Managerial Accounting

B11-A681
Chapter 23
Process Costing

Learning Objectives
1.
2.
3.
4.
5.
6.

Explain process operations and how they differ

from job order operations
Compare process cost accounting to job order
cost accounting systems
Record the flow of direct materials in process
costing
Record the flow of direct labour in process costing
Record the flow of factory overhead in process
costing
Define equivalent units and explain their use in
process cost accounting

Learning Objectives
7.
8.
9.
10.
11.
12.
13.

Compute equivalent units produced in a period

Explain the four steps in accounting for
production activity
Define a process cost summary and describe
its purposes
Prepare a process cost summary
Record the transfer of goods between
departments
Record the transfer of goods from finished
goods to cost of goods sold
Analyze cost per equivalent unit with and
without spoiled units

Process Costing
Process costing is the mass
production of many homogenous
units.
Examples of process costing
include oil refineries, automobile
production plants, carpeting, paint,
hand tools and even Canada Post.

Process vs Job Order

Process Costing
Repetitive production
Homogenous
products
High production
volume
Low product
flexibility
High standardization

Job Order Costing

Custom orders
Heterogeneous
products
Low production volume
High product flexibility
Low to medium
standardization

Objective
The objective of job order costing was to
determine the cost per unit of each finished
product
This is the same in process costing but the
environment is completely different.
In job order costing costs could be directly
attributed to a batch or job.
In process costing this is impossible.
Instead the cost object is not the product but
the process or more specifically departments
or stages in the production process.

Process Costing
In process costing each process is identified as
a separate department, workstation or work
centre.
A manager is usually responsible for at least
one of these.
With the exception of the first department
each department receives the output from the
prior department.
As the product moves from one department to
the next additional labour, overhead and
sometimes material are added.

Cost Objects
In job order costing the cost object was the
product being produced.
Cost were accumulated to a particular product
because material and labour could be traced
directly to the product.
In process costing the cost object is the process
itself, or the departments which make up the
process.
Direct materials are materials that can be traced
to a particular department
Direct labour is the labour used in that
department

Cost Objects
Whats the difference?
A supervisor in a department in job
order manufacturing would be indirect
labour, as the work done could not be
directly attributed to any particular job
in production
In process costing that same supervisor
would be direct labour as the work is
directly associated with the department.

Materials Costs
When $3,000 of materials are received in raw
materials inventory:
Dr: Raw materials inventory $3,000
Cr: Cash or A/P $3,000
To record the requisition of $1,000 worth of raw
materials into production for department A
Dr: Goods in process
inventory department A $1,000
Cr: Raw materials inventory
$1,000
As each department will have separate costs, and
it is these cost we track, each department has its
own goods in process inventory account.
Notice this is virtually identical to job order
costing

Labour Costs
To record factory payroll of $15,000 for the
factory the journal entry is:
Dr: Factory payroll
$15,000
Cr: Cash
$15,000
Based on time records $10,000 is for
department A and $5,000 for department B
Dr: Goods in process dept A $10,000
Dr: Goods in process dept B $5,000
Cr: Factory payroll
$15,000
Notice the similarity to job order costing

Factory Overhead
To record $500 of indirect materials the journal entry is:
Dr: Factory Overhead$500
Cr: Raw materials inventory
$500
To record $800 of indirect labour the journal entry is:
Dr: Factory Overhead$800
Cr: Factory payroll $800
To record $2,500 in amortization, $1,000 in expired
insurance, $3,500 in other miscellaneous overhead costs:
Dr: Factory overhead $7,000
Cr: Accumulated amortization
$2,500
Cr: Prepaid insurance
$1,000
Cr: Accounts payable
$3,500
Notice the similarity to job order costing

Factory Overhead
As was the case in job order costing, we
also apply factory overhead in process
costing.
This can be done with one global or
factory wide rate
Some companies prefer to have a rate set
by department.
It is also possible to have separate factory
overhead costs for every department to
aid in having multiple rates

Factory Overhead
Assume the predetermined rate is
50% of labour, the journal entry is:
Dr: Goods in process dept A $5,000
Dr: Goods in process dept B $2,500
Cr: Factory Overhead
$7,500

Equivalent Units
As examined so far the entry of inputs
such as materials, labour and overhead
is virtually identical to job order costing.
The major problem in process costing is
determining the cost of the outputs from
each department.
To approach this problem we must
determine the cost per unit and then
apply that cost to the number of units
transferred.

Equivalent Units
This problem is simple if there is no inventory.
Costs transferred out = costs transferred in.
However, we often have inventory and must come
to a measure of how complete the inventory is.
If we have 100 units of inventory that are 40%
complete how many units is that?
We have created a theoretical measure called
equivalent units.
100 units 40% complete = 100 x40% = 40
equivalent units
Equivalent units is the theoretical measure of how
many whole units would have been completed.

Equivalent Units
The logic of this is:

If a department had only worked on 40 units in the same time

they would have been 100% complete.

Equivalent units are often different for

Materials
Labour

Example

A production department adds all its material at the beginning

of the production process
Labour and overhead take place evenly throughout the process
In this case if ending inventory is 50% complete the 50% would
apply only to labour and overhead
Materials would be 100% complete, material is added only at
the beginning of the process.
Anytime after that materials are 100% complete.

Equivalent Units
Critical to the computation of equivalent units
is how we assume the department actually
processes units.
We will assume that units are produced on a
FIFO (first in first out) basis.
This is a very common assumption and is used
widely in industry.
There is an alternative called weighted
average.
In this course, and in this text, we will only
concern ourselves with FIFO.

Accounting for a Periods

Activity
To account for a periods activity
we examine a four step process:
1. Physical flow
2. Equivalent units
3. Cost per equivalent unit
4. Cost reconciliation

Physical Flow of Units

Step 1 of the 4 step process:
A simple reconciliation of the units started in
the period to the physical units completed.
Units to account for:
Beginning inventory plus
Units started in the period
Total units to be accounted for

Units accounted for as:

Units transferred out plus
Ending inventory
Total units to be accounted for

Physical Flow of Units

The two total must always agree.
Effectively the units to account for are the
units the department is responsible for.
The department is responsible for those
units in opening inventory plus those units
transferred in (units started)
Those units can only be in one of two
places:
Either the units are still in the department
(ending inventory) or
The units were transferred out to the next
department

Example

Consider the following example of Fort Garry Potato

Chips
Fort Garry has a four step process:
1.
2.
3.
4.

Peeling
Cutting
Frying
Packaging

Assume the following for the peeling department:

Opening inventory is 5,000 kg.

Units transferred in is 100,000 kg.
Ending inventory is 3,000 kg.
Units transferred out is 102,000 kg.

Example
Units to account for:
Beginning inventory
5,000
Units started during the month 100,000
Total number of units
105,000
Units accounted for as:
Units transferred from peeling to cutting
102,000
Ending inventory
3,000
Total number of units 105,000

Example
A key number used in subsequent
calculations is the number of units
started and completed this month.
Completed this month is 102,000 units
Under the FIFO assumption, the
oldest inventory is processed first.
Therefore 102,000 5,000 = 97,000
units started and completed this
month.

Equivalent Units of
Production Overview
In this step we need to multiply the
% by the whole units for:
Beginning inventory
Started and completed
Ending inventory

Equivalent Units of
Production Beginning
Inventory

Recall that beginning inventory this month was ending

inventory last month
The % given is always based on the % complete for
ending inventory last month
This oddity is always true

If beginning inventory was 20% complete

This means ending inventory last month was 20% complete

Under FIFO costing we assume we work on this inventory first
If it was 20% complete last month, and if we assume it was
completed this month (a reasonable assumption), that means
we completed the rest which is 100% - 20% = 80%.

This is always true for beginning inventory, the % to be

used is always 100% - the percent given.

The reason is that the % given related to ending inventory

complete last month.

Equivalent Units of
Production
Started and Completed
By definition, units that are both started and
completed in the month are 100% complete
This is always true

Ending Inventory
Ending inventory are those units started but
not yet completed
The % complete is almost always the %
given.

Equivalent Units of
Production
Step 2 of 4 step process
In the peeling process all (materials) are added at the
beginning of the process
As far as direct materials is concerned an item is 100%
complete the instant it enters the department
Beginning inventory had to have entered production last
month, therefore no additional costs were added this
month.
% complete is therefore 0% (100% - 100% = 0%)
Items added in the month are 100% complete as they
were added this month
Ending inventory, because of the FIFO assumption, must
have been added this month.
Therefore they are 100% complete with respect to
materials

Equivalent Units of
Production
For labour and overhead they behave similarly
since overhead is applied based on labour
Assume opening inventory is 40% complete.
Following our rule 100% - 40% = 60% is added
this month.
For items started and completed this month,
by definition are 100% complete
If ending inventory is 70% complete, under the
FIFO assumption those costs were added this
month, therefore ending inventory is 70%
complete.

Equivalent units
Material
Beginning inventory 5,000 x 0%= 0
Started and completed 97,000 x 100% =
97,000
Ending inventory 3,000 x 100% = 3,000
Labour & Overhead
Beginning inventory 5,000 x 60%= 3,000
Started and completed 97,000 x 100% =
97,000
Ending inventory 3,000 x 70% = 2,100

Cost Per Equivalent Unit

Step 3 of 4
Material equivalent units
Beginning inventory
0
Started and completed
97,000
Ending inventory
3,000
Total equivalent units
100,000
Labour & Overhead
Beginning inventory
3,000
Started and completed
97,000
Ending inventory
2,100
Total equivalent units 102,100

Cost Per Equivalent Unit

Assume the following data:
Direct materials costs
Dr: Goods in process peeling $100,000
Cr: Raw materials inventory
$100,000
Direct Labour costs
Dr: Goods in process peeling $306,300
Cr: Factory payroll
$306,300
Factory overhead applied (50% of direct labour)
Dr: Goods in process peeling $153,150
Cr: Factory payroll
$153,150

Cost Per Equivalent Unit

Materials
$100,000 / equivalent units 100,000 = $1.00
Labour
$306,300 / equivalent units 102,100 = $3.00
Overhead
$153,150 / 102,100 equivalent units = $1.50

Cost Reconciliation
Step 4 of 4
Reconcile costs to account for with the
costs accounted for in the period.
Cost to account for are similar
conceptually to units to account for in
step 1:
Beginning inventory plus
Costs assigned in the month
Total Costs to account for

Cost Reconciliation
Costs accounted for:
Beginning inventory plus
Costs assigned during the current period

(equivalent units beginning inventory x cost per equivalent unit)

For each of Direct Material, Labour and Overhead

Plus Cost of units started and completed in the month

(equivalent units started and completed x cost per equivalent

unit)
For each of Direct Material, Labour and Overhead

Plus Ending inventory

(equivalent units ending inventory x cost per equivalent unit)

For each of Direct Material, Labour and Overhead

Total costs to be accounted for.

Total costs to be accounted for must equal total costs to be
accounted for.

Cost Reconciliation
To pull everything together a process
cost summary report is produced.
Different companies will use different
forms of the report but they all serve
the same function
Helps managers control departments
Helps managers evaluate performance
Provide cost information for financial
statements

Process Cost Summary

The Process Cost Summary is too
large and cumbersome to show
using PowerPoint.
Please refer to the demonstration
excel spreadsheet.
Assume that opening inventory is
$10,000

Transferring Goods Between

Departments
As per the report $557,000 is to be
transferred to the cutting department
(the next department in processing
order)
The journal entry to record this is:
Dr: Goods in process-cutting $557,000
Cr: Goods in process-peeling
$557,000

Cutting Department Data

Beginning inventory
Units of product
Percent complete

12,000
25%

Units received from peeling department

102,000
Units transferred to frying 98,000
Ending inventory
Units of product
Percentage complete

16,000
65%

Spoiled Units
In our example we assume no spoiled units.
This is of course unrealistic
There is considerable discussion on whether
the cost of the spoiled units should be
included in the cost per equivalent units
Some argue that it should be included so that
proper pricing to cover all costs is achieved
Others argue including it will make the product to
expensive and uncompetitive