1. Process Cost Accounting Equivalent Units
Manufacturing
Process Cost Accounting
Equivalent Units
Dr. Clive Vlieland-Boddy

2. After reading this chapter, you should be able to:
Objectives
Understand process costing and when it is appropriate to be used.
Determine unit costs, inventories, and costs transferred.
Explain the concept of equivalent units of production.
Understand Production Reports
After reading this chapter, you should be able to:

3. Process Costing Example

4. Process Cost Accounting
Nature of Process Cost Systems
Equivalent Units
Comprehensive Example of Process Costing
Contemporary Developments
Uses
Process Cost Flow
Assignment of Manufacturing Costs
Weighted-Average Method
Refinements
Production Cost Report
Physical Units
Equivalent Units of Production
Unit Production Costs
Just-in-Time Processing
Computer Controlled Manufacturing
TQM
Activity-Based Costing
Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation.
Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt.
Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets.
Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees.
Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss:
difference between the actual return and the expected return on plan assets and,
amortization of the unrecognized net gain or loss from previous periods

5. Preview of Chapter
Process cost accounting focuses on mass-production of products that are identical or very similar in nature.
Evaluate Equivalent Units of production that are not complete but are equated in complete units.
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

6. Nature of Process Cost Systems
Use to apply costs to similar products that are
massed produced in a continuous fashion
Examples include the production of
Cereal, Paint, and Soft Drinks

7. Process Costing
The essence of process costing is the accumulation of costs by process, or department, for a period of time.
It is applied to mass production of similar products. Materials, labour & direct overheads can be easily established based on the number of units produced per hour.

8. Overview of Process Costing Systems

9. Product and Cost Flows Cost Flows Through Accounts Direct Material
Direct Labor
Manufacturing Overhead

10. Process Costing System

11. Basic Steps in Process Costing
Account for the number of physical units
Calculate the cost per unit or equivalent unit for materials, labor, and overhead
Assign cost to items completed and items in ending Work in Process
Account for the amount of product cost

12. Process Costing Unit cost =
Total Costs of Production
Unit cost =
Total Units of Production
Basic process costing formula used by a manufacturer of a single, homogeneous product.

13. Process Costing and Incremental Analysis
Compare change in revenue with change in cost
Process Costing
Utilizes an average of fixed and variable costs
Could impact decision making when considering additional production
We will return to this later

14. Product and Cost Flows Product Flows Through Departments
A product typically passes through multiple departments
Conversion Costs (Labor and Overhead)

15. Illustrating Process Costing Two Departments
Direct Materials, Direct Labor
Manufacturing Overhead
Department A
Department B
Cost of Goods Sold
Finished Goods

16. Process Costing System Diagram
Conversion Costs
Material
Costs
Material
Costs
Conversion Costs
Transferred
Costs
Testing
Department
Finished
Goods
Inventory
Assembly
Department

17. Flow of Cost Between Processing Departments
Product and Cost Flows Two Departments
Flow of Cost Between Processing Departments

18. Five Steps in Process Costing
Summarize the flow of physical units of output.
Compute output in terms of equivalent units
Compute equivalent unit costs
Summarize total costs to account for
Assign total costs to units completed and to units in ending work in process inventory

19. Use Process Cost Information to:
Measure costs of products mass-produced products
Assign costs to inventory and cost of goods sold for financial statements and income tax returns
Monitor operations and costs
Develop estimates of future costs for decision making
Analyze the costs and benefits of quality improvements
Identify potential areas for process improvements

20. Uncertainties and Measurement Errors in Process Costing
Actual cost flows might not be known:
* When are direct materials added?
* When are conversion costs incurred?
* How complete are the units in ending work in process?
* What amount of spoilage is normal?

21. Equivalent Units

22. Equivalent Units: A Key Concept
Costs are accumulated for a period of time for products in work-in-process inventory.
Products in work-in-process inventory at the beginning and end of the period are only partially complete.
Equivalent units is a concept expressing these partially completed products as a smaller number of fully completed products.
The term equivalent units is used in process costing to refer to the amount of manufacturing activity that has been applied to a batch of physical units. (LO3) 22

23. What Are Equivalent Units, and How Do They Relate to the Production Process?
Measure the resources used in partially completed units relative to the resources needed to complete the units.
Equivalent Units Depend on the Pattern of Cost Flow:
Direct Materials:
* Added at the beginning of the process
* Added during the process
Conversion Costs:
* Incurred uniformly throughout the process
* Incurred non-uniformly

24. Calculating Unit Cost Equivalent Units
Partially completed units are converted to a comparable number of completed units

25. Equivalent Units Example
Two one-half completed products are equivalent to one completed product. + = l
For example, if two units are 50 percent complete, that is equivalent to 1 unit that is 100 percent complete. Likewise, 10,000 units that are 70 percent complete is 7,000 equivalent units. (LO3)
So, 10,000 units 70 percent complete are equivalent to 7,000 complete units. 25

26. Calculating and Using Equivalent Units of Production
To calculate the direct materials and conversion costs per equivalent unit for the period:
Materials cost per equivalent unit
Materials cost for the period Materials equivalent units for the period =
Direct material is usually placed into production at beginning of the production process. In contrast, direct labor and manufacturing overhead, called conversion costs, usually are incurred uniformly throughout the process. When an accounting period ends, the partially completed goods that remain in process generally are at different stages of completion with respect to material and conversion activity. The most important feature of process costing is that the costs of direct material and conversion are assigned to equivalent units rather than to physical units. (LO3)
Conversion cost per equivalent unit
Conversion cost for the period Conversion equivalent units for the period = 26

27. Uniformity of Cost Flows!
Calculation Equivalent Units is simple if the production process is even.
That the conversion cost are level through the process.
However, this is not unusually the case.
For this reason a weighting process to correct this distortion is required.

28. How Is the Weighted Average Method Used in Process Costing?
Costs from beginning WIP (performed last period) are averaged with costs incurred during the current period and then allocated to all units completed and ending WIP.

29. Calculation of Cost Per Equivalent Unit Under the Weighted Average Method
Beg. WIP Costs + Costs Added This Period
Weighted Average Equivalent Units

30. Equivalent Units of Production – Weighted-Average Method
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 from the prior period and the current period.
The method of process costing that we will focus on in this chapter is called the weighted-average method. This method is almost always used in practice by companies using process costing. There is another process-costing method called the first-in, first-out, or FIFO, method. (LO3) 30

31. Production Report

32. Departmental Production Report
Analysis of physical flow of units.
Calculation of equivalent units.
Computation of unit costs.
Analysis of total costs.
Production Report
The key document in a typical process-costing system is the departmental production report, prepared for each production department at the end of every accounting period. The departmental production report summarizes the flow of production quantities through the department, and it shows the amount of production cost transferred out of the department’s Work-in-Process Inventory account during the period. There are four steps used in preparing a departmental production report:
1. Analysis of physical flow of units.
2. Calculation of equivalent units.
3. Computation of unit costs.
4. Analysis of total costs.
(LO3) 32

33. Production Report Example
MVP Sports Equipment Company makes baseball gloves in two departments, Cutting and Stitching.
MVP uses the weighted-average cost procedure.
Material is added at the beginning of the Cutting Department, and conversion is incurred uniformly throughout the process.
The MVP Sports Equipment Company manufactures baseball gloves. Two production departments are used in sequence: the Cutting Department and the Stitching Department. In the Cutting Department, direct material is placed into production at the beginning of the process. Direct-labor and manufacturing overhead costs are incurred uniformly throughout the process. The predetermined overhead rate used in the Cutting Department is 125 percent of direct-labor cost. (LO3) 33

34. Production Report Example
Using the following information for the month of March, let’s prepare a production report for the Cutting Department.
The MVP Sports Equipment Company manufactures baseball gloves. Two production departments are used in sequence: the Cutting Department and the Stitching Department. In the Cutting Department, direct material is placed into production at the beginning of the process. Direct-labor and manufacturing overhead costs are incurred uniformly throughout the process. The predetermined overhead rate used in the Cutting Department is 125 percent of direct-labor cost. (LO3) 34

35. Production Report Example
Analysis of Physical Flow of Units
The first step is to prepare a table summarizing the physical flow of production units during March. (LO3) 35

36. Production Report Example
Calculation of Equivalent Units
Beginning inventory % is not used in weighted-average method.
50% of 10,000 units
The second step is to calculate the equivalent units of direct material and conversion activity. The table of equivalent units, displayed on this slide, is based on the table of physical flows prepared in step 1. The Cutting Department completed their work on 40,000 physical units. Thus, they represent 40,000 equivalent units for both direct material and conversion. The 10,000 units in the Cutting Department’s ending work-in-process inventory are 50 percent complete with respect to conversion. Therefore, the ending work-in-process inventory represents 5,000 equivalent units of conversion activity (10,000 physical units x 50% complete). (LO3) 36

37. Production Report Example
Calculation of Equivalent Units
100% of 10,000 units, all material added at beginning
With respect to direct material, the 10,000 units in the Cutting Department’s ending work-in-process inventory are 100 percent complete. Therefore, the ending work-in-process inventory represents 10,000 equivalent units of direct material. (LO3) 37

38. Production Report Example
Computation of unit costs
$140,000 ÷ 50,000 equivalent units
$200,700 ÷ 45,000 equivalent units
$ $4.46
The third step in the process-costing procedure is calculating the cost per equivalent unit for both direct material and conversion activity. The cost per equivalent unit for direct material is computed by dividing the total direct-material cost, including the cost of the beginning work in process and the cost incurred during March, by the total equivalent units (from step 2). The same procedure is used for conversion costs. (LO4)
1-38 38

39. Reconciliation of Units

40. Equivalent Units Example – XYZ College
Compute the cost of instruction at XYZ College per full-time equivalent student based on the following information:
Total cost of instruction is $9,000,000.
There are 900 full-time students and 1,000 part-time students.
Part-time students take 60% of the classes of a regular student.

41. Equivalent Units Example Continued
Cost of instruction
per full-time equivalent student
equals
Total cost of instruction
divided by
Number of full-time equivalent students
$9,000,000 / 1,500 = $6,000
LO 5: Compute equivalent units.

42. Equivalent units – Material and Conversion costs

43. Example Exercise #1
McMillian Tire Company produces tires used on small trailers. The month of June ended with 300 tires in process, 85% complete as to direct materials and 50% complete as to conversion costs; 2,500 tires were transferred to finished goods during the month and 2,300 were started during the month. The beginning WIP inventory was 65% complete as the direct materials and 45% complete as to conversion costs.
Determine the denominators to be used in the calculations of cost per equivalent unit for materials and conversion costs.

44. Example Exercise #1 Solution
Materials
Units completed 2,500
Equivalent units (300*85%)
2,755 units
Labor
Equivalent units (300*50%)
2,650 units

45. Example Exercise #2
The balance in beginning WIP at Bing Rubber Company for direct labor was $135,000. During the month of March, an additional $650,000 of direct labor was incurred, and 25,000 pounds of rubber were produced. At the end of March, 8,000 pounds of rubber were in process and the units were 50% complete. At the start of March, the company had 5,000 pounds of rubber that were 30% complete.
Calculate the cost per equivalent unit for labor assuming that labor is added uniformly throughout the production process.

46. Example Exercise #2 Solution
Direct Labor
Beginning WIP $135,000
March labor $650,000
Total Labor Cost $785,000
Units
Units completed ,000
Equivalent units (8,000*50%) ,000
Total Units ,000
Cost per Equivalent Unit
$785,000 / 29,000 pounds = $27.07 per pound

47. Example – Process Costing

48. Example – Tyler Company
Maker of automatic can openers
Manufacturing consists of two processes:
Machining – raw materials are shaped, honed, and drilled
Assembly – parts assembled and packaged
Materials, labor, and manufacturing overhead added in both departments

49. Example – Tyler Company

50. Assignment of Manufacturing Costs
Accumulation of materials, labor, and overhead costs:
Debit Raw Materials Inventory for purchases of raw materials
Debit Factory Labor for factory labor incurred
Debit Manufacturing Overhead for overhead cost incurred

51. Assignment of Manufacturing Costs
Material Costs
All materials consumed within
a production department are
a cost of processing.

52. Assignment of Manufacturing Costs
Factory Labor Costs
Time tickets are used
All labor costs incurred within
a production department are
a cost of processing.

53. Assignment of Manufacturing Costs
Manufacturing Overhead Costs
Objective of assigning overhead –
allocate overhead to departments on an
objective and equitable basis
Use the activity that “drives”
or causes the costs
Machine or Labor time used
primary driver in continuous manufacturing operations

54. Production Cost Report
Key document used to understand activities.
Prepared for each department and shows:
Production Quantity
Cost data
Four steps in preparation:
Step 1: Compute physical unit flow
Step 2: Compute equivalent units of production
Step 3: Compute unit production costs
Step 4: Prepare a cost reconciliation schedule

55. Flow of Costs in Making Frozen Buns

56. Basic Information

57. Step 1: Compute Physical Unit Flow.
Physical units
actual units to be accounted for during
a period, regardless of work performed
Total units to be accounted for
units started (or transferred) into production during the period + units in production at beginning of period
Total units accounted for
units transferred out during period + units in production at end of period

58. Step 1: Compute Physical Unit Flow

59. Step 2: Compute Equivalent Units of Production
Measure of a department’s productivity
Two computations required:
one for materials and one for conversion costs
Beginning work in process ignored

60. Step 3: Compute Unit Production Costs
Costs expressed in terms of equivalent units of production
When equivalent units of production are different for materials and for conversion costs, three unit costs are computed:
Materials
Conversion
Total Manufacturing

61. Step 3: Compute Unit Production Cost - continued
Total Materials Cost Computation:
Direct Materials Cost in Beginning Work in Process $ 50,000
Conversion Costs Added to Production During Month ,000
Total Materials Costs $450,000
The Computation of Unit Materials Costs:

62. Step 3: Compute Unit Production Cost - continued
Conversion Cost Computation:
Conversion Costs in Beginning Work in Process $ 35,000
Conversion Costs Added to Production in Month ,000
Total Conversion Costs $205,000
The Computation of Unit Conversion Costs:

63. Step 3: Compute Unit Production Cost – continued
Total Manufacturing Cost Per Unit
The computation of unit total manufacturing cost:

64. Step 4: Prepare Cost Reconciliation Schedule
Costs Charged to Mixing Department:
Cost of Beginning Work in Process $ 85,000
Costs Started into Production During Period ,000
Total Costs to be Accounted For $ 655,000

65. Production Cost Report - Mixing Department

66. Contemporary Developments
Just-in-Time (JIT) Processing
A processing system that is dedicated to having the right products or parts as they are needed
Objective: To eliminate all manufacturing inventories to make funds and space available for more productive purposes
Elements of JIT: Dependable suppliers; Multi-skilled workforce; Total quality control system
Benefits of JIT: Reduced inventory; Enhanced product quality; Reduced rework and storage costs; Savings from improved flow of goods

67. Contemporary Developments - JIT

68. Contemporary Developments
Activity-Based Costing (ABC)
An overhead cost allocation system that focuses on activities performed in producing a product.
Traditional Costing System: allocates overhead to products using predetermined unit-based output rate
ABC System: allocates overhead to multiple activity cost pools and assigns cost pools to products using cost drivers that represent activities used
Assumptions of ABC: All overhead costs for an activity must have the same cost driver and should respond proportionally to changes in the activity of the cost driver.

69. Contemporary Developments
Activity-Based Costing (ABC) - continued
May be used with either a job order or a process costing system.
Primary Benefit: More accurate and meaningful product costing
Secondary Benefit: Improved cost data regarding an activity may lead to reduced costs for that activity
ABC makes managers realize that activities not products ultimately determine company profitability

70. Question Time
Production costs chargeable to the Finishing Department in June in Cliven Company are:
Materials $15,000,
Labor $29,500,
Production Overheads $18,000.
Equivalent units of production are
Materials 20,000 and
Conversion costs 19,000.
Compute the unit costs for materials and conversion costs.

71. Unit costs for Materials:
$15,000 ÷ 20,000 units = $.75 per unit

72. Unit costs for Conversion Costs:
= $29, ,000 = $47,500
$47,500 ÷ 19,000 = $2.50 per unit

73. Total Manufacturing Costs per Unit:

74. Operation Costing
Operation costing employs some aspects of both job-order and process costing.
Job-order Operation Costing Process Costing (Products produced in batches) Costing
Job-order and process costing represent the polar extremes of product-costing systems. But some production processes exhibit characteristics of both job-order and process costing environments. These production processes often are referred to as batch manufacturing processes. Such processes are characterized by high-volume production of several product lines that differ in some important ways but are nearly identical in others. Since batch manufacturing operations have characteristics of both job-order costing and process-costing environments, a hybrid product-costing system is required. One common approach is called operation costing. (LO7) 74

75. Operation Costing
Operation costing employs some aspects of both job-order and process costing.
Job-order Operation Costing Process Costing (Products produced in batches) Costing
Material Costs charged to batches as in job-order costing.
Conversion costs assigned to batches as in process costing.
This product-costing system is used when conversion activities are very similar across product lines, but the direct materials differ significantly. Conversion costs are accumulated by department, and process costing methods are used to assign these costs to products. In contrast, direct-material costs are accumulated by job order or batch, and job-order costing is used to assign material costs to products. (LO7) 75

76. Modern Manufacturing Practices
Just-in-Time Production (JIT)
Computer-Controlled Manufacturing
Total Quality Management (TQM)
Activity Based Costing (ABC)

77. JIT or Just-in-Case?

78. I’m ready for some leisure time.
Bye for now!
I’m ready for some leisure time.
Please ensure you
Prepare for next session 78