Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 8 Process-Costing Systems

8-2 Learning Objective 1

8-3 Production environment Homogenous units Mass produced Automated Continuous flow Process Costing

8-4 Costing procedure  Costs are recorded for a department.  Department costs are assigned equally to units produced. Production environment Homogenous units Mass produced Automated Continuous flow Process Costing

8-5 Learning Objective 2

8-6 To determine balance sheet inventory To evaluate production efficiency To evaluate products To help set prices How are unit costs used? Why Process Costing Is Useful

8-7 Direct Materials Type of Product Cost Dollar Amount Direct Labor Manufacturing Overhead Direct labor costs are usually small in comparison to other product costs in process cost systems. (high level of automation) Process Costing – The Cost Inputs

8-8 So, direct labor and manufacturing overhead are often combined into one product cost called conversion. Direct Materials Type of Product Cost Dollar Amount Conversion Direct labor costs are usually small in comparison to other product costs in process cost systems. (high level of automation) Process Costing – Conversion Costs

8-9 Job costing Costs accumulated by the job. Work in process has a job cost record for each job. Many unique, high cost 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. A few identical, low cost products. Units continuously produced for inventory in automated process. Comparing Job Costing and Process Costing

8-10 Work in process contains individual jobs in a job cost system. Direct Materials Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead Jobs Comparing Job Costing and Process Costing

8-11 Finished Goods Cost of Goods Sold Products Work in process contains homogenous products in a process cost system. Direct Labor & Overhead ( Conversion) Direct Materials Comparing Job Costing and Process Costing

8-12 Same objective: determine the cost of products Same Inventory accounts: raw materials, work in process, and finished goods Same overhead assignment method: predetermined rate times actual activity Same objective: determine the cost of products Same Inventory accounts: raw materials, work in process, and finished goods Same overhead assignment method: predetermined rate times actual activity Comparing Job Costing and Process Costing

8-13 Learning Objective 3

8-14 Same objective: determine the cost of products Same Inventory accounts: raw materials, work in process, and finished goods Same overhead assignment method: predetermined rate times actual activity No beginning or ending Work in Process Inventory Common when a company is successful at just-in-time production Department With No Beginning or Ending WIP Inventory Cost per unit = Manufacturing costs for a period Units produced for the period

8-15 Spirit Beverages produces a sport drink. During October, the Blending Department had the following manufacturing costs: Spirit started and completed 8,000 four-bottle packages during October. Spirit had no beginning work in process inventory. Compute the manufacturing unit costs for October. Department With No Beginning or Ending WIP Inventory

8-16 Department With Ending WIP Inventory Same objective: determine the cost of products Same Inventory accounts: raw materials, work in process, and finished goods Same overhead assignment method: predetermined rate times actual activity No beginning Work in Process Inventory Ending Work in Process Inventory consists of incomplete units at the end of the period. We must now deal with the concept of equivalent units.

8-17 Same objective: determine the cost of products Same Inventory accounts: raw materials, work in process, and finished goods Same overhead assignment method: predetermined rate times actual activity Equivalent units is a concept expressing partially complete units as a smaller number of fully complete units. Cost per equivalent unit = Manufacturing costs for a period Equivalent units for the period We must now deal with the concept of equivalent units. Department With Ending WIP Inventory

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

8-19 Let’s look at the five-step process for assigning costs to units produced, followed by an example using the five steps. Assigning Costs to Products

8-20  Summarize the flow of physical units (number of units completed and number of units remaining in process).  Compute the number of equivalent units produced.  Summarize the total costs to be accounted for (costs in beginning work in process inventory and the costs incurred in the current period).  Compute costs per equivalent unit.  Assign unit costs from  to units completed and to units in ending work-in-process inventory.  Summarize the flow of physical units (number of units completed and number of units remaining in process).  Compute the number of equivalent units produced.  Summarize the total costs to be accounted for (costs in beginning work in process inventory and the costs incurred in the current period).  Compute costs per equivalent unit.  Assign unit costs from  to units completed and to units in ending work-in-process inventory. Assigning Costs to Products – The Five-step Process

8-21 Spirit incurred the following manufacturing costs in October (same data as before): Spirit started 8,000 units and completed 6,000 units in October. Spirit had no beginning work in process inventory. All direct materials had been added to each unit still in process, but only 20 percent of conversion costs had been incurred for the 2,000 units still in process. Complete the five-step process to assign costs to units produced in October. Department With Ending WIP Inventory

8-22 Department With Ending WIP Inventory – Equivalent Units

8-23 Units completed and transferred are 100% complete for both material and conversion. Department With Ending WIP Inventory – Equivalent Units

8-24 All material had been added to units remaining in process. Department With Ending WIP Inventory – Equivalent Units

% of 2,000 units Department With Ending WIP Inventory – Equivalent Units

8-26 Department With Ending WIP Inventory – Assigning Costs

8-27 $16,000 ÷ 8,000 equivalent units $5,600 ÷ 6,400 equivalent units Department With Ending WIP Inventory – Assigning Costs

8-28 6,000 equivalent $2.00 6,000 equivalent $0.875 Department With Ending WIP Inventory – Assigning Costs

8-29 2,000 equivalent $ equivalent $0.875 Department With Ending WIP Inventory – Assigning Costs

8-30 Learning Objective 4

8-31 Primary question to be answered: Which units were completed first during the period? (How you answer this question will affect the Total EU for the period.) Primary question to be answered: Which units were completed first during the period? (How you answer this question will affect the Total EU for the period.) Department with Beginning & Ending WIP Inventory When there is Beginning WIP, the determination of equivalent units becomes somewhat more complicated.

8-32 Weighted Average vs. FIFO Weighted- Average All units and costs are considered together to determine average cost per EU, regardless of whether the costs were incurred last period or currently. Weighted- Average All units and costs are considered together to determine average cost per EU, regardless of whether the costs were incurred last period or currently. FIFO Costs are accounted for by layer. Cost per EU for this period is computed separately from the Cost per EU for last period. FIFO Costs are accounted for by layer. Cost per EU for this period is computed separately from the Cost per EU for last period. Department with Beginning & Ending WIP Inventory

8-33 Weighted- Average All units and costs are considered together to determine average cost per EU, regardless of whether the costs were incurred last period or currently. Weighted- Average All units and costs are considered together to determine average cost per EU, regardless of whether the costs were incurred last period or currently. Weighted- Average is the most commonly used method. Weighted Average vs. FIFO Department with Beginning & Ending WIP Inventory

8-34 Let’s revisit Spirit in December where we have a beginning inventory from the previous month. Assigning Costs Using 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. The FIFO method is covered in Appendix A. 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. The FIFO method is covered in Appendix A.

8-35 Spirit had the following cost and unit data for December: Complete the five-step process to assign costs to units completed and to units left in process for December. Beginning and Ending Inventory Weighted-Average Costing

8-36 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. Beginning and Ending Inventory Weighted-Average Costing

8-37 Beginning Inventory 2,000 units 12,000 units started Ending Inventory 4,000 units 14,000 units 10,000 units completed Now let’s examine the five-step process. Beginning and Ending Inventory Weighted-Average Costing

8-38 Beginning and Ending Inventory Weighted-Average Costing

8-39 Units completed and transferred are 100% complete for both material and conversion. Beginning and Ending Inventory Weighted-Average Costing

% of 4,000 units60% of 4,000 units Beginning and Ending Inventory Weighted-Average Costing

8-41 Beginning and Ending Inventory Weighted-Average Costing

8-42 $22,000 ÷ 11,000 equivalent units $8,000 ÷ 12,400 equivalent units Beginning and Ending Inventory Weighted-Average Costing

,000 equivalent $ ,000 equivalent $ Beginning and Ending Inventory Weighted-Average Costing

8-44 1,000 equivalent $2.00 2,400 equivalent $ Beginning and Ending Inventory Weighted-Average Costing

8-45 Learning Objective 5

8-46 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. Let’s revisit Spirit. with the addition of transferred-in units and costs. We will use the December information and the weighted-average method. 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. Let’s revisit Spirit. with the addition of transferred-in units and costs. We will use the December information and the weighted-average method.

8-47 Complete the five-step process for Spirit to assign costs to units completed and to units left in process for December. Costs Transferred in from Prior Departments

8-48 Costs Transferred in from Prior Departments

8-49 Costs Transferred in from Prior Departments 100% complete for material, conversion, and transferred-in units.

8-50 Costs Transferred in from Prior Departments 25% of 4,000 units 60% of 4,000 units Transferred-in units are 100% complete

8-51 Costs Transferred in from Prior Departments

8-52 $22,000 ÷ 11,000 equivalent units Costs Transferred in from Prior Departments $8,000 ÷ 12,400 equivalent units $57,000 ÷ 14,000 equivalent units

,000 equivalent $ ,000 equivalent $ Costs Transferred in from Prior Departments 10,000 equivalent $4.0714

8-54 1,000 equivalent $2.00 Costs Transferred in from Prior Departments 2,400 equivalent $ ,000 equivalent $4.0714

8-55 Learning Objective 6

8-56 Accounting for Spoilage Costs Spoilage represents the amount of resources that go into the process, but DO NOT result in finished product. Managers face key problems related to spoilage: 1. Identifying whether it exists. 2. Determining whether it can be eliminated. 3. Deciding whether eliminating it is worthwhile. 4. Determining the cost of spoilage. The 5-step approach discussed earlier can be modified by including spoilage Spoilage represents the amount of resources that go into the process, but DO NOT result in finished product. Managers face key problems related to spoilage: 1. Identifying whether it exists. 2. Determining whether it can be eliminated. 3. Deciding whether eliminating it is worthwhile. 4. Determining the cost of spoilage. The 5-step approach discussed earlier can be modified by including spoilage

8-57 Accounting for Spoilage Costs Abnormal spoilage is the result of unusual operating problems. Abnormal spoilage is in addition to normal spoilage, and is recorded as a loss of the period. Normal spoilage occurs as a part of the regular operations of an efficient process. We will illustrate the spoilage using the December data for Spirit Beverages, but without the transferred-in costs.

8-58 Accounting for Spoilage Costs Spoilage is found at an inspection when 20% of the material has been added and the conversion is 50% complete.

8-59 Beginning Inventory 2,000 units 12,000 units started Spoilage 500 units 14,000 units 10,000 units completed Accounting for Spoilage Costs Complete the five-step process to assign costs to units completed and to units left in process for December. Ending Inventory 3,500 units

8-60 Accounting for Spoilage Costs

8-61 Accounting for Spoilage Costs Units completed and transferred are 100% complete for both material and conversion.

8-62 Accounting for Spoilage Costs 20% of 500 units 50% of 500 units

% of 3,500 units60% of 3,500 units Accounting for Spoilage Costs

8-64 Accounting for Spoilage Costs

8-65 $22,000 ÷ 10,975 equivalent units $8,000 ÷ 12,350 equivalent units Accounting for Spoilage Costs

,000 equivalent $ ,000 equivalent $ Accounting for Spoilage Costs

equivalent $ equivalent $ Accounting for Spoilage Costs

equivalent $ ,100 equivalent $ Accounting for Spoilage Costs

8-69 Let’s conclude our discussion of process costing by examining the cost flows in a two- department process, A and B. We will use T-accounts and start with materials. Process Cost Flows

8-70 Other Overhead Factory Overhead WIP Dept. A Direct Materials WIP Dept. B Purchases Direct Materials Materials Inventory Process Cost Flows

8-71 Other Overhead Factory Overhead Indirect Materials WIP Dept. A Direct Materials WIP Dept. B Indirect Materials Purchases Materials Inventory Direct Materials Process Cost Flows

8-72 Next let’s add labor and manufacturing overhead to the process cost flows. Are you with me? Process Cost Flows

8-73 Other Overhead Factory Overhead Wages Payable Indirect Labor WIP Dept. A Direct Materials WIP Dept. B Indirect Labor Indirect Materials Process Cost Flows

8-74 Other Overhead Factory Overhead Overhead Applied to Work in Process Wages Payable Direct Labor Indirect Labor WIP Dept. A Direct Materials Conversion Direct Materials Conversion WIP Dept. B Indirect Labor Indirect Materials Process Cost Flows

8-75 Next let’s transfer work from Department A to Department B. Are you ready? Process Cost Flows

8-76 Transferred to Dept. B Transferred from Dept. A WIP Dept. A Direct Materials Conversion Direct Materials Conversion WIP Dept. B Process Cost Flows

8-77 Now let’s complete the goods in Department B and sell them. Still with me? Process Cost Flows

8-78 Finished Goods Cost of Goods Mfd. Cost of Goods Sold WIP Dept. B Direct Materials Conversion Transferred from Dept. A Process Cost Flows

8-79 Finished Goods Cost of Goods Sold Cost of Goods Mfd. Cost of Goods Sold Cost of Goods Mfd. Cost of Goods Sold WIP Dept. B Direct Materials Conversion Transferred from Dept. A Process Cost Flows

8-80 Learning Objective 7

8-81 Cost Assignment to Products Using FIFO The weighted-average inventory method mixes previous period costs with those of the present period. FIFO assumes that units in the beginning inventory were completed. Count production in this period only when calculating equivalent units. This allows managers to identify and manage current period costs.

8-82 Learning Objective 8

8-83 Comparing Weighted-Average and FIFO Costing Methods Using FIFO to isolate current period costs is useful when the beginning inventory balance is very large. Otherwise, the smaller the beginning inventory balance, the closer the unit cost results under both methods. Though either method is acceptable for external reporting, separating the costs with FIFO is preferable.

8-84 Learning Objective 9

8-85 Operation Costing A hybrid of job-order and process costing. Applied to production activities: with repetitive operations (so conversion costs do not change). when different materials may be used (so materials costs could change). Examples: Fabrics used in shirt manufacturing Engines used in similar cycle bodies

8-86 End of Chapter 8