Chapter 3: Process Costing
The process cost system accumulates costs with out attempting to allocate them during the accounting period to specific units of goods being manufactured. At the end of the fiscal period, the average cost per unit is determined by dividing the total cost accumulated to the total number of units produced.
Because of these techniques, process costing is often referred to as average costing. If the process costing system is used, the goods manufactured must be similar in nature so that an average cost will be meaningful. The process cost system is commonly used in such manufacturing operations as cement plants and flour mills, in which the production process is standardized and continuous and the product remains essentially the same from day to day.
In many types of business use process costing, manufacturing consists of a progressive series of distinct operations or processes. Usually each process is carried out in different department. A unit cost may be computed for each process or department. This departmental unit cost may be a useful to in measuring and controlling efficiency. The total cost of production determined by adding up the departmental costs.
A process costing is most commonly used in industries that produce essentially homogeneous (i.e. uniform) products on a continuous basis.
Firms producing distinct and unique products use job order costing where as firms producing similar or identical units use process-costing system.
Process costing system accumulate costs by department for a period of time, just as a job order costing system accumulate costs by job, and the total cost then will be assigned to the units produced during that period.
Similarities between job-Order and Process Costing
1. The same basic purposes exist in both systems, which are to assign material, labor, and overhead cost to products and to provide a mechanism for computing unit costs.
2. Both systems maintain and use the same basic manufacturing accounts, including MO, Raw Materials, Work in Process, and Finished Goods.
3. The flow of costs through the manufacturing accounts is basically the same in both systems.
Differences between Job-Order and Process Costing
Job-Order Costing Process Costing
1. Many different jobs are worked on during each period, with each job having different production requirements.
2. Costs are accumulated by identical job. 3. The job cost sheet is the key document controlling the accumulation of costs by a job.
4. Unit costs are computed by job on the job cost sheet.
1. A single product is produced either on a continuous basis for long periods of time. All units of product are identical.
2. Costs are accumulated by department. 3. The department production report is the key document showing the accumulation and disposition of costs by a department. 4. Unit costs are computed by department on the department production report.
The principal difference between process costing and job costing is the extent of averaging used to compute unit costs of products or services. In job-costing system, individual jobs use different quantities of production resources. Thus, it would be incorrect to cost each job at the same average production cost.
In contrast, when identical or similar units of products or services are mass produced, and not processed as individual jobs, process costing averages production costs over all units produced.
The difference between job order and process costing system is, thus, the extent of the averaging used to compute unit cost. In job order costing each job differs in terms of material used, labor incurred, and manufacturing overhead. Hence, it is impossible to assign the same cost for different jobs. On the contrary, identical units produced in mass took equal amount of direct material, direct labor, and manufacturing overhead. Thus, the unit cost can be found by dividing total cost by the number of units produced.
The Flow of Costs in Process-Costing System with Sequential Production Departments
1. As direct materials and direct labor are used in production department A, these costs are added to the Work-in Process inventory account for Department A. Overhead is applied using predetermined overhead rate. The POR is determined in the same way in job order and process costing.
Work-in Process: Production Department A xxx
Raw Materials xxx
Wage Payable xxx
Manufacturing overhead applied xxx
2. When production department A completes its work on some units of product, these units of product are transferred to production department B. The costs assigned to these goods are transferred from the Work-in Process Inventory account for department A to work-in Process inventory account in department B, the costs assigned to those partially completed products are called transferred-in costs1.
Work-in Process: Production Department B xxx
Work-in Process: Production Department A xxx 3. Direct material and direct labor are used in production department B, and
manufacturing overhead is applied using POR.
Work-in Process: Production Department B xxx
Raw Materials xxx
Wages Payable xxx
Manufacturing overhead applied xxx
4. Goods are completed in production department B and transferred to the finished goods warehouse.
Finished-Goods xxx
Work-in Process: Production Department B xxx 5. Goods are sold
Cost of Goods Sold xxx
1Transferred-in costs are assigned to partially completed products that are transferred into one production
Finished-Goods xxxx
Cost Accumulation Methods in Process Costing
System
o When a firm produces identical lots of goods repetitively, maintaining a separate job cost sheet would be unnecessarily expensive. The aggregate cost and the unit cost can be computed without a job cost sheet, thus saving the costs associated with producing such records.
o Costs accumulate by department over a certain period and the unit cost can be found by dividing the total cost to the units produced during that period. Process costing system fit among others to, paint manufacturers, oil refineries, sugar refineries, and salt producers.
o In process costing system, manufacturing costs, direct material, direct labor, and manufacturing overhead costs are accumulated in the same way as job order costing system. However, the costs are accumulated by department over some period of time than by individual jobs.
o The time period over which the cost is to be accumulated depends on the information needs of the company. It can be a week, two weeks, but no longer than a month most often. Cost accumulation is much simpler for a process costing system than for a job order cost system.
Illustrating Process Costing
Assumptions: ABC Manufacturing Company manufactures thousands of Products A. These components are assembled in the Assembly Department, upon completion the units are completely transferred to the Testing Department. The process-costing system for Product A has a single direct cost category (direct materials) and a single indirect-cost category (conversion costs). Direct materials are added at the beginning of the process in Assembly. Conversion costs are added evenly during Assembly. Case 1: Process costing with zero beginning and zero ending work in process inventory that is all units are started and fully completed by the end of the accounting period.
Data for the Assembly Department for January 2001 Physical Units for January 2001
Work in Process, beginning inventory (January 1) 0 units
Started during January 400 units
Completed and transferred out during January 400 units Work in Process, ending inventory (January 31) 0 units Total Costs for January 2001
Direct materials costs added during January Br.32,000
Conversion costs added during January 24,000
Total Assembly Department costs added during January 56,000 Solution:
Direct Material costs per unit (32,000/400) Br. 80 Conversion costs per unit (24000/400) 60
Case 2: Process Costing with zero beginning but some ending work in process inventory
Data for the Assembly Department for February 2001 Physical Units for February 2001
Work in Process, beginning inventory (February 1) 0 units
Started during February 400 units
Completed and transferred out during February 175 units Work in Process, ending inventory (February 28) 225 units Total Costs for February 2001
Direct materials costs added during February Br.32,000
Conversion costs added during February 18,600
Total Assembly Department costs added during February 50,600 In addition, the Assembly Department estimates that the partially assembled units are on averages 60% complete as to conversion costs.
How should the co. calculate the cost of fully assembled units in February 2001 and the cost of partially assembled units still in process at the end of February 2001? Steps:
Summarize the flow of physical units of output. Compute output in terms of equivalent units. Compute equivalent unit costs.
Summarize total costs to account for.
Assign total costs to unit’s completed and to units in ending work in process.
Equivalent Units: A key Concept
Material, labor and overhead costs are incurred at different rates in production process. Direct material usually placed in production at one or more discreet points in the process. In contrast, direct labor and manufacturing overhead, called conversion costs, and usually are incurred continuously throughout the process. When an accounting period ends, the partially completed goods that remain in
process generally are at different stages of completion with respect to material and conversion activity.
Example: Suppose there are 1000 physical units in process at the end of an accounting period. Each of the physical units is 75% complete with respect to conversion. How much conversion activity has been applied to these partially completed units?
Conversion activity occurs uniformly throughout the production process. Therefore, the amount of conversion activity required to do 75% of the conversion on 1000 units is equivalent to the amount of the conversion on 750 units. The number is computed as follows:
1000 partially completed physical units in process * 75% complete with respect to
Conversion = 750
The term equivalent unit is also used to measure the amount of direct materials represented by the partially completed goods. Since direct materials are incorporated at the beginning of the production process, the 1000 physical units represent 1000 equivalent units of direct material ( 1000 physical units * 100% complete with respect to direct materials).
Physical units and Equivalent units (Step 1&2)
Equivalent units is a derived amount of output units that takes the quantity of each input (factor of production) in units completed or in work in process, and converts it into the amount of completed output units that could be made with that quantity of input.
Equivalent Units
Flow of Production Physical
Units
Direct Materials
Conversion costs
Work in process, beginning Started during current period To account for
Completed and transferred out during current period
Work in process, ending 225*100%; 225*60% Accounted for
Work done in current period
0 400 400
175 225
400
175
225
400
175
225
310
Calculation of Product Costs (Steps 3, 4, and 5) Total Productio n Costs
Direct Materials
Conversion Costs
(Step 3) Costs added during February divided by equivalent units of work done incurrent period Cost per equivalent unit
(Step 4) Total costs to account for (Step 5) Assignment of costs:
Completed & transferred out (175 units) Work in process, ending (225 units) Direct Materials
Conversion costs
Total work in process Total costs accounted for
50,600
Br. 50,600
Br. 24,500
18,000 8,100 26,100 Br.50,600
Br.32,000/ 400 Br. 80
(175*800)
225*80
Br.18,000/ 310 Br. 60
(175*60)
135*60
Journal Entries
Work in Process- Assembly 32,000
Account Payable Control 32,000
(To record direct materials purchased and used in production) Work in Process- Assembly 18,600
Work in Process- Assembly 24,500
(To record cost of goods completed and transferred from Assembly to Testing Department)
Case 3: Process costing with some beginning and some ending work in process inventory.
Data for the Assembly Department for March 2001 Physical Units for March 2001
Work in Process, beginning inventory (March 1) 225 units Direct Materials (100% complete)
Conversion costs (60% complete)
Started during March 275 units
Completed and transferred out during March 400 units Work in Process, ending inventory (March 31) 100 units
Direct Materials (100% complete) Conversion costs (50% complete) Total Costs for March 2001
Work in process, beginning inventory
Direct materials (225 equivalent units * Br. 80/unit) Br. 18,000
Conversion costs (135 equivalent units * Br.60/unit) 8,100 Br. 26,100 Direct materials costs added during March 19,800
Conversion costs added during March 16,380
Total costs to account for Br.62, 280
Weighted-Average process costing method
This method calculates the equivalent unit cost of the work done to date (regardless of the period in which it was done) and assigns this cost to equivalent units completed and transferred out of the process and to equivalent units in ending work in process inventory.
The weighted average cost is the total of all costs entering in the work in process account (regardless of whether it is from the beginning work in process or from work started during the period) divided by total equivalent units of work done to date.
Physical units and Equivalent units (Step 1&2)
Equivalent Units
Flow of Production Physical
Units
Direct Materials
Conversion costs
Work in process, beginning Started during current period To account for
Completed and transferred out during current period
Work in process, ending 100*100%; 100*50% Accounted for
Work done in current period
225 275 500
400 100
500
400
100
500
400
50
Calculation of Product Costs (Steps 3, 4, and 5) Total Production Costs
Direct
Materials Conversioncosts
(Step 3) Work in process, beginning
Costs added during the current period Costs incurred to date divided by Equivalent units of work done to date Cost per equivalent unit of work done (Step 4) Total costs to account for
(Step 5) Assignment of Costs
Completed and transferred out (400 units) Work in process, ending (100 units) Direct Materials
Conversion costs Total work in process Total costs accounted for
Br.26,100 36,180
Br.62,280 52,000
7,560 2,720 10,280 Br. 62,280
Br.18,000 19,800 Br. 37,800/ 500 Br.75.60
(400*75.60)
100*75.60
Br.8,100 16,380 Br. 24,480/ 450 Br.54.40
(400*54.40)
50*54.40
Journal Entries
Work in Process- Assembly 19,800
Account Payable Control 19,800
(To record direct materials purchased and used in production) Work in Process- Assembly 16,380
Various accounts 16,380 (To record Assembly department conversion costs) Work in Process- Testing 52,000
Work in Process- Assembly 52,000
(To record cost of goods completed and transferred from Assembly to Testing Department)
First-in, First-out Method
The FIFO process costing method assigns the cost of the previous period’s equivalent units in beginning work-in process inventory to the first units completed and transferred out of the process, and assigns the cost of equivalent units worked on during the current period first to complete beginning inventory, then to start and complete new units in ending work in process inventory.
This method assigns that the earliest equivalent units in the work in process-Assembly account are completed first.
A distinct feature of the FIFO process-costing method is that work done on beginning inventory before the current period is kept separate from work done in the current period.
In contrast equivalent unit and cost per equivalent unit calculations in the weighted average method merge the units and costs in beginning inventory with units and costs of work done in the current period.
Physical units and Equivalent units (Step 1&2)
Equivalent Units
Flow of Production Physical
Units
Direct Materials
Conversion costs
Work in process, beginning Started during current period To account for
Completed and transferred out during current period
From beginning work in process 225*(100%-100%); 225*(100%-60%) Started and Completed
175*100%, 175*100% Work in process, ending 100*100%; 100*50% Accounted for
Work done in current period
225 275 500 225 175 100 500 0 175 100 275 90 175 50 315
Calculation of Product Costs (Steps 3, 4, and 5) Total Production Costs
Direct
Materials Conversioncosts
(Step 3) Work in process, beginning Costs added current period
Divided by equivalent units of work done in current period
Costs per equivalent unit of work done in the current period
(Step 4) Total costs to account for (Step 5) Assignment of Costs
Completed and transferred out (400 units) Work in process, beginning (225 units) Direct Materials added in current period Conversion costs added in current period Total from beginning inventory Started and completed (175 units) Total costs of units completed & transferred Work in process, ending (100 units) Direct Materials
Conversion costs
Total work in process, ending Total costs accounted for
Br.26,100 36,180 Br.62,280 Br. 26,100 0 4,680 30,780 21,700 52,480 7,200 2,600 9,800 Br. 62,280 19,800/ 275 Br. 72 (400*75.60) 0*72 175*72 100*72 16,380/ 315 Br. 52 (400*54.40) 90*52 175*52 50*52
Work in Process- Testing 52,480
(To record cost of goods completed and transferred from Assembly to Testing Department)
Important points to note:
The first physical units assumed to be completed and transferred out during the period are the 225 units from the beginning work-in process inventory.
Of the 275 physical units started, 175 are assumed to be completed. 400 physical units were completed during March, the FIFO method assumes that the first 225 of these units must have been started and completed during March.
Ending work-in process inventory consists of 100 physical units-the 275 physical units started minus the 175 of these physical units completed.
Note that the physical units “to account for” equal the physical units “accounted for” (500 units)
The equivalent unit calculated for each cost category focus on the equivalent units of work done in the current period only. Under the FIFO method, the work done in the current period is assumed to first complete the 225 units in beginning work in process. The equivalent unit’s works done in March on the bigining wirk-in process inventory are computed by multiplying the 225 physical units by the percentage of work remaining to be done to complete these units: 0% for direct materials, and 40% for conversion costs.
Transferred-in Costs in Process Costing
Transferred-in costs also called previous department costs are the costs incurred in a previous department that are carried forward as the product’s cost when it moves to a subsequent process in the production cycle. That is as the units move from one department to the next, their costs are transferred with them.
Transferred in costs are treated as if they are a separate type of direct material added at the beginning of the process. In other words, when successive departments are involved, transferred units from one department become all or a part of the direct materials of the next department; however they are called transferred-in costs, not direct material costs.
Example: In our example as the assemble process is completed the department transfers the units to its Testing Department. Here the units receive additional direct materials, such as packing materials for shipment, at the end of the process. Conversion costs are added evenly during the Testing Department’s process. As units are completed in Testing, they are immediately transferred to Finished Goods.
Data for the Testing Department for the month of March 2001 are: Physical Units for March 2001
Work in Process, beginning inventory (March 1) 240 units Transferred-in costs (100% complete)
Direct Materials (0% complete) Conversion costs (62.5% complete)
Transferred in during March 400 units
Completed during March 440 units
Work in Process, ending inventory (March 31) 200 units Transferred-in costs (100% complete)
Conversion costs (80% complete)
Costs of Testing Department for March 2001 Work in process, beginning inventory
Transferred-in costs (240 equivalent units*140/ equ. Un) Br. 33,600
Direct materials 0
Conversion costs (150 equivalent units * Br.120/unit) 18,000 Br. 51,600 Transferred-in costs during March
Weighted-average 52,000
FIFO 52,480
Direct materials costs added during March 13,200
Conversion costs added during March 48,600
A. Transferred-in costs and the Weighted-Average Method
Equivalent Units
Flow of Production Physical
Units Transferred in costs DM CC
Work in process, beginning
Transferred in during current period To account for
Completed and transferred out during current period
Work in process, ending 200*100%; 200*0%; 200*80% Accounted for
Work done to date
240 400 640 440 200 500 440 200 640 440 0 440 440 160 600 Total Production Costs Transferr
ed in costs DMs CCs
(Step 3) Work in process, beginning Costs added in the current period Costs incurred to date divided by Equivalent units of work done to date Cost per equivalent unit of work done (Step 4) Total costs to account for (Step 5) Assignment of Costs
Completed and transferred out (440 units)
Work in process, ending (200 units) Transferred-in costs
Direct Materials Conversion costs
Total work in process Total costs accounted for
Br.51,600 113,800 Br.165,400 120,890 26,750 0 17,760 44,510 Br. 165,400 Br.33,600 52,000 Br.85,600/ 640 Br.133.75 (440*133. 75) 200*133.7 5 Br.0 13,200 Br.13,20/ 440 Br.30 (440*30) 0*30 Br.18,000 48,600 Br 66,600/ 600 Br.111 (440*111) 160*111
Finished Goods Control 120,890
Work-in Process: Testing 120,890 B. Transferred-in costs and the FIFO Method
Equivalent Units Flow of Production Physical
Units Transferred-in costs DirectMaterials Conversioncosts Work in process, beginning
Transferred-in current period To account for
Completed and transferred out during current period
From beginning work in process 240*0%; 240*(100%-0%); 200* (100%-62.5%)
Started and Completed 200*100%; for the three Work in process, ending 200*100%; 200*0%;200*80% Accounted for
Work done in current period
240 400 640 240 200 200 640 0 200 200 400 240 200 0 440 90 200 160 450 Total Production Costs Transferred-in cost DMs CCs
(Step 3)Work in process, beginning Costs added current period Divided by equivalent units of work done in current period
Costs per equivalent unit of work done in the current period
(Step 4) Total costs to account for (Step 5) Assignment of Costs Completed and transferred out (440 units Work in process, beginning (240 units) Transferred-in costs added in current Direct Materials added in current Conversion costs added in current Total from beginning inventory Started and completed (200 units) Total costs of units completed & transferred
Work in process, ending (200 units) Transferred-in costs
Direct Materials Conversion costs
Total work in process, ending Total costs accounted for
Br.51,600 114,280 Br.165,880 Br.51,600 0 7,200 9,720 68,520 53,840 122,360 26,240 0 17,280 43,520 Br. 165,880 52,480/ 400 Br.131.20 0*131.20 200*131.20 200*131.20 13,200/ 440 Br. 30 240*30 200*30 0*30 48,600/ 450 Br. 108 90*108 200*108 160*108
Finished Goods Control 122,360
