Chapter 11 Process Costing

Learning Objectives Identify the types of firms or operations for which a process costing system is most suitable Explain and calculate equivalent units Describe the five steps in process costing Demonstrate the weighted-average method of process costing

Learning Objectives Demonstrate the FIFO method of process costing Analyze process costing with multiple departments Prepare journal entries to record the flow of costs in a process costing system

Learning Objectives Explain how process costing systems are implemented and enhanced in practice Account for spoilage in process costing

Learning Objective One Identify the types of firms or operations for which a process costing system is most suitable

Types of Businesses Using Process Costing Chemicals Oil refining Textiles Paints Flour Canneries Rubber Steel Food processing

Characteristics of Process Costing Direct Materials Direct labor costs are usually small in comparison to other product costs in process cost systems. Factory Overhead Dollar Amount Direct Labor Type of Product Cost

Characteristics of Process Costing Direct Materials Direct labor costs are usually small in comparison to other product costs in process cost systems. Conversion Dollar Amount Type of Product Cost So, direct labor and factory overhead are often combined into one product cost called conversion.

Comparing Job Costing and Process Costing Costs accumulated by the job. Work in process has a job cost record for each job. Many unique jobs. Jobs built to customer order. Process costing Costs accumulated by department or process. Work in process has a production report for each batch of products. Homogenous products. Units continuously produced for inventory in automated process.

Comparing Job Costing and Process Costing Work in process contains individual jobs in a job cost system. Direct Materials Finished Goods Work in Process Direct Labor Factory Overhead Cost of Goods Sold

Comparing Job Costing and Process Costing Work in process contains homogenous products in a process cost system. Direct Materials Direct Labor & Overhead (Conversion) Finished Goods Products Cost of Goods Sold

Comparing Job Costing and Process Costing Same objective: determine the cost of products Same objective: determine the cost of products Same Inventory accounts: raw materials, work in process, and finished goods Same Inventory accounts: raw materials, work in process, and finished goods Same overhead assignment method: predetermined rate times actual activity Same overhead assignment method: predetermined rate times actual activity

Characteristics of Process Costing Process costing accumulates costs by process or department and then assigns them to a large number of nearly identical products. Similar processes Continuous mass production Homogeneous products Unit cost = Process costs Equivalent units produced

Learning Objective Two Explain and calculate equivalent units

Equivalent Units Same objective: determine the cost of products We must now deal with the concept of equivalent units. Same objective: determine the cost of products Equivalent units is a concept expressing partially complete units as a smaller number of fully complete units. Same Inventory accounts: raw materials, work in process, and finished goods Cost per equivalent unit = Manufacturing costs for a period Equivalent units for the period Same overhead assignment method: predetermined rate times actual activity

Two one-half filled cups are equivalent to one full cup. Equivalent Units Two one-half filled cups are equivalent to one full cup. + = 1 So, 10,000 units 70 percent complete are equivalent to 7,000 complete units.

Equivalent Units During its first month of business, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 30 percent complete. How many equivalent units of production did Jones have for the month? a. 10,000 b. 11,500 c. 13,500 d. 15,000

Equivalent Units During its first month of business, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 30 percent complete. How many equivalent units of production did Jones have for the month? a. 10,000 b. 11,500 c. 13,500 d. 15,000 10,000 units + (5,000 units × .30) = 11,500 equivalent units

Cost per Equivalent Units Now assume that Jones incurred $27,600 in production costs for the 11,500 equivalent units. What was Jones’ cost per equivalent unit for the period? a. $1.84 b. $2.40 c. $2.76 d. $2.90

Cost per Equivalent Units Now assume that Jones incurred $27,600 in production costs for the 11,500 equivalent units. What was Jones’ cost per equivalent unit for the period? a. $1.84 b. $2.40 c. $2.76 d. $2.90 $27,600 ÷ 11,500 equivalent units = $2.40 per equivalent unit

Learning Objective Three Describe the five steps in process costing

Five Steps in Process Costs Analyze the physical flow of physical units. Calculate equivalent units of production for all manufacturing cost elements. Determine total cost for each manufacturing cost element. Compute cost per equivalent unit for each manufacturing cost element. Assign the total manufacturing costs to units completed and units of work in process at the end of the period. These five steps are the basis for the production cost report as we will see in the following examples.

Learning Objective Four Demonstrate the weighted-average method of process costing

Weighted-Average Costing 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 in beginning inventory with units and costs in the current period. Let’s look at an example using data from the Molding Department of Hsu Toy Company for the month of June.

Example for Weighted-Average Costing

Weighted-Average Costing First let’s look at a flow chart showing the blending of units in beginning work in process inventory with units started during the month.

Step 1: Analyze the Physical Units Weighted-Average Costing Beginning Inventory 10,000 units Ending Inventory 6,000 units 44,000 units completed 50,000 units in process 40,000 units started Now let’s examine the five-step process.

Step 2: Calculate Equivalent Units Weighted-Average Costing

Step 2: Calculate Equivalent Units Weighted-Average Costing Units completed and transferred are 100% complete for material, labor, and overhead.

Step 2: Calculate Equivalent Units Weighted-Average Costing 100% of 6,000 units 50% of 6,000 units 60% of 6,000 units

Step 2: Calculate Equivalent Units Weighted-Average Costing

Step 3: Determine Total Costs Weighted-Average Costing

Step 4: Calculate Unit Costs Weighted-Average Costing $54,000 ÷ 50,000 equivalent units $23,500 ÷ 47,000 equivalent units $45,220 ÷ 47,600 equivalent units

Step 5: Assign Total Costs Weighted-Average Costing 44,000 equivalent units @ $1.08 44,000 equivalent units @ $0.50 44,000 equivalent units @ $0.95

Step 5: Assign Total Costs Weighted-Average Costing 6,000 equivalent units @ $1.08 3,000 equivalent units @ $0.50 3,600 equivalent units @ $0.95

Step 5: Assign Total Costs Weighted-Average Costing

Learning Objective Five Demonstrate the FIFO method of process costing

First-In, First-Out (FIFO) Costing Distinguishes between work done in the prior period and work done in the current period. Assumes units in beginning work in process inventory are completed and transferred first.

FIFO Costing Advantages of FIFO costing Managers can better identify and manage current period costs. Inventory costs are more current as current period costs are assigned to units in process and units completed.

FIFO Costing Let’s revisit the Molding Department of Hsu Toy company for the month of June. We will use the same data as before, but now we will use FIFO costing.

Example for FIFO Costing

FIFO Costing (continued) First let’s look at a flow chart showing the flow of units in beginning work in process inventory and the flow of units started during the month.

Step 1: Analyze the Physical Units FIFO Costing Beginning Inventory 10,000 units 10,000 units completed 44,000 units completed 40,000 units started 34,000 units completed Ending Inventory 6,000 units Now let’s examine the five-step process.

Step 2: Calculate Equivalent Units FIFO Costing

Step 2: Calculate Equivalent Units FIFO Costing All material added in prior period for units in beginning WIP 70% of 10,000 units 60% of 10,000 units

Step 2: Calculate Equivalent Units FIFO Costing 100% of material, labor, and overhead is incurred in June for units started and completed in June.

Step 2: Calculate Equivalent Units FIFO Costing 50% of 6,000 units 100% of 6,000 units 60% of 6,000 units

Step 2: Calculate Equivalent Units FIFO Costing

Step 3: Determine Total Costs FIFO Costing

Step 4: Calculate Unit Costs FIFO Costing $43,600 ÷ 43,600 equivalent units $44,000 ÷ 40,000 equivalent units $22,440 ÷ 44,000 equivalent units

Step 5: Assign Total Costs FIFO Costing

Step 5: Assign Total Costs FIFO Costing All material added in prior period for beginning WIP 7,000 equivalent units @ $0.51 6,000 equivalent units @ $1.00

Step 5: Assign Total Costs FIFO Costing 34,000 equivalent units @ $1.10 34,000 equivalent units @ $0.51 34,000 equivalent units @ $1.00

Step 5: Assign Total Costs FIFO Costing 6,000 equivalent units @ $1.10 3,000 equivalent units @ $0.51 3,600 equivalent units @ $1.00

Step 5: Assign Total Costs FIFO Costing

Which is Better: FIFO or Weighted-Average FIFO costing results in a current period cost that can be used for performance evaluation. If there is no beginning inventory (JIT) or if beginning inventory is small, FIFO and weighted-average produce the same results.

Learning Objective Six Analyze process costing with multiple departments

Costs Transferred in from Prior Departments Multiple departments in a process result in units and costs that are transferred from a prior department to the current department. These transferred-in costs are treated exactly like a direct material that is added at the beginning of a production process.

Costs Transferred in from Prior Departments Let’s revisit Hsu Toy Company with the addition of transferred-in units and costs. We will transfer units from the Molding Department to the Finishing Department. The Finishing Department uses: Conversion cost (a combination of labor and overhead). The weighted-average method.

Costs Transferred in from Prior Departments

Costs Transferred in from Prior Departments (Step 1)

Costs Transferred in from Prior Departments (Step 2) 100% complete for material, conversion, and transferred-in units.

Costs Transferred in from Prior Departments (Step 2) 50% of 8,000 units Transferred-in units are 100% complete

Costs Transferred in from Prior Departments (Step 2)

Costs Transferred in from Prior Departments (Step 3)

Costs Transferred in from Prior Departments (Step 4) $25,000 ÷ 50,000 equivalent units $145,570 ÷ 58,000 equivalent units $54,000 ÷ 54,000 equivalent units

Costs Transferred in from Prior Departments (Step 5) 50,000 equivalent units @ $0.50 50,000 equivalent units @ $2.5099 50,000 equivalent units @ $1.00

Costs Transferred in from Prior Departments (Step 5) Rounding Error 0 equivalent units @ $0.50 8,000 equivalent units @ $2.5099 4,000 equivalent units @ $1.00

Costs Transferred in from Prior Departments (Step 5)

Learning Objective Seven Prepare journal entries to record the flow of costs in a process costing system

Direct Materials were Requisitioned and Used Work-in-Process Inventory—Molding Dept. 44,000 Work-in-Process Inventory—Finishing Dept. 25,000 Materials Inventory 69,000 To record direct materials costs added during June.

Direct Labor Incurred Work-in-Process Inventory—Molding Dept. 27,440 Work-in-Process Inventory—Finishing Dept. 23,500 Accrued Payroll 45,940 To record direct labor costs incurred during June.

Factory Overhead Applied Work-in-Process Inventory—Molding Dept. 43,600 Work-in-Process Inventory—Finishing Dept. 23,500 Factory Overhead Applied 67,100 To record the application of factory overhead to departments.

Transferred-in Costs from the Molding Department Work-in-Process Inventory—Finishing Dept. 111,320 Work-in-Process Inventory—Molding Dept. 111,320 To record the weighted-average method of the cost of goods completed in the molding department and transferred out to the finishing department.

Units Completed Finished Goods Inventory 200,490 Work-in-Process Inventory—Finishing Dept. 200,490 To record the weighted-average method of the cost of goods completed in the finishing department.

Learning Objective Nine Account for spoilage in process costing

Spoilage in Process Costing Normal Spoilage occurs under efficient operating conditions. These costs are absorbed by the good units produced. Abnormal spoilage exceed expected losses under efficient operating conditions and is charged as a loss to operations in the period detected.

End of Chapter Eleven