Process Costing

1
Process Costing

• Chapter 17

2
Introduction

• In many industries, products are mass produced,
  that is, relatively homogeneous products are
  processed in a very similar manner.
• Companies in these industries use process
  costing.
• This chapter presents process costing.

3
Learning Objectives

• Determine when process-costing systems are
  appropriate
• Describe five key steps in process costing
• Calculate and use equivalent units
• Prepare journal entries for process-costing
  systems

4
Learning Objectives

• Demonstrate the weighted-average method of
  process costing
• Demonstrate the first-in, first-out (FIFO) method
  of process costing
• Incorporate standard costs into a process-costing
  system
• Apply process-costing methods to cases with
  transferred-in costs

5
Learning Objective 1

• Determine when process-costing systems are
  appropriate

6
Process Costing

• In a process-costing system, the unit cost of
  a product or service is obtained by assigning
  total costs to many identical or similar units.
• In a manufacturing setting, each unit is assumed
  to receive the same amount of direct material
  costs, direct manufacturing labor costs, and
  indirect manufacturing costs.

7
Process Costing

• The principal difference between process costing
  and job costing is the extent of averaging used
  to compute unit costs of products or services.
• In a job-costing system, individual jobs use
  different quantities of production resources.
• Thus, it would be incorrect to cost each job
  at the same average production cost.

8
Process Costing

• In contrast, when similar or identical units
  of products or services are mass produced, and
  not processed as individual jobs, process costing
  averages production costs over all units
  produced.

9
Process Costing

• Direct Materials
  Direct Labor Department Depart
  ment
  Indirect Mfg. A
  B Costs
• Finished Goods Cost of Goods Sold

10
Learning Objective 2

• Describe five key steps in
  process costing

11
Five Steps in Process Costing

• Step 1 Summarize the flow of physical units
  of output.
• Step 2 Compute output in terms of equivalent
  units.
• Step 3 Compute equivalent unit costs.

12
Five Steps in Process Costing

• Step 4 Summarize total costs to account for.
• Step 5 Assign total costs to units completed
  and to units in ending work-in-process
  inventory.

13
Learning Objective 3

• Calculate and use equivalent units

14
Equivalent Units

• Equivalent units is a derived amount of output
  units that takes the quantity of each input in
  units completed or in work in process and
  converts it into the amount of completed output
  units that could be made with that quantity of
  input.
• Equivalent unit calculations are necessary when
  all physical units of output are not uniformly
  completed during the period.

15
Equivalent Units

• The following information relates to Aspen Inc.,
  a manufacturer of skiing accessories.
• Ending work-in-process inventory is 100 complete
  for materials and 20 complete for conversion.

16
Physical Units (Step 1)

• Physical
• Flow of Production units
• Work-in-process, beginning
  0
• Started during current period 35,000
• To account for 35,000
• Completed and transferred out
• during current period 30,000
• Work-in-process, ending (100/20) 5,000
• Accounted for 35,000

17
Compute Equivalent Units (Step 2)

• 
  Equivalent units
• Direct Conversion
• Flow of Production Materials
  Costs
• Completed and
• transferred out 30,000 30,000
• Work-in-process,
• ending 5,000 (100) 1,000
  (20)
• Current period work 35,000 31,000

18
Compute Equivalent Unit Costs (Step
3)

• Total production costs are 146,050.
  Direct Conversion Materials
  Costs 84,050 62,000 Equivalent
  units 35,000 31,000 Cost per
  equivalent unit 2.4014 2.00

19
Summarize and Assign Total Costs (Steps 4 and 5)

• Step 4 Total costs to account for 146,050
• Step 5 Assign total costs
  Completed and transferred out
  30,000 x 4.4014 132,043
  Work-in-process ending (5,000
  units) Direct materials 5,000 x 2.4014
  12,007 Conversion costs 1,000 x 2.00
  2,000 Total 146,050

20
Learning Objective 4

• Prepare journal entries for process-costing
  systems

21
Journal Entries

• Journal entries in process-costing systems are
  basically like those made in job-costing systems
  with respect to direct materials and conversions
  costs.
• The main difference is that in a process-costing
  system, there is a separate work-in-process
  account for each department rather than for each
  job.

22
Journal Entries

• Assume that Aspen Inc. has two processing
  departments Assembly and Finishing.
• Aspen Inc. purchases direct materials as needed.
• What is the journal entry for materials?
• Work-in-Process, Assembly 84,050
  Accounts Payable Control 84,050
  To record direct materials purchased and used

23
Journal Entries

• What is the journal entry for conversion costs?
• Work-in-Process, Assembly 62,000 Various
  accounts 62,000 To
  record Assembly Department conversion costs
• What is the journal entry to transfer completed
  goods from Assembly to Finishing?

24
Journal Entries

• Work-in-Process, Finishing 132,043
  Work-in-Process, Assembly
  132,043 To record cost of goods completed and
  transferred from Assembly to Finishing during
  the period

25
Flow of Costs
Accounts Payable
WIP Assembly
84,050
84,050 62,000
132,043
Various Accounts
14,007
62,000
WIP Finishing
132,043
Finished Goods
Cost of Goods Sold
26
Learning Objective 5

• Demonstrate the weighted-average method of
  process costing

27
Weighted-Average Method

• The weighted-average process-costing method
  calculates the average equivalent unit cost of
  the work done to date (regardless of the period
  in which it was done).
• It assigns this cost to equivalent units
  completed and transferred out and to equivalent
  units in ending work-in-process inventory.

28
Weighted-Average Method

• The weighted-average cost is the total of all
  costs entering the Work-in-Process account
  (regardless of whether it is from beginning work
  in process or from work started during the
  period) divided by total equivalent units of
  work done to date.

29
Weighted-Average Method

• Assume that Aspen Inc. had 1,000 units in the
  Assembly Department beginning work-in- process
  inventory.
• These units were 100 complete for materials
  (2,350) and 60 complete for conversion
  (5,200).
• Ending work-in-process inventory consisted of
  5,000 units (100 materials) and (20 conversion).

30
Physical Units (Step 1)

• Work-in-process, beginning
  100 material
  60 conversion costs
  1,000 Units started in
  process 35,000 36,000
• Units transferred out 31,000
  Units in ending inventory
  100 material
  20 conversion
  costs 5,000 36,000

31
Compute Equivalent Units (Step 2)

• Partially completed units are converted into
  equivalent units.
• Ending inventory is only 20 complete for
  conversion which equals 1,000 equivalent units
  (5,000 x 20).

32
Compute Equivalent Units (Step 2)

• Materials Conversion
  
  Completed and
  transferred 31,000 31
  ,000
  Ending inventory 5,000 1,000 Equivalent
  units 36,000 32,000
  

100
20
33
Compute Equivalent Unit Costs (Step
3)

• Materials Conversion Beginning
  
  inventory 2,350 5,200
• Current costs 84,050 62,000
• Total 86,400 67,200
• Equivalent units 36,000 32,000
• Cost per unit 2.40 2.10

34
Summarize and Assign Total Costs (Steps 4 and 5)

• Work-in-process beginning inventory
  Materials 2,350
  Conversion
  5,200 Total beginning
  inventory 7,550
• Current costs in Assembly Department
  Materials 84,050 Conversion
  62,000
• Costs to account for 153,600

35
Summarize and Assign Total Costs (Steps 4 and 5)

• This step distributes the departments costs
  to units transferred out
  31,000 units 4.50 139,500
• And to units in ending work-in-process inventory
  12,000 2,100 14,100

36
Summarize and Assign Total Costs (Steps 4 and 5)

• Costs transferred out
  31,000 (2.40 2.10) 139,500
• Costs in ending inventory
  Materials 5,000 2.40 12,000
  Conversion 1,000 2.10
  2,100
• Total costs accounted for 153,600

37
Journalizing Weighted-Average

• What are the journal entries in the Assembly
  Department?
• Work-in-Process, Assembly 84,050 Accounts
  Payable Control 84,050 To record direct
  materials purchased and used
• Work-in-Process, Assembly 62,000 Various
  accounts 62,000 To record Assembly
  Department conversion costs

38
Journalizing Weighted-Average

• Work-in-Process, Finishing 139,500
  Work-in-Process, Assembly
  139,500 To record cost of goods completed and
  transferred from Assembly to Finishing during
  the period

39
Key T-Account Weighted-Average

• Work-in-Process Inventory, Assembly
  Beg. Inv. 7,550 Transferred to
  Materials 84,050 Finishing
  Conversion 62,000 139,500
  Balance 14,100

40
Learning Objective 6

• Demonstrate the first-in, first-out
  (FIFO) method of process costing

41
First-In, First-Out Method

• FIFO process-costing method assigns the cost of
  the prior accounting periods equivalent units in
  beginning work-in-process inventory to the first
  units completed and transferred out.

42
First-In, First-Out Method

• FIFO assigns the cost of equivalent units worked
  on during the current period first to complete
  beginning inventory, then to start and complete
  new units, and finally to units in ending
  work-in-process inventory.
• This method assumes that the earliest equivalent
  units in the Work-in-Process, Assembly account
  are completed first.

43
First-In, First-Out Method

• A distinctive feature of the FIFO process-
  costing method is that work done on beginning
  inventory before the current period is kept
  separate from work done in the current period.

44
First-In, First-Out Method

• Assume that Aspen Inc. uses FIFO.
• How many units will be in the quantity schedule
  (Step 1)?
• 36,000 (same as weighted-average method)
• What are the equivalent units (Step 2)?

45
Compute Equivalent Units (Step 2)

• Materials
  Conversion
  
  Completed and
  transferred
  From beginning
  
  inventory 0 400
  Started and
  completed 30,000 30,000
  Ending inventory 5,000
  1,000
  35,000 31,400

46
Compute Equivalent Units (Step 2)

• Materials
  Conversion
  
  Completed and
  transferred 31,000 31,000
  Ending
  inventory 5,000 (100) 1,000 (20)
  
  36,000 32,000 Beginning
  inventory 1,000
  (100) 600 (60) Equivalent
  units 35,000 31,400

47
Compute Equivalent Unit Costs (Step
3)

• Materials Conversion Current
  costs 84,050 62,000 Equivalent units
  35,000 31,400 Cost per
  unit 2.40 1.975

48
Summarize and Assign Total Costs (Steps 4 and 5)

• Work-in-process beg. inventory 7,550
• Current costs
  Material 84,050
  Conversion 62,000
  Total 153,600
• Same as using weighted-average

49
Summarize and Assign Total Costs (Steps 4 and 5)

• Costs transferred out
• From beginning inventory 7,550
  Conversion costs added
  1,000 x 40 x 1.975 790
  8,340
• From current production
  30,000 x 4.375 131,250
• Total 139,590

50
Summarize and Assign Total Costs (Steps 4 and 5)

• Work-in-process ending inventory
• Materials 5,000 2.40 12,000
• Conversion
  5,000 20 1.975 1,975
  Total 13,975

51
Summarize and Assign Total Costs (Steps 4 and 5)

• Costs transferred out 139,590
• Costs in ending inventory 13,975
• 153,565 (35 rounding error)
• An alternative approach
• Costs to account for 153,600
• Cost in ending inventory 13,975
• Costs transferred out 139,625

52
Key T-Account FIFO

• Work-in-Process Inventory, Assembly
  Beg. Inv. 7,550 Transferred to
  Materials 84,050 Finishing
  Conversion 62,000 139,625
  Balance 13,975

53
Comparison of Weighted-Average and FIFO Methods

• Weighted
  Average
  FIFO Difference Costs of units
  completed
  and
  transferred out 139,500 139,625 125
  Work-in-process,
  ending 14,100 13,975 -125
  Total costs
  accounted for 153,600 153,600
  0

54
Comparison of Weighted-Average and FIFO Methods

• The weighted-average ending inventory is higher
  than the FIFO ending inventory by 125.
• This results in a lower cost of goods sold and
  hence higher operating income and higher income
  taxes than does the FIFO method.

55
Comparison of Weighted-Average and FIFO Methods

• Differences in equivalent unit costs of beginning
  inventory and work done during the current
  period account for the differences in
  weighted-average and FIFO costs.

W-A FIFO
56
Learning Objective 7

• Incorporate standard costs into a
  process-costing system

57
Standard-Costing Method of Process
Costing

• Setting standards for quantities of inputs needed
  to produce output in companies that use
  process-costing is often relatively
  straightforward.
• Standard costs per input unit may then be
  assigned to these physical standards to develop
  standard costs per output unit.

58
Standard-Costing Method of Process
Costing

• Assume that Aspen Inc. uses the standard-costing
  method of process costing.
• Steps 1 and 2 are identical to the steps
  described for the FIFO method.
• Step 3 is easier than under weighted-average and
  FIFO methods.
• Why?

59
Standard-Costing Method of Process
Costing

• Because the cost per equivalent unit does not
  have to be computed, as was done for the
  weighted-average and FIFO methods.
• The cost per equivalent unit are the standard
  costs.
• The entries to the Work-in-Process account are
  at standard costs rather than actual.

60
Standard-Costing Method of Process
Costing

• Process-costing systems using standard costs
  usually accumulate actual costs incurred
  separately from the inventory accounts.
• Assume that actual materials cost is 84,050 and
  standard materials cost is 84,250
• What are the journal entries in the Assembly
  Department?

61
Standard-Costing Method of Process
Costing

• Direct Materials Control 84,050
  Accounts Payable Control 84,050
  Work-in-Process 84,250 Direct
  material
  variances 200 Direct Materials Control
  84,050 To record direct materials
  purchased and used in production during the
  period and variances

62
Learning Objective 8

• Apply process-costing methods to cases with
  transferred-in costs

63
Transferred-In Costs Weighted Average

• Assume that the Finishing Department of Aspen
  Inc. had 4,000 units in beginning
  work-in-process inventory and 2,000 in ending
  work-in-process inventory.
• 31,000 units were transferred from the Assembly
  Department to the Finishing Department during
  this period.

64
Transferred-In Costs Weighted Average

• The beginning work-in-process inventory was
  60 complete for materials and 25 for
  conversion.
• The ending work-in-process inventory was 100
  complete for materials and 40 for conversion.

65
Transferred-In Costs Weighted Average

• There are three equivalent unit computations for
  the Finishing Department.
• Transferred-in
• Direct materials
• Conversion

66
Physical Units (Step 1)

• Beginning inventory 4,000
  Units started in process 31,000 35,000
• Units completed and
  transferred to
  finished goods 33,000
  Ending inventory 2,000 35,000

67
Compute Equivalent Units (Step 2)

• Equivalent units for transferred-in costs
• Transferred to finished goods 33,000 Ending
  inventory 2,000
  35,000
• Inventory is 100 complete for the work performed
  in the Assembly Department.

68
Compute Equivalent Units (Step 2)

• Equivalent units for direct materials costs
  Transferred to finished goods 33,000 Ending
  inventory (100) 2,000
  35,000

69
Compute Equivalent Units (Step 2)

• Equivalent units for conversion costs (ending
  inventory 2,000)
• Transferred to finished goods 33,000 Ending
  inventory (40) 800
  33,800

70
Compute Equivalent Unit Costs (Step
3)

• Assume the following costs in the Finishing
  Department
• Work-in-process beginning inventory from
  Assembly Department 30,200
  Direct materials 9,400
  Conversion costs 8,000
  Total cost in beginning
  inventory 47,600

71
Compute Equivalent Unit Costs (Step
3)

• Current costs in Finishing Department are as
  follows
  Costs received from the
  Assembly Department 139,500 Direct
  materials 9,780
  Conversion 42,640
  Total 191,920

72
Compute Equivalent Unit Costs (Step
3)

• (Transferred-in costs 30,200 Costs
  transferred-in from the Assembly Department
  139,500) 35,000 units 4.85
• (Direct materials 9,400 9,780) 35,000
  0.55
• (Conversion costs 8,000 42,640) 33,800
  1.50
• Total unit cost 6.90

73
Summarize and AssignTotal Costs (Steps 4 and 5)

• Total costs in beginning
  inventory 47,600 Current costs in
  Finishing
  Department 191,920
  239,520
• Costs to account for
  47,600 191,920 239,520

74
Summarize and AssignTotal Costs (Steps 4 and 5)

• Costs in work-in-process ending inventory
• Transferred-in costs
  2,000 4.85 9,700
• Direct materials 2,000 0.55
  1,100
• Conversion 2,000 40 1.50 1,200
• Total cost in ending inventory 12,000

75
Summarize and AssignTotal Costs (Steps 4 and 5)

• Costs to account for 239,520
• Costs transferred to
  finished goods inventory
  33,000 6.90 227,700
• Costs in ending work-in-
  process inventory
  12,000 180 rounding error 11,820
• Total 239,520

76
T-Account Finishing Department

• Work-in-Process Inventory, Finishing
  Beg. Inv. 47,600 Transferred to
  Transferred-in 139,500 Finished Goods
  Materials 9,780 227,700 Conversion
  42,640 Balance
  11,820

77
Transferred-In Costs FIFO Method

• The physical units (Step 1) is the same as in
  weighted-average.
• Beginning inventory 4,000
  Units started in process 31,000 35,000
• Units transferred to
  finished goods 33,000
  Ending inventory 2,000 35,000

78
Compute Equivalent Units FIFO (Step 2)

• Equivalent units for transferred-in costs From
  beginning work-in-process 0 Started and
  completed 29,000 Work-in-process, ending
  (100) 2,000 Total equivalent units 31,000

79
Compute Equivalent Units FIFO (Step 2)

• Equivalent units for transferred-in costs
• Transferred to finished goods 33,000 Ending
  work-in-process inventory 2,000 Total
  35,000
• Beg. work-in-process inventory 4,000
• Equivalent units 31,000
• Inventories are 100 complete for the work
  performed in the Assembly Department.

80
Compute Equivalent Units FIFO (Step 2)

• Equivalent units for materials costs
  From beginning work-in-process 1,600
  Started and completed 29,000 Work-in-process,
  ending (100) 2,000 Total equivalent
  units 32,600

81
Compute Equivalent Units FIFO (Step 2)

• Equivalent units for material costs (beginning
  inventory 4,000)
• Transferred to finished goods 33,000
• Ending inventory (100) 2,000
  Total 35,000
• Beginning inventory (60) 2,400
• Equivalent units 32,600

82
Compute Equivalent Units FIFO (Step 2)

• Equivalent units for conversion costs
  From beginning work-in-process 3,000
  Started and completed 29,000 Work-in-process,
  ending (40) 800 Total equivalent
  units 32,800

83
Compute Equivalent Units FIFO (Step 2)

• Equivalent units for conversion costs (beginning
  inventory 4,000, ending
  inventory 2,000)
• Transferred to finished goods 33,000
• Ending inventory (40) 800
• Total 33,800
• Beginning inventory (25) 1,000
• Equivalent units 32,800

84
Compute Equivalent Unit Costs FIFO (Step 3)

• Cost per equivalent unit
• Transferred-in 139,590 31,000 4.50
• Direct materials 9,780 32,600 0.30
• Conversion 42,640 32,800 1.30
• Total unit cost 6.10

85
Summarize and Assign Total Costs FIFO (Steps 4
and 5)

• Current costs in Finishing Department 192,010
• Work-in-process beginning inventory 47,600
• Costs to account for 239,610
• Same as weighted-average

86
Summarize and Assign Total Costs FIFO (Steps 4
and 5)

• Work-in-process ending inventory
• Transferred-in 2,000 4.50 9,000
• Direct materials 2,000 0.30 600
• Conversion 800 1.30 1,040
• Total 10,640

87
Summarize and Assign Total Costs FIFO (Steps 4
and 5)

• Costs transferred out
• From beginning inventory 47,600
• Direct materials added
  4,000 40 0.30 480
• Conversion costs added
  4,000 75 1.30 3,900
• Total 51,980

88
Summarize and Assign Total Costs FIFO (Steps 4
and 5)

• Total costs transferred out
  From beginning inventory 51,980
  From current production
  29,000 6.10 176,900 Total 228,880

89
Summarize and Assign Total Costs FIFO (Steps 4
and 5)

• Total costs accounted for
• Transferred to finished goods
  176,900 51,980 228,880
• Work-in-process ending inventory 10,640
• Rounding 90
• Total 239,610

90
Summarize and Assign Total Costs FIFO (Steps 4
and 5)

• Costs to account for 239,610
• Work-in-process ending inventory -10,640
• Transferred to finished goods 228,970

91
End of Chapter 17