Chap 04 Notes

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Copyright 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

11th EditionChapter 4


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Chapter Four

Systems Design:Process Costing


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Similarities Between Job-Order and ProcessCosting

Both systems assign material, labor andoverhead costs to products and they provide amechanism for computing unit product cost.

Both systems use the same manufacturingaccounts, 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.


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Differences Between Job-Order and ProcessCosting

Process costing is used when a single product is produced onProcess costing is used when a single product is produced ona continuing basis or for a long period of time. Joba continuing basis or for a long period of time. Job--orderordercosting is used when many different jobs are worked on eachcosting is used when many different jobs are worked on eachperiod.period.

Process costing systems accumulate costs by department.Process costing systems accumulate costs by department.JobJob--order costing systems accumulated costs by individualorder costing systems accumulated costs by individualjobs.jobs.

Process costing systems use department production reports toProcess costing systems use department production reports to

accumulate costs. Jobaccumulate costs. Job--order costing systems use job costorder costing systems use job costsheets to accumulate costs.sheets to accumulate costs.

Process costing systems compute unit costs by department.Process costing systems compute unit costs by department.JobJob--order costing systems compute unit costs by job.order costing systems compute unit costs by job.


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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.

Quick Check


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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.

Quick Check


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What is a Processing Department?

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

The activities performed in a processingThe activities performed in a processingdepartment aredepartment areperformed uniformlyperformed uniformlyon allon all

units of production. Furthermore, the output ofunits of production. Furthermore, the output ofa processing department must bea processing department must be

homogeneoushomogeneous..


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Comparing Job-Orderand Process Costing

FinishedGoods

Cost ofGoodsSold

Work inProces

s

Direct

Materials

Direct Labor

Manufacturing

Overhead


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FinishedGoods

Cost ofGoodsSold

Direct Labor

Manufacturing

Overhead

Jobs

Costs are traced andapplied to individualjobs in a job-order

cost system.

Direct

Materials


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FinishedGoods

Cost ofGoodsSold

Direct Labor

Manufacturing

Overhead

ProcessingDepartment

Costs are traced andapplied to departments

in a process cost

system.

Direct

Materials


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T-Account and Journal Entry Views of Cost Flows

For purposes of this example,assume there are two

processing departments Departments A and B.

We will use T-accounts andjournal entries.


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Raw Materials

Process Cost Flows(in T-account form)

Work in ProcessDepartment B

Work in ProcessDepartment A

DirectMaterials

DirectMaterials

DirectMaterials


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Process Cost Flows(in journal entry form)

GENERAL JOURNAL Page 4

Date Description

Post.

Ref. Debit Credit

Work in Process - Department A XXXXX

Work in Process - Department B XXXXX

Raw Materials XXXXX

To record the use of direct material.


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Wages Payable

DirectMaterials

DirectMaterials

DirectLabor

DirectLabor Direct

Labor


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ManufacturingOverhead

OverheadApplied toWork inProcess

AppliedOverhead

Applied

Overhead

DirectLabor

DirectMaterials

Direct

Labor

DirectMaterials

ActualOverhead


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DirectMaterials

DirectLabor

AppliedOverhead

DirectMaterials

DirectLabor

AppliedOverhead

Transferredto Dept. B

Transferredfrom Dept. A


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Process Costing(in journal entry form)


Date Description

Post.

Ref. Debit Credit

Work in Process - Department B XXXXX

Work in Process - Department A XXXXX

To record the transfer of goods from

Department A to Department B.


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Finished Goods



Cost of

GoodsManufactured

Direct

MaterialsDirectLabor

AppliedOverhead

Transferred

from Dept. A

Cost of

GoodsManufactured


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Finished Goods

Cost of Goods Sold

Process Cost Flows(in journal entry form)


Cost of

GoodsManufactured

Direct

MaterialsDirectLabor

AppliedOverhead

Transferred

from Dept. A

Cost ofGoodsSold

Cost of

GoodsSold

Cost of

GoodsManufactured


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Process Costing(in journal entry form)


Date Description

Post.

Ref. Debit Credit

AccountsReceivable XXXXX

Sales XXXXX

To record sales on account.

Cost of Goods Sold XXXXX

Finished Goods XXXXX

To record cost of goods sold.


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Equivalent Units of Production

Equivalent units are the product of the number ofpartially completed units and the percentage

completion of those units.

We need to calculate equivalent units because adepartment usually has some partially completed units

in its beginning and ending inventory.


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Equivalent Units The Basic Idea

Two half completed products areequivalent to one completed product.

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

+ = 1


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For the current period, Jones started 15,000units and completed 10,000 units, leaving5,000 units in process 30 percent complete.

How many equivalent units of production didJones have for the period?

a. 10,000

b. 11,500c. 13,500

d. 15,000

Quick Check


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For the current period, Jones started 15,000units and completed 10,000 units, leaving5,000 units in process 30 percent complete.

How many equivalent units of production didJones have for the period?

a. 10,000

b. 11,500c. 13,500

d. 15,000

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

Quick Check


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Calculating Equivalent Units

Equivalent units can be calculated twoEquivalent units can be calculated twoways:ways:

The FirstThe First--In, FirstIn, First--Out MethodOut Method FIFO isFIFO iscovered in the appendix to this chapter.covered in the appendix to this chapter.

The WeightedThe Weighted--A

verage MethodA

verage Method ThisThis

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


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Equivalent Units of ProductionWeighted-Average Method

Cost perequivalent

unit=

Costs for the periodEquivalent units of production

for the period

The weighted-average method . . .

Makes no distinction between work done in prior orcurrent periods.

Blends together units and costs from prior andcurrent periods.


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Process Costing and Direct Labor

Type of Product Cost

DollarAmount Conversion

Direct labor and manufacturing overhead may beDirect labor and manufacturing overhead may becombined into one product cost calledcombined into one product cost called conversionconversion..

DirectMaterials Direct labor costs

may be smallin comparison to

other productcosts in process

cost systems.


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Weighted-Average Example

Smith Company reported the following activity inDepartment A for the month of June:

Percent Completed

Units Materials Conversion

Work in process, June 1 300 40% 20%

Units started into production in June 6,000

Units completed and transferred out 5,400

of Department A during June



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The first step in calculating the equivalent units isto identify the units completed and transferred

out of Department A in June (5,400 units)


Materials Conversion

Units completed and transferred

out of Department A in June 5,400 5,400


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The second step is to identify the equivalent units ofproduction in ending work in process with respect to

materials for the month (540 units) and add this to the5,400 units from step one.





Work in process, June 30:

900 units 60% 540

Equivalent units of Production in

Department A during June 5,940


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900 units 60% 540

900 units 30% 270


Department A during June 5,940 5,670

The third step is to identify the equivalent units ofproduction in ending work in process with respect to

conversion for the month (270 units) and add this to the5,400 units from step one.


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900 units 60% 540

900 units 30% 270



Equivalent units of production always equals:


+ Equivalent units remaining in work in process



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BeginningWork in Process

300 Units40% Complete

EndingWork in Process900 Units

60% Complete

6,000 Units Started

5,400 Units Completed

5,100 Units Startedand Completed


Materials

5,400 Units Completed540 Equivalent Units 900 60%

5,940 Equivalent units

of produ

ction


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6,000 Units Started

5,400 Units Completed


270 Equivalent Units900 30%

5,670 Equivalent units

of produ

ction

BeginningWork in Process300 Units

20% Complete

EndingWork in Process



Conversion


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Production Report Weighted-Average

A computation ofA computation ofcost per equivalent unit.cost per equivalent unit.

Section 1

Section 2

Section 3

Production ReportA quantity scheduleA quantity schedule

showing the flow ofunitsshowing the flow ofunitsand the computation ofand the computation of

equivalent units.equivalent units.


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Production Report

Cost Reconciliation

section shows thereconciliation of all costflows into and out of thedepartment during theperiod.

Section 1

Section 2

Section 3

Production Report


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Assume that Double Diamond Skis uses theweighted-average method of process costing todetermine unit costs in it Shaping and Milling

Department.

Production Report Example


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Work in process, May 1: 200 units

Materials: 55% complete $ 9,600Conversion: 30% complete 5,575

Production started during May 5,000 unitsProduction completed during May 4,800 units

Costs added to production in MayMaterials cost $ 368,600Conversion cost 350,900

Work in process, May 31 400 unitsMaterials: 40% completeConversion: 25% complete



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Units to be accounted for:

Work in process, May 1 200

Started into production 5,000Total units 5,200

Equivalent units

Materia ls Conversion

Units accounted for as follows:

Completed and transferred 4,800 4,800 4,800


Materials 40% complete 160

5,200 4,960

Step1: Prepare Quantity Schedule with Equivalent Units.


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Started into production 5,000Total units 5,200

Equivalent units

Materia ls Conversion

Units accounted for as follows:

Completed and transferred 4,800 4,800 4,800


Materials 40% complete 160

Conversion 25% complete 100

5,200 4,960 4,900

Step1: Prepare Quantity Schedule with Equivalent Units.

St 2 C l l ti th C t P E i l t


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Step 2: Calculating the Costs Per EquivalentUnit

To calculate the cost per equivalentunit for the period:

Cost perequivalent

unit=

Costs for the period

Equivalent units of production

for the period


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Step 2: Compute the cost per equivalent unit.


Total

Cost Materials Conversion

Cost to be accounted for:

Work in process, May 1 15,175$ 9,600$ 5,575$

Costs added in the Shipping

and Milling Department 719,500 368,600 350,900

Total cost 734,675$ 378,200$ 356,475$

Equivalent units 4,960 4,900

Cost per equivalent unit


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Total






Total cost 734,675$ 378,200$ 356,475$


Cost per equivalent unit 76.25$



$378,200 4,960 units = $76.25


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Total






Total cost 734,675$ 378,200$ 356,475$


Cost per equivalent unit 76.25$ 72.75$

Total cost per equivalent unit = $76.25 + $72.75 = $149.00


$356,475$356,475 4,900 units = $72.754,900 units = $72.75



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Step 3: Prepare a Cost Reconciliation


Total Equivalent Units

Cost Materials ConversionCost accounted for as follows:

Transferred out during May 4,800 4,800

Work in process, May 31:

Materials 160

Conversion 100Total work in process, May 31

Total cost accounted for


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Cost Materials ConversionCost accounted for as follows:

Transferred out during May 715,200$ 4,800 4,800


Materials 160

Conversion 100Total work in process, May 31

Total cost accounted for

4,800 units @ $149.00


Step 3: Prepare a Cost Reconciliation


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Operation Costing

Operation costing is aOperation costing is a hybridhybridof jobof job--orderorderand process costing because itand process costing because it

possesses attributes of both approaches.possesses attributes of both approaches.

Conversion costsassigned to batches

as in process costing.

Material Costs chargedto batches as in

job-order costing.

Job-orderCosting

ProcessCosting

Operation Costing(Products produced in batches)


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FIFO Method

Appendix 4A


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FIFO vs. Weighted-Average Method

The FIFO method (generally considered moreaccurate that the weighted-average method)differs from the weighted-average method in

two ways:

1.1. The computation of equivalent units.The computation of equivalent units.

2.2. The way in which the costs of beginningThe way in which the costs of beginning

inventory are treated in the costinventory are treated in the costreconciliation report.reconciliation report.


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Equivalent Units FIFO Method

Lets revisit the Smith Company example.Assume the following activity is reported in

DepartmentA for the month of June:

Percent Completed








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Percent Completed







Step 1Step 1: Determine the number of units completed andtransferred out of Department A in June.


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900 units 60% 540

900 units 30% 270



Step 2Step 2: Add the equivalent units of production in endingwork in process inventory (540 units for material and 270

units for conversion) to the units completed and transferredour during June.


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Equivalent units or Production in


Equivalent units in beginning inventory

300 units 40% 120

300 units 20% 60



Step 3Step 3: Subtract the equivalent units in beginning work in processinventory (120 units for materials and 60 units for conversion) from the

sum of the units completed and transferred out and the equivalentunits in ending work in process inventory.


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40% Complete

EndingEndingWork in ProcessWork in Process

900 Units900 Units60% Complete60% Complete

6,000 Units Started



Materials

Material


Equivalent units in ending WIP inventory 540

Equivalent units in beginning WIP inventory (120)

Equivalent units of production 5,820


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6,000 Units Started



20% Complete

EndingWork in Process



Conversion

Conversion


Equivalent units in ending WIP inventory 270

Equivalent units in beginning WIP inventory (60)

Equivalent units of production 5,610


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Equivalent Units: Weighted Average vs. FIFO

Materials ConversionEquivalent units - weighted average method 5,940 5,670

Less equivalent units in beginning inventory:

300 units 40% 120

300 units 20% 60

Equ

ivalentu

nits - FIFO method 5,820 5,610

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

the FIFO method.

Th P d i R FIFO M h d


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The Production Report - FIFO Method

Lets revisit the Double Diamond Skis Shaping and MillingDepartment for the Month of May to prepare our production report.

Work in process, May 1: 200 units

Materials: 55% complete $ 9,600

Conversion: 30% complete 5,575$15, 175

Production started during May 5,000 unitsProduction completed during May 4,800 units

Costs added to production in MayMaterials cost $ 368,600Conversion cost 350,900

Work in process, May 31 400 unitsMaterials: 40% completeConversion: 25% complete

Th P d ti R t FIFO M th d


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Step 1Step 1: Prepare the quantity schedule and computeequivalent units.


Work in process, May 1 200Started into production 5,000

Total units 5,200

Equivalent units

Units accounted for as follows: Materials Conversion

Beginning inventory:

Materials 200 units 45% 90Conversion 200 units 70% 140

Units started and completed 4,600 4,600

Ending inventory:


Total equivalent units 4,850 4,840



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Step 2Step 2: Calculate the equivalent units of material and conversionthat were transferred from beginning work in process to the next

department.



Total units 5,200

Equivalent units





Ending inventory:





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Total units 5,200

Equivalent units



Materials 200u

nits 45% 90Conversion 200 units 70% 140


Ending inventory:



Step 3Step 3: Determine the number of units started andcompleted during the period.



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Total units 5,200

Equivalent units



Materials 200u



Ending inventory:



Step 4Step 4: Calculate the equivalent units of material andconversion that are in ending work in process inventory.



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Total units 5,200

Equivalent units



Materials 200u



Ending inventory:



Step 5Step 5: Calculate the total equivalent units formaterials and conversion.

C t E i l t U it


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Cost per Equivalent Unit

TotalCost Materials Conversion


Work in process, May 1 15,175$


and Milling Department 719,500 368,600 350,900Total cost 734,675$ 368,600$ 350,900$



T

otal cost per equ

ivalentu

nit = $76.25 + $72.75 = $149.00

Notice that the costs of beginning work in processinventory of $15,175, is notnot broken down bymaterials and conversion components

C t E i l t U it


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Total






Total cost 734,675$ 368,600$ 350,900$




We divide the costs added in the Shipping andMilling Department by the number of equivalentunit for materials.

C t E i l t U it


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Total






Total cost 734,675$ 368,600$ 350,900$




We follow the same procedure for conversion andadd the two equivalent unit costs to get the total costper equivalent unit.

Cost Reconciliation


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Cost Reconciliation


Cost Materials Conversion Work in process, May 1: 15,175$

Materials (90 $76.00) 6,840 90

Conversion (140 $72.50) 10,150 140

Total 32,165

Started and completed in May 683,100 4,600 4,600


Materials (160 $76.00) 12,160 160

Conversion (100 $72.50) 7,250 100

Total 19,410Total cost accounted for 734,675$

Step 1Step 1: Calculate the total cost from beginninginventory transferred to the next department.

Cost Reconciliation


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Cost Reconciliation



Materials (90 $76.00) 6,840 90

Conversion (140 $72.50) 10,150 140

Total 32,165



Materials (160 $76.00) 12,160 160

Conversion (100 $72.50) 7,250 100


4,600 units $148.50

Step 2Step 2: Calculate the cost of units started andcompleted during the period.

Cost Reconciliation


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Materials (90 $76.00) 6,840 90

Conversion (140 $72.50) 10,150 140

Total 32,165



Materials (160 $76.00) 12,160 160

Conversion (100 $72.50) 7,250 100


Cost Reconciliation

All costs

accounted for

Step 3Step 3: Calculate the costs in ending working in processinventory and the sum of the cost accounted for.

End of Chapter 4


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End of Chapter 4

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