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Systems Design: Process Costing. Chapter 9. Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product costs.

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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.

Similarities Between Job-Order and Process Costing
differences between job order and process costing
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 many different jobs having different production requirements are worked on each period.

Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs.

Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet.

Differences Between Job-Order and Process Costing
slide4

Quick Check 

Process costing is used for products that are:

a. Different and produced continuously.

b. Similar and produced continuously.

c. Individual units produced to customer specifications.

d. Purchased from vendors.

slide5

Quick Check 

Process costing is used for products that are:

a. Different and produced continuously.

b. Similar and produced continuously.

c. Individual units produced to customer specifications.

d. Purchased from vendors.

processing departments
Processing Departments

Any unit in an organization where materials, labor or overhead are added to the product.

The activities performed in a processingdepartment are performed uniformly on allunits of production. Furthermore, the output ofa processing department must be homogeneous. Products in a process costing environment

typically flow in a sequence from one departmentto another.

learning objective 1
Learning Objective 1

Record the flow of materials, labor, and overhead through a process costing system.

comparing job order and process costing

FinishedGoods

Work inProcess

Cost of GoodsSold

Comparing Job-Order and Process Costing

Direct Materials

Direct Labor

Manufacturing Overhead

comparing job order and process costing1
Comparing Job-Order and Process Costing

Costs are traced andapplied to individualjobs in a job-ordercost system.

Direct Materials

FinishedGoods

Jobs

Direct Labor

Manufacturing Overhead

Cost of GoodsSold

comparing job order and process costing2
Comparing Job-Order and Process Costing

Costs are traced and applied to departments in a process cost system.

Direct Materials

Processing

Department

FinishedGoods

Direct Labor

Manufacturing Overhead

Cost of GoodsSold

t account and journal entry views of process cost flows
T-Account and Journal Entry Views of Process Cost Flows

For purposes of this example, assume there are two processing departments – Departments A and B. We will use T-accounts and journal entries.

process cost flows the flow of raw materials in t account form

Direct Materials

  • DirectMaterials
  • Direct Materials
Process Cost Flows: The Flow of Raw Materials (in T-account form)

Work in Process Department A

Raw Materials

Work in Process Department B

process cost flows the flow of labor costs in t account form

Direct Labor

  • Direct Labor
  • Direct Labor
Process Cost Flows: The Flow of Labor Costs (in T-account form)

Salaries and Wages Payable

Work in Process Department A

  • Direct Materials

Work in Process Department B

  • Direct Materials
process cost flows the flow of manufacturing overhead costs in t account form
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
  • OverheadApplied to Work inProcess
  • AppliedOverhead

Work in Process Department B

  • Direct Materials
  • Direct Labor
  • AppliedOverhead
process cost flows transfers from wip dept a to wip dept b in t account form

Transferred to Dept. B

  • Transferred from Dept. A
Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept. B (in T-account form)

Work in Process Department B

Work in ProcessDepartment A

  • Direct Materials
  • Direct Materials
  • Direct Labor
  • Direct Labor
  • AppliedOverhead
  • AppliedOverhead

DepartmentA

DepartmentB

slide19

Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept. B (in journal entry form)

process cost flows transfers from wip dept b to finished goods in t account form

Cost of GoodsManufactured

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
  • Direct Labor
  • AppliedOverhead
  • Transferred from Dept. A
process cost flows transfers from finished goods to cogs in t account form
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 GoodsManufactured
  • Cost of GoodsSold
  • Direct Labor
  • AppliedOverhead
  • Transferred from Dept. A

Cost of Goods Sold

  • Cost of GoodsSold
equivalent units of production
Equivalent Units of Production

Equivalent units are the product of the number of partially completed units and the percentage completion of those units.

We need to calculate equivalent units 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.

equivalent units the basic idea

+

=

1

Equivalent Units – The Basic Idea

Two half completed products are equivalent to one complete product.

So, 10,000 units 70% completeare equivalent to 7,000 complete units.

quick check
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

quick check1
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

10,000 units + (5,000 units × 0.30) = 11,500 equivalent units

calculating equivalent units
Calculating Equivalent Units

Equivalent units can be calculatedtwo ways:

The First-In, First-Out Method – FIFO is covered in the appendix to this chapter.

The Weighted-Average Method – This method will be covered in the main portion of the chapter.

learning objective 2
Learning Objective 2

Compute the equivalent units of production using the weighted-average method.

equivalent units of production weighted average method
Equivalent Units of ProductionWeighted-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.

treatment of direct labor
Treatment of Direct Labor

DirectMaterials

Direct labor costsmay be smallin comparison toother product

costs in processcost systems.

ManufacturingOverhead

Dollar Amount

DirectLabor

Type of Product Cost

treatment of direct labor1
Treatment of Direct Labor

DirectMaterials

Direct labor and manufacturing overhead may be combined into one classification of product cost called conversion costs.

Conversion

DirectLabor

Dollar Amount

DirectLabor

ManufacturingOverhead

Type of Product Cost

weighted average an example
Weighted-Average – An Example

Smith Company reported the following activity in the Assembly Department for the month of June:

weighted average an example1
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)

weighted average an example2
Weighted-Average – An Example

The second step is to identify the equivalent unitsof production in ending work in processwith respect to materialsfor the month (540 units) and adding this to the 5,400 units from step one.

weighted average an example3
Weighted-Average – An Example

The third step is to identify the equivalent unitsof production in ending work in processwith respect to conversion for the month (270 units) and adding this to the 5,400 units from step one.

weighted average an example4
Weighted-Average – An Example

Equivalent units of production always equals:

Units completed and transferred

+ Equivalent units remaining in work in process

weighted average an example5
Weighted-Average – An Example

Materials

6,000 Units Started

EndingWork in Process900 Units60% Complete

BeginningWork in Process300 Units40% Complete

5,100 Units Startedand Completed

5,400 Units Completed

5,400 Units Completed

900 × 60%

540 Equivalent Units

5,940 Equivalent units of production

weighted average an example6
Weighted-Average – An Example

Conversion

6,000 Units Started

EndingWork in Process900 Units30%Complete

BeginningWork in Process300 Units20%Complete

5,100 Units Startedand Completed

5,400 Units Completed

900 × 30%

270 Equivalent Units

5,670 Equivalent units of production

learning objective 3
Learning Objective 3

Compute the cost per equivalent unit using the weighted-average method.

compute and apply costs
Compute and Apply Costs

Beginning Work in Process Inventory: 400 units

Materials: 40% complete $ 6,119

Conversion: 20% complete $ 3,920

Production started during June 6,000 units

Production completed during June 5,400 units

Costs added to production in June

Materials cost $ 118,621

Conversion cost $ 81,130

Ending Work in Process Inventory: 900 units

Materials: 60% complete

Conversion: 30% complete

compute and apply costs1

Cost of beginningWork in ProcessInventory

Cost perequivalent unit

+

Cost added during the period

=

Equivalent units of production

Compute and Apply Costs

The formula for computing the cost per equivalent unit is:

compute and apply costs2
Compute and Apply Costs

Here is a schedule with the cost and equivalent unit information.

compute and apply costs3
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

Cost per equivalent unit = $21.00 + $15.00 = $36.00

learning objective 4
Learning Objective 4

Assign costs to units using the weighted-average method.

learning objective 5
Learning Objective 5

Prepare a cost reconciliation report.

operation costing
Operation Costing

Operation cost is a hybrid of job-order and process costing because it possesses attributes of both approaches

Operation costing is commonly used when batches of many different products pass through the same processing department.

to summarize the physical flow of units
To Summarize the Physical Flow of Units

For the weighted average calculation, the percentages of completion related to BWIP with respect to material and conversion are not used.

compute the equivalent units of production
Compute the equivalent Units of Production

For the weighted average calculation, the Inputs information is not required for the remaining calculation.

fifo method

FIFO Method

Appendix 9A

fifo vs weighted average method
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.
learning objective 6
Learning Objective 6

Compute the equivalent units of production using the FIFO method.

equivalent units fifo method
Equivalent Units – FIFO Method

Let’s revisit the Smith Company example. Here is information concerning the Assembly Department for the month of June.

equivalent units fifo method1
Equivalent Units – FIFO Method

Step 1: Determine equivalent units needed to completebeginning Work in Process Inventory.

equivalent units fifo method2
Equivalent Units – FIFO Method

Step 2: Determine units started and completed during the period.

equivalent units fifo method3
Equivalent Units – FIFO Method

Step 3: Add the equivalent units in ending Work in Process Inventory.

fifo example
FIFO Example

Materials

6,000 Units Started

EndingWork in Process900 Units60% Complete

BeginningWork in Process300 Units40% Complete

5,100 Units Startedand Completed

300 × 60%

180 Equivalent Units

5,100 Units Completed

900 × 60%

540 Equivalent Units

5,820 Equivalent units of production

fifo example1
FIFO Example

Conversion

6,000 Units Started

EndingWork in Process900 Units30% Complete

BeginningWork in Process300 Units20% Complete

5,100 Units Startedand Completed

300 × 80%

240 Equivalent Units

5,100 Units Completed

900 × 30%

270 Equivalent Units

5,610 Equivalent units of production

equivalent units weighted average vs fifo
Equivalent Units: Weighted-Average vs. FIFO

As shown below, the equivalent units in beginning inventory are subtracted from the equivalent units of production per the weighted-average method to obtain the equivalent units of production under the FIFO method.

learning objective 7
Learning Objective 7

Compute the cost per equivalent unit using the FIFO method.

cost per equivalent unit fifo
Cost per Equivalent Unit - FIFO

Let’s revisit the Smith Company Assembly Department for the month of June to prepare our production report.

Beginning work in process: 400 units

Materials: 40% complete $ 6,119

Conversion: 20% complete $ 3,920

Production started during June 6,000 units

Production completed during June 5,400 units

Costs added to production in June

Materials cost $ 118,621

Conversion cost $ 81,130

Ending work in process 900 units

Materials: 60% complete

Conversion: 30% complete

cost per equivalent unit fifo1

Cost perequivalent unit

Cost added during the period

=

Equivalent units of production

Cost per Equivalent Unit - FIFO

The formula for computing the cost per equivalent unit under FIFO method is:

cost per equivalent unit fifo2
Cost per Equivalent Unit - FIFO

$118,600 ÷ 5,820

$81,130 ÷ 5,610

Total cost per equivalent unit = $20.3816 + $14.4617 = $34.8433

learning objective 8
Learning Objective 8

Assign costs to units using the FIFO method.

applying costs fifo
Applying Costs - FIFO

Step 1: Record the equivalent units of production in ending Work in Process Inventory.

900 units × 60%

900 units × 30%

applying costs fifo1
Applying Costs - FIFO

Step 2: Record the cost per equivalent unit.

applying costs fifo2
Applying Costs - FIFO

Step 3: Compute the cost of ending Work in Process Inventory.

540 × $20.3816

270 × 14.4617

cost of units transferred out
Cost of Units Transferred Out

Step 1: Record the cost in beginning Work in Process Inventory.

cost of units transferred out1
Cost of Units Transferred Out

Step 2: Compute the cost to complete the units in beginningWork in Process Inventory.

cost of units transferred out2
Cost of Units Transferred Out

Step 3: Compute the cost of units started and completed this period.

cost of units transferred out3
Cost of Units Transferred Out

Step 4: Compute the total cost of units transferred out.

learning objective 9
Learning Objective 9

Prepare a cost reconciliation report using the FIFO method.

a comparison of costing methods
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.

physical flow of units fifo
Physical Flow of Units: FIFO

Completed – BWIP

= 5400 – 300

= 5100

check cost reconciliation1
Check Cost Reconciliation

BWIP

$ 6,119

$ 3,920

$10,039

Total Cost Accountable For

Total Inventory Value

production losses
Production Losses
  • Losses in production can be classified into:
    • Expected – Normal Losses
      • In packaged/canned manufacturing – parts of vegetables purchased are not suitable for consumption
    • Expected – Normal Losses with scrap value
      • In clothes/shirts manufacturing – part of the fabrics are in irregular formats after trimming out the shape required, leaving some losses which may be able to sell as scrap
    • Unexpected – Abnormal Losses
      • In packaged/canned manufacturing – the refrigerator broke down without notice and food stored inside cannot be used – abnormal losses
    • Unexpected – Abnormal Losses with scrap value
      • In clothes/shirts manufacturing – a batch of shirts being rejected due to wrong fabric being used could be sold to rejected clothing merchandisers after removing the logos.
accounting for normal losses and scrap value
Accounting for Normal Losses and Scrap Value
  • Normal Losses
    • It is part of the production outputs
    • It is treated as part of the normal production cost for the finished items (i.e. is absorbed into all products and is included in inventory valuation)
  • Normal Losses with scrap value
    • Scrap value is part of the expected income to offset the expense therefore is net-off from the expenses.
accounting for abnormal losses and scrap value
Accounting for Abnormal Losses and Scrap Value
  • Abnormal Losses
    • It is a part of the production outputs
    • It is not part of the normal production cost therefore is expensed off separately from the production costs (i.e. cannot be used for inventory valuation)
  • Abnormal Losses with scrap value
    • Scrap value receivable is also not part of the normal production income therefore is treated as other income.
an example losses with scrap value
An Example: Losses with Scrap Value

Let’s revisit the Smith Company Assembly Department for the month of June with the additional losses information.

Beginning Work in Process Inventory: 400 units

Materials: 40% complete $ 6,119

Conversion: 20% complete $ 3,920

Production started during June 6,000 units

Production completed during June 5,400 units

Expected losses of 2% completed units cannot pass quality check. These rejected items can normal be sold for $5 each as scrap.

In addition to the normal losses of 2%, 200 of the latest produced items were found out of shape during the problem of the finishing touch from the machine.

Costs added to production in June

Materials cost $ 118,621

Conversion cost $ 81,130

Ending Work in Process Inventory: 900 units

Materials: 60% complete

Conversion: 30% complete

physical flow of units the weighted average method
Physical Flow of Units (the Weighted Average Method)
  • Normal and Abnormal Losses are parts of the outputs
  • Completed quantity is most effectively calculated as a balancing figure
summarize the total cost incurred and compute the cost per equivalent unit
Summarize the Total Cost Incurred and Compute the Cost Per Equivalent Unit

Scrap value receivable from Normal Losses normally is netting-off the cost as the loss and the income are part of the expected process. In most cases, scrap value is off-setting the material cost because scrap is normal valuing the material. In some cases, conversion work may even reduce the value of the scrap because the conversion may make it difficult to salvage the scrap material.

calculate the values of completed and ending wip inventories
Calculate the Values of Completed and Ending WIP Inventories

Abnormal loss is not a part of the inventory valuation

cost reconciliation
Cost Reconciliation

Abnormal loss is not a part of the inventory valuation. It is treated as a part of the expense in COGS.

activity based process costing1
Activity-based Process Costing
  • Large quantity homogeneous products with similarities
  • Sharing production facilities
  • Premium and low-end products with different consumption of the shared production facilities
  • Resource and activity consumption being traceable by using the activity-based costing technique within the process costing environment
  • Examples: Candies manufacturing, instant noodle manufacturing and wine bottling