Chapter 6 Process Costing

Chapter 6

Process Costing

Cost Accounting Foundations and Evolutions

Learning Objectives

costing

• Explain why equivalent units of production are used in process costing

• Calculate equivalent units of production, unit costs, and inventory values using weighted average method of process costing

Learning Objectives

• Compute equivalent units of production, unit costs, and inventory values using FIFO

method of process costing

• Explain how standard costs are used in a process costing system

• Explain why a company would use a hybrid costing system

Job Order vs. Process Costing

Job Order

• Assign costs to job and then to units within the job

Process Costing

• Using an averaging

technique, assign costs directly to units

produced during the period

Process Costing

Averaging technique to assign costs to units produced

Unit Cost = Production Costs Production Quantity

Process Costing

– Accumulate costs by department – Accumulate costs by product

– Direct material from material requisitions

– Direct labor from time sheets and wage rates – Overhead

• Actual

• Predetermined application rates

Unit Cost = Production Costs

Process Costing

• Production Costs

– Direct material from material requisitions

– Direct labor from time sheets and wage rates – Overhead

• Actual

Process Costing

– Units started last period and completed this period

– Units started this period and not completed • Convert partially completed units to

equivalent whole units

Unit Cost = Production Costs Production Quantity

Equivalent Units of Production (EUP)

• Approximation of the number of whole units of output that could have been

produced from the actual effort expended • Includes units

– started last period and finished this period – started and finished this period

– started this period and not finished

• Assumes FIFO physical flow through the production department

Two Process Costing Methods

• Weighted Average Method

– combines

• beginning work in process • current period production • FIFO Method

– separates

• beginning work in process • current period production

Process Costing

• Direct material

– added at the beginning, during, and/or at the end of process

• Direct labor

– added throughout the process • Overhead

– added throughout the process • based on direct labor

Process Costing Steps

2 Units accounted for

3 Determine equivalent units

4 Costs to account for

5 Compute cost per equivalent unit

6 Assign costs to inventories

Units

Step 1 - Units to Account For

Beginning WIP 5,000

Started 200,700

Step 2 - Units Accounted For

Finished and transferred 203,000

Ending WIP 2,700

Units accounted for 205,700

Beginning WIP 5,000

Started 200,700

Units to account for 205,700

must be

Step 3 - Compute Equivalent Units

Beginning WIP inventory 5,000 5,000 Started and completed 198,000 198,000 Ending WIP inventory 2,700 2,160*

Equivalent units 205,700 205,160

* ending units * % complete 2,700 * 80% = 2,160

Step 4 - Costs to Account For

DM Conversion Total

Beginning WIP $ 5,943 $ 16,758 $ 22,701 Current costs 321,120 660,270 981,390

To account for $327,063 $677,028 $1,004,091

Step 5 - Cost per Equivalent Unit

Divide by EUP 205,700 205,160

Cost per EUP $1.59 + $3.30 = $4.89

Weighted Average Method

DM Conversion Total

Beginning WIP $ 5,943 $ 16,758 $ 22,701

Current costs 321,120 660,270 981,390

Step 6 - Assign Costs to Inventories

Transferred (203,000 * $4.89) $992,670 Ending WIP Inventory

Direct Materials

(2,700 * $1.59) $ 4,293 Conversion Costs

(2,700 * 80% * $3.30) 7,128 11,421 Cost accounted for $1,004,091* *must agree with costs to account for

Weighted Average Method

Transferred

Out _Ending

Process Costing -

FIFO

• Emphasizes current period costs and production

Process Costing -

FIFO

• Step 3

DM Conversion

Beginning WIP/completed 0 3,000* Started and completed 198,000 198,000 Ending WIP Inventory 2,700 2,160 Equivalent units 200,700 203,160

* beginning units * % complete in current period 5,000 * 60% = 3,000

Process Costing -

FIFO

• Step 4 is the same • Step 5

DM Conversion Total

Current costs $321,120 $660,270 $981,390

Divide by EUP 200,700 203,160

Step 6 Assign Costs to

Inventories -

FIFO

Beginning WIP Inventory $22,701 Cost to complete

Conversion (3,000 * $3.25) 9,750 $ 32,451 Started and completed

(198,000 * $4.85) 960,300

Total cost transferred $992,751

Ending inventory Direct Materials

(2,700 * $1.60) $4,320 Conversion Costs

(2,7000 * 80% * $3.25) 7,020 11,340

Cost accounted for $1,004,091*

*must agree with costs to account for

Transferred

Out _Ending

Process Costing Comparison

Weighted Average

• EUP DM 205,700 • EUP Conversion 205,160 • Cost per unit DM $ 1.59 • Cost per unit Conv. 3.30 • Total $4.89 • Transferred Out $992,670 • Ending WIP 11,421 • Total $1,004,091 FIFO • EUP DM 200,700 • EUP Conversion 203,160 • Cost per unit DM $ 1.60 • Cost per unit Conv. 3.25 • Total $ 4.85 • Transferred Out $ 992,751 • Ending WIP 11,340 • Total $1,004,091

Process Costing

• The purpose of the six steps

– Assign a value to ending work in process – Assign a value to items transferred out – Prepare this journal entry

Finished Goods

Work in Process

or

Transferred In Cost (successor department) Work in Process (current department)

Process Costing with Standard Costs

• Simplify costing process

• Eliminate periodic cost recomputations • Same as FIFO computations

– emphasize current period costs and production • Inventories are stated at standard cost

• Variances are calculated for material, labor, and overhead

Process Costing with Standard Costs

• Assigns a “normal” production cost to the equivalent units of output each period

• Allows managers to quickly recognize and investigate significant deviations from

expected production costs

Hybrid Costing Systems

• Characteristics of job order and process costing systems

• Various product lines

– different direct material - job order costing

– different direct labor – job order costing

– same process - process costing

• Hybrid costing used for furniture, clothing, jam

Questions

• What is an equivalent unit of production? • What is the difference between the

weighted average and FIFO methods of calculating equivalent units?

• Why would a company use a hybrid costing system?