Chapter 6Chapter 6

Process Cost AccountingProcess Cost Accounting

Additional Procedures: Accounting Additional Procedures: Accounting for Joint Products and By-Productsfor Joint Products and By-Products

Learning ObjectivesLearning Objectives

LO1LO1 Compute unit costs when materials Compute unit costs when materials are not added uniformly throughout are not added uniformly throughout the process.the process.

LO2LO2 Account for units lost in the Account for units lost in the production production process.process.

LO3LO3 Account for units gained in the Account for units gained in the production process.production process.

Learning ObjectivesLearning Objectives

LO4LO4 Assign costs to inventories, using Assign costs to inventories, using the the first-in, first-out method.first-in, first-out method.

LO5LO5 Identify the methods used to Identify the methods used to apportion apportion joint costs to joint products and joint costs to joint products and to to account for by-products.account for by-products.

Equivalent Production Equivalent Production and Equivalent Unitsand Equivalent Units

When industries apply materials into When industries apply materials into production in different quantities and at production in different quantities and at varying points in the production cycle, varying points in the production cycle, equivalent units must be computed for each equivalent units must be computed for each element of production cost.element of production cost.

The valuation of the ending work in process The valuation of the ending work in process requires the allocation of cost for each requires the allocation of cost for each element.element.

Equivalent Production and Equivalent Production and Equivalent Units - Materials Equivalent Units - Materials Added at BeginningAdded at Beginning

The only difference between equivalent unit The only difference between equivalent unit calculations for the material components and the calculations for the material components and the labor and overhead components would concern labor and overhead components would concern the ending work in process inventory.the ending work in process inventory.

Example: Ending inventory of 400 units that were Example: Ending inventory of 400 units that were ¾ complete.¾ complete. Materials – 400 equivalent units (received all Materials – 400 equivalent units (received all

materials when started)materials when started) Labor and overhead – 300 equivalent units (400 x Labor and overhead – 300 equivalent units (400 x

¾ completed as to processing costs)¾ completed as to processing costs)

Equivalent Production and Equivalent Production and Equivalent Units - Materials Equivalent Units - Materials Added at Beginning (cont.)Added at Beginning (cont.)

Once the equivalent production figures are Once the equivalent production figures are calculated, the unit cost for the period can be calculated, the unit cost for the period can be calculated.calculated.

Add the cost of each element in beginning WIP Add the cost of each element in beginning WIP to the cost of production for that element incurred to the cost of production for that element incurred in the current month.in the current month.

Total cost is then divided by the appropriate Total cost is then divided by the appropriate equivalent production figure.equivalent production figure.

Cost is then applied to inventory to arrive at cost Cost is then applied to inventory to arrive at cost of goods finished and the cost of the ending WIP.of goods finished and the cost of the ending WIP.

Equivalent Production and Equivalent Production and Equivalent Units - Materials Equivalent Units - Materials Added at Close of Added at Close of ProcessingProcessing Only units finished will have materials cost Only units finished will have materials cost

applied.applied. Units in process at the end of the Units in process at the end of the

accounting period will have no equivalent accounting period will have no equivalent production for the period.production for the period.

Equivalent units for labor and factory Equivalent units for labor and factory overhead would be computed as the overhead would be computed as the previous example.previous example.

Equivalent Production and Equivalent Production and Equivalent Units - Materials Equivalent Units - Materials Added at Different StagesAdded at Different Stages

The state of completion must be carefully The state of completion must be carefully considered.considered.

Finished units will include all materials Finished units will include all materials costs.costs.

Units that were 50% completed will only Units that were 50% completed will only have the percent of materials that are have the percent of materials that are added in the first half of the cycle.added in the first half of the cycle.

Equivalent Production and Equivalent Production and Equivalent Units - Materials Equivalent Units - Materials Added at Different Stages Added at Different Stages (cont.)(cont.)

Example:Example: 40% at the beginning40% at the beginning 25% at one-quarter completed25% at one-quarter completed 35% at the end35% at the end 1000 units are one-half completed1000 units are one-half completed Equivalent production for materialsEquivalent production for materials

1000 units X (40% + 25%) = 650 units1000 units X (40% + 25%) = 650 units

Units Lost in ProductionUnits Lost in Production

Due to the nature of Due to the nature of the processing cycle, the processing cycle, many industries will many industries will have units that are have units that are lost due to lost due to evaporation, evaporation, shrinkage, spillage, shrinkage, spillage, or other factors.or other factors.

Normal LossesNormal Losses

Are treated as products costs and are spread Are treated as products costs and are spread over the units finished and still in process.over the units finished and still in process.

On the cost of production summary, the lost units On the cost of production summary, the lost units are ignored in the calculation of equivalent are ignored in the calculation of equivalent production and in the determination of inventory production and in the determination of inventory costs.costs.

If lost at the end of the production cycle, the cost If lost at the end of the production cycle, the cost of lost units may be absorbed by the completed of lost units may be absorbed by the completed units only.units only.

Normal Losses (cont.)Normal Losses (cont.)

The lost units are included in the number of The lost units are included in the number of units used to determine equivalent production.units used to determine equivalent production.

Unit cost is applied to units finished, units in Unit cost is applied to units finished, units in process, and units that were lost.process, and units that were lost.

Cost of lost units is added to the cost of goods Cost of lost units is added to the cost of goods completed, and the total is transferred to the completed, and the total is transferred to the next department or to Finished Goods.next department or to Finished Goods.

Abnormal LossesAbnormal Losses

These are losses that are not inherent in the These are losses that are not inherent in the manufacturing process and are not expected.manufacturing process and are not expected.

The lost units are included in the calculation of The lost units are included in the calculation of equivalent production and unit costs.equivalent production and unit costs.

Abnormal losses are not included in the cost of Abnormal losses are not included in the cost of transferred or finished goods and are charged transferred or finished goods and are charged to a separate expense account.to a separate expense account.

Units Gained in Units Gained in ProductionProduction

In some processes, the addition of materials in In some processes, the addition of materials in a subsequent department increases the a subsequent department increases the number of units being processed.number of units being processed.

Has the opposite effect of lost units and Has the opposite effect of lost units and requires an adjustment to the unit cost for the requires an adjustment to the unit cost for the previous department’s transferred-in units.previous department’s transferred-in units.

The cost from the department is now spread The cost from the department is now spread over more units.over more units.

Equivalent Production - Equivalent Production - First-In, First-Out (FIFO) First-In, First-Out (FIFO) MethodMethod

This method assumes that the costs of This method assumes that the costs of the current period are first applied to the current period are first applied to complete the beginning units in process, complete the beginning units in process, then to start and finish a number of units, then to start and finish a number of units, and finally to start other units that are still and finally to start other units that are still in process.in process.

Features of FIFOFeatures of FIFO

No need to break down the beginning WIP into its cost No need to break down the beginning WIP into its cost elements.elements.

If there is no beginning inventory, total equivalent If there is no beginning inventory, total equivalent production figures will differ from those for the average production figures will differ from those for the average method because the output required to complete the method because the output required to complete the beginning inventory must be calculated.beginning inventory must be calculated.

When there is no beginning inventory, both methods When there is no beginning inventory, both methods yield the same results.yield the same results.

If units are lost, a decision must be made as to whether If units are lost, a decision must be made as to whether the units lost came from the beginning inventory or the units lost came from the beginning inventory or from the units started during the process.from the units started during the process.

Comparison of MethodsComparison of Methods

First-In, First-OutFirst-In, First-Out Cost is determined by Cost is determined by

dividing the current dividing the current period’s cost of each period’s cost of each element by the unit element by the unit output for the period.output for the period.

Total costs to charge Total costs to charge to the beginning WIP is to the beginning WIP is the balance from the the balance from the prior month plus the prior month plus the costs incurred to costs incurred to complete these units in complete these units in the current period.the current period.

Average CostAverage Cost Cost is determined by Cost is determined by

dividing the merged dividing the merged costs of the current costs of the current period and those period and those carried over as WIP by carried over as WIP by the unit output.the unit output.

Comparison of Methods – Comparison of Methods – ComputationsComputationsBeginning Work in Process 3,000 units Beginning Work in Process 3,000 units ⅔⅔ complete. complete.5,000 units started and completed.5,000 units started and completed.Ending Work in Process 4,000 units ½ complete.Ending Work in Process 4,000 units ½ complete.

Average CostingAverage Costing

Units in Beginning Work in ProcessUnits in Beginning Work in Process 3,000 3,000 Units Started and CompletedUnits Started and Completed 5,0005,000 Units Completed & Transferred OutUnits Completed & Transferred Out

(3,000 + 5,000)(3,000 + 5,000) 8,0008,000

Ending Work in ProcessEnding Work in Process (4,000 x ½)(4,000 x ½) 2,0002,000

Equivalent Units in ProductionEquivalent Units in Production 10,00010,000

FIFO CostingFIFO Costing

Work Done to Complete BeginningWork Done to Complete Beginning Work in Process (3,000 x 1/3)Work in Process (3,000 x 1/3)

1,0001,000 Units Started and CompletedUnits Started and Completed 5,0005,000

Work Done this Period on EndingWork Done this Period on Ending Work in Process (4,000 x ½)Work in Process (4,000 x ½)

2,0002,000 Equivalent Units in ProductionEquivalent Units in Production 8,0008,000

Joint ProductsJoint Products

The manufacturing The manufacturing process originates process originates with one or more raw with one or more raw materials started in materials started in process and two or process and two or more primary more primary products are derived.products are derived.

Common Bases for Common Bases for Allocation of Joint CostsAllocation of Joint Costs

1.1. Relative sales valueRelative sales value

2.2. Physical unit of measurePhysical unit of measure

3.3. Chemical, engineering, or other types of Chemical, engineering, or other types of analysesanalyses

The method most commonly used in The method most commonly used in the relative sales value method.the relative sales value method.

Joint Costs and Joint Joint Costs and Joint ProductsProducts

Joint Processing

Product B

Product A

Split-off Point

By-ProductsBy-Products

These are secondary products with These are secondary products with relatively little value that are derived from relatively little value that are derived from the manufacturing process.the manufacturing process.

The most common practice is to make no The most common practice is to make no allocation of the processing costs up to allocation of the processing costs up to the split-off point.the split-off point.

By-Products (cont.)By-Products (cont.)

Entry to record the Entry to record the estimated sales value of estimated sales value of the by-productthe by-product

When the by-products When the by-products are sold, the difference are sold, the difference between the actual sales between the actual sales price and the estimated price and the estimated sales value is credited or sales value is credited or debited to Gain or Loss debited to Gain or Loss on Sales of By-Products.on Sales of By-Products.

By-Products (Inventory)By-Products (Inventory) XXXX

Work in ProcessWork in Process XXXX

If the sales value is If the sales value is uncertain or insignificant, uncertain or insignificant, the cost of the main the cost of the main products will not be products will not be reduced, and the only reduced, and the only entry will be made at the entry will be made at the time of sale.time of sale.