3 Process Cost Systems

After studying this chapter, you should be able to: Explain and illustrate the characteristics and cost flows for a process manufacturer. Prepare a cost of production report accounting for completed units under the Fifo method.

After studying this chapter, you should be able to: Prepare journal entries for transactions of a process manufacturer. Use cost of production reports for decision making. Contrast just-in-time processing with conventional manufacturing practices.

3-1 Objective 1 Explain and illustrate the characteristics and cost flows for a process manufacturer.

Accumulate product costs. Comparing Job Order and Process Cost Systems 3-1 Both systems: Accumulate product costs. Categorize manufacturing costs into direct material, direct labor, and factory overhead. Allocate costs to products. (Continued)

Use product cost data for decision making. 3-1 Both systems: Maintain perpetual materials, work in process, and finished goods inventory records. Use product cost data for decision making.

Manufacturing costs are accumulated to departments, rather than jobs. 3-1 Primary differences: Manufacturing costs are accumulated to departments, rather than jobs. Manufacturing costs are allocated to products based on units of production. Manufacturing costs are accumulated and transferred between departments. (Continued)

3-1 Primary differences: Work in process inventory consists of partially completed production within a department, rather than the sum of job cost sheets of partially completed jobs. (Concluded)

3-1 9 (Continued)

3-1 10 (Concluded)

3-1 Process cost systems are used to manufacture homogeneous products. Examples are: Tennis balls Motor oil Candy bars Soft drinks

3-1 In contrast, job cost systems are used to manufacture unique products or provide unique services. Examples are: Custom-built homes Landscape design services Customer cabinets Airplanes (767)

Home construction Computer chips Beverages Cookies 3-1 Example Exercise 3-1 Which of the following industries would normally use job order costing systems and which would normally use process costing systems? Home construction Computer chips Beverages Cookies Military aircraft Video game design and production 13

Home construction Job Order Beverages Process 3-1 Follow My Example 3-1 Home construction Job Order Beverages Process Military aircraft Job Order Computer chips Process Cookies Process Video game design and production Job Order 14 For Practice: PE3-1A, PE3-1B

3-1 15

Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Materials WIP – Mixing WIP – Packaging (a) Purchases DM DM DM DM (b) Direct Materials 16

Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Materials WIP – Mixing WIP – Packaging DL (a) Purchases DM DM DM DM (c) Direct Labor—Mixing 17

Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Materials WIP – Mixing WIP – Packaging DL (a) Purchases DM DM DM IM Factory OH – Mixing Factory OH – Packaging (d) Factory overhead incurred (d) Factory overhead incurred IM (d) Indirect materials 18

Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Materials WIP – Mixing WIP – Packaging DL (a) Purchases DM DM DM IM FOA Factory OH – Mixing Factory OH – Packaging (d) Factory overhead incurred FOA FOA (e) Factory overhead applied—Mixing 19

Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Materials WIP – Mixing WIP – Packaging DL (f) Costs trans-ferred out (a) Purchases DM DM DM IM FOA CTI Factory OH – Mixing Factory OH – Packaging (d) Factory overhead incurred FOA CTI (f) Costs transferred in 20

Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Materials WIP – Mixing WIP – Packaging DL (f) Costs trans-ferred out DL (a) Purchases DM DM DM IM FOA CTI Factory OH – Mixing Factory OH – Packaging (d) Factory overhead incurred FOA DL (g) Direct labor in Packaging 21

Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Materials WIP – Mixing WIP – Packaging DL (f) Costs trans-ferred out DL (a) Purchases DM DM DM IM FOA CTI FOA Factory OH – Mixing Factory OH – Packaging (d) Factory overhead incurred FOA FOA FOA (h) Factory overhead applied—Packaging 22

Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Materials WIP – Mixing WIP – Packaging DL (f) Costs trans-ferred out DL (i) Costs trans-ferred out (a) Purchases DM DM DM IM FOA CTI FOA Factory OH – Mixing Factory OH – Packaging (d) Factory overhead incurred Finished Goods FOA FOA CTI CTI (i) Cost transferred in from WIP—Packaging 23

Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Exhibit 3 Cost Flows for a Process Manufacturer 3-1 Materials WIP – Mixing WIP – Packaging DL (f) Costs trans-ferred out DL (i) Costs trans-ferred out (a) Purchases DM DM DM IM FOA CTI FOA Factory OH – Mixing Factory OH – Packaging (d) Factory overhead incurred Finished Goods FOA FOA CTI CGS Cost of Goods Sold CGS CGS (j) Cost transferred to Cost of Goods Sold 24

3-2 Objective 2 Prepare a cost of production report accounting for completed and partially completed units under the FIFO method.

Mixing Department of Frozen Delight 3-2 Mixing Department of Frozen Delight 3-2 Inventory in process, July 1, 5,000 gallons Direct materials cost, 5,000 gallons $ 5,000 Conversion costs, 5,000 gallons, 70% completed 1,225 Total inventory in process, July 1 $ 6,225 Direct materials cost for July, 60,000 gallons $66,000 Direct labor for July 10,500 Factory overhead applied for July 7,275 83,775 Total production costs to account for $90,000 Goods transferred to Packaging in July (including units in process on July 1), 62,000 gallons ? Inventory in process, July 31, 3,000 gallons, 25% complete as to conversion costs ? 26

Total gallons charged to production: In process July 1 5,000 gallons Step 1: Determine the Units to Be Assigned Costs 3-2 Total gallons charged to production: In process July 1 5,000 gallons Received from materials storage 60,000 gallons Total units accounted for by the Mixing Department 65,000 gallons

3-2 28

Inventory in process, July 1, completed in July 5,000 gal. Total Units to Be Assigned Costs 3-2 Inventory in process, July 1, completed in July 5,000 gal. Started and completed in July 57,000 gal. Transferred out to the Packaging Department in July 62,000 gal. Inventory in process, July 31 3,000 gal. Total gallons to be assigned costs 65,000 gal.

3-2 Example Exercise 3-2 The Rocky Springs Beverage Company has two departments, Blending and Bottling. The Bottling Department received 57,000 liters from the Blending Department. During the period, the Blending Department completed 58,000 liters, including 4,000 liters of work in process at the beginning of the period. The ending work in process was 3,000 liters. How many liters were started and completed during the period? 30

3-2 Follow My Example 3-2 54,000 liters started and completed (58,000 completed – 4,000 beginning work in process) 31 For Practice: PE3-2A, PE3-2B

Step 2: Calculate Equivalent Units of Production 3-2 Whole units are the number of units in production during a period, whether completed or not. Equivalent units of production are the number of units that were completed with respect to either materials or conversion costs within a given accounting period.

Important: Note the word “Added” Frozen Delight’s Equivalent Units Computation for Materials in July 3-2 Important: Note the word “Added” Percent Equivalent Total Materials Units for Whole Added Direct Units in July Materials Inventory in process, July 1 5,000 0% 0 Started and completed in July (62,000 – 5,000) 57,000 100% 57,000 Transferred out to Packaging Dept. 62,000 — 57,000 Inventory in process, July 31 3,000 100% 3,000 Total gallons to be assigned cost 65,000 60,000 33

3-2 34

3-2 Example Exercise 3-3 The Bottling Department of Rocky Springs Beverage Company had 4,000 liters in beginning work in process inventory (30% complete). During the period, 58,000 liters were completed. The ending work in process inventory was 3,000 liters (60% complete). What are the total equivalent units for direct materials if materials are added at the beginning of the process? 35

For Practice: PE3-3A, PE3-3B 3-2 Follow My Example 3-3 Percent Materials Equiva- Whole Added lent Units in July Units Inventory in process, beginning of period 4,000 0% 0 Started and completed during the period 54,000 100% 54,000 Transferred out of Bottling (completed) 58,000 54,000 Inventory in process, end of period 3,000 100% 3,000 Total units to be assigned costs 61,000 57,000 Answer: 57,000 equivalent units 36 For Practice: PE3-3A, PE3-3B

Conversion Equivalent Units 3-2 The direct labor and applied factory overhead are often combined as conversion costs because they are both usually incurred evenly throughout a process.

Total Conversion Equivalent Whole Completed Units for 3-2 Percent Total Conversion Equivalent Whole Completed Units for Units in July Conversion Inventory in process, July 1 (70% complete) 5,000 30% 1,500 Started and completed in July (62,000 – 5,000) 57,000 100% 57,000 Transferred out to Packaging Dept. 62,000 — 58,500 Inventory in process, July 31 (25% complete) 3,000 25% 750 Total gallons to be assigned cost 65,000 59,250 38

3-2 39

3-2 Example Exercise 3-4 The Bottling Department of Rocky Springs Beverage Company had 4,000 liters in beginning work in process inventory (30% complete). During the period, 58,000 liters were completed. The ending work in process inventory was 3,000 liters (60% complete). What are the total equivalent units for direct materials if materials are added at the beginning of the process? 40

For Practice: PE3-4A, PE3-4B 3-2 Follow My Example 3-4 Percent Conversion Equiva- Whole Completed lent Units in Period Units Inventory in process, beginning of period 4,000 70% 2,800 Started and completed during the period 54,000 100% 54,000 Transferred out of Bottling (completed) 58,000 56,800 Inventory in process, end of period 3,000 60% 1,800 Total units to be assigned costs 61,000 58,600 *(58,000 – 4,000) 41 For Practice: PE3-4A, PE3-4B

Equivalent Units from Step 2 Step 3: Determine the Cost per Equivalent Unit 3-2 Equivalent Units from Step 2 Direct Materials Conversion Inventory in process, July 1 0 1,500 Started and completed in July (62,000 – 5,000) 57,000 57,000 Transferred out of Packaging Dept. In July 57,000 58,500 Inventory in process, July 31 3,000 750 Total gallons to be assigned costs 60,000 59,250 42

$66,000 direct materials cost 59,250 conversion equivalent units 3-2 Direct Materials Equivalent Unit Cost $66,000 direct materials cost 60,000 direct materials equivalent units $1.10 per equivalent unit of direct materials = Conversion Equivalent Unit Cost $0.30 per equivalent unit of con- version = $17,775 conversion cost 59,250 conversion equivalent units 43

3-2 Example Exercise 3-5 The cost of direct materials transferred into the Bottling Department of Rocky Springs Beverage Company is $22,800. The conversion cost for the period in the Bottling Department is $8,790. The total equivalent units for direct materials and conversion are 57,000 and 58,600 liters, respectively. Determine the direct materials and conversion cost per equivalent unit. 44

Equivalent units of materials: $22,800 57,000 liters = $0.40 per liter 3-2 Follow My Example 3-5 Equivalent units of materials: $22,800 57,000 liters = $0.40 per liter Equivalent units of conversion: $8,790 58,600 liters = $0.15 per liter 45 For Practice: PE3-5A, PE3-5B

Step 4: Allocate Costs to Transferred and Partially Completed Units Step 4: Allocate Costs to Transferred and Partially Completed Units 3-2 Direct Conver- Materials sion Total Costs Costs Costs Inventory in process, July 1, balance $6,225 Equivalent units for completing the July 1 in-process inventory 0 1,500 Equivalent unit cost x $1.10 x $0.30 Cost of completed July 1 in- process inventory 0 $450 450 Cost of July 1 in-process inventory transferred to Packaging Department $6,675 46

Costs Associated With the Units Started and Completed 3-2 Costs Associated With the Units Started and Completed 3-2 Direct Materials Conversion Total Costs Costs Costs Units started and completed in July 57,000 57,000 Equivalent unit cost x $1.10 x $0.30 Cost to complete the units started and completed in July $62,700 $17,100 $79,800 47

Equivalent units in ending inventory 3,000 750 Costs Associated With the Partially Completed Units in the Ending Inventory 3-2 Direct Materials Conversion Total Costs Costs Costs Equivalent units in ending inventory 3,000 750 Equivalent unit cost x $1.10 x $0.30 Cost to ending inventory $ 3,300 $ 225 $3,525 48

Example Exercise3-6 Direct 3-2 3-2 Example Exercise3-6 The cost per equivalent unit of direct materials and conversion in the Bottling Department of Rocky Springs Beverage Company is $0.40 and $0.15, respectively. The equivalent units to be assigned cost are as follows: Direct Materials Conversion Inventory in process, beginning of period 0 2,800 Started and completed during the period 54,000 54,000 Transferred out of Bottling (completed) 54,000 56,800 Inventory in process, end of period 3,000 1,800 Total units to be assigned costs 57,000 58,600 The beginning work in process inventory had a cost of $1,860. Determine the cost of completed and transferred out production, and the ending work in process inventory. 49

For Practice: PE3-6A, PE3-6B 3-2 Follow My Example 3-6 Direct Materials Conversion Total Inventory in process, balance $ 1,860 Inventory in process, beginning of period 0 + 2,800 x $0.15 420 Started and completed during the period 54,000 x $0.40 + 54,000 x $0.15 29,700 Transferred out of Bottling (completed) $31,980 Inventory in process, end of period 3,000 x $0.40 + 1,800 x $0.15 1,470 Total units to be assigned costs $33,450 Completed and transferred out of production $31,980 Inventory in process, ending $ 1,470 50 For Practice: PE3-6A, PE3-6B

Cost of Production Report 3-2 A cost of production report is normally prepared for each processing department at periodic intervals.

Cost of Production Report for Frozen Delight’s Mining Department—FIFO 3-2 52 (Continued)

Cost of Production Report for Frozen Delight’s Mining Department—FIFO 3-2 53 (Concluded)

3-2 The cost of production report provides the following production quantity and cost data: The units for which the department is accountable and the disposition of those units. The production costs incurred by the department and the allocation of those costs between completed and partially completed units.

Direct material cost per equivalent unit (June): Frozen Delight Cost per Equivalent Unit 3-2 Direct material cost per equivalent unit (June): $5,000 5,000 equivalent units of materials $1.00 per equivalent unit = Conversion cost per equivalent unit (June): $1,225 (5,000 x 70%) equivalent units of conversion cost $0.35 per equivalent unit = 55

Prepare journal entries for transactions of a process manufacturer. 3-3 Objective 3 Prepare journal entries for transactions of a process manufacturer.

Journal Entries for Frozen Delight 3-3 a. Materials, including milk, cream, sugar, packaging, and indirect materials, were purchased on account, $88,000. Materials 88,000 Accounts Payable 88,000

3-3 b. Milk, cream, and sugar were requisitioned by the Mixing Department, $66,000. Another $8,000 of packaging materials was requisitioned by the Packaging Department. Indirect materials for the Mixing and Packaging Department were $4,125 and $3,350, respectively.

Work in Process—Mixing 66,000 Work in Process—Packaging 8,000 3-3 b. Work in Process—Mixing 66,000 Work in Process—Packaging 8,000 Factory Overhead—Mixing 4,125 Factory Overhead—Packaging 3,000 Materials 81,125

Work in Process—Mixing 10,500 Work in Process—Packaging 12,000 3-3 c. Direct labor in the Mixing and Packaging departments was $10,500 and $12,000, respectively. Work in Process—Mixing 10,500 Work in Process—Packaging 12,000 Wages Payable 22,500

Factory Overhead—Mixing 3,350 Factory Overhead—Packaging 1,000 3-3 d. Equipment depreciation for the Mixing and Packaging departments was $3,350 and $1,000, respectively. Factory Overhead—Mixing 3,350 Factory Overhead—Packaging 1,000 Accumulated Depreciation— Equipment 4,350

Work in Process—Mixing 7,275 Work in Process—Packaging 3,500 3-3 e. The factory overhead applied to Mixing and Packaging was $7,275 and $3,500, respectively. Work in Process—Mixing 7,275 Work in Process—Packaging 3,500 Factory Overhead— Mixing 7,275 Factory Overhead— Packaging 3,500

Work in Process—Packaging 86,475 Work in Process—Mixing 86,475 3-3 f. The amount of costs transferred from the Mixing Department to the Packaging Department was $86,750 per the cost of production report in Exhibit 7. Work in Process—Packaging 86,475 Work in Process—Mixing 86,475

Finished Goods—Ice Cream 106,000 Work in Process— Packaging 106,000 3-3 g. The goods transferred out of the Packaging Department to Finished Goods according to the Packaging Department cost of production report was $106,000. Finished Goods—Ice Cream 106,000 Work in Process— Packaging 106,000

Finished Goods—Ice Cream 107,000 3-3 h. The cost of goods sold out of the finished goods inventory was $107,000. Cost of Goods Sold 107,000 Finished Goods—Ice Cream 107,000

Work in Process—Mixing Dept. 3,525 Ending Inventories for Frozen Delight 3-3 July 31 Materials $ 6,875 Work in Process—Mixing Dept. 3,525 Work in Process—Packaging Department 7,725 Finished Goods 4,000 Total inventories $22,125 66

3-3 Example Exercise 3-7 The cost of materials transferred into the Bottling Department of Rocky Springs Beverage Company is $22,800, with $20,000 from the Blending Department, plus an additional $2,800 from the materials storeroom. The conversion cost for the period in the Bottling Department is $8,790 ($3,790 factory overhead applied and $5,000 direct labor). (Continued) 67

3-3 Example Exercise 3-7 The total costs transferred to Finished Goods for the period was $31,980. The Bottling Department had a beginning inventory of $1,860. Journalize (1) the cost of transferred-in materials, (2) conversion costs, and (3) the costs transferred out to Finished Goods. Determine the balance of Work in Process—Bottling at the end of the period. 68 (Concluded)

1. Work in Process—Bottling 22,800 Work in Process—Blending 20,000 3-3 Follow My Example 3-7 1. Work in Process—Bottling 22,800 Work in Process—Blending 20,000 Materials 2,800 2. Work in Process—Bottling 8,790 Factory Overhead—Bottling 3,790 Wages Payable 5,000 3. Finished Goods 31,980 Work in Process—Bottling 31,980 b. $1,470 ($1,860 + $22,800 + $8,790 – $31,980) 69 For Practice: PE3-7A, PE3-7B

Use cost of production reports for decision making. 3-4 Objective 4 Use cost of production reports for decision making.

Cost of Production Reports 3-4 Cost of Production Reports Holland Beverage Company—Blending Department For the Months Ended April 30 and May 31, 2008 April May Direct materials $ 20,000 $ 40,600 Direct labor 15,000 29,400 Energy 8,000 20,000 Repairs 4,000 8,000 Tank cleaning 3,000 8,000 Total $ 50,000 $ 106,000 Units completed / 100,000 / 200,000 Cost per unit $ 0.50 $ 0.53 71

Per-Unit Expense Comparisons 3-4 Per-Unit Expense Comparisons 3-4 72

3-4 In addition to unit production cost trends, managers of process manufacturers are also concerned about yield trends. Yield is the ratio of materials output quantity to the input quantity.

3-4 Example Exercise 3-8 The cost of energy consumed in producing good units in the Bottling Department of Rocky Springs Beverage Company was $8,400 and $7,400 for March and April, respectively. The number of equivalent units produced in March and April was 70,000 and 74,000 liters, respectively. Evaluate the cost of energy between the two months. 74

Energy cost per liter, March: $8,400 70,000 liters = $0.12 3-4 Follow My Example 3-8 Energy cost per liter, March: $8,400 70,000 liters = $0.12 Energy cost per liter, April: $7,400 74,000 liters = $0.10 The cost of energy has appeared to improve by 2 cents per liter between March and April. 75 For Practice: PE3-8A, PE3-8B

3-5 Objective 5 Contrast just-in-time processing with conventional manufacturing practices.

Just-in-Time Processing 3-5 JIT is a business philosophy that focuses on reducing time and cost and eliminating poor quality. JIT organizes manufacturing cells that perform several manufacturing steps. Workers are cross-trained to perform more than one task. This provides flexibility and worker pride and involvement in the final product. Because products have limited movement between departments, the nonvalue-added cost of transporting products and parts is reduced.

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