1. Process Costing Chapter 4 9/16/2013 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. 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 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, 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
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 you have many different products.
Process cost accumulate costs by department. Job-order systems accumulated costs by individual jobs.
Process systems compute unit costs by department. Job-order costing systems compute unit costs by job.
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:
Different and produced continuously.
Similar and produced continuously.
Individual units produced to customer specifications.
Purchased from vendors.
Can you identify the most likely circumstances where a process costing system may be used?

5. 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. Products in a process costing environment typically flow in a sequence from one department to another.

6. 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
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

7. 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. 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

8. T-Account Views of Process Cost Flows
For purposes of this example, assume there are two processing departments – Departments A and B.
Let’s look at the flow of process costs through the t-accounts and related journal entries for a manufacturing company that has two departments – Department A and Department B.

9. 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.

10. 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

11. 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

12. 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

13. 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 good manufactured.

14. 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

15. Units of Production
Units produced in process costing is a combination of
Units completed during the period
Partially completed units still in WIP
Partially completed units are then converted into equivalent units completed
Equivalent units are added to completed units to come up with total production for the period

16. 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.
Percentage of completion is determined by best estimate of the department management

17. 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.

18. 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.

19. 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.

20. 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

21. 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

22. Weighted-Average – An Example
Smith Company reported the following activity in the Assembly Department for the month of June:
Let’s look at an example of calculating the cost per equivalent unit for the Assembly Department of Smith Company. The Assembly Department is only one of the company’s processing departments. Notice that the Department started the month of June with 300 units that are 40% complete as to materials and 20% complete as to conversion (direct labor and overhead). During the month the Department started 6,000 units into production. During the month 5,400 units were transferred out to the next department. At the end of June, the Department had 900 units, 60% complete as to materials and 30% complete as to conversion.
Since the Department began the month with 300 units and started 6,000 units into production, we have 6,300 units to account for. Of these 6,300 units, 5,400 were completed and transferred out and 900 remain in Department as work in process inventory.

23. Weighted-Average – An Example
The first step in calculating the equivalent units is to identify the units completed and transferred out of Assembly Department in June (5,400 units)
The first step in calculating the equivalent units is to identity the units completed and transferred out. In the case of the Assembly Department there were 5,400 units completed and transferred out. We know these units are 100% complete as to materials and conversion.

24. Weighted-Average – An Example
The second step is to identify the equivalent units of production in ending work in process with respect to materials for the month (540 units) and adding this to the 5,400 units from step one.
The second step is to calculate the equivalent units as to materials in ending inventory. We know there are 900 units in ending inventory that are 60% complete as to materials. So we know that there are 540 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 5,940 units.

25. Weighted-Average – An Example
The third step is to identify the equivalent units of production in ending work in process with respect to conversion for the month (270 units) and adding this to the 5,400 units from step one.
The third step is to calculate the equivalent units in ending inventory as to conversion. We know there are 900 units in ending work in process inventory that are 30% complete as to conversion. So there are 270 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 5,670 units.
We always follow these three steps when using the weighted-average method.

26. Weighted-Average – An 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.

27. Weighted-Average – An Example
Materials
6,000 Units Started
Beginning Work in Process 300 Units 40% Complete
Ending Work in Process 900 Units 60% Complete
5,100 Units Started and Completed
Here is a visual showing the computation of equivalent units as to materials. Recall, we started 6,000 units into production this month. The equivalent units of production equals the units completed and transferred out (5,400 units) plus the equivalent units remaining in work in process (540 units for materials and 270 units for conversion).
5,400 Units Completed
5,400 Units Completed
900 × 60%
540 Equivalent Units
5,940 Equivalent units of production

28. Weighted-Average – An Example
Conversion
6,000 Units Started
Ending Work in Process 900 Units 30% Complete
Beginning Work in Process 300 Units 20% Complete
5,100 Units Started and Completed
Here is a similar visual for conversion costs. Again, the key to understanding the visual is units started and completed this period.
5,400 Units Completed
900 × 30%
270 Equivalent Units
5,670 Equivalent units of production

29. Compute and Apply Costs
Beginning Work in Process Inventory: units
Materials: % complete $ 6,119
Conversion: 20% complete $ 3,920
Production started during June ,000 units
Production completed during June ,400 units
Costs added to production in June
Materials cost $ 118,621
Conversion cost $ 81,130
Ending Work in Process Inventory: units
Materials: 60% complete
Conversion: 30% complete
We used this information to calculate the equivalent units earlier. Here we have added the dollar amount in beginning Work in Process Inventory, and the material and conversion costs incurred during June. Let’s begin the process of calculating cost per equivalent unit for June.

30. 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.

31. 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 5,940 equivalent units as to materials, and 5,670 equivalent units as to conversion.
Let’s look at the calculation of the cost per equivalent unit.

32. Compute and Apply Costs
Here is a schedule with the cost and equivalent unit information.
$124,740 ÷ 5,940 units = $21.00
$85,050 ÷ 5,670 units = $15.00
We begin by calculating the cost per equivalent unit as to materials and as to conversion costs.
We have a total cost of $124,740 and 5,940 equivalent units, so the cost per equivalent unit is $21.00 for materials.
With total costs of $85,050 and total equivalent units of 5,670, we have an average cost per equivalent unit of $15.00 for conversion.
So, the total cost of materials and conversion is $36.00 per equivalent unit.
Cost per equivalent unit = $ $15.00 = $36.00

33. 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 (540 units for materials and 270 units for conversion).

34. Applying Costs
The second step is to record the cost per equivalent unit ($21.00 for materials and $15.00 for conversion).

35. Applying Costs
The third step is to compute the cost of ending Work in Process Inventory ($11,340 for materials, $4,050 for conversion, and $15,390 in total).

36. 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 (5,400 units for materials and conversion).

37. Computing the Cost of Units Transferred Out
The third step is to compute the cost of units transferred out ($113,400 for materials, $81,000 for conversion and $194,400 in total).

38. Reconciling Costs
Now, we must reconcile the costs. The first step is to record the cost of beginning Work in Process Inventory of $10,039. The second step is to record the costs added to production during the period as shown of $199,751. The third step is to sum these two costs for a total to be accounted for of $209,790.

39. Reconciling Costs
Computing the costs accounted for: The first step is to record the previously computed cost of ending Work in Process Inventory $15,390. The second step is to record the previously computed cost of units transferred out $194,400. The third step is to sum these two costs for a total of $209,790. Notice the two totals agree indicating that all costs have been accounted for.