Chapter 6 Process Costing Cost Accounting Foundations and Evolutions Kinney and Raiborn Seventh Edition COPYRIGHT © 2009 South-Western, a part of Cengage Learning. South-Western is a trademark used herein under license.

Learning Objectives (1 of 3) Contrast process costing and job order costing Explain why equivalent units of production are used in process costing Calculate equivalent units of production, unit costs, and inventory values using weighted average method of process costing

Learning Objectives (2 of 3) Compute equivalent units of production, unit costs, and inventory values using FIFO method of process costing Compute equivalent units of production, unit costs, and inventory values using standard costing Explain why a company would use a hybrid costing system

Learning Objectives (3 of 3) (Appendix 1) Explain the alternative methods used to calculate equivalent units of production (Appendix 2) Describe how normal and abnormal spoilage losses are treated in an EUP schedule

Job Order vs. Process Costing Job Order Small quantities of distinct products or services Assign costs to job and then to units within the job Process Costing Large quantities of homogeneous products or services Using an averaging technique, assign costs directly to units produced during the period

Process Costing The Numerator - Production Costs –Accumulate costs by department –Accumulate costs by product –Direct material from material requisitions –Direct labor from time sheets and wage rates –Overhead Actual Predetermined application rates Unit Cost =Production Costs Production Quantity

Process Costing Production Costs –Direct material from material requisitions –Direct labor from time sheets and wage rates –Overhead Actual Predetermined application rates

Process Costing The Denominator - Units Produced Complicated by work in process –Units started last period and completed this period –Units started this period and not completed Convert partially completed units to equivalent whole units Unit Cost =Production Costs Production Quantity

Equivalent Units of Production (EUP) Approximation of the number of whole units of output that could have been produced from the actual effort expended Includes units –started last period and finished this period –started and finished this period –started this period and not finished Assumes FIFO physical flow through the production department

Two Process Costing Methods Weighted Average Method –combines beginning work in process current period production FIFO Method –separates beginning work in process current period production

Process Costing Methods Weighted Average Beginning WIP 100% Started and finished 100% Ending WIP % completed FIFO Beginning WIP % completed Started and finished100% Ending WIP% completed THE DIFFERENCE

Process Costing Direct material –added at the beginning, during, and/or at the end of process Direct labor –added throughout the process Overhead –added throughout the process based on direct labor based on other, multiple cost drivers

Process Costing Steps 1Units to account for 2Units accounted for 3Determine equivalent units 4Costs to account for 5Compute cost per equivalent unit 6Assign costs to inventories Units Costs

Cost of Production Report Name of Department for the period --- Production Data: Units to account for Units accounted forEUP for each cost Cost Data: Costs to account for Cost per EUP Cost Assignment: Transferred Out Ending Work In Process Inventory

Process Costing with Standard Costs Simplify costing process Eliminate periodic cost recomputations Same as FIFO computations –emphasize current period costs and production Inventories are stated at standard cost Variances are calculated for material, labor, and overhead

Process Costing with Standard Costs Assigns a “normal” production cost to the equivalent units of output each period Allows managers to quickly recognize and investigate significant deviations from expected production costs Allows benchmarking with other firms

Hybrid Costing Systems Characteristics of job order and process costing systems Various product lines –different direct material - job order costing –different direct labor – job order costing –same process - process costing Hybrid costing used for furniture, clothing, jam

Normal Spoilage Abnormal Spoilage Continuous Loss Discrete Loss Loss in all ending inventory and transferred out units on an EUP basis Period expense in EUP Period expense in EUP Appendix 2 - Spoilage Loss in all units past inspection point in ending inventory and transferred out on an EUP basis

Questions What is an equivalent unit of production? What is the difference between the weighted average and FIFO methods of calculating equivalent units? Why would a company use a hybrid costing system?

Potential Ethical Issues Over or under estimating completion % for ending WIP inventory to distort results Using outdated standard costs Ignoring the assignment of significant direct costs to specific jobs Treating abnormal spoilage as normal spoilage