1. Systems Design: Process Costing
April
Systems Design:
Process Costing
Chapter 4: Systems Design: Process Costing.
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. April 14, 2010 System Design – Process Costing
Review of Process Costing versus Job-Order Costing
When should Process Costing be Used?
How is it Used?
Journal entries
Calculating balances by the Weighted Average Cost method

3. Product Costing
Product Costing is the mapping and allocating of costs to a specific product
Its purpose is to provide executives with critical information including:
How to minimize costs
How to price a product competitively and profitably
There are two main methodologies of Product Costing
1. Job-Order Costing – each job is different
2. Process Costing – many of the same products

4. Job Order Costing
Job-Order Costing is the costing methodology applied in companies in the following circumstances:
Produce many different products or packages
Manufacture to order so each job is different
Examples would be:
SNC (engineering and construction)
Airbus (aircraft)
Other?
In these cases, a company needs to know, often on an order by order basis, what are the costs associated with fulfilling the order
Cost records for each job will be required to support decision making and billing of the customer

5. Process Costing
Process Costing is the costing methodology applied in companies in the following circumstances:
Produce many units of a single product
Each unit is substantially similar to other units
Examples would be:
Lenovo (PC manufacturing)
Frito lay (Snacks and beverages)
Others?
That each of these products are substantially the same, managers are able to apply the same average cost to each unit
Cost records for each job will be required to support decision making and billing of the customer

6. Similarities & Differences Between Job-Order and Process Costing
Both are Product Costing systems assigning material, labour and overhead to products
Both systems use the same manufacturing accounts
The flow of costs are very similar in both systems
Differences
Process Costing is used for single products which run continuously (versus differing products/packages)
Process Costing tracks cost by department (versus by job)
Tracks unit cost by department (versus by job sheet)

7. Flow of Materials, Labor and Overhead Costs
Costs are traced and applied to departments in a process cost system.
Direct Materials
Processing
Department
Finished Goods
Direct Labor
Process costing systems trace and apply manufacturing costs to departments. A separate Work in Process account is maintained for each processing department.
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.
ManufacturingOverhead
Cost of Goods Sold

8. Processing Departments
The same three inputs go into Work in Process as in Job-Order Costing
In Process Costing, Processing Departments must be identified
A Processing department is any department in which the activities and output are uniform:
Assembly Department
Testing Department
Others?
Inventories get transferred from one department through to the other
Costs are accumulated in each department and average unit costs are used

9. Process Cost Flows & Journal Entries
Journal entry examples:

10. Equivalent Units of Production
Usually, there will be some Work in Process Inventory in a department at the beginning of the period
Each unit or group of units may be a certain percentage complete
To obtain an opening inventory balance, the Equivalent Units methodology is used roughly as follows
Estimate to what extent each unit is complete
Multiply the percentage complete by the number of units
Sum all the units
Equivalent units are defined as the product of the number of partially completed units and the percentage of completion of those units.
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.

11. Two Methodologies for Calculating Costed Equivalent Units
There are two main methodologies for Calculating Equivalent Units
Weighted Average
No distinction between work done or costs incurred in prior and current periods
Equivalent units of production is the sum of
Units transferred out to the next department or finished goods, plus
Ending Equivalent Units in WIP
Note: Opening Equivalent Units in WIP were Equivalent Units of Production from the preceding period
First-In-First-Out (FIFO)
Distinguishes between work done and costs in different periods

12. Weighted Average Method
Direct Labour and Manufacturing Overhead are often consolidated into a single account called “Conversion”
This is a simplifying step taken as DL is often very small relative to DM and Manufacturing Overhead

13. Weighted Average Method – Equivalent Units of Production
Calculation of Equivalent Units of Production
= Units transferred out plus ending Equivalent Units (definitional)
Assume:
Cost of beginning WIP-Materials was $4,000; WIP-Conversion was $9,000
Cost of additional production –Materials was $200,000, Conversion was $250,000
What was the cost per equivalent unit?

14. Weighted Average Method
Cost per equivalent unit =
Cost of beginning work in process inventory
Cost added during the period
Equivalent units of production +
Cost of beginning WIP-Materials was $4,000; WIP-Conversion was $9,000
Cost of additional production –Materials was $200,000, Conversion was $250,000

15. Weighted Average Method
Cost per equivalent unit =
Cost of beginning work in process inventory
Cost added during the period
Equivalent units of production +

16. Computing the Cost of Units Transferred Out & Ending WIP
These totals will be entered into the Balance Sheet accounts

17. Reconciling Costs
The following exercise will provide a reconciliation, a “check” on your calculations

18. Review System Design – Process Costing
Review of Process Costing versus Job-Order Costing
When should Process Costing be Used?
How is it Used?
Journal entries
Calculating balances by the Weighted Average Cost method

19. Tutorial

20. FIFO Method
Appendix 4A: FIFO Method.

21. April 15, 2010 System Design – Process Costing – FIFO Inventory Method
What is FIFO?
FIFO versus Average Cost method
When should FIFO be used?
Journal entries
Calculating balances by the FIFO Cost method

22. FIFO FIFO is a method of calculating inventory balances
First in - First out
Materials, labour and overhead is drawn into production over time
FIFO attributes the earlier costs drawn to the inventory that leaves the department or finished goods first
FIFO is generally considered more accurate than the Weighted Average method
Better attributes costs in any given period
Identifies cost overruns more quickly and distinctly allowing managers to address problems with minimal delay

23. Equivalent Units – FIFO Method
Back to “Department B” from the Weighted Average Example
This will help us compare the methodologies side-by-side

24. FIFO – Equivalent Units of Production
Calculation of Equivalent Units of Production
Note: Units started & completed = units started less ending WIP units

25. Equivalent Units of Production - Reconciling WA to FIFO
The fundamental difference between Equivalent Units of Production under FIFO is that beginning WIP is subtracted from the WA conclusion

26. Calculating Unit Cost - FIFO Method
Note: Equivalent Units are usually not the same
Cost per equivalent unit =
Cost added during the period
Equivalent units of production

27. Computing the Cost of Ending WIP - FIFO
This total will be entered into the Balance Sheet accounts

28. Computing the Cost of Units Transferred Out - FIFO
This total will be entered into the Balance Sheet accounts

29. Reconciling Costs
As with the Weighted Average Method, the following exercise will provide a reconciliation, a “check” on your calculations for the FIFO Method

30. A Comparison of Costing Methods
In a lean production environment, FIFO and weighted-average methods yield similar unit costs.
When considering cost control, FIFO is superior to weighted-average because it does not mix costs of the current period with costs of the prior period.
In most situations, the weighted-average and FIFO methods will produce very similar unit costs, particularly in a lean production environment. From a cost control standpoint, the FIFO method is superior to the weighted-average method because it does not mix costs of the current period with costs of the prior period.

31. Review System Design – Process Costing – FIFO Inventory Method
What is FIFO?
FIFO versus Average Cost method
When should FIFO be used?
Journal entries
Calculating balances by the FIFO Cost method

32. Tutorial