Chapter 4

System Design: Process Costing

PowerPoint Authors: Jon A. Booker, Ph.D., CPA, CIA Charles W. Caldwell, D.B.A., CMA Susan Coomer Galbreath, Ph.D., CPA
McGraw-Hill/Irwin Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

4-2

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 cost. 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.

4-3

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 are worked on each period. Process costing systems accumulate costs by department. Job-order costing systems accumulate 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.

4-4

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.

4-5

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.

4-6

Processing Departments
Any location 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.

4-7

Learning Objective 1
Record the flow of materials, labor, and overhead through a process costing system.

4-8

Flow of Materials, Labor, and Overhead Costs

Direct Materials Direct Labor Work in Process Finished Goods

Manufacturing Overhead

Cost of Goods Sold

4-9

Flow of Materials, Labor, and Overhead Costs

Direct Materials Direct Labor Costs are traced and applied to individual jobs in a job-order cost system. Finished Goods

Jobs

Manufacturing Overhead

Cost of Goods Sold

4-10

Flow of Materials, Labor, and Overhead Costs

Direct Materials Direct Labor Costs are traced and applied to departments in a process cost system. Processing Department Finished Goods

Manufacturing Overhead

Cost of Goods Sold

4-11

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.

4-12

The Flow of Raw Materials

(in T-Account form)
Raw Materials
Direct Materials

Work in Process Department A

Direct Materials

Work in Process Department B

Direct Materials

4-13

The Flow of Raw Materials

(in journal entry form)
GENERAL JOURNAL
Date Description Work in Process - Department A Work in Process - Department B Raw Materials To record the use of direct material. Post. Ref. Debit XXXXX XXXXX XXXXX

Page 4
Credit

4-14

The Flow of Labor Costs

(in T-Account form)
Salaries and Wages Payable
Direct Labor

Work in Process Department A

Direct Materials Direct Labor

Work in Process Department B

Direct Materials Direct Labor

4-15

The Flow of Labor Costs

(in journal entry form)
GENERAL JOURNAL
Date Description Work in Process - Department A Work in Process - Department B Salaries and Wages Payable To record direct labor costs. Post. Ref. Debit XXXXX XXXXX XXXXX

Page 4
Credit

4-16

The Flow of Manufacturing Overhead Costs

(in T-Account form)
Work in Process Department A Manufacturing Overhead
Actual Overhead Overhead Applied to Work in Process Direct Materials Direct Labor Applied Overhead

Work in Process Department B

Direct Materials Direct Labor Applied Overhead

4-17

The Flow of Manufacturing Overhead Costs

(in journal entry form)
GENERAL JOURNAL
Date Description Work in Process - Department A Work in Process - Department B Manufacturing Overhead To apply overhead to departments. Post. Ref. Debit XXXXX XXXXX XXXXX

Page 4
Credit

4-18

Partially Completed Units Transferred

(in T-Account form)
Work in Process Department A
Direct Materials Direct Labor Applied Overhead Transferred to Dept. B

Work in Process Department B

Direct Materials Direct Labor Applied Overhead Transferred from Dept. A

4-19

Partially Completed Units Transferred

(in journal entry form)
GENERAL JOURNAL
Date Description Work in Process - Department B Work in Process - Department A To record the transfer of goods from Department A to Department B. Post. Ref. Debit XXXXX XXXXX

Page 4
Credit

4-20

Transfer of Cost of Completed Units

(in T-Account form)
Work in Process Department B
Direct Cost of Materials Goods Direct Manufactured Labor Applied Overhead Transferred from Dept. A

Finished Goods
Cost of Goods Manufactured

4-21

Transfer of Cost of Completed Units

(in journal entry form)

GENERAL JOURNAL
Date Description Finished Goods Work in Process - Department B To record the completion of goods and their transfer from Department B to finished goods inventory. Post. Ref. Debit XXXXX

Page 4
Credit XXXXX

4-22

Cost of Finished Goods Sold

(in T-Account form)
Work in Process Department B Finished Goods

Direct Cost of Cost of Cost of Materials Goods Goods Goods Direct Manufactured Manufactured Sold Labor Applied Overhead Transferred from Dept. A Cost of Goods Sold

Cost of Goods Sold

4-23

Cost of Finished Goods Sold

(in journal entry form)
GENERAL JOURNAL
Date Description Cost of Goods Sold Finished Goods To record cost of goods sold. Post. Ref. Debit XXXXX XXXXX

Page 4
Credit

4-24

Equivalent Units of Production

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

4-25

Equivalent Units The Basic Idea

Two half completed products are equivalent to one completed product.

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

4-26

Quick Check

For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process that are 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

4-27

Quick Check

For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process that are 30 percent complete. How many equivalent units of production did Jones have for the period? a. 10,000 10,000 units + (5,000 units 0.30) b. 11,500 = 11,500 equivalent units c. 13,500 d. 15,000

4-28

Calculating Equivalent Units

Equivalent units can be calculated two ways:
The First-In, First-Out Method FIFO
is covered in the appendix available on the web.

The Weighted-Average Method This

method will be covered in the main portion of the chapter.

4-29

Learning Objective 2

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

4-30

Characteristics of the 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. 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 departments ending Work in Process inventory.

4-31

Treatment of Direct Labor

Direct Materials Dollar Amount

Direct Labor

Direct labor costs may be small in comparison to Conversion other product costs in process costing systems.

Type of Product Cost

4-32

Treatment of Direct Labor

Direct Materials Dollar Amount

Direct labor costs may be small Conversion in comparison to other product costs in process costing systems.

Type of Product Cost

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

4-33

Weighted-Average An Example
Smith Company reported the following activity in the Assembly Department for the month of June:
Percent Completed Units Work in Process, June 1 Units started into production in June Units completed and transferred out of Department A during June Work in Process, June 30 300 6,000 5,400 Materials Conversion 40% 20%

900

60%

30%

4-34

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)
Materials Units completed and transferred out of the Department in June 5,400 Conversion 5,400

4-35

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.
Materials Units completed and transferred out of the Department in June Work in Process, June 30: 900 units 60% 540 5,400 Conversion 5,400

Equivalent units of Production in the Department during June

5,940

4-36

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.
Materials Units completed and transferred out of the Department in June Work in Process, June 30: 900 units 60% 900 units 30% Equivalent units of Production in the Department during June 5,940 540 270 5,670 5,400 Conversion 5,400

4-37

Weighted-Average An Example
Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in Work in Process
Materials Units completed and transferred out of the Department in June Work in Process, June 30: 900 units 60% 900 units 30% Equivalent units of Production in the Department during June 5,940 540 270 5,670 5,400 Conversion 5,400

4-38

Weighted-Average An Example Materials

Beginning Work in Process 300 Units 40% Complete

6,000 Units Started

5,100 Units Started and Completed

Ending Work in Process 900 Units 60% Complete

5,400 Units Completed 540 Equivalent Units 5,940 Equivalent units of production

900 60%

4-39

Weighted-Average An Example Conversion

Beginning Work in Process 300 Units 20% Complete

6,000 Units Started

5,100 Units Started and Completed

Ending Work in Process 900 Units 30% Complete

5,400 Units Completed 270 Equivalent Units 5,670 Equivalent units of production

900 30%

4-40

Learning Objective 3

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

4-41

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 Production completed during June Costs added to production in June Materials cost Conversion cost Ending Work in Process Inventory: Materials: 60% complete Conversion: 30% complete 6,000 units 5,400 units $ 118,621 $ 81,130 900 units

4-42

Compute and Apply Costs

The formula for computing the cost per equivalent unit is:
Cost per equivalent = unit Cost of beginning Work in Process + Cost added during inventory the period Equivalent units of production

4-43

Compute and Apply Costs

Here is a schedule with the cost and equivalent unit information.
Total Cost Cost to be accounted for: Work in Process, June 1 Cost added in Assembly Total cost Equivalent units $ $ 10,039 199,751 209,790 Materials $ 6,119 118,621 Conversion $ $ 3,920 81,130 85,050 5,670

$ 124,740 5,940

4-44

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
Total Cost Cost to be accounted for: Work in Process, June 1 Cost added in Assembly Total cost Equivalent units Cost per equivalent unit $ $ $ 10,039 199,751 209,790 Materials $ 6,119 118,621 Conversion $ $ 3,920 81,130 85,050 5,670 $ 15.00

$ 124,740 5,940 21.00

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

4-45

Learning Objective 4

Assign costs to units using the weighted-average method.

4-46

Applying Costs
Assembly Department Cost of Ending WIP Inventory and Units Transferred Out Materials Conversion Total Ending WIP inventory: Equivalent units 540 270

4-47

Applying Costs
Assembly Department Cost of Ending WIP Inventory and Units Transferred Out Materials Conversion Total Ending WIP inventory: Equivalent units 540 270 Cost per equivalent unit $ 21.00 $ 15.00

4-48

Applying Costs
Assembly Department Cost of Ending WIP Inventory and Units Transferred Out Materials Conversion Total Ending WIP inventory: Equivalent units 540 270 Cost per equivalent unit $ 21.00 $ 15.00 Cost of Ending WIP inventory $ 11,340 $ 4,050 $ 15,390

4-49

Computing the Cost of Units Transferred Out

Assembly Department Cost of Ending WIP Inventory and Units Transferred Out Materials Conversion Total Ending WIP inventory: Equivalent units 540 270 Cost per equivalent unit $ 21.00 $ 15.00 Cost of Ending WIP inventory $ 11,340 $ 4,050 $ 15,390 Units completed and transferred out: Units transferred 5,400 5,400

4-50

Computing the Cost of Units Transferred Out

Assembly Department Cost of Ending WIP Inventory and Units Transferred Out Materials Conversion Total Ending WIP inventory: Equivalent units 540 270 Cost per equivalent unit $ 21.00 $ 15.00 Cost of Ending WIP inventory $ 11,340 $ 4,050 $ 15,390 Units completed and transferred out: Units transferred 5,400 5,400 Cost per equivalent unit $ 21.00 $ 15.00

4-51

Computing the Cost of Units Transferred Out

Assembly Department Cost of Ending WIP Inventory and Units Transferred Out Materials Conversion Total Ending WIP inventory: Equivalent units 540 270 Cost per equivalent unit $ 21.00 $ 15.00 Cost of Ending WIP inventory $ 11,340 $ 4,050 $ 15,390 Units completed and transferred out: Units transferred 5,400 5,400 Cost per equivalent unit $ 21.00 $ 15.00 Cost of units transferred out $ 113,400 $ 81,000 $ 194,400

4-52

Learning Objective 5

Prepare a cost reconciliation report.

4-53

Reconciling Costs
Assembly Department Cost Reconciliation Costs to be accounted for: Cost of beginning Work in Process Inventory Costs added to production during the period Total cost to be accounted for

$ $

10,039 199,751 209,790

4-54

Reconciling Costs
Assembly Department Cost Reconciliation Costs to be accounted for: Cost of beginning Work in Process Inventory Costs added to production during the period Total cost to be accounted for Cost accounted for as follows: Cost of ending Work in Process Inventory Cost of units transferred out Total cost accounted for

$ $

10,039 199,751 209,790

$ $

15,390 194,400 209,790

4-55

Appendix 4A
FIFO Method
PowerPoint Authors: Jon A. Booker, Ph.D., CPA, CIA Charles W. Caldwell, D.B.A., CMA Susan Coomer Galbreath, Ph.D., CPA
McGraw-Hill/Irwin Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

4-56

FIFO vs. Weighted-Average Method

The FIFO method (generally considered more accurate that the weighted-average method) differs from the weighted-average method in two ways:
1. The computation of equivalent units. 2. The way in which the costs of beginning inventory are treated.

4-57

Learning Objective 6

Compute the equivalent units of production using the FIFO method.

4-58

Equivalent Units FIFO Method

Lets revisit the Smith Company example. Here is information concerning the Assembly Department for the month of June.
Percent Completed Units Work in Process, June 1 Units started into production in June Units completed and transferred out of Department A during June Work in Process, June 30 300 6,000 5,400 Materials Conversion 40% 20%

900

60%

30%

4-59

Equivalent Units FIFO Method

Step 1: Determine equivalent units needed to complete beginning Work in Process inventory.
Materials To complete beginning Work in Process: Materials: 300 units (100% - 40%) Conversion: 300 units (100% - 20%) 180 240 Conversion

4-60

Equivalent Units FIFO Method

Step 2: Determine units started and completed during the period.
Materials To complete beginning Work in Process: Materials: 300 units (100% - 40%) Conversion: 300 units (100% - 20%) Units started and completed during June 5,100 180 240 5,100 Conversion

4-61

Equivalent Units FIFO Method

Step 3: Add the equivalent units in ending Work in Process inventory.
Materials To complete beginning Work in Process: Materials: 300 units (100% - 40%) Conversion: 300 units (100% - 20%) Units started and completed during June Ending Work in Process: Materials: 900 units 60% complete Conversion: 900 units 30% complete Equivalent units of production 540 270 5,820 5,610 5,100 180 240 5,100 Conversion

4-62

FIFO Example Materials

Beginning Work in Process 300 Units 40% Complete

6,000 Units Started

5,100 Units Started and Completed

Ending Work in Process 900 Units 60% Complete

300 60%

180 Equivalent Units 5,100 Units Completed 540 Equivalent Units 5,820 Equivalent units of production

900 60%

4-63

FIFO Example Conversion

Beginning Work in Process 300 Units 20% Complete

6,000 Units Started

5,100 Units Started and Completed

Ending Work in Process 900 Units 30% Complete

300 80%

240 Equivalent Units 5,100 Units Completed 270 Equivalent Units 5,610 Equivalent units of production

900 30%

4-64

Equivalent Units: WeightedAverage 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.
Equivalent units - weighted-average method Less equivalent units in beginning inventory: 300 units 40% 300 units 20% Equivalent units - FIFO method Materials 5,940 120 5,820 60 5,610 Conversion 5,670

4-65

Learning Objective 7

Compute the cost per equivalent unit using the FIFO method.

4-66

Cost per Equivalent Unit - FIFO

Lets revisit the Smith Company Assembly Department for the month of June to prepare our production report.
Beginning Work in Process: Materials: 40% complete Conversion: 20% complete $ $ 400 units 6,119 3,920 6,000 units 5,400 units $ 118,621 $ 81,130 900 units

Production started during June Production completed during June Costs added to production in June: Materials cost Conversion cost Ending Work in Process: Materials: 60% complete Conversion: 30% complete

4-67

Cost per Equivalent Unit - FIFO

The formula for computing the cost per equivalent unit under FIFO method is: Cost per equivalent = unit Cost added during the period

Equivalent units of production

4-68

Cost per Equivalent Unit - FIFO

Total Cost Cost added in June Equivalent units Cost per equivalent unit $ 199,751 Materials $ 118,621 5,820 $ 20.3816 Conversion $ 81,130 5,610

$ 14.4617

$118,600 5,820

$81,130 5,610

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

4-69

Learning Objective 8

Assign costs to units using the FIFO method.

4-70

Applying Costs - FIFO

Step 1: Record the equivalent units of production in ending Work in Process inventory.
Assembly Department Cost of Ending WIP Inventory Materials Conversion Ending WIP inventory: Equivalent units 540 270

Total

900 units 60%

900 units 30%

4-71

Applying Costs - FIFO

Step 2: Record the cost per equivalent unit.
Assembly Department Cost of Ending WIP Inventory Materials Conversion Ending WIP inventory: Equivalent units Cost per equivalent unit 540 $ 20.3816 270 $ 14.4617

Total

4-72

Applying Costs - FIFO

Step 3: Compute the cost of ending Work in Process inventory.
Assembly Department Cost of Ending WIP Inventory Materials Conversion Ending WIP inventory: Equivalent units Cost per equivalent unit Cost of Ending WIP inventory 540 $ 20.3816 $ 11,006 270 $ 14.4617 $ 3,905

Total

14,911

540 $20.3816

270 14.4617

4-73

Cost of Units Transferred Out

Step 1: Record the cost in beginning Work in Process inventory.
Assembly Department Cost of Units Transferred Out in June Materials Conversion Cost of Units Transferred Out: Cost in beginning WIP inventory $ 6,119 $ 3,920

Total $ 10,039

4-74

Cost of Units Transferred Out

Step 2: Compute the cost to complete the units in beginning Work in Process inventory.
Assembly Department Cost of Units Transferred Out in June Materials Conversion Cost of Units Transferred Out: Cost in beginning WIP inventory $ 6,119 $ 3,920 Cost to complete beginning WIP Equivalent units to complete 180 240 Cost per equivalent unit $ 20.3816 $ 14.4617 Cost to complete beginning WIP $ 3,668 $ 3,471 Total $ 10,039

7,139

4-75

Cost of Units Transferred Out

Step 3: Compute the cost of units started and completed this period.
Assembly Department Cost of Units Transferred Out in June Materials Conversion Cost of Units Transferred Out: Cost in beginning WIP inventory $ 6,119 $ 3,920 Cost to complete beginning WIP Equivalent units to complete 180 240 Cost per equivalent unit $ 20.3816 $ 14.4617 Cost to complete beginning WIP $ 3,668 $ 3,471 Cost of units started and completed: Units started and completed 5,100 5,100 Cost per equivalent unit $ 20.3816 $ 14.4617 Cost of units started and completed $ 103,946 $ 73,755 Total $ 10,039

7,139

177,701

4-76

Cost of Units Transferred Out

Step 4: Compute the total cost of units transferred out.
Assembly Department Cost of Units Transferred Out in June Materials Conversion Cost of Units Transferred Out: Cost in beginning WIP inventory $ 6,119 $ 3,920 Cost to complete beginning WIP Equivalent units to complete 180 240 Cost per equivalent unit $ 20.3816 $ 14.4617 Cost to complete beginning WIP $ 3,668 $ 3,471 Cost of units started and completed: Units started and completed 5,100 5,100 Cost per equivalent unit $ 20.3816 $ 14.4617 Cost of units started and completed $ 103,946 $ 73,755 Cost of Units Transferred Out

Total $ 10,039

7,139

177,701 $ 194,879

4-77

Learning Objective 9

Prepare a cost reconciliation report using the FIFO method.

4-78

Reconciling Costs
Assembly Department Cost Reconciliation for June Costs to be accounted for: Cost of beginning Work in Process Inventory Costs added to production during the period Total cost to be accounted for

$ $

10,039 199,751 209,790

4-79

Reconciling Costs
Assembly Department Cost Reconciliation for June Costs to be accounted for: Cost of beginning Work in Process Inventory Costs added to production during the period Total cost to be accounted for Cost accounted for as follows: Cost of ending Work in Process Inventory Cost of units transferred out Total cost accounted for

$ $

10,039 199,751 209,790

$ $

14,911 194,879 209,790

4-80

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.

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End of Chapter 4