2After reading this chapter, you should be able to: ObjectivesUnderstand 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 ReportsAfter reading this chapter, you should be able to:
4Process Cost Accounting Nature of Process Cost SystemsEquivalent UnitsComprehensive Example of Process CostingContemporary DevelopmentsUsesProcess Cost FlowAssignment of Manufacturing CostsWeighted-Average MethodRefinementsProduction Cost ReportPhysical UnitsEquivalent Units of ProductionUnit Production CostsJust-in-Time ProcessingComputer Controlled ManufacturingTQMActivity-Based CostingService 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
5Preview of ChapterProcess 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 InformationSoft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).Timeliness (no real time financial information)
6Nature of Process Cost Systems Use to apply costs to similar products that aremassed produced in a continuous fashionExamples include the production ofCereal, Paint, and Soft Drinks
7Process CostingThe 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.
11Basic Steps in Process Costing Account for the number of physical unitsCalculate the cost per unit or equivalent unit for materials, labor, and overheadAssign cost to items completed and items in ending Work in ProcessAccount for the amount of product cost
12Process Costing Unit cost = Total Costs of ProductionUnit cost =Total Units of ProductionBasic process costing formula used by a manufacturer of a single, homogeneous product.
13Process Costing and Incremental Analysis Compare change in revenue with change in costProcess CostingUtilizes an average of fixed and variable costsCould impact decision making when considering additional productionWe will return to this later
14Product and Cost Flows Product Flows Through Departments A product typically passes through multiple departmentsConversion Costs (Labor and Overhead)
15Illustrating Process Costing Two Departments Direct Materials, Direct LaborManufacturing OverheadDepartmentADepartmentBCost of Goods SoldFinished Goods
16Process Costing System Diagram Conversion CostsMaterialCostsMaterialCostsConversion CostsTransferredCostsTestingDepartmentFinishedGoodsInventoryAssemblyDepartment
17Flow of Cost Between Processing Departments Product and Cost Flows Two DepartmentsFlow of Cost Between Processing Departments
18Five Steps in Process Costing Summarize the flow of physical units of output.Compute output in terms of equivalent unitsCompute equivalent unit costsSummarize total costs to account forAssign total costs to units completed and to units in ending work in process inventory
19Use Process Cost Information to: Measure costs of products mass-produced productsAssign costs to inventory and cost of goods sold for financial statements and income tax returnsMonitor operations and costsDevelop estimates of future costs for decision makingAnalyze the costs and benefits of quality improvementsIdentify potential areas for process improvements
20Uncertainties 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?
22Equivalent 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
23What 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 processConversion Costs:* Incurred uniformly throughout the process* Incurred non-uniformly
24Calculating Unit Cost Equivalent Units Partially completed units are converted to a comparable number of completed units
25Equivalent Units Example Two one-half completed products are equivalent to one completed product.+=lFor 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
26Calculating and Using Equivalent Units of Production To calculate the direct materials and conversion costs per equivalent unit for the period:Materials cost per equivalent unitMaterials 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 unitConversion cost for the period Conversion equivalent units for the period=26
27Uniformity 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.
28How 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.
29Calculation of Cost Per Equivalent Unit Under the Weighted Average Method Beg. WIP Costs + Costs Added This PeriodWeighted Average Equivalent Units
30Equivalent 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
32Departmental Production Report Analysis of physical flow of units.Calculation of equivalent units.Computation of unit costs.Analysis of total costs.Production ReportThe 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
33Production 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
34Production 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
35Production Report Example Analysis of Physical Flow of UnitsThe first step is to prepare a table summarizing the physical flow of production units during March. (LO3)35
36Production Report Example Calculation of Equivalent UnitsBeginning inventory % is not used in weighted-average method.50% of 10,000 unitsThe 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
37Production Report Example Calculation of Equivalent Units100% of 10,000 units, all material added at beginningWith 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
38Production Report Example Computation of unit costs$140,000 ÷ 50,000 equivalent units$200,700 ÷ 45,000 equivalent units$ $4.46The 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)1-3838
40Equivalent 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.
41Equivalent Units Example Continued Cost of instructionper full-time equivalent studentequalsTotal cost of instructiondivided byNumber of full-time equivalent students$9,000,000 / 1,500 = $6,000LO 5: Compute equivalent units.
42Equivalent units – Material and Conversion costs
43Example Exercise #1McMillian 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.
44Example Exercise #1 Solution MaterialsUnits completed 2,500Equivalent units (300*85%)2,755 unitsLaborEquivalent units (300*50%)2,650 units
45Example Exercise #2The 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.
46Example Exercise #2 Solution Direct LaborBeginning WIP $135,000March labor $650,000Total Labor Cost $785,000UnitsUnits completed ,000Equivalent units (8,000*50%) ,000Total Units ,000Cost per Equivalent Unit$785,000 / 29,000 pounds = $27.07 per pound
48Example – Tyler Company Maker of automatic can openersManufacturing consists of two processes:Machining – raw materials are shaped, honed, and drilledAssembly – parts assembled and packagedMaterials, labor, and manufacturing overhead added in both departments
50Assignment of Manufacturing Costs Accumulation of materials, labor, and overhead costs:Debit Raw Materials Inventory for purchases of raw materialsDebit Factory Labor for factory labor incurredDebit Manufacturing Overhead for overhead cost incurred
51Assignment of Manufacturing Costs Material CostsAll materials consumed withina production department area cost of processing.
52Assignment of Manufacturing Costs Factory Labor CostsTime tickets are usedAll labor costs incurred withina production department area cost of processing.
53Assignment of Manufacturing Costs Manufacturing Overhead CostsObjective of assigning overhead –allocate overhead to departments on anobjective and equitable basisUse the activity that “drives”or causes the costsMachine or Labor time usedprimary driver in continuous manufacturing operations
54Production Cost Report Key document used to understand activities.Prepared for each department and shows:Production QuantityCost dataFour steps in preparation:Step 1: Compute physical unit flowStep 2: Compute equivalent units of productionStep 3: Compute unit production costsStep 4: Prepare a cost reconciliation schedule
57Step 1: Compute Physical Unit Flow. Physical unitsactual units to be accounted for duringa period, regardless of work performedTotal units to be accounted forunits started (or transferred) into production during the period + units in production at beginning of periodTotal units accounted forunits transferred out during period + units in production at end of period
59Step 2: Compute Equivalent Units of Production Measure of a department’s productivityTwo computations required:one for materials and one for conversion costsBeginning work in process ignored
60Step 3: Compute Unit Production Costs Costs expressed in terms of equivalent units of productionWhen equivalent units of production are different for materials and for conversion costs, three unit costs are computed:MaterialsConversionTotal Manufacturing
61Step 3: Compute Unit Production Cost - continued Total Materials Cost Computation:Direct Materials Cost in Beginning Work in Process $ 50,000Conversion Costs Added to Production During Month ,000Total Materials Costs $450,000The Computation of Unit Materials Costs:
62Step 3: Compute Unit Production Cost - continued Conversion Cost Computation:Conversion Costs in Beginning Work in Process $ 35,000Conversion Costs Added to Production in Month ,000Total Conversion Costs $205,000The Computation of Unit Conversion Costs:
63Step 3: Compute Unit Production Cost – continued Total Manufacturing Cost Per UnitThe computation of unit total manufacturing cost:
64Step 4: Prepare Cost Reconciliation Schedule Costs Charged to Mixing Department:Cost of Beginning Work in Process $ 85,000Costs Started into Production During Period ,000Total Costs to be Accounted For $ 655,000
66Contemporary Developments Just-in-Time (JIT) ProcessingA processing system that is dedicated to having the right products or parts as they are neededObjective: To eliminate all manufacturing inventories to make funds and space available for more productive purposesElements of JIT: Dependable suppliers; Multi-skilled workforce; Total quality control systemBenefits of JIT: Reduced inventory; Enhanced product quality; Reduced rework and storage costs; Savings from improved flow of goods
68Contemporary 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 rateABC System: allocates overhead to multiple activity cost pools and assigns cost pools to products using cost drivers that represent activities usedAssumptions 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.
69Contemporary Developments Activity-Based Costing (ABC) - continuedMay be used with either a job order or a process costing system.Primary Benefit: More accurate and meaningful product costingSecondary Benefit: Improved cost data regarding an activity may lead to reduced costs for that activityABC makes managers realize that activities not products ultimately determine company profitability
70Question TimeProduction 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 areMaterials 20,000 andConversion costs 19,000.Compute the unit costs for materials and conversion costs.
71Unit costs for Materials: $15,000 ÷ 20,000 units = $.75 per unit
72Unit costs for Conversion Costs: = $29, ,000 = $47,500$47,500 ÷ 19,000 = $2.50 per unit
74Operation CostingOperation costing employs some aspects of both job-order and process costing.Job-order Operation Costing Process Costing (Products produced in batches) CostingJob-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
75Operation CostingOperation costing employs some aspects of both job-order and process costing.Job-order Operation Costing Process Costing (Products produced in batches) CostingMaterial 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
76Modern Manufacturing Practices Just-in-Time Production (JIT)Computer-Controlled ManufacturingTotal Quality Management (TQM)Activity Based Costing (ABC)