Chapter Six Process Costing COPYRIGHT © 2012 Nelson Education Ltd. Learning Objectives 1. Describe the basic characteristics and cost flows associated with process manufacturing 2. Define equivalent units and explain their role in process costing. Explain the differences between the weighted average method and the FIFO method of accounting for process costs 3. Prepare a departmental production report using the weighted average method 4. Explain how non-uniform inputs and multiple processing departments affect process costing 5. (Appendix) Prepare a departmental production report using the FIFO method 6-2 COPYRIGHT © 2012 Nelson Education Ltd. OBJECTIVE 1 Describe the basic characteristics and cost flows associated with process manufacturing Characteristics of Process Manufacturing Process costing works well whenever relatively homogeneous products pass through a series of processes and they receive similar amount of manufacturing costs Example Industries: Food Chemicals Tire manufacturers Large manufacturing plants 6-4 COPYRIGHT © 2012 Nelson Education Ltd. Types of Processes Sequential processing Requires that units pass through one process before they can be worked on in later processes Parallel processing Partially completed units can be worked on simultaneously in different processes and then brought together in a final process for completion 6-5 COPYRIGHT © 2012 Nelson Education Ltd. Raw Materials Cost Flow Manufacturing cost flows are same as those for a job-order system Raw Materials Materials purchases As raw materials are purchased, cost of these materials flow into a raw materials account 6-6 COPYRIGHT © 2012 Nelson Education Ltd. Cost Flows Into Work In Process Work in Process + Materials + Direct labour Finished Goods Completed Goods + Completed Goods + Overhead Materials, labour and overhead flow into the Work-In-Process account Completed goods are transferred out of WorkIn-Process and into Finished Goods COPYRIGHT © 2012 Nelson Education Ltd. 6-7 Cost Flows Into Work In Process Finished Goods + Completed Goods Cost of Goods Sold Sold Goods + Sold Goods Goods that are sold are transferred out of Finished Goods and into Cost of Goods Sold 6-8 COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 6-1 How to Calculate Cost Flows Without Work-In-Process (WIP) Information: Healthblend produces 2,000 bottles of multivitamins with the following costs: Picking Encapsulating Bottling Dept. Dept. Dept. Direct materials Direct labour Applied overhead $1,700 50 450 $1,000 60 500 $800 300 600 Required: • Calculate the costs transferred out of each department • Prepare journal entries that reflect these cost transfers 6-9 COPYRIGHT © 2012 Nelson Education Ltd. Costs Transferred Out Picking Encapsulating Bottling Dept. Dept. Dept. Direct materials $1,700 $1,000 $ 800 50 450 60 500 300 600 Costs added Costs transferred in $2,200 $1,560 $1,700 0 2,200 3,760 Costs transferred out $2,200 $3,760 $5,460 Direct labour Applied overhead 6-10 COPYRIGHT © 2012 Nelson Education Ltd. Journal Entries Work in Process (Encapsulating) Work in Process (Picking) $2,200 Work in Process (Bottling) $3,760 $2,200 Work in Process (Encapsulating) Finished Goods $3,760 $5,460 Work in Process (Bottling) $5,460 6-11 COPYRIGHT © 2012 Nelson Education Ltd. Transferred-In Costs Transferred-In Costs are costs transferred from a prior process to a subsequent process From the viewpoint of the subsequent process, transferred-in costs are a type of raw material cost 6-12 COPYRIGHT © 2012 Nelson Education Ltd. Production Report Summary of manufacturing activity of a process department for a given period of time Unit Information section Units to Account For Cost Information section Units Accounted For Unit Information Section has two major subdivisions 6-13 COPYRIGHT © 2012 Nelson Education Ltd. Production Report Unit Information section Cost Information section Costs to Account For Costs Accounted For Cost Information Section has two major subdivisions 6-14 COPYRIGHT © 2012 Nelson Education Ltd. OBJECTIVE 2 Define equivalent units and explain their role in process costing. Explain the differences between the weighted average method and the FIFO method of accounting for process costs Equivalent Units Example Assume that Department A had the following data for October: Units in BWIP --- Units completed Units in EWIP (25% complete) Total manufacturing costs 1,000 600 $11,500 What is the output for this department? 1000 units? 1600 units? 6-16 COPYRIGHT © 2012 Nelson Education Ltd. Equivalent Units of Output • Equivalent units – Total number of complete units that could have been produced given the total manufacturing effort used during the period • Dilemma – Some units are physically complete – Some units are not complete 6-17 COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 6-2 How to Calculate Equivalent Units of Production: No Beginning Work-In-Process Information: October Data: 1,000 units completed 600 units 25 percent complete Required: Calculate the equivalent units for October 6-18 COPYRIGHT © 2012 Nelson Education Ltd. Equivalent Units Equivalent Units Units Completed 1,000 Units in Ending WIP × 25% complete 150 1,150 6-19 COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 6-3 How To Measure Output and Assign Costs: No Beginning Work-In-Process Information: Manufacturing Costs for the period Units Transferred Out Units in Ending Work In Process (25% Complete) 11,500 1,000 600 Required: • Calculate the unit cost • Calculate the cost of goods transferred out and the cost of ending work-in-process (EWIP) 6-20 COPYRIGHT © 2012 Nelson Education Ltd. Calculating Unit Cost Cost per equivalent unit = Cost per equivalent unit = Cost per equivalent unit = Manufacturing costs Number of Equivalent Units $11,500 1,150 $10 6-21 COPYRIGHT © 2012 Nelson Education Ltd. Cost of Goods Transferred Out Cost of goods transferred out Cost of goods transferred out = = Unit Cost × $10 × Units Transferred Out 1,000 units $10,000 6-22 COPYRIGHT © 2012 Nelson Education Ltd. Cost of Ending Work-InProcess (EWIP) Cost of ending = work in process Unit Cost $10 Cost of ending = work in process Units in × EWIP × 150 $1,500 Things get more complicated if there are units in work-in-process at the beginning of the period 6-23 COPYRIGHT © 2012 Nelson Education Ltd. Beginning Work In Process • Work done on these beginning inventory units – Represents prior period costs • How should these costs figure into the computation of current period unit costs? 1. Weighted Average method 2. FIFO method 6-24 COPYRIGHT © 2012 Nelson Education Ltd. Weighted Average Method • Combines – Beginning inventory costs – Current period costs • Calculates Unit Cost for the period – By averaging • Unit cost is used to compute costs for: – Goods transferred out – Goods remaining in work-in-process 6-25 COPYRIGHT © 2012 Nelson Education Ltd. FIFO Method Separates work and costs for the equivalent units in beginning inventory from work and costs of the equivalent units produced during the current period Only current work and costs are used to calculate this period’s unit cost 6-26 COPYRIGHT © 2012 Nelson Education Ltd. OBJECTIVE 3 Prepare a departmental production report using the weighted average method Preparing a Weighted Average Production Report Step 1: Physical Flow Analysis • Trace the physical units of production – Two amounts are computed • Units Started and Completed – (Units Completed minus Units in BWIP) • Units Started – (Add Units Started and Completed plus EWIP) 6-28 COPYRIGHT © 2012 Nelson Education Ltd. Preparing a Weighted Average Production Report Step 2: Calculation of Equivalent Units • Adding together – Units Completed – Units in Ending Work In Process × Fraction Complete • Beginning Inventory – Included in the units completed – Treats beginning inventory as if it was started and completed the current period 6-29 COPYRIGHT © 2012 Nelson Education Ltd. Preparing a Weighted Average Production Report Step 3: Computation of Unit Cost • Manufacturing Costs ÷ Equivalent Unit – Costs include: • Prior period costs associated with beginning work-in-process • Current period manufacturing costs 6-30 COPYRIGHT © 2012 Nelson Education Ltd. Preparing a Weighted Average Production Report Step 4: Valuation of Inventories • Computing cost of goods transferred out – Multiplying • Unit cost (computed in step #3) • Units completed (computed in step #1) • Computing cost of ending work in process – Multiplying • Unit cost (computed in step #3) • Equivalent units (computed in step #2) 6-31 COPYRIGHT © 2012 Nelson Education Ltd. Preparing a Weighted Average Production Report Step 5: Cost Reconciliation • Checks to see if: – Costs to account for • Beginning Work In Process + Costs incurred during the period – Equal • Costs assigned to inventory – Transferred out + Ending Work-In-Process Cornerstones 6-4, 6-5, and 6-6 will walk us through an example 6-32 COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 6-4 How to Measure Output and Assign Costs: Weighted Average Information: Production: Units in process, July 1, 75% complete Units completed and transferred out Units in process, July 31, 25% complete Costs: Work in process, July 1 Costs added during July 20,000 litres 50,000 litres 10,000 litres $3,525 $10,125 6-33 COPYRIGHT © 2012 Nelson Education Ltd. Example Required: • Calculate an output measure for July • Assign costs to units transferred out and ending work in process using the weighted average method 6-34 COPYRIGHT © 2012 Nelson Education Ltd. Measuring Output Add Units in Beginning WIP to the Units Started and Completed Started & Completed BWIP 20,000 + 30,000 50,000 units completed this period 6-35 COPYRIGHT © 2012 Nelson Education Ltd. Measuring Output Add equivalent units in Ending WIP Units Completed 50,000 EWIP 10,000 units (25% complete) + 50,000 + 2,500 52,500 equivalent units manufactured this period 6-36 COPYRIGHT © 2012 Nelson Education Ltd. Assigning Costs Compute Unit Cost Work in process, July 1 $ 3,525 Costs added during July Total costs assigned 10,125 $13,650 Unit cost = $13,650/52,500 equivalent units Unit cost = $0.26 per equivalent unit 6-37 COPYRIGHT © 2012 Nelson Education Ltd. Assigning Costs Assign Costs to Units Transferred Out (50,000 units × $0.26) $13,000 Ending WIP (2,500 equiv. units × $0.26) 650 $13,650 Total Costs Assigned All the manufacturing costs have been assigned 6-38 COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 6-5 How to Prepare a Physical Flow Schedule Information: Production: Units in process, July 1, 75% complete Units completed and transferred out Units in process, July 31, 25% complete 20,000 litres 50,000 litres 10,000 litres Required: Prepare a physical flow schedule 6-39 COPYRIGHT © 2012 Nelson Education Ltd. Physical Flow Schedule Units to account for: Units in beginning work in process (75% complete) 20,000 Units started during the period This needs to be computed 6-40 COPYRIGHT © 2012 Nelson Education Ltd. Units Started and Completed Units started and completed Units – Units, BWIP = completed Units started and completed = Units started and completed = 50,000 – 20,000 30,000 6-41 COPYRIGHT © 2012 Nelson Education Ltd. Units Started Units started Units = started and + Units, EWIP completed Units started = Units started = 30,000 + 10,000 40,000 6-42 COPYRIGHT © 2012 Nelson Education Ltd. Physical Flow Schedule Units to account for: Units in beginning work in process (75% complete) Units started during the period Total units to account for 20,000 40,000 60,000 6-43 COPYRIGHT © 2012 Nelson Education Ltd. Physical Flow Schedule continued Units accounted for: Units completed and transferred out: Started and completed 30,000 From beginning work in process 20,000 50,000 Units in ending work in process (25% complete) Total units accounted for 10,000 60,000 All the units “to be accounted for” have been “accounted for” 6-44 COPYRIGHT © 2012 Nelson Education Ltd. Example Calculation of Equivalent Units Units completed Add: Units in ending work in process × fraction complete 50,000 Equivalent units of output 52,500 10,000 × 25% 2,500 Now we need to calculate the unit cost 6-45 COPYRIGHT © 2012 Nelson Education Ltd. Example Computation of Unit Cost Work in process, July 1 $ 3,525 Costs added during July Total manufacturing costs for July 10,125 $13,650 Unit cost = $13,650/52,500 Unit cost = $0.26 per equivalent unit 6-46 COPYRIGHT © 2012 Nelson Education Ltd. Example Cost Reconciliation Total manufacturing costs assigned to inventories are as follows: Goods transferred out Goods in ending work in process Total costs accounted for 50,000 units × $0.26 $13,000 650 $13,650 2,500 units × $0.26 6-47 COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 6-6 How to Prepare a Production Report: Weighted Average Method Information: Calculations in Cornerstones 6-4 & 6-5 Required: Prepare a production report 6-48 COPYRIGHT © 2012 Nelson Education Ltd. Healthblend Company Picking Department Production Report for July 2011 Physical Flow Units To Account For: Units in Beg. WIP Units started Total units to account for Equivalent Units Units completed Units in EWIP Total equivalent units Unit Information 20,000 40,000 60,000 Units Accounted For: Units completed 50,000 Units in End. WIP 10,000 Total units accounted for 60,000 50,000 2,500 52,500 6-49 COPYRIGHT © 2012 Nelson Education Ltd. Healthblend Company Picking Department Production Report for July 2011 (Continued) Cost Information Costs to account for: Beginning Work In Process Incurred during the period $ 3,525 10,125 Total costs to account for $13,650 Cost per equivalent unit $ 0.26 6-50 COPYRIGHT © 2012 Nelson Education Ltd. Healthblend Company Picking Department Production Report for July 2011 (Continued) Transferred Out Costs accounted for: Goods transferred out $13,000 Goods in Ending WIP --Total costs accounted for $13,000 Ending WIP Total --$650 $650 $13,000 650 $13,650 6-51 COPYRIGHT © 2012 Nelson Education Ltd. Evaluation of the Weighted Average Method Major benefit of this method is the simplicity Main disadvantage is reduced accuracy in computing unit costs If greater accuracy is desired, a company should use the FIFO method to determine unit costs 6-52 COPYRIGHT © 2012 Nelson Education Ltd. OBJECTIVE 4 Explain how nonuniform inputs and multiple processing departments affect process costing Nonuniform Application of Manufacturing Inputs • In the prior example – Materials, labour and overhead were applied uniformly throughout the process • But often materials is not added uniformly – Instead it is added at the beginning and ending of the process Separate equivalent units, unit costs and category costs are computed for materials and conversion costs 6-54 COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 6-7 How to Calculate Equivalent Units, Unit Costs, and Value Inventories with Nonuniform Inputs Information: Production: Units in process, Sept 1, 50% complete* Units completed and transferred out Units in process, Sept 30, 40% complete* 10,000 60,000 20,000 * Percentage complete as to conversion costs 6-55 COPYRIGHT © 2012 Nelson Education Ltd. Example Information continued: Costs: Work in process, Sept 1: Materials* Conversion costs Total Current costs: Materials* Conversion costs Total $ 1,600 200 $ 1,800 $12,000 3,200 $15,200 * Materials are added at the beginning of the process 6-56 COPYRIGHT © 2012 Nelson Education Ltd. Example Required: • Calculate equivalent units • Calculate unit cost • Calculate the valuation of the inventories 6-57 COPYRIGHT © 2012 Nelson Education Ltd. Example Calculation of Equivalent Units Materials Conversion Units completed 60,000 60,000 Add: Units in ending work in process × fraction complete 20,000 8,000 20,000 × 100% Since these units have all their materials 20,000 × 40% These units have 40% of their labour and overhead COPYRIGHT © 2012 Nelson Education Ltd. 6-58 Example Calculation of Equivalent Units Materials Conversion Units completed 60,000 60,000 Add: Units in ending work in process × fraction complete Equivalent units of output 20,000 8,000 80,000 68,000 6-59 COPYRIGHT © 2012 Nelson Education Ltd. Example Calculation of Unit Cost Unit materials cost = ($1,600 + $12,000)/80,000 Unit materials cost = $0.17 Unit conversion cost = ($200 + $3,200)/68,000 Unit conversion cost = $0.05 Total unit cost = $0.17 + $0.05 Total unit cost = $0.22 6-60 COPYRIGHT © 2012 Nelson Education Ltd. Example Valuation of Ending Work in Process and Goods Transferred Out Cost of ending work in process: Materials $0.17 × 20,000 $3,400 400 Conversion $0.05 × 8,000 Total cost $3,800 Valuation of goods transferred out: Cost of goods transferred out $13,200 $0.22 × 60,000 6-61 COPYRIGHT © 2012 Nelson Education Ltd. Multiple Departments Some departments receive partially completed goods from prior departments Usual approach is to treat transferred-in goods as a separate material category Cost of this material is the cost of the goods transferred out as computed in the prior department 6-62 COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 6-8 How to Calculate the Physical Flow Schedule, Equivalent Units, Unit Costs, and Transferred-In Goods Information: • For September, Healthblend’s encapsulating dept had: – 15,000 units in beginning inventory • With transferred-in costs of $3,000 – 70,000 units completed during the month • Picking department – Completed and transferred-out • 60,000 units at a cost of $13,200 6-63 COPYRIGHT © 2012 Nelson Education Ltd. Example Required: • Prepare a physical flow schedule with transferred-in goods • Calculate equivalent units for the transferred-in category • Calculate unit cost for the transferred-in category 6-64 COPYRIGHT © 2012 Nelson Education Ltd. Example Physical Flow Schedule Units to account for: Units in beginning work in process 15,000 Units transferred in during Sept. 60,000 75,000 Total units to account for 6-65 COPYRIGHT © 2012 Nelson Education Ltd. Example Physical Flow Schedule Units accounted for: Units completed and transferred out: Started and completed 55,000 From beginning work in process 15,000 Units in ending work in process 5,000 Total units accounted for 75,000 6-66 COPYRIGHT © 2012 Nelson Education Ltd. Example Equivalent Units for the transferred-in category Transferred-in: Units completed 70,000 Add: Units in ending work in process × fraction complete 5,000 Equivalent units of output COPYRIGHT © 2012 Nelson Education Ltd. 70,000 5,000 × 100% since these units have all their materials Example Calculation of Unit Cost for the Transferred-in Category For the transferred-in category Unit cost = Unit cost = Unit cost = ($13,200 + $3,000)/75,000 $16,200 / 75,000 $0.216 6-68 COPYRIGHT © 2012 Nelson Education Ltd. OBJECTIVE 5 Appendix: Prepare a departmental production report using the FIFO method Production Report FIFO Costing • Separates the cost of BWIP from cost of current period • Review: – Cornerstone 6-9, How to calculate output and cost assignments: FIFO method, page 264; and – Cornerstone 6-10, How to prepare a production report: FIFO method, page 267 6-70 COPYRIGHT © 2012 Nelson Education Ltd.