Kinney ● Raiborn

Cost Accounting: Foundations and Evolutions, 8e

Chapter 6:Process Costing

Learning Objectives Why are equivalent units of production used in process costing? How are equivalent units of production, unit costs, and inventory values

determined using the weighted average (WA) method of process costing?

How are equivalent units of production, unit costs, and inventory values determined using the first-in, first-out (FIFO) method of process costing?

How are transferred-in costs and units accounted for in a multidepartment production setting?

How are equivalent units of production, unit costs, and inventory values determined using the standard costing method of process costing?

Why would a company use a hybrid costing system? (Appendix 1) What alternative methods can be used to calculate

equivalent units of production? (Appendix 2) How are normal and abnormal spoilage losses treated in

an EUP schedule?

Job Order vs. Process Costing

Job Order Small quantities of

distinct products or services

Assign costs to job and then to units within the job

Process Costing Large quantities of

homogeneous products or services

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

Production Costs

The Numerator—Production Costs 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 Production Quantity

Materials Requisition Form

Date ___________________ No. 341 Job No. _________________

Authorized by ___________

Department _______________Issued by _________________Inspected by _______________

Item Part Unit of Quantity Quantity Unit Total

No. No. Descrip. Measure Required Issued Cost Cost

Received by _____________

Employee Time Sheet

Employee Name _______________

Employee No. _______________

Department _______________ For week ending

_______

Start Stop Total Type of Work Job No. Time Time Day Hours

Employee Signature Supervisor’s Signature

Units Produced

The Denominator—Units Produced Complicated by work in process

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 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 (WA) Method Combines

beginning work in process current period production

First-in, First-Out (FIFO) Method Separates

beginning work in process current period production

Process Costing Methods

WA

Beginning WIP 100%

Started and finished 100%

Ending WIP % completed

FIFO

Beginning WIP % completed

Started and finished 100%

Ending WIP % completed

The Difference

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 Based on other, multiple cost drivers

Process Costing Steps

1 Units to account for2 Units accounted for3 Determine equivalent units4 Costs to account for5 Compute cost per equivalent unit6 Assign costs to inventories

Units

Costs

Cost of Production ReportName of Department

for the period ---

Production Data:Units to account forUnits accounted forEUP for each cost

Cost Data:Costs to account forCost per EUP

Cost Assignment:Transferred OutEnding Work in Process Inventory

* Numbers correlate to the process costing steps in the previous slide

Step 1—Units to Account For

Beginning WIP 5,000

Started 200,700

Units to account for 205,700

Step 2—Units Accounted For

Finished and transferred 203,000

Ending WIP 2,700

Units accounted for 205,700

Beginning WIP 5,000Started 200,700Units to account for 205,700

mustbeequal

Step 3—Compute Equivalent Units

DM ConversionBeginning WIP inventory 5,000 5,000Started and completed 198,000 198,000Ending WIP inventory 2,700 2,160* Equivalent units 205,700 205,160

* ending units * % complete2,700 * 80% = 2,160WA Method

Step 4—Costs to Account For

DM Conversion TotalBeginning WIP $ 5,943 $ 16,758 $ 22,701 Current costs 321,120 660,270 981,390To account for $327,063 $677,028 $1,004,091

WA Method

Step 5—Cost per Equivalent Unit

Divide by EUP 205,700 205,160

Cost per EUP $1.59 + $3.30 = $4.89

DM Conversion TotalBeginning WIP $ 5,943 $ 16,758 $ 22,701 Current costs 321,120 660,270 981,390To account for $327,063 $677,028 $1,004,091

WA Method

Step 6—Assign Costs to Inventories

Transferred (203,000 * $4.89) $992,670Ending WIP Inventory Direct Materials (2,700 * $1.59) $4,293 Conversion Costs (2,700 * 80% * $3.30) 7,128 11,421Cost accounted for $1,004,091**must agree with costs to account for

TransferredOut Ending

WIP

WA Method

Process Costing—FIFO

Emphasizes current period costs and production Steps 1, 2, and 4 are the same

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

* beginning units * % complete in current period5,000 * 60% = 3,000

Step 3—Compute Equivalent Units

FIFO Method

DM Conversion TotalCurrent costs $321,120 $660,270 $981,390

Divide by EUP 200,700 203,160

Cost per EUP $1.60 + $3.25 = $4.85

Step 5—Cost per Equivalent Unit

* Recall that Step 4 is the same as used for the WA methodFIFO Method

Transferred Beginning WIP Inventory $22,701 Cost to complete Conversion (3,000 * $3.25) 9,750 $ 32,451 Started and completed (198,000 * $4.85) 960,300Total cost transferred $992,751Ending inventory Direct Materials (2,700 * $1.60) $4,320Conversion Costs (2,7000 * 80% * $3.25) 7,020 11,340Cost accounted for $1,004,091**must agree with costs to account for

Step 6—Assign Costs to Inventories

TransferredOut

EndingWIP

FIFO Method

Process Costing Comparison

WA 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)

Multidepartment Processing

Process 1

Process 3

Process 2

MaterialsWait

Wait

Transferred-InCost

FinishedProduct

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 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 Allows benchmarking with other firms

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

Appendix 1—Alternative Cost Computation There are two alternative methods to

calculate WA and FIFO EUP Use alternative methods

To confirm standard computation As a simplified computation

Appendix 1—Traditional Cost Computation

Conversion Costs WA FIFO

Beginning WIP inventory 5,000 3,000

Started and completed 198,000 198,000

Ending WIP inventory 2,160 2,160

Equivalent units 205,160 203,160

Units transferred out (whole units)

Plus: Ending work in process (equivalent units)

WA EUP

Less: Beginning work in process (equivalent units)

FIFO EUP

Appendix 1— Alternative Cost Computation 1

Conversion Costs

Candles transferred 203,000

Ending WIP EUP 2,160

WA EUP 205,160

Beginning WIP EUP (2,000)

FIFO EUP 203,160

Appendix 1— Alternative Cost Computation 1

Total units to account for

Less: EUP to be completed next period

WA EUP

Less : EUP completed in prior period

FIFO EUP

Appendix 1— Alternative Cost Computation 2

Conversion Costs

Total units to account for 205,700

EUP to be completed next period (540)

WA EUP 205,160

EUP completed in prior period (2,000)

FIFO EUP 203,160

Appendix 1— Alternative Cost Computation 2

Appendix 2—Spoilage

Continuous loss—Loss occurs fairly uniformly through the process

Discrete loss—Loss occurs at a specific point and is detectable only when a quality check is performed

Appendix 2—Spoilage

Normal shrinkage and continuous losses Assign costs only to units that have passed the

inspection point Use Method of Neglect

Excludes spoiled units in the equivalent units schedule Spreads cost of lost units proportionately over the

good units transferred and those remaining in WIP inventory

Abnormal losses Period expense Accounted for on an equivalent unit basis

NormalSpoilage

AbnormalSpoilage

ContinuousLoss

DiscreteLoss

Loss in all ending inventory and

transferred-out units on an EUP basis

Period expensein EUP

Period expensein EUP

Loss in all units past inspection point in

ending inventory and transferred out on an

EUP basis

Appendix 2—Spoilage

Questions

What is an EUP? What is the difference between the WA and

FIFO methods of calculating equivalent units?

Why would a company use a hybrid costing system?

Potential Ethical Issues

Over- or underestimating completion % for ending WIP inventory to distort results

Using outdated standard costs Ignoring the assignment of significant

direct costs to specific jobs Treating abnormal spoilage as normal

spoilage