Process Costing Chapter 04 Chapter 4: Process Costing 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. McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Similarities Between Job-Order and Process Costing Both systems assign material, labor, and overhead costs to products and they provide a mechanism for computing unit product costs. Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods. The flow of costs through the manufacturing accounts is basically the same in both systems. Job-order and process costing are similar in that they both deal with assigning materials, labor, and overhead to products as a way to calculate the unit product cost. Both systems use Raw Materials Inventory, Work in Process Inventory, and Finished Goods Inventory. The flow of costs is similar, but not exactly the same, in the two systems.

Differences Between Job-Order and 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 having different production requirements are worked on each period. Systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet. Process costing is best suited for the production of a single product that is continuously produced for a long period of time. Recall the mixing and bottling of Coca-Cola from Chapter Three. Job-order costing is best suited when jobs are produced as discrete projects. For example, building a house. Process costing accumulates costs by department, while job-order costing accumulates costs by individual jobs. Process costing uses a fundamental document called a department production report, while job-order costing uses the job cost sheet. In process costing unit cost is computed by department, while in job-order systems unit cost is computed by job. While there are similarities between the two systems, there are also significant differences.

Processing Departments Any unit in an organization where materials, labor, or overhead are added to the product. 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. Products in a process costing environment typically flow in a sequence from one department to another. A processing department is any unit in an organization where materials, labor, or overhead are added to the product. The output from a processing department is homogeneous, that is, they all appear the same. Products in a process costing environment typically flow in a sequence from one department to another.

Comparing Job-Order and Process Costing Direct Materials Work in Process Finished Goods Direct Labor Cost of Goods Sold The flow of costs through the manufacturing accounts is basically the same for process and job-order costing. Direct materials, 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. Manufacturing Overhead

Comparing Job-Order and Process Costing Costs are traced and applied to individual jobs in a job-order cost system. Direct Materials Jobs Finished Goods Direct Labor There is a key fundamental difference between process and job-order costing systems. Job-order costing systems trace and apply manufacturing costs to jobs. One Work in Process account is often used to accumulate costs for all jobs. The individual job cost sheets serve as a subsidiary ledger. Manufacturing Overhead Cost of Goods Sold

Comparing Job-Order and Process Costing Costs are traced and applied to departments in a process cost system. Direct Materials Processing Department Finished Goods Direct Labor In a process costing systems, costs are traced to departments that process the goods. In some companies there may be several processing departments that goods must pass through to become finished goods. A separate Work in Process account is maintained for each processing department. Material, labor, and overhead costs transferred from one department’s Work in Process account to another department’s Work in Process account are called transferred-in costs. Manufacturing Overhead Cost of Goods Sold

Process Cost Flows: The Flow of Raw Materials (in T-account form) Work in Process Department A Raw Materials Direct Materials Direct Materials Work in Process Department B Direct materials can be requisitioned for use in both Department A and Department B. These direct materials are likely to be different in nature. 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 Inventory account is credited for the corresponding amounts.

Process Cost Flows: The Flow of Labor Costs (in T-account form) Salaries and Wages Payable Work in Process Department A Direct Materials Direct Labor Direct Labor Work in Process Department B Direct labor is transferred from the Salaries and Wages Payable account into the work in process account of Departments A and B depending upon where the individual employee worked. 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. Direct Materials

Manufacturing Overhead Overhead Applied to Work in Process Process Cost Flows: The Flow of Manufacturing Overhead Costs (in T-account form) Work in Process Department A Direct Materials Manufacturing Overhead Direct Labor Actual Overhead Overhead Applied to Work in Process Applied Overhead Work in Process Department B Manufacturing overhead is applied to each processing department based on a predetermined rate for each department. The predetermined rate does not have to be based on the same cost driver for each processing department. Manufacturing overhead costs are debited to the respective departmental Work in Process accounts. Manufacturing overhead is credited by the corresponding amounts. Direct Materials Direct Labor Applied Overhead

Work in Process Department A Work in Process Department B Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept. B (in T-account form) Work in Process Department A Work in Process Department B Direct Materials Transferred to Dept. B Transferred from Dept. A Direct Materials Direct Labor Direct Labor Applied Overhead Applied Overhead The cost of units complete as to processing in Department A are transferred into Department B for additional work. Department B has incurred additional costs to work on units that were in process at the beginning of the period. The transferred-in costs from Department A are added to the manufacturing costs incurred in Department B. Department A Department B

Cost of Goods Manufactured Process Cost Flows: Transfers from WIP-Dept. B to Finished Goods (in T-account form) Work in Process Department B Finished Goods Direct Materials Cost of Goods Manufactured Cost of Goods Manufactured Direct Labor Applied Overhead Transferred from Dept. A Here we see the transfer of completed goods from Work in Process – Department B into Finished Goods Inventory. The costs transferred represent the cost of good manufactured.

Process Cost Flows: Transfers from Finished Goods to COGS (in T-account form) Work in Process Department B Finished Goods Direct Materials Cost of Goods Manufactured Cost of Goods Manufactured Cost of Goods Sold Direct Labor Applied Overhead Transferred from Dept. A Once we sell finished goods, we debit Cost of Goods Sold and credit Finished Goods Inventory. Cost of Goods Sold Cost of Goods Sold

Equivalent Units – The Basic Idea Two half completed products are equivalent to one complete product. + = 1 The basic idea behind equivalent units is quite easy to understand, but the computation of equivalent can become complex. Here we can say the two half- completed units of production are equal to one complete unit. Using this logic, we can say that 10,000 units that are 70% complete are equivalent, or the same as, 7,000 complete units. So, 10,000 units 70% complete are equivalent to 7,000 complete units.

Treatment of Direct Labor Direct Materials Direct labor costs may be small in comparison to other product costs in process cost systems. Manufacturing Overhead Dollar Amount Direct Labor In today’s economy, direct labor costs are becoming small when compared to materials and overhead costs. Automation is one of the causes for this shift. Type of Product Cost

Treatment of Direct Labor Direct Materials Direct labor and manufacturing overhead may be combined into one classification of product cost called conversion costs. Conversion Direct Labor Dollar Amount Direct Labor Manufacturing Overhead As a consequence of the change in volume of direct labor costs, many companies combine labor and overhead costs and refer to the total as conversion costs. That is, these are the costs incurred to convert the direct materials into a finished good. We will make extensive use of the notion of direct materials and conversion costs in the remainder of this chapter. Type of Product Cost

End of Chapter 04 End of Chapter 4.