Chapter 4
System Design—Process Costing
Learning Objectives
LO1.
LO2.
LO3.
LO4.
LO5.
LO6.
LO7.
LO8.
LO9.
Record the flow of materials, labor, and overhead through a process costing system.
Compute the equivalent units of production using the weighted-average method.
Prepare a quantity schedule using the weighted-average method.
Compute the costs per equivalent unit using the weighted-average method.
Prepare a cost reconciliation using the weighted-average method.
(Appendix 4A) Compute the equivalent units of production using the FIFO method.
(Appendix 4A) Prepare a quantity schedule using the FIFO method.
(Appendix 4A) Compute the costs per equivalent unit using the FIFO method.
(Appendix 4A) Prepare a cost reconciliation using the FIFO method.
New in this Edition
• Additional simple exercises have been created.
Chapter Overview
A. Job-Order Costing vs. Process Costing. Process costing is used in industries that
produce homogenous products such as bricks, flour, and cement on a continuous basis.
1.
Similarities between job-order and process costing. Job-order and process costing
systems share some characteristics:
a. Both systems have the same basic purpose—to assign material, labor, and overhead
cost to products.
b. Both systems use the same basic manufacturing accounts: Manufacturing Overhead,
Raw Materials, Work In Process, and Finished Goods.
c. The flow of costs through the manufacturing accounts is basically the same.
2.
Differences between job-order and process costing. The differences between job-order
and process costing occur because the flow of units in a process costing system is more or
less continuous and the units are essentially indistinguishable from one another. Under
process costing:
a. A single homogenous product is produced on a continuous basis over a long period of
time. This differs from job-order costing in which many different products may be
produced in a single period.
b. Costs in process costing are accumulated by department, rather than by individual job.
c. The department production report is the key document in process costing, showing the
accumulation and disposition of cost. In job-order costing, the job-cost sheet is the key
document.
B. Overview of Process Costing. (Exercises 4-1 and 4-10.) Manufacturing costs are
accumulated in processing departments in a process costing system. A processing department is
any location in the organization where work is performed on a product and where materials,
labor, and overhead costs are added to the product. Processing departments should also have two
other features. First, the activity performed in the processing department should be essentially
the same for all units that pass through the department. Second, the output of the department
should be homogeneous. In process costing, the average cost of processing units for a period is
assigned to each unit passing through the department.
Two process costing methods are illustrated in the text—the weighted-average method and
the FIFO method. While the FIFO method provides more current cost data for decision-making
and performance evaluation purposes, it is more difficult for students to grasp. For that reason,
the FIFO method is covered in an appendix.
C. Equivalent Units of Product. (Exercises 4-2, 4-11, 4-13, and 4-17.) In order to
calculate the average cost per unit, the total number of units must be determined. Partially
completed units pose a difficulty that is overcome using the concept of equivalent units.
Equivalent units are the equivalent, in terms of completed units, of partially completed units.
The formula for computing equivalent units is:
Number of
Equivalent  partially completed  Percentage
units
completion
units
Equivalent units are the number of complete, whole units one could obtain from the materials
and effort contained in partially completed units.
Under the weighted-average method, the equivalent units for a particular cost category (e.g.,
materials or conversion cost) is computed by adding together the number of units completed and
transferred out to the next department during the period and the equivalent units in the ending
work in process inventory in the department.
Equivalent Units transferred to
Equivalent units
units of  the next department  in ending work in
production or to finished goods process inventory
D. Production Report. The purpose of a production report is to summarize all of the
activity that takes place in a department's work in process account for a period. A production
report consists of three parts:
• A quantity schedule and a computation of equivalent units.
• A computation of costs per equivalent unit.
• A reconciliation of all cost flows into and out of the department during the period.
E. Production Report: Weighted-Average Method. (Exercise 4-13 followed by
Exercise 4-14.) Emphasize that the weighted-average method does not attempt to separate units
in the beginning inventory from units started during the current period. Costs and units from
beginning inventory are blended together with costs and units from the current period.
1.
Quantity Schedule and Equivalent Units. (Exercises 4-2, 4-4, and 4-11.) The first step in
preparing a production report is to prepare a quantity schedule, which shows the physical
flow of units through the department. This schedule allows managers to see at glance how
many units moved through the department during the period. Using the quantity schedule,
the equivalent units can be easily computed.
2.
Costs per Equivalent Unit. (Exercises 4-6 and 4-13.) The second step in preparing a
production report is to calculate the costs per equivalent unit. The cost per equivalent unit is
computed for a particular cost category (i.e., materials, labor, overhead, or conversion) by
dividing its total cost by its total equivalent units. Note that under the weighted-average
method the costs include both the costs already in beginning inventory as well as the costs
added by the department during the current period.
3.
Cost Reconciliation. (Exercise 4-7.) The third step in preparing a production report is to
prepare a cost reconciliation. The purpose of a cost reconciliation is to show how the costs
from beginning work in process inventory and costs that have been added during the period
are accounted for.
a. Costs come into the department from units in beginning inventory, from material,
labor, and overhead costs that are added during the period, and from any units that
might have been transferred in from a prior department.
b. A department's costs are accounted for by showing the costs that are transferred out to
the next department (or to finished goods) and by specifying the costs that remain in
the ending work in process inventory.
F.
Operation Costing. The costing systems discussed in Chapters 3 and 4 represent the two
ends of a continuum. On one end is job-order costing and on the other is process costing.
Between the two extremes, there are many “hybrid” systems. Operation costing is an example of
such a hybrid system. It is used in situations where products have some common as well as
individual characteristics. TVs, for example, have some common characteristics in that all
models must be assembled and tested following the same basic steps. However, each model has
different components with different costs. The costs of the components (materials) would be
charged to a batch of a particular model individually, as in job-order costing, but the conversion
costs may be assigned using process costing.
G. FIFO Method (Appendix 4A). (Exercise 4-15 followed by Exercise 4-16.) The FIFO
method segregates the units and costs in the beginning inventory from the units and costs of the
current period.
1.
Quantity Schedule. (Exercises 4-5 and 4-12.) The quantity schedule prepared under the
FIFO method is identical to that prepared under the weighted-average method, except that
the “units transferred out” are separated into those units that came from beginning
inventory and those units that were started and completed this period.
2.
Equivalent Units. (Exercises 4-3 and 4-12.) The FIFO method differs from the weightedaverage method for computation of equivalent units in two ways.
a. First, under the FIFO method the “units transferred out” figure is split between units
completed from the beginning inventory and units started and completed during the
current period.
b. Second, the equivalent units refers to just the equivalent units for the work performed
during the current period. The equivalent units under the FIFO method consist of three
amounts: the work needed to complete the units in the beginning inventory; the work
expended on the units started and completed during the current period; and the work
expended on partially completed units in the ending inventory.
c. This method is called the FIFO method because it assumes that the units in beginning
inventory are completed and transferred out before any new units are started. The costs
of beginning inventory are segregated from costs added during the period.
d. The only difference in the equivalent unit calculations between the two methods is that
the equivalent units in beginning inventory are included in the weighted-average
method. Under the weighted-average method the costs already in beginning inventory
will be added to the costs incurred during the period to arrive at unit costs. To be
consistent we must add the equivalent units already in beginning inventory to the
equivalent units for the work performed during the current period.
3.
Costs per Equivalent Unit. (Exercise 4-8.) In computing costs per equivalent unit, costs
associated with the beginning work in process inventory are ignored. It is assumed that the
units in beginning inventory are completed and transferred to the next department before
any new units are worked on. Providing that more units are transferred out than were in
beginning inventory, all of the costs associated with beginning inventory will be transferred
to the next department.
4.
Cost Reconciliation. (Exercises 4-9 and 4-16.) As with the weighted-average method, the
purpose of a cost reconciliation is to show how the costs have been charged to a department
during a period and to show how these costs are accounted for.
a. The “Costs to be accounted for” section of the report is the same as for the weightedaverage method.
b. The “Cost accounted for” section differs from the weighted-average method in that
four layers of cost are involved. These layers are (1) the cost in the beginning
inventory, (2) the cost required to complete the units in the beginning inventory, (3) the
cost of units started and completed during the current period, and (4) the cost of the
ending work in process inventory.
H. Evaluation of Weighted-Average and FIFO (Appendix 4A). The weighted-average
method is simpler to learn and apply than the FIFO method, but the FIFO method is generally
considered to be superior for cost control. The reason is that the FIFO method helps to isolate
current performance by segregating current costs from prior period costs. The weighted-average
method mixes the costs of the current period with the costs of prior periods.