Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 11 th Edition Chapter 4

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Chapter Four Systems Design: Process Costing

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 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 cost. 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. Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product cost. 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.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Differences Between Job-Order and Process Costing 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 are worked on each period. 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 are worked on each period. Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Process costing systems use department production reports to accumulate costs. Job-order costing systems use job cost sheets to accumulate costs. Process costing systems use department production reports to accumulate costs. Job-order costing systems use job cost sheets to accumulate costs. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job. 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 are worked on each period. 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 are worked on each period. Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Process costing systems use department production reports to accumulate costs. Job-order costing systems use job cost sheets to accumulate costs. Process costing systems use department production reports to accumulate costs. Job-order costing systems use job cost sheets to accumulate costs. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin What is a Processing Department? Any location 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.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Sequential vs. Parallel Processing Sequential processing means that units flow in a sequence from one department to another. Parallel processing is used when after a point, some units go through different processing departments than others. For example, a petroleum refinery separates crude oil into products like gasoline, jet fuel, and heating oil.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Cotton prep. department Thread prod. department Packaging. department Parallel Processing Sequential Processing

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Work in Proces s Direct Materials Direct Labor Manufacturing Overhead

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead Jobs Costs are traced and applied to individual jobs in a job-order cost system. Direct Materials

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead Processing Department Processing Department Costs are traced and applied to departments in a process cost system. Direct Materials

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin T-Account and Journal Entry Views of Cost Flows For purposes of this example, assume there are two processing departments – Departments A and B. We will use T-accounts.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Process Cost Flows (in T-account form) Work in Process Department B Work in Process Department A Direct Materials Direct Labor Applied Overhead Direct Materials Direct Labor Applied Overhead Transferred to Dept. B Transferred from Dept. A

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Finished Goods Process Cost Flows (in T-account form) Work in Process Department B Cost of Goods Manufactured Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Cost of Goods Manufactured

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Finished Goods Cost of Goods Sold Process Cost Flows (in journal entry form) Work in Process Department B Cost of Goods Manufactured Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Cost of Goods Sold Cost of Goods Manufactured

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Raw Materials Arrive from Warehouse Mixing Department Chewing gums Completed and Sent for packaging Packed chewing Gums are ready For sale Packaging Department

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Equivalent Units of Production Equivalent units are the product of the number of partially completed units and the percentage completion of those units. We need to calculate equivalent units because a department usually has some partially completed units in its beginning and ending inventory.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin For the current period, 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 period? a. 10,000 b. 11,500 c. 13,500 d. 15,000 For the current period, 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 period? a. 10,000 b. 11,500 c. 13,500 d. 15,000 Quick Check

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin For the current period, 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 period? a. 10,000 b. 11,500 c. 13,500 d. 15,000 For the current period, 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 period? a. 10,000 b. 11,500 c. 13,500 d. 15,000 10,000 units + (5,000 units × 0.30) = 11,500 equivalent units Quick Check

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Calculating Equivalent Units Equivalent units can be calculated two ways:  The First-In, First-Out Method – FIFO is covered in the appendix to this chapter.  The Weighted-Average Method – This method will be covered in the main portion of the chapter. Equivalent units can be calculated two ways:  The First-In, First-Out Method – FIFO is covered in the appendix to this chapter.  The Weighted-Average Method – This method will be covered in the main portion of the chapter.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Equivalent Units of Production Weighted-Average Method Cost per equivalent unit = Costs for the period Equivalent units of production for the period The weighted-average method... Makes no distinction between work done in prior or current periods. Blends together units and costs from prior and current periods.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Process Costing and Direct Labor Direct labor costs may be small in comparison to other product costs in process cost systems. Direct labor costs may be small in comparison to other product costs in process cost systems. Direct Materials Type of Product Cost Dollar Amount Direct Labor Conversion

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Process Costing and Direct Labor Type of Product Cost Dollar Amount Conversion Direct labor and manufacturing overhead may be combined into one product cost called conversion. Direct Materials Direct labor costs may be small in comparison to other product costs in process cost systems. Direct labor costs may be small in comparison to other product costs in process cost systems.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Weighted-Average Example Smith Company reported the following activity in Department A for the month of June:

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin The first step in calculating the equivalent units is to identify the units completed and transferred out of Department A in June (5,400 units) Weighted-Average Example

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin The second step is to identify the equivalent units of production in ending work in process with respect to materials for the month (540 units) and add this to the 5,400 units from step one. Weighted-Average Example

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Weighted-Average Example The third step is to identify the equivalent units of production in ending work in process with respect to conversion for the month (270 units) and add this to the 5,400 units from step one.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in work in process Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in work in process Weighted-Average Example

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Production Report – Weighted-Average  A computation of cost per equivalent unit. Section 1 Section 2 Section 3 Production Report  A quantity schedule showing the flow of units and the computation of equivalent units.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Production Report  Cost Reconciliation section shows the reconciliation of all cost flows into and out of the department during the period. Section 1 Section 2 Section 3 Production Report

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Assume that Double Diamond Skis uses the weighted-average method of process costing to determine unit costs in it Shaping and Milling Department. Production Report Example

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Work in process, May 1: 200 units Materials: 55% complete $9,600 Conversion: 30% complete5,575 Production started during May5,000 units Production completed during May4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost 350,900 Work in process, May units Materials: 40% complete Conversion: 25% complete Work in process, May 1: 200 units Materials: 55% complete $9,600 Conversion: 30% complete5,575 Production started during May5,000 units Production completed during May4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost 350,900 Work in process, May units Materials: 40% complete Conversion: 25% complete Production Report Example

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Step1: Prepare Quantity Schedule with Equivalent Units. Production Report Example

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Production Report Example Step1: Prepare Quantity Schedule with Equivalent Units.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Production Report Example Step1: Prepare Quantity Schedule with Equivalent Units.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Step 2: Calculating the Costs Per Equivalent Unit To calculate the cost per equivalent unit for the period: Cost per equivalent unit = Costs for the period Equivalent units of production for the period

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Step 2: Compute the cost per equivalent unit. Production Report Example

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Production Report Example Step 2: Compute the cost per equivalent unit. $378,200 ÷ 4,960 units = $76.25

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Production Report Example $356,475 ÷ 4,900 units = $72.75 Step 2: Compute the cost per equivalent unit.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Step 3: Prepare a Cost Reconciliation Production Report Example

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Operation Costing Operation costing is a hybrid of job-order and process costing because it possesses attributes of both approaches. Conversion costs assigned to batches as in process costing. Material Costs charged to batches as in job-order costing. Job-order Costing Process Costing Operation Costing (Products produced in batches)

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin End of Chapter 4