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

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Presentation on theme: "1 Manufacturing Process Cost Accounting Equivalent Units Dr. Clive Vlieland-Boddy."— Presentation transcript:

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

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

3 3 Process Costing Example

4 4 Process Cost Accounting Nature of Process Cost Systems Equivalent Units Contemporary Developments Uses Process Cost Flow Assignment of Manufacturing Costs Weighted- Average Method Refinements Production Cost Report Just-in-Time Processing Computer Controlled Manufacturing TQM Activity-Based Costing Comprehensive Example of Process Costing Physical Units Equivalent Units of Production Unit Production Costs

5 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.

6 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 7 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. Process Costing

8 8 Overview of Process Costing Systems

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

10 10 Process Costing System

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

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

13 13 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 Process Costing and Incremental Analysis

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

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

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

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

18 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 19 Use Process Cost Information to: Measure costs of products mass-produced products Measure costs of products mass-produced products Assign costs to inventory and cost of goods sold for financial statements and income tax returns Assign costs to inventory and cost of goods sold for financial statements and income tax returns Monitor operations and costs Monitor operations and costs Develop estimates of future costs for decision making Develop estimates of future costs for decision making Analyze the costs and benefits of quality improvements Analyze the costs and benefits of quality improvements Identify potential areas for process improvements Identify potential areas for process improvements

20 20 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? Uncertainties and Measurement Errors in Process Costing

21 21 Equivalent Units

22 22 Equivalent Units: A Key Concept Costs are accumulated for a period of time for products in work-in-process inventory. 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. 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. Equivalent units is a concept expressing these partially completed products as a smaller number of fully completed products. Costs are accumulated for a period of time for products in work-in-process inventory. 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. 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. Equivalent units is a concept expressing these partially completed products as a smaller number of fully completed products.

23 23 What Are Equivalent Units, and How Do They Relate to the Production Process? Equivalent Units: Measure the resources used in partially completed units relative to the resources needed to complete the units. 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 24 Equivalent Units –Partially completed units are converted to a comparable number of completed units Calculating Unit Cost

25 25 Equivalent Units Example Two one-half completed products are equivalent to one completed product. So, 10,000 units 70 percent complete are equivalent to 7,000 complete units. + = l

26 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 Conversion cost per equivalent unit = Conversion cost for the period Conversion equivalent units for the period

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

28 28 How Is the Weighted Average Method Used in Process Costing? Weighted Average Method: 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 29 Calculation of Cost Per Equivalent Unit Under the Weighted Average Method Beg. WIP Costs + Costs Added This Period Beg. WIP Costs + Costs Added This Period Weighted Average Equivalent Units

30 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.

31 31 Production Report

32 32 Departmental Production Report Production Report Analysis of physical flow of units. Calculation of equivalent units. Computation of unit costs. Analysis of total costs.

33 33 Production Report Example MVP Sports Equipment Company makes baseball gloves in two departments, Cutting and Stitching. MVP Sports Equipment Company makes baseball gloves in two departments, Cutting and Stitching. MVP uses the weighted-average cost procedure. 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. Material is added at the beginning of the Cutting Department, and conversion is incurred uniformly throughout the process.

34 34 Production Report Example Using the following information for the month of March, lets prepare a production report for the Cutting Department. Using the following information for the month of March, lets prepare a production report for the Cutting Department.

35 35 Production Report Example Analysis of Physical Flow of Units

36 36 Production Report Example Ë Calculation of Equivalent Units 50% of 10,000 units Beginning inventory % is not used in weighted-average method.

37 37 Production Report Example Ë Calculation of Equivalent Units 100% of 10,000 units, all material added at beginning

38 38 Production Report Example 1-38 Ì Computation of unit costs $140,000 ÷ 50,000 equivalent units $200,700 ÷ 45,000 equivalent units $ $4.46

39 39 Reconciliation of Units

40 40 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. Equivalent Units

41 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 42 Equivalent units – Material and Conversion costs

43 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. 1. Determine the denominators to be used in the calculations of cost per equivalent unit for materials and conversion costs.

44 44 Example Exercise #1 Solution Materials –Units completed2,500 –Equivalent units (300*85%) 255 2,755 units Labor –Units completed2,500 –Equivalent units (300*50%) 150 2,650 units

45 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. 1. Calculate the cost per equivalent unit for labor assuming that labor is added uniformly throughout the production process.

46 46 Example Exercise #2 Solution Direct Labor –Beginning WIP$135,000 –March labor$650,000 –Total Labor Cost$785,000 Units –Units completed 25,000 –Equivalent units (8,000*50%) 4,000 –Total Units 29,000 Cost per Equivalent Unit –$785,000 / 29,000 pounds = $27.07 per pound

47 47 Example – Process Costing

48 48 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 Example – Tyler Company

49 49 Example – Tyler Company

50 50 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 Assignment of Manufacturing Costs

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

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

53 53 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 Assignment of Manufacturing Costs

54 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 55 Flow of Costs in Making Frozen Buns

56 56 Basic Information

57 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 58 Step 1: Compute Physical Unit Flow

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

60 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 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 400,000 Total Materials Costs $450,000 The Computation of Unit Materials Costs:

62 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 170,000 Total Conversion Costs $205,000 The Computation of Unit Conversion Costs:

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

64 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 570,000 Total Costs to be Accounted For $ 655,000

65 65 Production Cost Report - Mixing Department

66 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 67 Contemporary Developments - JIT

68 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 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 70 Question Time Production costs chargeable to the Finishing Department in June in Cliven Company are: Materials $15,000, Materials $15,000, Labor $29,500, Labor $29,500, Production Overheads $18,000. Production Overheads $18,000. Equivalent units of production are Materials 20,000 and Materials 20,000 and Conversion costs 19,000. Conversion costs 19,000. Compute the unit costs for materials and conversion costs.

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

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

73 73 Total Manufacturing Costs per Unit: $.75 + $2.50 = $3.25 per unit

74 74 Operation Costing Operation costing employs some aspects of both job-order and process costing. Operation Costing (Products produced in batches) Job-order Operation Costing Process Costing (Products produced in batches) Costing

75 75 Operation Costing Operation costing employs some aspects of both job-order and process costing. Operation Costing (Products produced in batches) Job-order Operation Costing Process Costing (Products produced in batches) Costing Conversion costs assigned to batches as in process costing. Material Costs charged to batches as in job-order costing.

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

77 77 JIT or Just-in-Case?

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


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