Chapter 20

Process Costing

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Learning Objective 1

Describe the flow of costs

through a process costing
system

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 How Do Costs Flow Through a
Process Costing System?
• Job order costing system
– Allocates costs by job.
– Used by companies that manufacture a unique
product or provide specialized services.
• Process costing system
– Allocates costs by process.
– Used by companies manufacturing identical
units.
– A process is one of the steps in manufacturing
production.

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Job Order Costing Versus Process
Costing

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 Flow of Costs Through a Process
Costing System
• Companies use process costing to
determine the per unit cost in order to:
– Control costs
– Set selling prices
– Calculate account balances for:
• Work-in-Process Inventory
• Finished Goods Inventory
• Cost of Goods Sold

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Flow of Costs Through a Process
Costing System

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Learning Objective 2

Calculate equivalent units of

production for direct materials
and conversion costs

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 What Are Equivalent Units of
Production, and How Are They
Calculated?

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 Equivalent Units of Production

• Equivalent units of production (EUP)

– Measures the amount of materials added to or
work done on partially completed units during
a period.
– Expressed in terms of fully complete units of
output.

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 Conversion Costs

• Direct labor is a small part of

manufacturing costs for highly automated
manufacturers.
• To simplify accounting, direct labor is
combined with manufacturing overhead
and called conversion costs.
• Conversions costs are the costs to
convert raw materials into finished goods.

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Learning Objective 3

Prepare a production cost

report using the weighted-
average method

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How Is a Production Cost Report
Prepared?

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 How Is a Production Cost Report
Prepared?
A production cost report show the
calculations for the physical flows and the
cost flows of the products.

1. Summarize the flow of physical units.

2. Compute output in terms of equivalent units of
production.
3. Compute the cost per equivalent unit of
production.
4. Assign costs to units completed and units in
process.

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 How Is a Production Cost Report
Prepared?
• Two unique terms are used on the production
cost report:

• To account for includes the amount in process at

the beginning of the period plus the amount
started or added during the period.

• Accounted for shows what happened to the

amounts to account for. They are either still in
process or completed and transferred out.

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 Production Cost Report—First
Process—Assembly Department

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 Production Cost Report—First
Process—Assembly Department

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 Production Cost Report—First
Process—Assembly Department

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 Production Cost Report—First
Process—Assembly Department

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 Production Cost Report—Second
Process—Cutting Department
• The costs of materials from the Assembly
Department are transferred into the
Cutting Department.
– The transferred costs are called transferred
in costs.
• The weighted-average method
combines the average cost of equivalent
units of production by combining
beginning inventory costs with current
period costs.
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Production Cost Report—Second
Process—Cutting Department

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Production Cost Report—Second
Process—Cutting Department

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Production Cost Report—Second
Process—Cutting Department

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Production Cost Report—Second
Process—Cutting Department

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Production Cost Report—Second
Process—Cutting Department

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Learning Objective 4

Prepare journal entries for a

process costing system

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What Journal Entries Are Required
in a Process Costing System?
• Costs flow through the process costing
system in four steps:
– Accumulate
– Assign
– Allocate
– Adjust
• Costs flow from one Work-in-Process
Inventory account to the next and
eventually to Finished Goods Inventory
and Cost of Goods Sold.
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 Transaction 1—Raw Materials
Purchased
During July, the company purchased
materials on account for $175,000.

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Transaction 2—Raw Materials Used
in Production
During July, direct materials were assigned to the
two production departments: $140,000 to the
Assembly Department and $19,000 to the Cutting
Department; $2,000 in indirect materials were
accumulated in Manufacturing Overhead.

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 Transaction 3—Labor Costs
Incurred
During the month, Puzzle Me incurred $20,000 in
direct labor costs in the Assembly Department;
$3,840 in direct labor costs in the Cutting
Department; and $1,500 in indirect labor costs
accumulated in Manufacturing Overhead.

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 Transaction 4—Additional
Manufacturing Costs Incurred
In addition to the indirect materials and indirect
labor costs, Puzzle Me incurred $35,000 in
machinery depreciation and $20,000 in indirect
costs that were paid in cash, which included rent
and utilities.

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 Transaction 5—Allocation of
Manufacturing Overhead
Puzzle Me used a predetermined overhead
allocation rate to allocate indirect costs to
the departments: $48,000 to the Assembly
Department and $11,000 to the Cutting
Department.

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 Transaction 6—Transfer from the
Assembly Department to the Cutting
Department
At the end of July, when the production cost report
for the Assembly Department was prepared, Puzzle
Me assigned $176,000 to the 40,000 units
transferred from the Assembly Department to the
Cutting Department.

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Transaction 7—Transfer from Cutting
Department to Finished Goods
Inventory
At the end of July, when the production cost report
for the Cutting Department was prepared, Puzzle
Me assigned $201,400 to the 38,000 units
transferred from the Cutting Department to
Finished Goods Inventory. This is the cost of goods
manufactured.

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 Transaction 8—Puzzles Sold
During July, Puzzle Me sold 35,000 puzzles. We have already
determined from the production cost report for the Cutting
Department that the cost of goods manufactured is $5.30 per
puzzle. Therefore, the cost of 35,000 puzzles is $185,500
(35,000 puzzles × $5.30). The puzzles were sold on account
for $8.00 each, which is a total of $280,000 (35,000 puzzles
× $8.00).

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Transaction 9—Adjust Manufacturing
Overhead
The actual manufacturing overhead costs incurred
were $58,500, which includes the indirect materials
in Transaction 2, the indirect labor in Transaction 3,
and the accumulated depreciation and other indirect
costs in Transaction 4. The amount of manufacturing
overhead allocated to the two departments was
$59,000, as shown in Transaction 5.

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Learning Objective 5

Use a production cost report to

make decisions

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 How Can the Production Cost
Report Be Used to Make Decisions?

• Controlling costs.
• Evaluating performance.
• Pricing products.
• Identifying the most profitable products.
• Preparing the financial statements.

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Learning Objective 6

Prepare a production cost

report using the first-in, first-
out method (Appendix 20A)

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 How Is a Production Cost Report
Prepared Using the FIFO Method?
• Equivalent unit of production cost
methods:
– Weighted-average method
– First-in, first-out
• The first-in, first-out method
determines the cost of equivalent units by
accounting for beginning inventory
separately.

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How Is a Production Cost Report
Prepared Using the FIFO Method?

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How Is a Production Cost Report
Prepared Using the FIFO Method?

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How Is a Production Cost Report
Prepared Using the FIFO Method?

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How Is a Production Cost Report
Prepared Using the FIFO Method?

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How Is a Production Cost Report
Prepared Using the FIFO Method?

© 2016 Pearson Education Ltd. 20-44

How Is a Production Cost Report
Prepared Using the FIFO Method?

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How Is a Production Cost Report
Prepared Using the FIFO Method?

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 How Is a Production Cost Report
Prepared Using the Weighted-Average
Method?

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