Cost Accounting (13)

8/10/2019 Cost Accounting (13)

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Chapter 17Process costing


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Process Costing

Process costingis a product costing system that

accumulates costs according to process or departmentsand assigns them to a large number of nearly identicalproducts.

Firms employ a standardized production process tomanufacture homogeneous and indistinguishable products

Firms having homogenous products that pass through a seriesof similar processes or departments, use process costing.

Example : Production of Coca-Cola.


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Process costing is used in many industries, such aschemicals, oil refining, textiles, paints, flour , canneries,rubber , steel, glass, food processing, mining, automobileproduction lines, drugs, paper, cement, leather, goods etc.

It is also be used by service organization withhomogeneous services and repetitive processes such as,check clearing processing in RBI, or mail sorting in PostOffices.

The departmental production cost report is a keydocument in tracking production quantity and costinformation.

Unit product cost is calculated by dividing process costs ineach department by the number of equivalent unitsproduced during the period.


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So.Process-Costing is.

Process-costing is a system where the unit cost of a

product or service is obtained by assigning total costs

to many identical or similar units

Each unit receives the same or similar amounts ofdirect materials costs, direct labor costs, and

manufacturing overhead

Unit costs are computed by dividing total costs

incurred by the number of units of output from the

production process


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Comparison of Job-Order Costing and

Process Costing

Process

Costing

Process

Costing

Job-order

Costing

Used for production of small,identical, low cost items.

Mass produced in automatedcontinuous production process.

Costs cannot be directly traced toeach unit of product.

4-5

Process costing is used in

repetitive production

environments, where largenumbers of identical or

very similar products are

manufactured in a

continuous flow.


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Process

Costing

Process

Costing

Job-order

Costing

Typical process cost applications:

Petrochemical refinery

Paint manufacturer

Paper mill

Comparison of Job-Order Costing and

Process Costing

4-6Industries using process costing include paper, petroleum, chemicals, textiles, foodprocessing, lumber, and electronics.


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Job-order costing

Costs accumulated by thejob.

Work in process has a job-cost sheet for eachjob.

Many unique, high costjobs.

Jobs built tocustomerorder.

Process costing

Costs accumulated bydepartment or process.

Work in process has aproduction report for eachbatch of products.

A few identical,low costproducts.

Unitscontinuouslyproduced for inventory inautomated process.

Comparison of Job-Order Costing and Process Costing

4-7

In many ways, job-order costing and process costing are similar. Both product-costing

systems have the same ultimate purposeassignment of production costs to units of

output. Moreover, the flow of costs through the manufacturing accounts is the same in

the two systems.


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Job-Costing and Process Costing:Opposite Ends of a Continuum

Job-Costing Systems

Distinct, identifiable

units of a product

or service

Examples:

Custom-made

machines,

Houses

Process-Costing

Systems

Masses of identical

or similar units of a

product or service

Examples:

Food,

Chemical processing


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Direct Material

Finished

Goods

Cost of

Goods

Sold

Direct Labor

Manufacturing

Overhead

Jobs

The work-in-process

account consists of

individualjobsin a

job-order cost system.

Differences Between Job-Order and Process Costing

4-9

In job-order costing, costs are accumulated by job order and recorded on job-cost

records. The cost of each unit in a particular job order is found by dividing the total

cost of the job order by the number of units in the job.


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Direct Material

Finished

Goods

Cost of

Goods

Sold

Products

The work-in-process

account consists of

individual productsin a

process cost system.

Differences Between Job-Order and Process Costing

Direct Labor

& Overhead

(Conversion)

When direct labor is a relatively small amount

compared to material and overhead, it is often

combined with overhead.

4-10

In process costing, costs are accumulated by department, rather than by job order or

batch. The cost per unit is found by averaging the total costs incurred over the units

produced.


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Process-Costing Assumptions

Direct Materials are added at the beginning

of the production process, or at the start of

work in a subsequent department down the

assembly line

Conversion Costs are added equally along

the production process


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Process Cost Flows

Direct material

Direct labor

Applied manufacturing and transferred to during currentoverhead finished goods period

Cost of goods completed Cost of goods sold

Work-in-Process Finished Goods

Cost of Goods Sold

One Production Department

Inventory Inventory

4-12

How to Prepare journal entries to record the flow of costs in a process-costing system

with sequential production departments

In a single production department situation, direct-material, direct-labor, and manufacturing-

overhead costs are added to a Work-in-Process Inventory account. As goods are finished, costs

are transferred to Finished-Goods Inventory. During the period when goods are sold, the

product costs are transferred to Cost of Goods Sold.


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Process Cost Flows

Direct materialDirect labor

Applied manufacturing transferred to and transferred to

overhead department B finished goods

Direct material

Direct labor

Applied manufacturing

overhead

during current period

Cost of goods sold

Cost of goods completedin department A and Cost of goods completed

Finished Goods Inventory Cost of Goods Sold

Two Sequential Production Departments

Work-in-Process Inventory Work-in-Process Inventory

Production Department A Production Department B

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In the two-department case, when goods are finished in the first production department,

costs accumulated in the Work-in-Process Inventory account for production department A

are transferred to the Work-in-Process Inventory account for production department B.


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Equivalent Units: A Key Concept

4-14

Costs are accumulated for a period of time for productsin work-in-process inventory.

Products in work-in-process inventory at the beginning

and end of the period are only partially complete. Equivalent units is a concept expressing these

partially completed products as a smaller number offully completed products.

The term equivalent units is used in process costing to

refer to the amount of manufacturing activity that has

been applied to a batch of physical units.


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Equivalent Units

A derived amount of output units that:Takes the quantity of each input in units

completed and in unfinished units of work in

process and

converts the quantity of input into the

amount of completed output units that could

beproduced with that quantity of input

Are calculated separately for each input (direct

materials and conversion cost)


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Equivalent Units Example

Two one-half completed products areequivalentto one completed product.

So, 10,000 units 70 percent complete

are equivalentto 7,000 complete units.

+ =l

4-16

That is ..if two units are 50 percent complete, that is equivalent to 1 unit

that is 100 percent complete.


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For the current period, Jones started 15,000 units

and completed 10,000 units, leaving 5,000 units in

process 30 percent complete. How many

equivalent units of production did Jones have forthe period?

a. 10,000

b. 11,500c. 13,500

d. 15,000

Equivalent Units Question 1

4-17


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For the current period, Jones started 15,000 units

and completed 10,000 units, leaving 5,000 units inprocess 30 percent complete. How many

equivalent units of production did Jones have for

the period?a. 10,000

b. 11,500

c. 13,500d. 15,000

10,000 units + (5,000 units .30)

= 11,500 equivalent units


4-18

The 5,000 units that are 30 percent complete are equivalent to 1,500 units. Add that to

the 10,000 units that are 100 percent complete for a total of 11,500 equivalent units.


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If Jones incurred $27,600 inproduction costs for the 11,500 equivalent

units. What was Joness cost per equivalent

unit for the period?a. $1.84

b. $2.40

c. $2.76

d. $2.90


4-19


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If Jones incurred $27,600 in

production costs for the 11,500 equivalentunits. What was Joness cost per equivalent

unit for the period?

a. $1.84b. $2.40

c. $2.76

d. $2.90


$27,600 11,500 equivalent units

= $2.40 per equivalent unit

4-20

The production costs are divided by the number of equivalent units to arrive at the

cost per equivalent unit.


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Calculating and Using Equivalent Units of Production

To calculate the direct materials and conversion costsper equivalent unit for the period:

Materialscost per

equivalent

unit

=Materials cost for the period

Materials equivalent units for the

period

Conversion

cost per

equivalent

unit

=Conversion cost for the period

Conversion equivalent units for the

period

4-21

Direct material is usually placed into production at beginning of the production process. In

contrast, direct labor and manufacturing overhead, called conversion costs, usually are

incurred uniformly 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. The most important feature of process costing is

that the costs of direct material and conversion are assigned to equivalent units rather than tophysical units.


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Departmental Production Report

Production

Report

Analysis ofphysical flow

of units.

Calculationof equivalent

units.

Computationof unit costs.

Analysis oftotal costs.

4-22


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The key document in a typical process-costing system isthe departmental production report, prepared for eachproduction department at the end of every accounting

period. The departmental production report summarizes the

flow of production quantities through the department,and it shows the amount of production cost transferredout of the departments Work-in-Process Inventory

account during the period. There are four steps used in preparing a departmental

production report:

1. Analysis of physical flow of units.

2. Calculation of equivalent units.3. Computation of unit costs.

4. Analysis of total costs.


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Equivalent Units of Production

Weighted-Average Method

The weighted-average method . . .

Makes no distinction between work done in theprior period and work done in the current period.

Blends together units and costs from the prior

period and the current period.

The FIFO method is a more

complex method and is

rarely used in practice. 4-24

The method of process costing that we will focus on ..is called the weighted-

average method. This method is almost always used in practice by

companies using process costing. There is another process-costing methodcalled the first-in, first-out, or FIFO, method


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Weighted-AverageProcess-Costing Method

Calculates cost per equivalent unit of all

work done to date (regardless of the

accounting period in which it was done)

Assigns this cost to equivalent units

completed & transferred out of theprocess, and to incomplete units in still

in-process


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Weighted-AverageProcess-Costing Method

Weighted-average costs is the total of all costs

in the Work-in-Process Account divided by the

total equivalent units of work done to date

The beginning balance of the Work-in-Process

account (work done in a prior period) isblended in with current period costs


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Result of the Process

Two critical figures arise out of the cost

allocation process:

The amount of the Journal Entrytransferring the allocated cost of units

completed and sent from Work-in-Process

Inventory to Finished Goods Inventory

The ending balance of the Work-in-ProcessInventory account that will appear on the

Balance Sheet


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First-in, First-OutProcess-Costing Method

Assigns the cost of the previous accounting periods

equivalent units in beginning work-in-process inventory

to the first units completed and transferred out of the

process

Assigns the cost of equivalent units worked on during

the current period first to complete beginning inventory,

next to stat and complete new units, and lastly to units

in ending work-in-process inventory

The beginning balance of the Work-in-Process account

(work done in a prior period) is kept separate from

current period costs


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Result of the Process (as before)

Two critical figures arise out of the cost allocation

process:

The amount of the Journal Entry transferring the

allocated cost of units completed and sent from

Work-in-Process Inventory to Finished Goods

Inventory

The ending balance of the Work-in-Process

Inventory account that will appear on the BalanceSheet


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MVP Sports Equipment Company makes baseball gloves in twodepartments, Cutting and Stitching.

MVP uses the weighted-averagecost procedure.

Material is added at the beginning of the Cutting Department,and conversion is incurred uniformly throughout the process.

Using the following information for the month of March, letsprepare a production report for the Cutting Department.

Production Report Example

4-30

The MVP Sports Equipment Company manufactures baseball gloves. Two production

departments are used in sequence: the Cutting Department and the StitchingDepartment.

In the Cutting Department, direct material is placed into production at the beginning

of the process. Direct-labor and manufacturing overhead costs are incurred uniformly

throughout the process.

The predetermined overhead rate used in the Cutting Department is 125 percent of

direct-labor cost.


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Work in process, March 1: 20,000 units Cost

Materials: 100% complete. $ 50,000Conversion: 10% complete. 7,200

Units started into production in March: 30,000 units

Units completed and transferred out in March: 40,000 units

Work in process, March 31: 10,000 units

Materials 100% complete.

Conversion 50% complete.

Costs incurred during March

Materials cost 90,000Conversion costs:

Direct labor $ 86,000

Applied manufacturing overhead 107,500

Total conversion costs 193,500

Total costs to account for $ 340,700


4-31


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The previous slide presents a summary of theactivity and costs in the Cutting Departmentduring March.

The direct-material and conversion costs for theMarch 1 work in process consist of costs thatwere incurred during February.

These costs were assigned to the units remaining

in process at the end of February. Materials costs of $90,000 and conversion costs

of 193,500 were added during the month ofMarch.

The beginning work in process and the costsadded during March are the total costs to beaccounted for.


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Analysis of Physical Flow of Units

Physical

Units

Work in process, March 1 20,000

Units started during March 30,000

Total units to account for 50,000

Units completed and transferred out during March 40,000

Work in process, March 31 10,000

Total units accounted for 50,000


4-33

The first step is to prepare a table summarizing the physical flow of production units

during March.



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Conversion Equivalent Units

Physical Percentage Direct

Units Complete Material Conversion

Work in process, March 1 20,000 10%



Units completed and transferred 40,000 100% 40,000 40,000Work in process, March 31 10,000 50% 10,000 5,000


Total equivalent units 50,000 45,000


Calculation of Equivalent Units

50% of 10,000 units

Beginning inventory % is not used in weighted-average method.

4-34

The second step is to calculate the equivalent units of direct material and conversion activity. The table of equivalent units,

displayed on this slide, is based on the table of physical flows prepared in step 1. The Cutting Department completed their

work on 40,000 physical units. Thus, they represent 40,000 equivalent units for both direct material and conversion. The

10,000 units in the Cutting Departments ending work-in-process inventory are 50 percent complete with respect to

conversion. Therefore, the ending work-in-process inventory represents 5,000 equivalent units of conversion activity

(10,000 physical units x 50% complete).

P d ti R t E l


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Conversion Equivalent Units

Physical Percentage Direct

Units Complete Material Conversion




Units completed and transferred 40,000 100% 40,000 40,000Work in process, March 31 10,000 50% 10,000 5,000




Calculation of Equivalent Units

100% of 10,000 units, all

material added at beginning

4-35

With respect to direct material, the 10,000 units in the Cutting Departments ending work-

in-process inventory are 100 percent complete. Therefore, the ending work-in-process

inventory represents 10,000 equivalent units of direct material.

P d ti R t E l


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Direct

Material Conversion Total

Work in Process, March 1 50,000$ 7,200$ 57,200$Costs incurred during March 90,000 193,500 283,500

Total costs to account for 140,000$ 200,700$ 340,700$

Equivalent units 50,000 45,000

Cost per equivalent unit 2.80$ 4.46$ 7.26$

Computation of unit costs




$2.80 + $4.46

4-36

The third step in the process-costing procedure is calculating the cost per equivalent unit for both direct

material and conversion activity. The cost per equivalent unit for direct material is computed by dividing the

total direct-material cost, including the cost of the beginning work in process and the cost incurred during

March, by the total equivalent units (from step 2). The same procedure is used for conversion costs.

P d i R E l


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Analysis of total costs

4-37

The final step is to determine the total cost to be transferred out of the Cutting Departments

Work-in-Process Inventory account and into the Stitching Departments Work-in-Process

Inventory account. The cost per equivalent unit, $7.26, was calculated in step 3. The number of

units transferred is multiplied by the cost per equivalent unit.

Cost of goods completed and transferred during March

40,000 units x $7.26 per equivalent unit 290,400$

Costs remaining in work-in-process on March 31Direct Material:

10,000 equivalent units x $2.80 per equivalent unit 28,000$

Convserion:

5,000 equivalent units x $4.46 per equivalent unit 22,300

Total cost of March 31 work-in-process 50,300

Total costs accounted for 340,700$

The direct material equivalent units is multiplied by the direct materials cost per equivalent

unit. The conversion equivalent units is multiplied by the conversion cost per equivalent

unit. These two amounts are added together.



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p p

Analysis of total costs



Costs remaining in work-in-process on March 31Direct Material:


Convserion:




All costsaccounted for

4-38

The sum of these costs is added to the cost of goods completed and transferred. Now all

costs on the production report have been accounted for. These calculations are used as the

basis for the journal entries to transfer the cost of goods completed and transferred out to

the Stitching Department


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We have now completed all four steps necessaryto prepare a production report.

The report in the next slide simply combines thetables prepared till now.

The report provides a convenient summary of allof the process-costing calculations made under

the weighted-average method. This method is called the weighted-average

method because the cost per equivalent unit, forboth direct material and conversion activity, is

computed as a weighted average of the costsincurred during two different accountingperiods.

MVP SPORTS EQUIPMENT COMPANY

Production Report: Cutting Department


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Percentage of

Completion Equivalent Units

Phys ical with Respect to Direc t

Units Conversion Material Conversion




Units completed and transferred 40,000 100% 40,000 40,000

Work in process, March 31 10,000 50% 10,000 5,000



Direct

Material Conversion Total

Work in Process, March 1 50,000$ 7,200$ 57,200$

Costs incurred during March 90,000 193,500 283,500

Total costs to account for 140,000$ 200,700$ 340,700$

Equivalent units 50,000 45,000

Cost per equivalent unit 2.80$ 4.46$ 7.26$



Costs remaining in work-in-process on March 31

Direct Material:


Conversion:




Production Report: Cutting Department

4-40


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Departmental Production Report

Analysis ofphysical flowof units.

Calculationof equivalent

units.Computation

of unit costs.

Analysis oftotal costs.

Process-costing procedures for

subsequent production departments are

covered in Cost Accounting texts

In our illustration, production requires

two sequential productionoperations: cutting and stitching.

Although the process-costing procedures for the

second department are similar to those illustrated for

the first, there is one additional complication.

The cost of goods completed and

transferred out of the Cutting

Department must remain assigned to

the partially completed product units

as they undergo further processing inthe Stitching Department.

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Cost Accounting (13)