1. Systems Design: Process Costing
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Systems Design: Process Costing
Chapter Four
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.

2. Similarities Between Job-Order and Process Costing
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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.
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.

3. Differences Between Job-Order and Process Costing
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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 systems accumulate costs by department. Job-order costing systems accumulate costs by individual jobs.
Process costing 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.

4. Quick Check  Process costing is used for products that are:
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Quick Check 
Process costing is used for products that are:
a. Different and produced continuously.
b. Similar and produced continuously.
c. Individual units produced to customer specifications.
d. Purchased from vendors.
Can you identify the most likely circumstances where a process costing system may be used?

5. Quick Check  Process costing is used for products that are:
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Quick Check 
Process costing is used for products that are:
a. Different and produced continuously.
b. Similar and produced continuously.
c. Individual units produced to customer specifications.
d. Purchased from vendors.
Can you identify the most likely circumstances where a process costing system may be used?

6. Processing Departments
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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.
A processing department is any location 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.

7. 4-7
Learning Objective 1
Record the flow of materials, labor, and overhead through a process cost system.
Learning objective number 1 is to record the flow of materials, labor, and overhead through a process cost system.

8. Comparing Job-Order and Process Costing
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Comparing Job-Order and Process Costing
Direct Materials
Finished Goods
Work in Process
Direct Labor
In all manufacturing systems, direct material, direct labor, and manufacturing overhead are charged to Work in Process Inventory. As we complete the production process, goods are transferred to the Finished Goods Inventory. Finally, when we sell the finished goods, we transfer the cost to cost of goods sold.
Manufacturing Overhead
Cost of Goods Sold

9. Comparing Job-Order and Process Costing
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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
In a job-order cost system costs are traced to individual jobs. All of the jobs in process make up the company’s Work in Process Inventory.
Manufacturing Overhead
Cost of Goods Sold

10. Comparing Job-Order and Process Costing
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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. 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

11. T-Account and Journal Entry Views of Cost Flows
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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 and journal entries.
Let’s look at the flow of costs through the tee accounts and related journal entries for a manufacturing process that has two departments – Department A and Department B.

12. Process Cost Flows (in T-account form)
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Process Cost Flows (in T-account form)
Work in Process Department A
Raw Materials
Direct Materials
Direct Materials
Work in Process Department B
Part I 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 account is credited for the corresponding amounts.

13. Process Cost Flows (in journal entry form)
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Process Cost Flows (in journal entry form)
The journal entry that shows the requisition of direct materials for use in Processing Departments A and B, is to debit the processing department of the direct materials requisitioned and credit Raw Materials Inventory. Notice that the direct materials are placed into a separate work in process account for each processing department.

14. Process Cost Flows (in T-account form)
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Process Cost Flows (in T-account form)
Work in Process Department A
Wages Payable
Direct Materials
Direct Labor
Direct Labor
Work in Process Department B
Direct labor is transferred from the 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

15. Process Costing (in journal entry form)
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Process Costing (in journal entry form)
Here is the journal entry to place the direct labor into the work in process inventory of departments A and B.

16. Process Cost Flows (in T-account form)
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Process Cost Flows (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

17. Process Costing (In journal entry form)
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Process Costing (In journal entry form)
This is the journal entry we use to apply overhead to the work in process inventory of each of the processing departments.

18. Process Cost Flows (in T-account form)
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Process Cost Flows (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.

19. Process Costing (in journal entry form)
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Process Costing (in journal entry form)
To transfer the costs, we debit the work in process inventory in Department B, and credit, or reduce, the work in process inventory in Department A.

20. Process Cost Flows (in T-account form)
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Process Cost Flows (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
Here we see the transfer of completed goods our of Work in Process – Department B and into Finished Goods Inventory. The costs transferred represent the cost of good manufactured.
Transferred from Dept. A

21. Process Costing (in journal entry form)
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Process Costing (in journal entry form)
The necessary journal entry is to debit finished goods inventory and credit work in process inventory in Department B to transfer finished production.

22. Process Cost Flows (in journal entry form)
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Process Cost Flows (in journal entry 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

23. Process Costing (in journal entry form)
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Process Costing (in journal entry form)
If we assume the company uses the perpetual inventory system, two entries are required to record a sale. The first entry is to record the sale and account receivable. The second entry is to transfer the finished goods sold to cost of goods sold.
Sales are recorded at selling price and cost of good sold is recorded at cost. The difference between the two is the gross margin on the sale.

24. Equivalent Units of Production
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Equivalent Units of Production
Equivalent units are the product of the number of partially completed units and the percentage completion of those units.
Partially completed units complicate the determination of a department’s output for a given period and the unit cost that should be assigned to that output. Equivalent units need to be calculated because a department usually has some partially completed units in its beginning and ending inventory. These partially completed units complicate the determination of a department’s output for a given period and the unit cost that should be assigned to that output.
We need to calculate equivalent units because a department usually has some partially completed units in its beginning and ending inventory.

25. Equivalent Units – The Basic Idea
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Equivalent Units – The Basic Idea
Two half completed products are equivalent to one completed 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 completed 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.

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Quick Check 
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
Read the information carefully and determine how many equivalent units of production were manufactured during the period.

27. 4-27
Quick Check 
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
The correct answer is 11,500 equivalent units. How did you do?
10,000 units + (5,000 units × 0.30) = 11,500 equivalent units

28. Calculating Equivalent Units
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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 may be calculated using the FIFO method or the weighted-average method. For the bulk of this chapter we will use the weighted-average method. We cover the FIFO method in the appendix to this chapter.

29. 4-29
Learning Objective 2
Compute the equivalent units of production using the weighted-average method.
Learning objective number 2 is to compute the equivalent units of production using the weighted average method.

30. Equivalent Units of Production Weighted-Average Method
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Equivalent Units of Production Weighted-Average Method
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.
Determines equivalent units of production for a department by adding together the number of units transferred out plus the equivalent units in ending work in process inventory.
When we use the weighted-average method we make no distinction between work done in the prior period and work done in the current period. We blend together the units and costs from both the prior and current period.
We determine the cost per equivalent unit by dividing costs for the period by the equivalent units of production. The equivalent units of production for a department are the number of units transferred to the next department (or finished goods) plus the equivalent units in the department’s ending work in process inventory.

31. Treatment of Direct Labor
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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

32. Treatment of Direct Labor
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Treatment of Direct Labor
Direct Materials
Direct labor costs may be small in comparison to other product
costs in process cost systems.
Conversion
Dollar Amount
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
Direct labor and manufacturing overhead may be combined into one product cost called conversion.

33. Weighted-Average Example
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Weighted-Average Example
Double Diamond Skis reported the following activity in Shaping and Milling Department for the month of May:
Let’s look at an example of calculating the cost per equivalent unit for the shaping and milling department of Double Diamond Skis. The shaping and milling department is only one of the company’s processing departments. Notice that Department A started the month of May with 200 units that are 55% complete as to materials and 30% complete as to conversion (direct labor and overhead). During the month the Department started 5,000 units into production. 4,800 units were transferred out to the next department during the month of May. At the end of May, the department had 400 units, 40% complete as to materials and 25% complete as to conversion.
Since the Department began the month with three hundred units and started six thousand units into production, we have sixty-three hundred units to account for. Of these sixty-three hundred units, fifty-four hundred were transferred out and nine hundred remain in work in process inventory.

34. Weighted-Average Example
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Weighted-Average Example
The first step in calculating the equivalent units is to identify the units completed and transferred out of the Department in May (4,800 units)
The first step in calculating the equivalent units is to identity the units completed and transferred out. In the case of the shaping and milling department, there were 4,800 units completed and transferred out. We know these units are 100% complete as to materials and conversion.

35. Weighted-Average Example
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Weighted-Average Example
The second step is to identify the equivalent units of production in ending work in process with respect to materials for the month (160 units) and add this to the 4,800 units from step one.
The second step is to calculate the equivalent units as to materials in ending inventory. We know there are 400 units in ending inventory that are 40% complete as to materials. So we know that there are 160 equivalent units as to materials in ending working in process inventory.
For materials we add the units completed and transferred out to the equivalent units as to materials, for total units as to materials of five thousand nine hundred forty units.

36. Weighted-Average Example
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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 (100 units) and add this to the 4,800 units from step one.
The third step is to calculate the equivalent units in ending inventory as to conversion. We know there are 400 units in ending work in process inventory that are 25% complete as to conversion. So there are 100 equivalent units as to conversion in ending inventory.
For conversion, we add the units completed and transferred out to the equivalent units as to conversion to arrive at a total equivalent units as to conversion of five thousand six hundred seventy units.
We always follow these three steps when using the weighted-average method.

37. Weighted-Average Example
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Weighted-Average Example
Equivalent units of production always equals:
Units completed and transferred
+ Equivalent units remaining in work in process
We can restate the three-step process more quickly by saying that, when using the weighted-average method, equivalent units of production will always be equal to the units completed and transferred out plus the equivalent units remaining in work in process inventory. Some of you may prefer the three-step approach while others may prefer the short-cut approach.

38. 4-38
Learning Objective 3
Compute the cost per equivalent unit using the weighted-average method.
Learning objective number 3 is to compute the cost per equivalent unit using the weighted-average method.

39. Compute and Apply Costs
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Compute and Apply Costs
Beginning work in process: units
Materials: % complete $ 9,600
Conversion: 30% complete 5,575
Production started during May 5,000 units
Production completed during May 4,800 units
Costs added to production in May
Materials cost $ 368,600
Conversion cost ,900
Ending work in process units
Materials: % complete
Conversion: % complete
Assume the following additional facts with respect to Double Diamond Skis’ Shaping and Milling Department.
The department started the month of May with two hundred units, fifty-five percent complete as to materials and thirty percent complete as to conversion (labor and overhead).
During May, five thousand units were started into production and forty-eight hundred units were completed and transferred out. You can see the costs associated with materials and conversion.
At the end of May, there were four hundred units in ending working in process inventory, forty percent complete as to materials and twenty five percent complete as to conversion.
Let’s prepare the Production Report for May. Remember, we start with the first section that computes the equivalent units as to materials and conversion.

40. Compute and Apply Costs
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Compute and Apply Costs
The formula for computing the cost per equivalent unit is :
Cost per equivalent unit =
Cost of beginning work in process inventory
Cost added during the period
/Equivalent units of production +
We calculate the cost per equivalent unit by adding together the cost of beginning work in process inventory and the cost added during the period. We divide the total dollar amount by the number of equivalent units we previously calculated.

41. Compute and Apply Costs
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Compute and Apply Costs
Here is a schedule with the cost and equivalent unit information.
We begin by adding the costs in beginning inventory to the costs incurred during the current period. The sum of the cost of materials and conversion equal the total cost to be accounted for during the period. Notice that we have 4,960 equivalent units as to materials, and 4,900 equivalent units as to conversion.
Let’s look at the calculate of the cost per equivalent unit.

42. Compute and Apply Costs
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Compute and Apply Costs
Here is a schedule with the cost and equivalent unit information.
Part I
We have a total cost of $378,200 and 4,960 equivalent units, so the cost per equivalent unit is $76.25 for materials.
Part II
With total costs of $356,475 and total equivalent units of 4,900, we have an average cost per equivalent unit of $72.75 for conversion.
Part III
So, the total cost of materials and conversion is $ per equivalent unit.
We add our materials and conversion cost per equivalent unit to get a total cost per equivalent unit during May of one hundred forty-nine dollars.
This completes the second section of the Production Report. The last section is the cost reconciliation.
$356,475 ÷ 4,900 units = $72.75
$378,200 ÷ 4,960 units = $76.25

43. Assign costs to units using the weighted-average method.
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Learning Objective 4
Assign costs to units using the weighted-average method.
Learning objective number 4 is to assign costs to units using the weighted-average method.

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Applying Costs
Let’s start the process of computing the cost of ending work in process inventory.
The first step is to record the equivalent units of production in ending work in process inventory (160 units for materials and 100 units for conversion).

45. 4-45
Applying Costs
The second step is to record the cost per equivalent unit ($76.25 for materials and $72.75 for conversion).

46. 4-46
Applying Costs
The third step is to compute the cost of ending work in process inventory ($12,200 for materials, $7,275 for conversion, and $19,475 in total).

47. Computing the Cost of Units Transferred Out
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Computing the Cost of Units Transferred Out
Now, let’s Compute the cost of units transferred
The first step is to record the units transferred out to the next department (4,800 units for materials and conversion).

48. Computing the Cost of Units Transferred Out
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Computing the Cost of Units Transferred Out
The second step is to record the cost per equivalent unit ($76.25 for materials and $72.75 for conversion).

49. Computing the Cost of Units Transferred Out
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Computing the Cost of Units Transferred Out
The third step is to compute the cost of units transferred out ($366,000 for materials, $349,200 for conversion and $715,200 in total).

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Reconciling Costs
Next, we must reconcile the costs. The first step is to record the cost of beginning work in process as shown on slide 39 ($15,175). The second step is to record the costs added to production during the period as shown on slide 39 ($719,500). The third step is to sum these two costs ($734,675).

51. 4-51
Reconciling Costs
Computing the costs accounted for: The first step is to record the previously computed cost of ending working process inventory ($19,475). The second step is to record the previously computed cost of units transferred out ($715,200). The third step is to sum these two costs ($734,675). Notice the two totals agree indicating that all costs have been accounted for.

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Operation Costing
Operation cost is a hybrid of job-order and process costing because it possesses attributes of both approaches
Operation costing is commonly used when batches of many different products pass through the same processing department.
Operation costing is similar to job-order costing. For example, a shoe manufacturer may charge each batch of shoes for its own specific material costs (e.g., shoes made with expensive leather would be charged accordingly, as would shoes made with inexpensive synthetic materials). It is also similar to process costing, the shoe manufacturer may accumulate the labor and overhead costs by department and assign the same conversion cost per unit to each shoe regardless of the shoe style

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End of Chapter 4
End of chapter 4.