,000 196,000 185,000

* Materials: 20,000 units × 80% complete = 16,000 EUs; Conversion: 20,000 units × 25% complete = 5,000 EUs

Note: The quantity schedule is based on the following equation:

Units in beginning work in process + Units started into production = Units transferred out + Units in ending work in process

TM 4-11


COMPUTATION OF COSTS PER EQUIVALENT UNIT: WEIGHTED-AVERAGE METHOD

Total Whole Cost Materials Conversion Unit Cost to be accounted for:

Work in process, beginning $ 11,900 $ 4,300 $ 7,600Costs added ...................... 214,500 74,100 140,400

Total cost to be accounted for (a)............................... $226,400 $78,400 $148,000

Equivalent units (b) .............. 196,000 185,000Cost per EU (a) ÷ (b) .......... $0.40 + $0.80 = $1.20

COST RECONCILIATION: WEIGHTED-AVERAGE METHOD

Total Equivalent Units (EU) Cost Materials ConversionCost accounted for as follows:

Transferred out: 180,000 units @ $1.20 each...... $216,000 180,000 180,000

Work in process, ending: Materials @ $0.40 per EU......... 6,400 16,000 Conversion @ $0.80 per EU...... 4,000 5,000

Total work in process, ending ...... 10,400 Total cost accounted for ................ $226,400

TM 4-12


FIFO METHOD (Appendix)

• The FIFO method separates the costs of beginning inventory from the costs incurred during the current period. (The weighted-average method combines them.)

• FIFO assumes the beginning inventory is completed before any new units are started.

QUANTITY SCHEDULE AND EQUIVALENT UNITS: FIFO METHOD

Quantity Schedule Units to be accounted for:

Work in process, beginning .......... 10,000 Started into production ................ 190,000

Total units to be accounted for........ 200,000 Equivalent Units (EU) Materials ConversionUnits accounted for as follows:

Transferred out: From beginning inventory*........ 10,000 4,000 5,000 Started and completed†............. 170,000 170,000 170,000

Work in process, ending............... 20,000 16,000 5,000 Total units accounted for ................ 200,000 190,000 180,000

* Materials: 10,000 × (100% – 60%) = 4,000 EUs Conversion: 10,000 × (100% – 50%) = 5,000 EUs † 19,000 units started – 20,000 units in ending WIP = 170,000 units

TM 4-13


COMPARISON OF EQUIVALENT UNITS

Beginning Workin Process: 10,000 Units 60% Complete

Started andCompleted: 170,000 Units

Ending Workin Process: 20,000 Units 80% Complete

Weighted-Average Method

190,000 Units Started

Units transferred to next department:Work in process, ending: 20,000 units x 80%Equivalent units of production

180,000

16,000196,000

FIFO Method

Work in process, beginning: 10,000 units x (100% - 60%)Units started and completed:Work in process, ending: 20,000 units x 80%Equivalent units of production

4,000170,000

16,000190,000

Beginning Workin Process: 10,000 Units 60% Complete

Started andCompleted: 170,000 Units

Ending Workin Process: 20,000 Units 80% Complete

190,000 Units Started

TM 4-14


COMPUTATION OF COSTS PER EQUIVALENT UNIT: FIFO METHOD

Total Whole Cost Materials Conversion Unit Cost to be accounted for:

Work in process, beginning .. $ 11,900Cost added in the

department (a) ................. 214,500 $ 74,100 $140,400Total cost to be accounted for. $226,400Equivalent units (b) ................ 190,000 180,000Cost per EU (a) ÷ (b) $0.39 + $0.78 = $1.17

Note: Unlike the weighted-average method, under the FIFO method only the costs added by the department during the current month are included when computing the costs per EU. The costs of beginning inventory are not included in the cost per EU under the FIFO method.

TM 4-15


COST RECONCILIATION: FIFO METHOD

Total Equivalent Units Cost Materials Conversion Cost accounted for as follows:

Transferred out: From beginning inventory:

Cost in beginning inventory..... $ 11,900 Cost to complete these units:

Materials @ $0.39 per EU ... 1,560 4,000 Conversion @ $0.78 per EU 3,900 5,000

Total cost from beginning inventory................................. 17,360

Units started and completed 170,000 units @ $1.17 each ..... 198,900 170,000 170,000

Total cost transferred..................... 216,260

Work in process, ending: Materials @ $0.39 per EU............ 6,240 16,000 Conversion @ $0.78 per EU......... 3,900 5,000

Total work in process, ending ......... 10,140

Total cost accounted for ................... $226,400

TM 4-16


A COMPARISON OF PRODUCTION REPORT CONTENT (Exhibit 4A-4)

bs chapter 4

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