Chapter 10

Process Costing

Learning Objectives

1. How does process costing differ from job order product costing?

2. Why are equivalent units of production used in

process costing?

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Continuing . . . Learning Objectives

3. How are equivalent units of production computed using the weighted average and FIFO methods of process costing?

4. How are unit costs and inventory values

calculated using the weighted average and FIFO methods of process costing?

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Continuing . . . Learning Objectives

5. How is a cost of production report prepared? 6. What use do standard costs have in a process

costing system?

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Continuing . . . Learning Objectives

7. What is the effect of multi-department processing on the computation of equivalent units of production?

8. How can quality control minimize spoilage?

9. How are journal entries prepared for a process costing system? (Appendix)

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Costing Systems
Process

Hybrid Job order

Differences Between Job Order and Process Costing

Quantity of production for which costs are being accumulated at any one time Cost object to which the costs are assigned

Flow of Product Through System

Process 1

Materials

Conversion Costs

Process 2

Finished Product

Process 3

Note: Raw materials can be added in all departments.

Assigning Costs to Production

Production costs = Material + Labor + Overhead Costs assigned to each process during period Unit costs determined for each cost component and each process Cost of completed unit = Sum of costs per unit for all processes through which product passes

Production Costs
Direct material cost measured from material requisition slips and invoiced prices Direct labor cost determined from employee time sheets and wage rates Overhead costs assigned through use of predetermined rates or actual costs
Actual overhead costs can be used if relatively constant each period and production volume is relatively steady

Quantity of Production
Process costing assigns costs to both fully and partially completed units by converting partially completed units to equivalent whole units or to equivalent units of production.

Equivalent Units of Production

+
OR and

Two Process Costing Methods

Weighted average (WA) method
Computes average cost per unit of production Focuses on units completed during period and units that remain in ending WIP

FIFO method
Keeps beginning inventory and current period production and costs separated

Steps in Processing Costing

1. Calculate the total physical units for which the department is responsible 2. Determine what happened to the units
Where are they at the end of the period?

Completed and transferred Partially completed and remaining in ending WIP 3. Use either weighted average or FIFO method to determine EUP for each cost component

Continuing . . . Steps in Processing Costing

4. Find the total cost to account for
Beginning WIP costs All current costs

5. Compute cost per EUP for each cost component using either WA or FIFO EUP 6. Assign costs
Units completed and transferred Units remaining in ending WIP

Exhibit 10-5 Example

Material added at start of production Labor and overhead added evenly
Complete as to Conversion Costs Beginning inventory 30% Cards started during the month Cards completed during the month Ending inventory 80%

Units 12,000 115,500 120,700 6,800

Exhibit 10-5 Example

Cost of beginning inventory: Direct material Direct labor and OH Current period costs: Direct material Direct labor and OH

$ 45,000.00 4,678.60

$ 49,678.60

$334,950.00 202,191.00

537,141.00

Weighted Average: Steps 1 and 2

Beginning inventory Units started Units to account for Units completed and transferred out Units in ending WIP inventory Total units accounted for 12,000 115,500 127,500 ======

120,700 6,800 127,500 ======

WA: Determining EUP for Material

Completed: From Beginning WIP Started & Completed Total Completed Ending Inventory Accounted for ______EUP________ DM CC 12,000 108,700 6,800 127,500 ======

12,000 108,700 120,700 6,800 127,500 ======

WA: Determining EUP for Conversion Costs

Completed: From Beginning WIP Started & Completed Total Completed Ending Inventory Accounted for ______EUP________ DM CC 12,000 12,000 108,700 108,700 6,800 127,500 ====== 5,440 126,140 ======

12,000 108,700 120,700 6,800 127,500 ======

WA: Determining Total Costs to Account for

DM CC Total $ 45,000.00 $ 4,678.60 $ 49,678.60 334,950.00 202,191.00 537,141.00

Beginning WIP Current Period Total Cost to Account For

$379,950.00 $206,869.60 $586,819.60 ========= ========= =========

WA: Calculate Cost per EUP

DM CC Total $ 45,000.00 $ 4,678.60 $ 49,678.60 334,950.00 202,191.00 537,141.00

Beginning WIP Current Period Total Cost to Account For EUP Cost per EUP

$379,950.00 $206,869.60 $586,819.60 127,500 126,140 $2.98 $1.64 $4.62 ==== ==== ====

WA: Assign Costs

Cost of goods transferred (120,700 x $4.62) Ending Inventory: (6,800 units) Material (6,800 x $2.98) Conversion Costs (5,440 x $1.64) Total Costs Accounted for

$557,634.00 $20,264.00 8,921.60

29,185.60 $586,819.60 =========

FIFO: Determining EUP for Material

Completed: From Beginning WIP Started & Completed Total Completed Ending Inventory Accounted for ______EUP________ DM CC 0 108,700 6,800 115,500 ======

12,000 108,700 120,700 6,800 127,500 ======

FIFO: Determining EUP for Conversion Costs

Completed: From Beginning WIP Started & Completed Total Completed Ending Inventory Accounted for ______EUP________ DM CC 0 8,400 108,700 108,700 6,800 115,500 ====== 5,440 122,540 ======

12,000 108,700 120,700 6,800 127,500 ======

FIFO: Calculate Cost per EUP

DM Beginning WIP Current Period $334,950.00 Total Cost to Account For EUP Cost per EUP Total $ 49,678.60 $202,191.00 537,141.00 $586,819.60 ========= CC

115,500 122,540 $2.90 $1.65 ==== ====

$4.55 ====

FIFO: Assign Costs

Cost of goods transferred: Beginning inventory costs $ 49,678.60 Costs to complete: Conversion costs (8,400 x $1.65) 13,860.00 Total cost of BI transferred $ 63,538.60 Started and completed (108,700 x $4.55) 494,585.00 Ending Inventory: (6,800 units) Material (6,800 x $2.90) Conversion Costs (5,440 x $1.65) Total Costs Accounted for

$558,123.60

$19,720.00 8,976.00

28,696.00 $586,819.60 =========

Process Costing with Standard Costs

Actual costing requires that a new production cost be computed each production period. Standard costing eliminates such recomputations, although standards do need to be reviewed at least once a year to keep the amounts current.

Comparison of WA and FIFO Methods

Cost assignment is easier for WA method FIFO method reflects actual physical flow of goods through production When period costs fluctuate, FIFO method gives managers better information with which to control costs and on which to base decisions because it does not combine costs of different periods FIFO method focuses on current period costs managerial performance is evaluated on basis of costs incurred only in the current period

Multiple Departments: Succeeding Departments

EUP_____ TI DM CC 100% 100%

Beginning Inventory Transferred In To account for Completed Ending Inventory Accounted for

### ### ### ### ### ###

100%

Method of Neglect
Under the method of neglect:
Spoiled units are simply excluded from the equivalent unit production schedule. The total cost of producing both good and spoiled units is assigned solely to the good units, raising the cost of those units.

Implementing Quality Processes

Managers who are aware of spoilage costs can make better decisions as to whether to ignore the causes of spoilage or try to correct them.
Impediments to such awareness include using the method of neglect and burying the cost of spoilage in predetermined overhead rates rather than accounting for the spoilage separately.

Continuing . . . Implementing Quality Processes

Many companies now build quality into their processes, which reduces the need for quality control inspections.
Often, these companies use statistical process control (SPC) to reduce spoilage. SPC relies on the idea that natural variations occur in a process over time due to random factors and are to be expected.