1. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith Chapter 5 Process costing and operation costing

2. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 2 Product costing systems Job costing and process costing are two extremes of the continuum of conventional product costing systems Job costing systems accumulate the costs of each job Process costing systems accumulate the cost of each process, then average these costs across all units produced Many businesses use a combination of job and process costinghybrid costing

3. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 3 Process costing Used by businesses that mass-produce one product or a small range of almost identical products ÙInvolves a number of processes that are performed repetitively ÙUsed by oil refineries, food processors, manufactures of tobacco, chemicals and paper ÙAlso used by producers of repetitive services routine processing of cheques in banks and delivery of standard letters in Australia Post continued

4. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 4 Process costing Two main steps ÙEstimate the cost of the production process ÙCalculate the average cost per unit by dividing the cost of the process by the number of units produced Process costing can be used in situations where there is no opening or closing WIP inventory (see Chapter 4) More complex process costing takes place where there is WIP inventory

5. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 5 Process costing with WIP WIP inventory ÙProduct is not complete at the beginning or end of the month Production costs will relate to ÙUnits started in the previous period and completed in current period (beginning WIP) ÙUnits started and completed in the period ÙUnits that are incomplete at the end of the period (ending WIP) continued

6. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 6 Process costing with WIP Partially-completed goods at the beginning or end of the period change the way we allocate production costs Equivalent units ÙThe amount of production inputs that have been applied to the physical units in production ÙPhysical units are all units currently in production whether complete or incomplete ÙWIP inventory needs to be converted to equivalent units continued

7. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 7 Process costing with WIP Labour and overhead are incurred at different stages of the production process Units in ending WIP are generally at different stages of completion in respect to material and labour

8. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 8 Calculation of equivalent units for ending WIP If WIP is 50% complete for 10,000 litres on hand at the end of the month: Ù100% complete for direct materials, which are added at the start of the process 10,000 equivalent units of material Ù50% complete for conversion costs, assuming that conversion costs occur uniformly across the production process 5,000 equivalent units of conversion cost ÙEquivalent units are used to calculated unit costs when there is WIP

9. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 9 The effect of beginning and ending WIP Four steps in process costing 1. Analyse the physical flow of units 2. Calculate the equivalent units 3. Calculate the unit costs 4. Analyse the total costs Product are costed using either ÙWeighted average method ÙFirst in first out (FIFO) method

10. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 10 Process costing using the weighted average method Step one: analyse the physical flow of units Physical units in beginning WIP Physical units started Physical units completed and transferred out Physical units in ending WIP = - + continued

11. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 11 Process costing using the weighted average method Step two: calculate the equivalent units ÙThe equivalent units in beginning WIP are not identified separately, a key feature of weighted average cost method Equivalent units completed and transferred out Equivalent units in ending WIP Total equivalent units + = continued

12. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 12 Process costing using the weighted average method Step three: calculate the unit costs ÙThe cost per equivalent unit for direct material is the total direct material (conversion costs) costs divided by the total equivalent units ÙUnder the weighted average method the cost per equivalent unit is based on the total costs incurred, including the cost of beginning WIP Step four: analyse the costs

13. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 13

14. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 14

15. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 15

16. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 16 Process costing using the FIFO method It is assumed that the oldest inventory is completed before new production commences Step one: analyse the physical flow of units ÙIdentical to the weighted average method Step two: calculate the equivalent units ÙUnder FIFO, equivalent units in opening WIP are subtracted from total equivalent units to give new units of production continued

17. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 17

18. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 18 Process costing using the FIFO method Step three: calculate the unit costs ÙCost per equivalent unit is calculated for direct material (or conversion cost) by dividing the direct material cost incurred during the current month only by the new equivalent units added during the current month only. Step four: analyse total costs ÙAssumes that the units in beginning inventory are completed and transferred out first ÙCost of the beginning WIP are not mixed with those incurred during current month

19. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 19

20. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 20

21. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 21

22. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 22 Comparison of weighted average vs. FIFO Key difference is the treatment of the beginning WIP ÙUnder weighted average costs, cost of beginning WIP and equivalent units of work done on it are included in the calculation of the cost per equivalent unit ÙUnder FIFO, cost per equivalent unit is based only on costs incurred in the current month ÙWeighted average is more commonly used vSimpler and WIP inventory may be negligible

23. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 23 Process costing and spoilage Spoilage cost: the cost of defective product and wasted resources that cannot be recovered by rework or recycling When spoilage occurred there are three forms of output ÙUnits completed and transferred out ÙSpoiled units, and ÙUnfinished units remaining in WIP Spoiled units are costed using cost per equivalent unit along with other two outputs continued

24. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 24 Process costing and spoilage Spoilage is accounted for depending on whether it is normal or abnormal Normal spoilage: inherent in the production process and occurs even under efficient operating conditions ÙIncluded as part of the cost of good units completed Abnormal spoilage: should not occur under efficient operating conditions ÙCost of abnormal spoilage are expensed

25. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 25 Operation costing Some businesses have repetitive production processes, but produce a narrow range of products that differ in some significant aspects In batch manufacturing processes, individual product lines are produced in large batches and require specific combinations of direct materials and a specific sequence of production processes continued

26. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 26

27. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 27 Operation costing Hybrid costing has features of both job costing and process costing Operation costing is used to estimate product costs in a batch manufacturing environment ÙDirect costs are assigned to individual batchesa job costing approach ÙConversion costs are accumulated by departmenta process costing approach

28. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 28 Other issues in process costing Standard costs are more likely to be used that actual costs Process costing and operation costs are consistent with concepts of responsibility accounting ÙProcesses or operations are usually performance in different departments, and ÙDepartmental managers may be held responsible for the departments costs and output produced continued

29. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 29 Other issues in process costing A pre-determined overhead rate may be used in process costing and a pre- determined conversion cost rate in operation costing Production units are usually used as the cost driver in process costing and operation costing ÙInputs may be used as cost drivers in operation costing continued

30. Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 30 Other issues in process costing The percentage of completion is difficult to determine and is often only a rough estimate In service firms, some routine repetitive or similar services can be costing using process or operation costing