1. Process Costing Chapter 04 Chapter 4: 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. 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. 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, labor, or overhead are added to the product. The output from a processing department is homogeneous, that is, they all appear the same (homogeneous output). Products in a process costing environment typically flow in a sequence from one department to another.

3. 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 system, 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, 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

4. 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.

5. Process Cost Flows: The Flow of Labor Costs (in T-account form)
Salaries and Wages Payable
Work in Process Department A
Direct Materials
Direct Labor
Direct Labor
Work in Process Department B
Direct labor 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 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

6. 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 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

7. 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 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.
Department A
Department B

8. 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 Labor
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 goods manufactured.

9. 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 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

10. Equivalent Units of Production
Equivalent units are the product of the number of partially completed units and the percentage completion of those units.
Equivalent units are the product of the number of partially completed units and the percentage 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.
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. Equivalent Units – The Basic Idea
Two half-completed products are equivalent to one complete 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 complete 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.

12. 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.

13. Treatment of Direct Labor
Direct Materials
Direct labor and manufacturing overhead may be combined into one classification of product cost called conversion costs.
Conversion
Direct Labor
Dollar Amount
Direct Labor
Manufacturing Overhead
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

14. 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.

15. Process Costing Using the FIFO Method
Appendix 4A
Appendix 4A: FIFO Method

16. FIFO vs. Weighted-Average Method
The FIFO method (generally considered more accurate than the weighted-average method) differs from the weighted-average method in two ways:
The computation of equivalent units.
The way in which the costs of beginning inventory are treated.
FIFO is considered a more accurate measure of cost than weighted-average. It is important to be careful with your handling of beginning work in process inventory when using the FIFO method. While the calculations in weighted-average and FIFO appear to be similar, there are significant differences between the two methods. We will be using our previous example to illustrate the FIFO method.

17. Cost per Equivalent Unit - FIFO
The formula for computing the cost per equivalent unit under FIFO method is:
Cost per equivalent unit =
Cost added during the period
Equivalent units of production
We calculate the cost per equivalent unit by dividing costs added during the period by the equivalent units we previously calculated.

18. 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.

19. End of Chapter 04
End of Chapter 4.