1. Similarities Between Job-Order and Process Costing
Both systems assign material, labour, and overhead costs to products and they provide a mechanism for computing unit product costs.
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, labour, 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.
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2. 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 having different production requirements are worked on each period.
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 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.
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3. Process costing is used for products that are:
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?
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4. Process costing is used for products that are:
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?
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5. Processing Departments
Any unit in an organization where materials, labour, 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. Products in a process costing environment
typically flow in a sequence from one department to another.
A processing department is any unit in an organization where materials, labour, or overhead are added to the product. The output from a processing department is homogeneous, that is, they all appear the same. Products in a process costing environment typically flow in a sequence from one department to another.
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6. Comparing Job-Order and Process Costing
Direct Materials
Work in Process
Finished Goods
Direct Labour
Cost of Goods Sold
The flow of costs through the manufacturing accounts is basically the same for process and job-order costing.
Direct materials, direct labour, and manufacturing overhead are added to Work in Process. When work in process is completed, the costs are transferred to Finished Goods. When finished goods are sold, the costs are transferred to Cost of Goods Sold.
Manufacturing Overhead
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7. 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 Labour
There is a key fundamental difference between process and job-order costing systems. Job-order costing systems trace and apply manufacturing costs to jobs. One Work in Process account is often used to accumulate costs for all jobs. The individual job cost sheets serve as a subsidiary ledger.
Manufacturing Overhead
Cost of Goods Sold
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8. 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 Labour
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. A separate Work in Process account is maintained for each processing department. Material, labour, 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
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9. 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.
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10. Process Cost Flows: The Flow of Raw Materials (in T-account form)
Work in Process Department A
Raw Materials
Direct Materials
Direct Materials
Work in Process Department B
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 Inventory account is credited for the corresponding amounts.
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11. Process Cost Flows: The Flow of Raw Materials (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.
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12. Process Cost Flows: The Flow of Labour Costs (in T-account form)
Salaries and Wages Payable
Work in Process Department A
Direct Materials
Direct Labour
Direct Labour
Work in Process Department B
Direct labour is transferred from the Salaries and Wages Payable account into the work in process account of Departments A and B depending upon where the individual employee worked. Direct labour costs are debited to the appropriate departmental Work in Process account depending upon where the labour was added to the production process. Salaries and Wages Payable is credited for the corresponding amounts.
Direct Materials
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13. Process Cost Flows: The Flow of Labour Costs (in journal entry form)
Here is the journal entry to place the direct labour into the work in process inventory of departments A and B.
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14. Manufacturing Overhead Overhead Applied to Work in Process
Process Cost Flows: The Flow of Manufacturing Overhead Costs (in T-account form)
Work in Process Department A
Direct Materials
Manufacturing Overhead
Direct Labour
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 Labour
Applied Overhead
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15. Process Cost Flows: The Flow of Manufacturing Overhead Costs (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.
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16. Work in Process Department A Work in Process Department B
Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept. B (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 Labour
Direct Labour
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.
Department A
Department B
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17. Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept
Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept. B (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.
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18. Cost of Goods Manufactured
Process Cost Flows: Transfers from WIP-Dept. B to Finished Goods (in T-account form)
Work in Process Department B
Finished Goods
Direct Materials
Cost of Goods Manufactured
Cost of Goods Manufactured
Direct Labour
Applied Overhead
Transferred from Dept. A
Here we see the transfer of completed goods from Work in Process – Department B into Finished Goods Inventory. The costs transferred represent the cost of good manufactured.
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19. Process Cost Flows: Transfers from WIP-Dept
Process Cost Flows: Transfers from WIP-Dept. B to Finished Goods (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.
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20. Process Cost Flows: Transfers from Finished Goods to COGS (in T-account form)
Work in Process Department B
Finished Goods
Direct Materials
Cost of Goods Manufactured
Cost of Goods Manufactured
Cost of Goods Sold
Direct Labour
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
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21. Process Cost Flows: Transfers from Finished Goods to COGS (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.
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22. Step-Down Method Service Department (Cafeteria) Operating Department
(Machining)
Once a service department’s costs are allocated, other service department costs are not allocated back to it.
Service Department
(Custodial)
Operating Department
(Assembly)
The step method provides for the allocation of a service department’s costs to other service departments, as well as to operating departments. It is a sequential allocation procedure, and the sequence usually begins with the service department that provides the greatest amount of service to other service departments. Once a service department’s costs have been allocated to other departments, other service department costs are not allocated back to it.
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23. Step-Down Method
There are three key points to understand regarding the step method:
 In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.
 Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.
 Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments.
There are three key points to understand regarding the step method:
 In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.
 Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.
 Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments.
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24. Step-Down Method
We will use the same data used in the direct method example.
We will use the same information shown on your screen for the step-method example. There are two service departments, Cafeteria and Custodial, and two operating departments, Machining and Assembly. Cafeteria costs are allocated to the operating departments based on the number of employees in each department. Custodial costs are allocated to each operating department based on the number of square feet in each operating department.
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25. Step-Down Method
How much of the Cafeteria and Custodial costs should be allocated to each operating department using the step method of cost allocation?
We will allocate Cafeteria first since it is larger and provides more service to Custodial than Custodial provides to Cafeteria.
Allocate Cafeteria costs first since it provides more service than Custodial.
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26. Step-Down Method $360,000 × 10 10 + 20 + 30 = $60,000
$360,000 × 10
= $60,000
The total number of employees in the allocation base is 60, 10 for Custodial plus 20 for Machining plus 30 for Assembly. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Custodial, the allocation percentage is 16-2/3%, obtained by dividing 10 employees by 60 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Custodial, we multiply 16-2/3% times $360,000 and get $60,000.
Allocation base: Number of employees
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27. Step-Down Method $360,000 × 20 10 + 20 + 30 = $120,000
$360,000 × 20
= $120,000
Next, let’s allocate Cafeteria costs to Machining. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Machining, the allocation percentage is 33-1/3%, obtained by dividing 20 employees by 60 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Machining, we multiply 33-1/3% times $360,000 and get $120,000.
Allocation base: Number of employees
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28. Step-Down Method $360,000 × 30 10 + 20 + 30 = $180,000
$360,000 × 30
= $180,000
Next, let’s allocate Cafeteria costs to Assembly. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Assembly, the allocation percentage is 50%, obtained by dividing 30 employees by 60 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Assembly, we multiply 50% times $360,000 and get $180,000. The sum of the assigned costs ($60,000 + $120,000 + $180,000) equals the total Cafeteria Department costs of $360,000.
Allocation base: Number of employees
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29. Step-Down Method
New total = $90,000 original Custodial cost plus $60,000 allocated from the Cafeteria.
Now, we can allocate Custodial costs. The costs in Custodial are now $150,000. This amount includes the department’s own costs of $90,000 plus the $60,000 allocated from Cafeteria. None of the $150,000 will be allocated back to Cafeteria. How much of the Custodial costs should be allocated to each operating department using the step method of cost allocation?
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30. Step-Down Method $150,000 × 25,000 25,000 + 50,000 = $50,000
$150,000 ×
25,000
25, ,000
= $50,000
The total number of square feet in the allocation base is 75,000, 25,000 for Machining plus 50,000 for Assembly. The allocation percentage is calculated by dividing the square feet in a department by the total number of square feet in the allocation base. For Machining, the allocation percentage is 33-1/3%, obtained by dividing t25,000 square feet by 75,000 square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Machining we multiply 33-1/3% times $150,000 and get $50,000.
Allocation base: Square feet occupied
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31. Step-Down Method $150,000 × 50,000 25,000 + 50,000 = $100,000
$150,000 ×
50,000
25, ,000
= $100,000
Next, let’s allocate Custodial costs to Assembly. The total number of square feet in the allocation base is 75,000, 25,000 for Machining plus 50,000 for Assembly. The allocation percentage is calculated by dividing the square feet in an operating department by the total number of square feet in the allocation base. For Assembly, the allocation percentage is 66-2/3%, obtained by dividing 50,000 square feet by 75,000 square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Assembly we multiply 66-2/3% times $150,000 and get $100,000. The sum of the costs assigned to Assembly ($100,000) and Machining ($50,000) is equal to the total costs assigned from the Custodial Department ($150,000).
Allocation base: Square feet occupied
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32. Reciprocal Method
Service Department
(Cafeteria)
Operating Department
(Machining)
Interdepartmental services are given full recognition rather than partial recognition as with the step method.
Service Department
(Custodial)
Operating Department
(Assembly)
The reciprocal method gives full recognition to interdepartmental services. While the step method only allocates forward – never backwards – the reciprocal method allocates service department costs in both directions. Reciprocal allocation requires the use of simultaneous linear equations and is beyond the scope of our discussion.
The reciprocal method is rarely used in practice because of it complexity and because the results are usually close to the step method results.
Because of its mathematical complexity, the reciprocal method is rarely used.
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33. Quick Check Data for Direct and Step Methods
The direct method of allocation is used.
Allocation bases:
Business school administration costs (ADMIN): Number of employees
Business Administration computer services (BACS): Number of personal computers
On your screen, you see information for a series of questions. The first cost allocation questions use the direct method. You will probably want to refer back to this screen as you work through the questions.
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34. Quick Check 
How much cost will be allocated from Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000
Here’s your first question using the direct method of service department cost allocation.
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35. Quick Check 
How much cost will be allocated from Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000
The total number of employees in the allocation base is one hundred, twenty in Accounting plus eighty others. Recall that we ignore the number of employees in BACS as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Accounting, the allocation percentage is 20%, obtained by dividing 20 employees by 100 employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to Accounting we multiply 20% times $180,000 and get $36,000.
$180,000 × 20
= $36,000
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36. Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500
Here’s your second question using the direct method of service department cost allocation.
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37. Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500
$90,000 × 18
= $13,500
We will allocate BACS costs to Accounting and add the result to the answer for the previous question. BACS is allocated on the basis of the number of personal computers in each operating department. The total number of personal computers in the allocation base is 120, 18 for Accounting plus 102 others. The allocation percentage is calculated by dividing the number of personal computers in an operating department by the total number of personal computers in the allocation base. For Accounting, the allocation percentage is 15%, obtained by dividing 18 personal computers by 120 personal computers. To allocate BACS costs to Accounting, we multiply 15% times $90,000 and get $13,500. The total amount allocated to Accounting is the sum of $36,000 and $13,500 for a total of $49,500.
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38. The step method of allocation is used.
Quick Check Data
The step method of allocation is used.
Allocation bases:
Business school administration costs (ADMIN): Number of employees
Business administration computer services (BACS): Number of personal computers
Now we will look at a question where we will use the step method of service department cost allocation. The information on your screen for this question is the same information that we used for the direct method questions.
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39. Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333
Here’s your question using the step method of service department cost allocation.
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40. Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333
ADMIN provides more service than BACS so we allocate it first. The total number of employees in the allocation base is 105, 5 for BACS, plus 20 for Accounting, plus 80 others. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Accounting, the allocation percentage is found by dividing 20 employees by 105 employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to Accounting we multiply the allocation percentage times $180,000 and get $34,286.
We must also allocate ADMIN costs to BACS. The allocation percentage is found by dividing 5 employees by 105 employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to BACS, we multiply the allocation percentage times $180,000 and get $8,571.
The new amount to be allocated from BACS is the original $90,000 plus $8,571, for a total of $98,571.
Now we can allocate BACS costs to Accounting. For BACS, the allocation percentage of 15% is found by dividing 18 computers by 120 computers. Next we multiply the allocation percentage times the service department cost. To allocate BACS costs to Accounting, we multiply 15% times $98,571 and get $14,786.
The total amount allocated to Accounting is $49,072.
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