An introduction to cost terms and
purposes
Chapter 1
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
2-2
Costs and cost terminology
Cost
Actual cost
Budgeted cost
Cost
accumulation
2-3
Learning Objective 1
Understand cost
classifications used for
assigning costs to cost
objects: direct costs and
indirect costs.
2-4
Assigning Costs to Cost Objects
Direct costs
Indirect costs
• Costs that can be
easily and conveniently
traced to a unit of product
or other cost object.
• Costs that cannot be
easily and conveniently
traced to a unit of product
or other cost object.
• Examples: direct
material and direct labor
• Example: manufacturing
overhead
Common costs
Indirect costs incurred to support a number
of cost objects. These costs cannot be
traced to any individual cost object.
2-5
Learning Objective 2
Identify and give
examples of each of the
three basic
manufacturing cost
categories.
2-6
Classifications of Manufacturing Costs
Direct
Materials
Direct
Labor
The Product
Manufacturing
Overhead
2-7
Direct Materials
Raw materials that become an integral
part of the product and that can be
conveniently traced directly to it.
Example: A radio installed in an automobile
2-8
Direct Labor
Those labor costs that can be easily
traced to individual units of product.
Example: Wages paid to automobile assembly workers
2-9
Factors affecting Direct/ Indirect cost
classification
Several factors affect whether a cost is
classified as a direct or indirect
The materiality of the cost
in question
Available informationgathering technology
Design of operations
2-10
Cost behavior patterns: variable costs
and fixed costs
Variable costs
Fixed costs
Costs change in total in
procreation to changes in the
related level of total activity or
volume of output product
Costs remains unchanged in
total for a given time period
2-11
Example:
Variable costs . If BMW buys a steering wheal at $600 for each of its BMW X6
vechicles then the total cost of steering wheels is $600 times the number of
vehicales produced as the following table:
Number of x6s
producted (1)
Variable cost per Total variable
steering wheel
cost of steering
(2)
wheels (3)= 1*2
1
$600
600
1000
600
600000
3000
600
1800000
2-12
Fixed costs : suppose BMW INCURS A TOTAL COST OF 200000 per year for
supervisors who work exclusively on the X6 line. These costs are unchanged in
total over a designated range of vehicals produced. Fixed costs become
smaller and smaller on a per-unit basis as the number of vehicle assembled
increases, as the following table shows:
Annual total
fixed
supervision
costs (1)
Number of X6
produced (2)
Fixed
supervision cost
per X6 (3)= 1/2
$200000
10000
200
$200000
25000
80
$200000
50000
40
2-13
Learning Objective 3
Interpret unit costs
cautiously
2-14
Quick Check 
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
2-15
Quick Check 
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
2-16
Prime Costs and Conversion Costs
Manufacturing costs are often
classified as follows:
Direct
Material
Direct
Labor
Prime
Cost
Manufacturing
Overhead
Conversion
Cost
2-17
Learning Objective 4
Understand cost
classifications used to
predict cost behavior:
variable costs, fixed
costs, and mixed costs.
2-18
Cost Classifications for Predicting Cost
Behavior
Cost behavior refers to
how a cost will react to
changes in the level of
activity. The most
common
classifications are:
▫ Variable costs.
▫ Fixed costs.
▫ Mixed costs.
2-19
Variable Cost
Total Texting Bill
A cost that varies, in total, in direct proportion to
changes in the level of activity. Your total texting
bill may be based on how many texts you send.
Number of Texts Sent
2-20
Variable Cost Per Unit
Cost Per Text Sent
However, variable cost per unit is constant. The cost per
text sent may be constant at 5 cents per text message.
Number of Texts Sent
2-21
The Activity Base (Cost Driver)
Machine
hours
Units
produced
A measure of what
causes the
incurrence of a
variable cost
Miles
driven
Labor
hours
2-22
Fixed Cost
Monthly Cell Phone
Contract Fee
A cost that remains constant, in total, regardless of
changes in the level of the activity. Your monthly contract
fee for your cell phone may be fixed for the number of
monthly minutes in your contract.
Number of Minutes Used
Within Monthly Plan
2-23
Fixed Cost Per Unit
Monthly Cell Phone
Contract Fee
However, if expressed on a per unit basis, the average fixed cost per
unit varies inversely with changes in activity. The average fixed cost
per cell phone call made decreases as more calls are made.
Number of Minutes Used
Within Monthly Plan
2-24
Types of Fixed Costs
Committed
Discretionary
Long-term, cannot be
significantly reduced in
the short term.
May be altered in the
short term by current
managerial decisions
Examples
Examples
Depreciation on Buildings
and Equipment and Real
Estate Taxes
Advertising and
Research and
Development
2-25
Cost Classifications for Predicting Cost
Behavior
Behavior of Cost (within the relevant range)
Cost
In Total
Per Unit
Variable
Total variable cost Increase
and decrease in proportion
to changes in the activity level.
Variable cost per unit
remains constant.
Fixed
Total fixed cost is not affected
by changes in the activity
level within the relevant range.
Fixed cost per unit decreases
as the activity level rises and
increases as the activity level falls.
2-26
Quick Check 
Which of the following costs would be variable
with respect to the number of cones sold at a
Baskins & Robbins shop? (There may be more
than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.
2-27
Quick Check 
Which of the following costs would be variable
with respect to the number of cones sold at a
Baskins & Robbins shop? (There may be more
than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.
2-28
Mixed Costs
A mixed cost contains both variable and fixed
elements. Consider the example of utility cost.
Total Utility Cost
Y
Variable
Cost per KW
Activity (Kilowatt Hours)
X
Fixed Monthly
Utility Charge
2-29
Mixed Costs
The total mixed cost line can be expressed
as an equation: Y = a + bX
Where:
Y
Y
a
Total Utility Cost
b
X
= The total mixed cost.
= The total fixed cost (the
vertical intercept of the line).
= The variable cost per unit of
activity (the slope of the line).
= The level of activity.
Variable
Cost per KW
Activity (Kilowatt Hours)
X
Fixed Monthly
Utility Charge
2-30
Mixed Costs – An Example
If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?
Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100
2-31
Analysis of Mixed Costs
Account Analysis and the Engineering Approach
In account analysis, each account is
classified as either variable or fixed based
on the analyst’s knowledge of how
the account behaves.
The engineering approach classifies
costs based upon an industrial
engineer’s evaluation of production
methods, and material, labor, and
overhead requirements.
2-32
Learning Objective 5
Analyze a mixed cost
using a scattergraph
plot and the high-low
method.
2-33
Scattergraph Plots – An Example
Assume the following hours of maintenance work
and the total maintenance costs for six months.
2-34
The Scattergraph Method
Plot the data points on a graph (Total Cost Y “dependent
variable” vs. Activity X “independent variable”).
Scattergraph Method
Y
Total Maintenance Cost
$10 000
$9 500
$9 000
$8 500
$8 000
$7 500
X
$7 000
400
500
600
700
Hours of Maintenance
800
900
2-35
The High-Low Method – An Example
The variable cost
per hour of
maintenance is
equal to the change
in cost divided by
the change in hours.
$2,400
= $6.00/hour
400
2-36
The High-Low Method – An Example
Total Fixed Cost = Total Cost – Total Variable Cost
Total Fixed Cost = $9,800 – ($6/hour × 850 hours)
Total Fixed Cost = $9,800 – $5,100
Total Fixed Cost = $4,700
2-37
The High-Low Method – An Example
The Cost Equation for Maintenance
Y = $4,700 + $6.00X
2-38
Quick Check 
Sales salaries and commissions are
$10,000 when 80,000 units are sold, and
$14,000 when 120,000 units are sold. Using the
high-low method, what is the variable portion of
sales salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
2-39
Quick Check 
Sales salaries and commissions are $10,000
when 80,000 units are sold, and $14,000 when
120,000 units are sold. Using the high-low
method, what is the variable portion of sales
salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
2-40
Quick Check 
Sales salaries and commissions are $10,000
when 80,000 units are sold, and $14,000 when
120,000 units are sold. Using the high-low
method, what is the fixed portion of sales
salaries and commissions?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
2-41
Quick Check 
Sales salaries and commissions are $10,000
when 80,000 units are sold, and $14,000 when
120,000 units are sold. Using the high-low
method, what is the fixed portion of sales
salaries and commissions?
a. $ 2,000
Total cost = Total fixed cost +
Total variable cost
b. $ 4,000
$14,000 = Total fixed cost +
c. $10,000
($0.10 × 120,000 units)
d. $12,000
Total fixed cost
= $14,000 - $12,000
Total fixed cost
= $2,000
2-42
Least-Squares Regression Method
A method used to analyze mixed costs if a
scattergraph plot reveals an approximately linear
relationship between the X and Y variables.
This method uses all of the
data points to estimate
the fixed and variable
cost components of a
mixed cost. The goal of this method is
to fit a straight line to the
data that minimizes the
sum of the squared errors.
2-43
Least-Squares Regression Method
• Software can be used to fit a
regression line through the data
points.
• The cost analysis objective is the
same: Y = a + bX
Least-squares regression also provides a statistic,
called the R2, which is a measure of the goodness
of fit of the regression line to the data points.
2-44
Comparing Results From
the Two Methods
The two methods just discussed provide
different estimates of the fixed and variable cost
components of a mixed cost.
This is to be expected because each method
uses differing amounts of the data points to
provide estimates.
Least-squares regression provides the most
accurate estimate because it uses all the data
points.
2-45
Learning Objective 6
Prepare income
statements for a
merchandising company
using the traditional and
contribution formats.
2-46
The Traditional and Contribution
Formats
Used primarily for
external reporting.
Used primarily by
management.
2-47
Uses of the Contribution Format
The contribution income statement format is used
as an internal planning and decision-making tool.
We will use this approach for:
1.Cost-volume-profit analysis (Chapter 5).
2.Budgeting (Chapter 8).
3.Segmented reporting of profit data (Chapter 6).
4.Special decisions such as pricing and make-orbuy analysis (Chapter 12).
2-48
Learning Objective 7
Understand cost
classifications used in
making decisions:
differential costs,
opportunity costs, and
sunk costs.
2-49
Cost Classifications for Decision
Making
• Every decision involves a choice
between at least two
alternatives.
• Only those costs and benefits
that differ between alternatives
are relevant in a decision. All
other costs and benefits can and
should be ignored as irrelevant.
2-50
Differential Cost and Revenue
Costs and revenues that differ
among alternatives.
Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.
Differential revenue is:
$2,000 – $1,500 = $500
Differential cost is:
$300
2-51
Opportunity Cost
These costs are not
usually entered into the
accounting records of an
organization, but must be
explicitly considered in all
decisions.
What are the
opportunity costs you
incur to attend this class?
2-52
Sunk Costs
Sunk costs have already been incurred
and cannot be changed now or in the
future. These costs should be ignored
when making decisions.
Example: Suppose you had purchased gold for
$1,100 an ounce, but now it is selling for $950 an
ounce. Should you wait for the gold to reach $1,100
an ounce before selling it? You may say, “Yes” even
though the $1,100 purchase is a sunk costs.
2-53
Quick Check 
Suppose you are trying to decide whether to
drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you don’t want to waste money needlessly. Is
the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.
2-54
Quick Check 
Suppose you are trying to decide whether to
drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you don’t want to waste money needlessly. Is
the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.
2-55
Quick Check 
Suppose you are trying to decide whether to
drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you don’t want to waste money needlessly. Is
the annual cost of licensing your car relevant in
this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
2-56
Quick Check 
Suppose you are trying to decide whether to
drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you don’t want to waste money needlessly. Is
the annual cost of licensing your car relevant in
this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
2-57
Quick Check 
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
2-58
Quick Check 
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
2-59
End of Chapter 1
Job-Order Costing
Chapter 3
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
3-2
Job-Order Costing: An Overview
Job-order costing systems are
used when:
1. Many different products are produced each
period.
2. Products are manufactured to order.
3. The unique nature of each order requires
tracing or allocating costs to each job, and
maintaining cost records for each job.
3-3
Job-Order Costing: An Overview
Examples of companies that
would use job-order costing include:
1. Boeing (aircraft manufacturing)
2. Bechtel International (large scale construction)
3. Walt Disney Studios (movie production)
3-4
Job-Order Costing – An Example
Direct Costs
Direct Materials
Job No. 1
Direct Labor
Job No. 2
Job No. 3
Charge
direct
material and
direct labor
costs
(tracing) to
each job as
work is
performed.
3-5
Job-Order Costing – An Example
Direct Costs
Direct Materials
Job No. 1
Direct Labor
Job No. 2
Indirect Costs
Manufacturing
Overhead
Job No. 3
Manufacturing
Overhead,
including
indirect
materials and
indirect labor,
are allocated
to all jobs
rather than
directly traced
to each job.
3-6
The Job Cost Sheet
PearCo Job Cost Sheet
Job Number A - 143
Department B3
Item Wooden cargo crate
Direct Materials
Req. No. Amount
Date Initiated 3-4-14
Date Completed
Units Completed
Direct Labor
Manufacturing Overhead
Ticket Hours Amount Hours
Rate
Amount
Cost Summary
Direct Materials
Direct Labor
Manufacturing Overhead
Total Cost
Unit Product Cost
Units Shipped
Date Number Balance
3-7
Measuring Direct Materials Cost
Will E. Delite
3-8
Measuring Direct Materials Cost
3-9
Measuring Direct Labor Costs
3-10
Job-Order Cost Accounting
3-11
Learning Objective 1
Compute a
predetermined overhead
rate.
3-12
Why Use an Allocation Base?
An allocation base, such as direct labor hours,
direct labor dollars, or machine hours, is used to
assign manufacturing overhead to individual jobs.
We use an allocation base because:
a. It is impossible or difficult to trace overhead costs to particular
jobs.
b. Manufacturing overhead consists of many different items
ranging from the grease used in machines to the production
manager’s salary.
c. Many types of manufacturing overhead costs are fixed even
though output fluctuates during the period.
3-13
Manufacturing Overhead Application
The predetermined overhead rate
(POHR) used to apply overhead to jobs
is determined before the period begins.
POHR =
Estimated total manufacturing
overhead cost for the coming period
Estimated total units in the
allocation base for the coming period
Ideally, the allocation base
is a cost driver that causes
overhead.
3-14
The Need for a POHR
Predetermined overhead rates that rely upon
estimated data are often used because:
1. Actual overhead for the period is not
known until the end of the period, thus
inhibiting the ability to estimate job costs
during the period.
2. Actual overhead costs can fluctuate
seasonally, thus misleading decision
makers.
3-15
Computing Predetermined Overhead Rates
The predetermined overhead rate is computed before the period begins
using a four-step process.
1. Estimate the total amount of the allocation base (the denominator)
that will be required for next period’s estimated level of production.
2. Estimate the total fixed manufacturing overhead cost for the coming
period and the variable manufacturing overhead cost per unit of the
allocation base.
3. Use the following equation to estimate the total amount of
manufacturing overhead:
Y = a + bX
Where,
Y = The estimated total manufacturing overhead cost
a = The estimated total fixed manufacturing overhead cost
b = The estimated variable manufacturing overhead cost
per unit of the allocation base
X = The estimated total amount of the allocation base.
4. Compute the predetermined overhead rate.
3-16
Learning Objective 2
Apply overhead cost to
jobs using a
predetermined overhead
rate.
3-17
Overhead Application Rate
PearCo estimates that it will require 160,000 direct labor-hours to meet the
coming period’s estimated production level. In addition, the company
estimates total fixed manufacturing overhead at $200,000, and variable
manufacturing overhead costs of $2.75 per direct labor hour.
Y = a + bX
Y = $200,000 + ($2.75 per direct labor-hour × 160,000 direct labor-hours)
Y = $200,000 + $440,000
Y = $640,000
POHR =
$640,000 estimated total manufacturing overhead
160,000 estimated direct labor hours (DLH)
POHR = $4.00 per direct labor-hour
3-18
Job-Order Cost Accounting
3-19
Learning Objective 3
Compute the total cost
and average cost per
unit of a job.
3-20
Job-Order Cost Accounting
3-21
Job-Order Cost Accounting
3-22
Quick Check 
Job WR53 at NW Fab, Inc. required $200 of direct
materials and 10 direct labor hours at $15 per hour.
Estimated total overhead for the year was $760,000
and estimated direct labor hours were 20,000. What
would be recorded as the cost of job WR53?
a. $200.
b. $350.
c. $380.
d. $730.
3-23
Quick Check 
Job WR53 at NW Fab, Inc. required $200 of direct
materials and 10 direct labor hours at $15 per hour.
Estimated total overhead for the year was $760,000
and estimated direct labor hours were 20,000. What
would be recorded as the cost of job WR53?
a. $200.
b. $350.
c. $380.
d. $730.
POHR = $760,000/20,000 hours
$38
Direct materials
$200
Direct labor
$15 x 10 hours $150
Manufacturing overhead $38 x 10 hours $380
Total cost
$730
3-24
Learning Objectives 4 and 5
Learning Objective 4 is to
understand the flow of costs in
the job-order costing system and
prepare appropriate journal
entries to record costs.
Learning Objective 5 is to use
T-accounts to show the flow of
costs in a job-order costing
system.
3-25
Key Definitions
1. Raw materials include any materials that go
into the final product.
2. Work in process consists of units of production
that are only partially complete and will require
further work before they are ready for sale to
customers.
3. Finished goods consist of completed units of
product that have not been sold to customers.
4. Cost of goods manufactured include the
manufacturing costs associated with the goods
that were finished during the period,
3-26
Flow of Costs: A Conceptual Overview
Costs
Balance Sheet
Inventories
Material Purchases
Raw Materials
Direct Labor
Work in
Process
Manufacturing
Overhead
Selling and
Administrative
Finished
Goods
Period Costs
Income
Statement
Expenses
Cost of
Goods
Sold
Selling and
Administrative
3-27
Job-Order Costing: The Flow of Costs
The transactions (in
T-account and journal
entry form) that capture
the flow of costs in a
job-order costing
system are illustrated on
the following slides.
3-28
The Purchase and Issue of Raw
Materials: T-Account Form
Raw Materials
Material Direct
Purchases Materials
Indirect
Materials

Mfg. Overhead
Actual Applied
Indirect
Materials
Work in Process
(Job Cost Sheet)
Direct
Materials

3-29
Cost Flows – Material Purchases
On October 1, Smith Corporation had $5,000 in
raw materials on hand. During the month, the
company purchased $45,000 in raw materials.
(1)
Raw Materials
Accounts Payable
45,000
45,000
3-30
Issue of Direct and Indirect Materials
On October 3, Smith had $43,000 in raw materials
requisitioned from the storeroom for use in
production. These raw materials included $40,000
of direct and $3,000 of indirect materials.
(2)
Work in Process
Manufacturing Overhead
Raw Materials
40,000
3,000
43,000
3-31
The Recording of Labor Costs
Salaries and
Wages Payable
Direct
Labor
Indirect
Labor

Mfg. Overhead
Actual
Indirect
Materials
Indirect
Labor
Applied
Work in Process
(Job Cost Sheet)
Direct
Materials
Direct
Labor

3-32
The Recording of Labor Costs
During the month the employee time tickets
included $35,000 of direct labor and $12,000 for
indirect labor.
(3)
Work in Process
Manufacturing Overhead
Salaries and Wages Payable
35,000
12,000
47,000
3-33
Recording Actual Manufacturing
Overhead Costs
Salaries and
Wages Payable
Direct
Labor
Indirect
Labor

Mfg. Overhead
Actual Applied
Indirect
Materials
Indirect
Labor
Other
Overhead
Work in Process
(Job Cost Sheet)
Direct
Materials
Direct
Labor

3-34
Recording Actual Manufacturing
Overhead Costs
During the month the company incurred the
following actual overhead costs:
1. Utilities (heat, water, and power) $1,700
2. Depreciation of factory equipment $2,900
3. Property taxes payable on factory $1,000
(4)
Manufacturing Overhead
Utilities Payable
Accumulated Depreciation
Property Taxes Payable
5,600
1,700
2,900
1,000
3-35
Applying Manufacturing Overhead
Salaries and
Wages Payable
Direct
Labor
Indirect
Labor

Mfg. Overhead
Actual Applied
Indirect
Materials Overhead
Indirect
Applied to
Labor
Work in
Other
Process
Overhead
Work in Process
(Job Cost Sheet)
Direct
Materials
Direct
Labor
Overhead
Applied

If actual and applied
manufacturing overhead
are not equal, a year-end
adjustment is required.
3-36
Applying Manufacturing Overhead
Smith uses a predetermined overhead rate of
$3.50 per machine-hour. During the month,
5,000 machine-hours were worked on jobs.
(5)
Work in Process
Manufacturing Overhead
(5,000 machine hours × $3.50 = $17,500)
17,500
17,500
3-37
Accounting for Nonmanufacturing Cost
Nonmanufacturing costs are not assigned to
individual jobs, rather they are expensed in the
period incurred.
Examples:
1.
Salary expense of employees
who work in a marketing, selling,
or administrative capacity.
2.
Advertising expenses are expensed
in the period incurred.
3-38
Accounting for Nonmanufacturing Cost
During the month, Smith incurred but has not
paid sales salaries of $2,000, and advertising
expense of $750.
(6)
Salaries Expense
Advertising Expense
Salaries Payable
Accounts Payable
2,000
750
2,000
750
3-39
Transferring Completed Units
Work in Process
(Job Cost Sheet )
Direct
Materials
Direct
Labor
Overhead
Applied

Finished Goods
Cost of
Goods
Manufactured

Cost of
Goods
Manufactured

3-40
Transferring Completed Units
During the period, Smith completed jobs with a
total cost of $27,000.
(9)
Finished Goods
Work in Process
27,000
27,000
3-41
Transferring Units Sold
Work in Process
(Job Cost Sheet)
Direct
Materials
Direct
Labor
Overhead
Applied

Finished Goods
Cost of
Goods
Mfd.

Cost of
Goods
Mfd.

Cost of Goods Sold
Cost of
Goods
Sold

Cost of
Goods
Sold

3-42
Transferring Units Sold
Smith sold the $27,000 in Finished Goods
Inventory to customers for $43,500 on account.
(10)
Accounts Receivable
Sales
43,500
Cost of Goods Sold
Finished Goods
27,000
43,500
27,000
3-43
Learning Objective 6
Prepare schedules of
cost of goods
manufactured and cost
of goods sold and an
income statement.
3-44
Schedule of Cost of Goods
Manufactured: Key Concepts
This schedule contains three
types of costs, namely direct
materials, direct labor, and
manufacturing overhead.
It calculates the cost of raw
material and direct labor used in
production and the amount of
manufacturing overhead
applied to production.
It calculates the
manufacturing
costs associated
with goods that
were finished
during the
period.
3-45
Product Cost Flows
Raw Materials
+
=
–
=
Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production
Manufacturing
Costs
Work
In Process
Direct materials
As items are removed from raw
materials inventory and placed into
the production process, they are
called direct materials.
3-46
Product Cost Flows
Raw Materials
+
=
–
=
Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production
Manufacturing
Costs
Work
In Process
Direct materials
+ Direct labor
+ Mfg. overhead applied
= Total manufacturing
costs
Conversion
costs are costs
incurred to
convert the
direct material
into a finished
product.
3-47
Product Cost Flows
Raw Materials
+
=
–
=
Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production
Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead applied
= Total manufacturing
costs
Work
In Process
Beginning work in
process inventory
+ Total manufacturing
costs
= Total work in
process for the
period
All manufacturing costs added to
production during the period are
added to the beginning balance of
work in process.
3-48
Product Cost Flows
Raw Materials
Beginning raw
materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
in production
Costs
associated
Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead applied
= Total manufacturing
costs
with the goods that
are completed during the period are
transferred to finished goods
inventory.
Work
In Process
+
=
–
=
Beginning work in
process inventory
Total manufacturing
costs
Total work in
process for the
period
Ending work in
process inventory
Cost of goods
manufactured
3-49
Product Cost Flows
Work
In Process
+
=
–
=
Beginning work in
process inventory
Manufacturing costs
for the period
Total work in process
for the period
Ending work in
process inventory
Cost of goods
manufactured
Finished Goods
Beginning finished
goods inventory
+ Cost of goods
manufactured
= Cost of goods
available for sale
- Ending finished
goods inventory
Cost of goods
sold
3-50
Quick Check 
Beginning raw materials inventory was $32,000.
During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material
used?
a. $276,000
b. $272,000
c. $280,000
d. $ 222,000
3-51
Quick Check 
Beginning raw materials inventory was $32,000.
During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material
used?
Beg. raw materials
$ 32,000
+ Raw materials
a. $276,000
purchased
276,000
b. $272,000
= Raw materials available
for use in production $ 308,000
c. $280,000
– Ending raw materials
inventory
28,000
d. $ 2,000
= Raw materials used
in production
$ 280,000
3-52
Quick Check 
Direct materials used in production totaled
$280,000. Direct labor was $375,000, and
$180,000 of manufacturing overhead was added
to production for the month. What were total
manufacturing costs incurred for the month?
a. $555,000
b. $835,000
c. $655,000
d. Cannot be determined.
3-53
Quick Check 
Direct materials used in production totaled
$280,000. Direct labor was $375,000, and
$180,000 of manufacturing overhead was added
to production for the month. What were total
manufacturing costs incurred for the month?
a. $555,000
b. $835,000
c. $655,000
Direct Materials
$ 280,000
d. Cannot be determined.
+ Direct Labor
+ Mfg. Overhead Applied
= Mfg. Costs Incurred
for the Month
375,000
180,000
$ 835,000
3-54
Quick Check 
Beginning work in process was $125,000.
Manufacturing costs added to production for the
month were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
a. $1,160,000
b. $ 910,000
c. $ 760,000
d. Cannot be determined.
3-55
Quick Check 
Beginning work in process was $125,000.
Manufacturing costs added to production for the
month were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
Beginning work in
process inventory
$ 125,000
a. $1,160,000
+ Mfg. costs incurred
b. $ 910,000
for the period
835,000
= Total work in process
c. $ 760,000
during the period
$ 960,000
d. Cannot be determined.
– Ending work in
process inventory
= Cost of goods
manufactured
200,000
$ 760,000
3-56
Quick Check 
Beginning finished goods inventory was
$130,000. The cost of goods manufactured for the
month was $760,000. And the ending finished
goods inventory was $150,000. What was the cost
of goods sold for the month?
a. $ 20,000
b. $740,000
c. $780,000
d. $760,000
3-57
Quick Check 
Beginning finished goods inventory was
$130,000. The cost of goods manufactured for the
month was $760,000. And the ending finished
goods inventory was $150,000. What was the cost
of goods sold for the month?
a. $ 20,000
$130,000 + $760,000 = $890,000
b. $740,000
$890,000 - $150,000 = $740,000
c. $780,000
d. $760,000
3-58
Learning Objective 7
Compute underapplied
or overapplied overhead
cost and prepare the
journal entry to close the
balance in
Manufacturing Overhead
to the appropriate
accounts.
3-59
Underapplied and Overapplied
Overhead―A Closer Look
The difference between the overhead cost applied to
Work in Process and the actual overhead costs of a
period is referred to as either underapplied or
overapplied overhead.
Underapplied overhead
exists when the amount of
overhead applied to jobs
during the period using the
predetermined overhead
rate is less than the total
amount of overhead actually
incurred during the period.
Overapplied overhead
exists when the amount of
overhead applied to jobs
during the period using the
predetermined overhead
rate is greater than the total
amount of overhead actually
incurred during the period.
3-60
Overhead Application Example
PearCo’s actual overhead for the year was
$650,000 with a total of 170,000 direct labor hours
worked on jobs.
How much total overhead was applied to PearCo’s
jobs during the year? Use PearCo’s
predetermined overhead rate of $4.00 per direct
labor hour.
Overhead Applied During the Period
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
3-61
Overhead Application Example
PearCo’s actual overhead for the year was
$650,000 with a total of 170,000 direct labor hours
worked on jobs.
has overhead
overapplied
HowPearCo
much total
was applied to PearCo’s
overhead
for the
jobs during
theyear
year? Use PearCo’s
by $30,000. overhead
What will rate of $4.00 per direct
predetermined
PearCo do?
labor hour.
Overhead Applied During the Period
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
3-62
Quick Check 
Tiger, Inc. had actual manufacturing overhead
costs of $1,210,000 and a predetermined
overhead rate of $4.00 per machine hour. Tiger,
Inc. worked 290,000 machine hours during the
period. Tiger’s manufacturing overhead is:
a. $50,000 overapplied.
b. $50,000 underapplied.
c. $60,000 overapplied.
d. $60,000 underapplied.
3-63
Quick Check 
Tiger, Inc. had actual manufacturing overhead
costs of $1,210,000 and a predetermined
overhead rate of $4.00 per machine hour. Tiger,
Inc. worked 290,000 machine hours during the
period. Tiger’s manufacturing overhead is:
a. $50,000 overapplied.
b. $50,000 underapplied. Overhead Applied
c. $60,000 overapplied.
$4.00 per hour × 290,000 hours
= $1,160,000
d. $60,000 underapplied. Underapplied Overhead
$1,210,000 - $1,160,000
= $50,000
3-64
Disposition of Under- or Overapplied
Overhead
PearCo’s Method
$30,000
may be allocated
to these accounts.
$30,000 may be
closed directly to
cost of goods sold.
OR
Work in
Process
Finished
Goods
Cost of
Goods Sold
Cost of
Goods Sold
3-65
Disposition of Under- or Overapplied
Overhead
PearCo’s Cost
of Goods Sold
Actual Overhead
overhead applied
costs
to jobs
Unadjusted
Balance
$30,000
Adjusted
Balance
PearCo’s
Mfg. Overhead
$650,000
$30,000
$680,000
$30,000
overapplied
3-66
Allocating Under- or Overapplied
Overhead Between Accounts
Assume the overhead applied in ending Work in
Process Inventory, ending Finished Goods
Inventory, and Cost of Goods Sold is shown below:
Work in process
Finished Goods
Cost of Goods Sold
Total
Amount
68,000
$
204,000
408,000
680,000
$
3-67
Allocating Under- or Overapplied
Overhead Between Accounts
We would complete the following allocation of
$30,000 overapplied overhead:
Work in process
Finished Goods
Cost of Goods Sold
Total
Amount
68,000
$
204,000
408,000
680,000
$
Percent of
Total
10%
30%
60%
100%
$68,000 ÷ $680,000
Allocation of
$30,000
3,000
$
9,000
18,000
30,000
$
10% × $30,000
3-68
Allocating Under- or Overapplied
Overhead Between Accounts
Work in process
Finished Goods
Cost of Goods Sold
Total
Amount
$
68,000
204,000
408,000
$
680,000
Manufacturing Overhead
Work in Process Invenory
Finished Goods Inventory
Cost of Goods Sold
Percent of
Total
10%
30%
60%
100%
Allocation of
$30,000
$
3,000
9,000
18,000
$
30,000
30,000
3,000
9,000
18,000
3-69
Overapplied and Underapplied
Manufacturing Overhead - Summary
PearCo’s
Method
If Manufacturing
Overhead is . . .
UNDERAPPLIED
Alternative 1
Close to Cost
of Goods Sold
Alternative 2
INCREASE
Cost of Goods Sold
INCREASE
Work in Process
Finished Goods
Cost of Goods Sold
DECREASE
Cost of Goods Sold
DECREASE
Work in Process
Finished Goods
Cost of Goods Sold
(Applied OH is less
than actual OH)
OVERAPPLIED
(Applied OH is greater
than actual OH)
More accurate but more complex to compute.
Allocation
3-70
Quick Check 
What effect will the overapplied overhead
have on PearCo’s net operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.
c. Net operating income will decrease.
3-71
Quick Check 
What effect will the overapplied overhead
have on PearCo’s net operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.
c. Net operating income will decrease.
3-72
Multiple Predetermined Overhead
Rates
To this point, we have assumed that there is a single
predetermined overhead rate called a plantwide
overhead rate.
Large companies
often use multiple
predetermined
overhead rates.
May be more complex
but . . .
May be more accurate because
it reflects differences across
departments.
3-73
Job-Order Costing in Service
Companies
Job-order costing is used in many different types
of service companies. For example, law firms,
accounting firms, and medical treatment.
3-74
End of Chapter 3
Chapter 4
Systems Design:
Process Costing
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Similarities Between Job-Order
and Process Costing
 Both systems assign material, labor and
overhead costs to products and they provide a
mechanism for computing unit product cost.
 Both systems use the same manufacturing
accounts, including Manufacturing Overhead,
Raw Materials, Work in Process, and Finished
Goods.
 The flow of costs through the manufacturing
accounts is basically the same in both systems.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Differences Between Job-Order
and Process Costing
 Process costing is used when a single product is
produced on a continuing basis or for a long
period of time. Job-order costing is used when
many different jobs are worked on each period.
 Process costing systems accumulate costs by
department. Job-order costing systems
accumulated costs by individual jobs.
 Process costing systems compute unit costs by
department. Job-order costing systems compute
unit costs by job on the job cost sheet.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Quick Check 
Process costing is used for products that are:
a. Different and produced continuously.
b. Similar and produced continuously.
c. Individual units produced to customer
specifications.
d. Purchased from vendors.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Quick Check 
Process costing is used for products that are:
a. Different and produced continuously.
b. Similar and produced continuously.
c. Individual units produced to customer
specifications.
d. Purchased from vendors.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Processing Departments
Any location in an organization where materials,
labor or overhead are added to the product.
The activities performed in a processing
department are performed uniformly on all
units of production. Furthermore, the output of
a processing department must be
homogeneous.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 1
Record the flow
of materials, labor, and
overhead through a
process costing system.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Flow of Materials, Labor and
Overhead Costs
Direct
Materials
Direct Labor
Manufacturing
Overhead
McGraw-Hill /Irwin
Work in
Proces
s
Finished
Goods
Cost of
Goods
Sold
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Flow of Materials, Labor and
Overhead Costs
Costs are traced and
applied to individual
jobs in a job-order
cost system.
Direct
Materials
Direct Labor
Manufacturing
Overhead
McGraw-Hill /Irwin
Jobs
Finished
Goods
Cost of
Goods
Sold
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Flow of Materials, Labor and
Overhead Costs
Direct
Materials
Direct Labor
Manufacturing
Overhead
McGraw-Hill /Irwin
Costs are traced and
applied to departments
in a process cost
system.
Processing
Department
Finished
Goods
Cost of
Goods
Sold
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
T-Account and Journal Entry
Views of Process Cost Flows
For purposes of this example,
assume there are two
processing departments –
Departments A and B.
We will use T-accounts and
journal entries.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in T-Account form)
Raw Materials
•Direct
Materials
Work in Process
Department A
•Direct
Materials
Work in Process
Department B
•Direct
Materials
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in journal entry form)
GENERAL JOURNAL
Date
Post.
Ref.
Description
Page 4
Debit
Work in Process - Department A
XXXXX
Work in Process - Department B
XXXXX
Credit
XXXXX
Raw Materials
To record the use of direct material.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in T-Account form)
Salaries and
Wages Payable
•Direct
Labor
Work in Process
Department A
•Direct
Materials
•Direct
Labor
Work in Process
Department B
•Direct
Materials
•Direct
Labor
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in journal entry form)
GENERAL JOURNAL
Date
Post.
Ref.
Description
Page 4
Debit
Work in Process - Department A
XXXXX
Work in Process - Department B
XXXXX
Salaries and Wages Payable
Credit
XXXXX
To record direct labor costs.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in T-Account form)
Work in Process
Department A
Manufacturing
Overhead
•Actual
Overhead
•Overhead
Applied to
Work in
Process
•Direct
Materials
•Direct
Labor
•Applied
Overhead
Work in Process
Department B
•Direct
Materials
•Direct
Labor
•Applied
Overhead
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in journal entry form)
GENERAL JOURNAL
Date
Post.
Ref.
Description
Page 4
Debit
Work in Process - Department A
XXXXX
Work in Process - Department B
XXXXX
Manufacturing Overhead
Credit
XXXXX
To apply overhead to departments.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in T-Account form)
Work in Process
Department A
•Direct
Transferred
Materials
to Dept. B
•Direct
Labor
•Applied
Overhead
McGraw-Hill /Irwin
Work in Process
Department B
•Direct
Materials
•Direct
Labor
•Applied
Overhead
•Transferred
from Dept. A
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in journal entry form)
GENERAL JOURNAL
Date
Post.
Ref.
Description
Work in Process - Department B
Page 4
Debit
Credit
XXXXX
Work in Process - Department A
XXXXX
To record the transfer of goods from
Department A to Department B.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in T-Account form)
Work in Process
Department B
•Direct
•Cost of
Materials
Goods
•Direct
Manufactured
Labor
•Applied
Overhead
•Transferred
from Dept. A
McGraw-Hill /Irwin
Finished Goods
•Cost of
Goods
Manufactured
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in journal entry form)
GENERAL JOURNAL
Date
Post.
Ref.
Description
Finished Goods
Page 4
Debit
Credit
XXXXX
Work in Process - Department B
XXXXX
To record the completion of goods
and their transfer from Department B
to finished goods inventory.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in T-Account form)
Work in Process
Department B
Finished Goods
•Direct
•Cost of
•Cost of
•Cost of
Materials
Goods
Goods
Goods
•Direct
Manufactured
Manufactured
Sold
Labor
•Applied
Overhead
•Transferred
Cost of Goods Sold
from Dept. A
•Cost of
Goods
Sold
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Process Cost Flows
(in journal entry form)
GENERAL JOURNAL
Date
Description
Cost of Goods Sold
Finished Goods
Post.
Ref.
Page 4
Debit
Credit
XXXXX
XXXXX
To record cost of goods sold.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Equivalent Units of Production
Equivalent units are the product of the number
of partially completed units and the percentage
of completion of those units.
We need to calculate equivalent units because a
department usually has some partially completed
units in its beginning and ending inventory.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Equivalent Units – The Basic Idea
Two half completed products are
equivalent to one completed product.
+
=
1
So, 10,000 units 70% complete
are equivalent to 7,000 complete units.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Quick Check 
For the current period, Jones started 15,000
units and completed 10,000 units, leaving
5,000 units in process that are 30 percent
complete. How many equivalent units of
production did Jones have for the period?
a. 10,000
b. 11,500
c. 13,500
d. 15,000
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Quick Check 
For the current period, Jones started 15,000
units and completed 10,000 units, leaving
5,000 units in process that are 30 percent
complete. How many equivalent units of
production did Jones have for the period?
a. 10,000
10,000 units + (5,000 units × 0.30)
b. 11,500
= 11,500 equivalent units
c. 13,500
d. 15,000
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Calculating Equivalent Units
Equivalent units can be calculated two
ways:
The First-In, First-Out Method – FIFO
is covered in the appendix to this chapter.
The Weighted-Average Method – This
method will be covered in the main portion of
the chapter.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 2
Compute the equivalent units
of production using the
weighted-average method.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Characteristics of the Weighted
Average Method
The weighted-average method . . .
• Makes no distinction between work done in
prior or current periods.
• Blends together units and costs from prior
and current periods.
The equivalent units of production for a
department are the number of units transferred
to the next department (or finished goods) plus
the equivalent units in the department’s ending
work in process inventory.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Treatment of Direct Labor
Dollar Amount
Direct
Materials
Direct
Labor
Direct labor costs
may be small
in comparison to
Conversion
other product
costs in process
costing systems.
Type of Product Cost
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Treatment of Direct Labor
Dollar Amount
Direct
Materials
Direct labor costs
may be small
Conversion
in comparison to
other product
costs in process
costing systems.
Type of Product Cost
Direct labor and manufacturing overhead may be
combined into one product cost called conversion.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Weighted-Average Example
Double Diamond Skis reported the following
activity in Shaping and Milling Department
for the month of May:
Percent Completed
Shaping and Milling Department
Beginning work in process
Units
200
Materials Conversion
55%
30%
Units started into production in May
5,000
Units completed during May and
transferred to the next department
4,800
100%
100%
400
40%
25%
Ending working process
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Weighted-Average Example
The first step in calculating the equivalent units
is to identify the units completed and transferred
out of the Department in May (4,800 units).
Materials
Units completed and transferred
to the next department
McGraw-Hill /Irwin
4,800
Conversion
4,800
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Weighted-Average Example
The second step is to identify the equivalent units of
production in ending work in process with respect to
materials for the month (160 units) and add this to the
4,800 units from step one.
Materials
Units completed and transferred
to the next department
4,800
Conversion
4,800
Work in process, June 30:
400 units × 40%
Equivalent units of Production in
during the month of May
McGraw-Hill /Irwin
160
4,960
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Weighted-Average Example
The third step is to identify the equivalent units of
production in ending work in process with respect to
conversion for the month (100 units) and add this to
the 4,800 units from step one.
Materials
Units completed and transferred
to the next department
4,800
Conversion
4,800
Work in process, June 30:
400 units × 40%
160
400 units × 25%
Equivalent units of Production in
during the month of May
McGraw-Hill /Irwin
100
4,960
4,900
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Weighted-Average Example
Equivalent units of production always equals:
Units completed and transferred
+ Equivalent units remaining in work in process
Materials
Units completed and transferred
to the next department
4,800
Conversion
4,800
Work in process, June 30:
400 units × 40%
160
400 units × 25%
Equivalent units of Production in
during the month of May
McGraw-Hill /Irwin
100
4,960
4,900
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Weighted-Average Example
Materials
Beginning
Work in Process
200 Units
55% Complete
5,000 Units Started
4,800 Units Started
and Completed
4,800 Units Completed
160 Equivalent Units
4,960 Equivalent units
of production
McGraw-Hill /Irwin
Ending
Work in Process
400 Units
40% Complete
400 × 40%
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Weighted-Average Example
Conversion
Beginning
Work in Process
200 Units
30% Complete
5,000 Units Started
4,800 Units Started
and Completed
4,800 Units Completed
100 Equivalent Units
4,900 Equivalent units
of production
McGraw-Hill /Irwin
Ending
Work in Process
400 Units
25% Complete
400 × 25%
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 3
Compute the costs per
equivalent unit using the
weighted-average method.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing Cost Per Equivalent Unit
The following table includes some additional facts for Double
Diamond Skis’ Shaping and Milling Department for May.
Beginning work in process:
200 units
Materials: 55% complete
Conversion: 30% complete
$
9,600
5,575
Production started during May
Production completed during May
5,000 units
4,800 units
Costs added to production in May
Materials cost
Conversion cost
$ 368,600
350,900
Ending work in process
400 units
Materials:
40% complete
Conversion: 25% complete
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Compute and Apply Costs
The formula for computing the
cost per equivalent unit is :
Cost per
equivalent =
unit
McGraw-Hill /Irwin
Cost of beginning
work in process + Cost added during
inventory
the period
Equivalent units of production
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Compute and Apply Costs
Here is a schedule with the cost
and equivalent unit information.
Total
Cost
Cost to be accounted for:
Work in process, May 1
Costs added in the Shipping
and Milling Department
Total cost
Equivalent units
$
15,175
Materials
Conversion
$
$
9,600
5,575
719,500
368,600
350,900
$ 734,675
$ 378,200
$ 356,475
4,960
4,900
Cost per equivalent unit
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Compute and Apply Costs
Here is a schedule with the cost
and equivalent unit information.
$356,475 ÷ 4,900 units = $72.75
Total
Cost
Cost to be accounted for:
Work in process, May 1
Costs added in the Shipping
and Milling Department
Total cost
Equivalent units
$
15,175
Materials
Conversion
$
$
9,600
719,500
368,600
350,900
$ 734,675
$ 378,200
$ 356,475
4,960
4,900
Cost per equivalent unit
$ 76.25
Total cost per equivalent unit = $76.25 + $72.75 = $149.00
McGraw-Hill /Irwin
5,575
$
72.75
$378,200 ÷ 4,960 units = $76.25
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 4
Assign costs to units using
the weighted-average
method.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of Ending
Work in Process Inventory
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Total
Conversion
Materials
Ending work in process inventory:
100
160
Equivalent units of production
Cost of ending work in process inventory
Units completed and transferred out:
Units transferred to the next department
Cost per equivalent unit
Cost of units transferred out
$
$
$
-
4,800
76.25
366,000
$
$
$
-
4,800
72.75
349,200
-
$
$
715,200
Step 1: Record the equivalent units of production
in ending work in process inventory.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of Ending
Work in Process Inventory
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Total
Conversion
Materials
Ending work in process inventory:
100
160
Equivalent units of production
72.75
$
76.25
$
Cost per equivalent unit
19,475
$
7,275
$
12,200
$
Cost of ending work in process inventory
Units completed and transferred out:
Units transferred to the next department
Cost per equivalent unit
Cost of units transferred out
$
$
4,800
76.25
366,000
$
$
4,800
72.75
349,200
$
715,200
Step 2: Record the cost per equivalent unit.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of Ending
Work in Process Inventory
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Total
Conversion
Materials
Ending work in process inventory:
100
160
Equivalent units of production
72.75
$
76.25
$
Cost per equivalent unit
19,475
$
7,275
$
12,200
$
Cost of ending work in process inventory
Units completed and transferred out:
Units transferred to the next department
Cost per equivalent unit
Cost of units transferred out
$
$
4,800
76.25
366,000
$
$
4,800
72.75
349,200
$
715,200
Step 3: Compute the cost of ending
work in process inventory.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of
Units Transferred Out
Shaping and Milling Department
Cost of Ending Work in Porcess Inventory and the Units Transferred Out
Total
Conversion
Materials
Ending work in process inventory:
100
160
Equivalent units of production
72.75
$
76.25
$
Cost per equivalent unit
7,275
$
12,200
$
Cost of ending work in process inventory
19,475
$
Units completed and transferred out:
Units transferred to the next department
Cost per equivalent unit
Cost of units transferred out
$
$
4,800
76.25
366,000
$
$
4,800
72.75
349,200
$
715,200
Step 1: Record the units transferred out
to the next department.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of
Units Transferred Out
Shaping and Milling Department
Cost of Ending Work in Porcess Inventory and the Units Transferred Out
Total
Conversion
Materials
Ending work in process inventory:
100
160
Equivalent units of production
72.75
$
76.25
$
Cost per equivalent unit
7,275
$
12,200
$
Cost of ending work in process inventory
19,475
$
Units completed and transferred out:
Units transferred to the next department
Cost per equivalent unit
Cost of units transferred out
$
$
4,800
76.25
366,000
$
$
4,800
72.75
349,200
$
715,200
Step 2: Record the cost per equivalent unit.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of
Units Transferred Out
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Total
Conversion
Materials
Ending work in process inventory:
100
160
Equivalent units of production
72.75
$
76.25
$
Cost per equivalent unit
19,475
$
7,275
$
12,200
$
Cost of ending work in process inventory
Units completed and transferred out:
Units transferred to the next department
Cost per equivalent unit
Cost of units transferred out
$
$
4,800
76.25
366,000
$
$
4,800
72.75
349,200
$
715,200
Step 3: Compute the cost of units transferred out.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Reconciling Costs
Shaping and Milling Department
Cost Reconciliation
Costs to be accounted for:
$
Cost of beginning work in process inventory
Costs added to production during the period
$
Total cost to be accounted for
15,175
719,500
734,675
Step 1: Compute the costs to be accounted for by
adding the cost of beginning work in process
and the production costs added in May.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Reconciling Costs
Shaping and Milling Department
Cost Reconciliation
Costs to be accounted for:
$
Cost of beginning work in process inventory
Costs added to production during the period
$
Total cost to be accounted for
15,175
719,500
734,675
Cost accounted for as follows:
Cost of ending work in process inventory
Cost of units transferred out
Total cost accounted for
19,475
715,200
734,675
$
$
Step 2: Compute the costs to accounted for by
adding the cost of ending work in process
and the cost of units transferred out in May.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Appendix 4A
FIFO Method
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
FIFO vs. Weighted-Average Method
The FIFO method (generally considered
more accurate that the weighted-average
method) differs from the weighted-average
method in two ways:
1. The computation of equivalent units.
2. The way in which the costs of beginning
inventory are treated.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 5
Compute the
equivalent units of
production using
the FIFO method.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Equivalent Units – FIFO Method
Let’s revisit the Double Diamond Skis example.
Assume the following activity is reported in the
Shaping and Milling Department for May:
Percent Completed
Units
Work in process, June 1
300
Units started into production in June
6,000
Units completed and transferred out
of Department A during June
5,400
Work in process, June 30
McGraw-Hill /Irwin
900
Materials Conversion
40%
20%
60%
30%
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Equivalent Units – FIFO Method
Step 1: Determine equivalent units needed
to complete beginning inventory.
Materials
To complete beginning work in process:
Materials: 200 units × (100% - 55%)
Conversion: 200 units × (100% - 30%)
McGraw-Hill /Irwin
Conversion
90
140
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Equivalent Units – FIFO Method
Step 2: Determine units started and
completed during the period.
Materials
To complete beginning work in process:
Materials: 200 units × (100% - 55%)
90
Conversion: 200 units × (100% - 30%)
Units started and completed during May
McGraw-Hill /Irwin
Conversion
140
4,600
4,600
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Equivalent Units – FIFO Method
Step 3: Add the equivalent units in ending
working in process inventory.
Materials
To complete beginning work in process:
Materials: 200 units × (100% - 55%)
90
Conversion: 200 units × (100% - 30%)
Units started and completed during May
Conversion
140
4,600
4,600
Ending work in process
Materials: 400 units × 40% complete
Conversion: 400 units × 25% complete
Equivalent units of production
McGraw-Hill /Irwin
160
100
4,850
4,840
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
FIFO Example
Materials
Beginning
Work in Process
200 Units
55% Complete
200 × 45%
McGraw-Hill /Irwin
5,000 Units Started
4,600 Units Started
and Completed
90 Equivalent Units
4,600 Units Completed
160 Equivalent Units
4,850 Equivalent units
of production
Ending
Work in Process
400 Units
40% Complete
400 × 40%
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
FIFO Example
Conversion
Beginning
Work in Process
200 Units
30% Complete
200 × 70%
McGraw-Hill /Irwin
5,000 Units Started
4,600 Units Started
and Completed
140 Equivalent Units
4,600 Units Completed
100 Equivalent Units
4,840 Equivalent units
of production
Ending
Work in Process
400 Units
25% Complete
400 × 25%
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Equivalent Units:
Weighted Average vs. FIFO
As shown below, the equivalent units in
beginning inventory are subtracted from the
equivalent units of production per the weightedaverage method to obtain the equivalent units
of production under the FIFO method.
Equivalent units - weighted average method
Less equivalent units in beginning inventory:
200 units × 55%
200 units × 30%
Equivalent units - FIFO method
McGraw-Hill /Irwin
Materials
4,960
Conversion
4,900
110
4,850
60
4,840
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 6
Compute the cost per
equivalent unit using
the FIFO method.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Cost per Equivalent Unit - FIFO
The following table includes some additional facts for Double
Diamond Skis’ Shaping and Milling Department for May.
Beginning work in process:
200 units
Materials: 55% complete
Conversion: 30% complete
$
9,600
5,575
Production started during May
Production completed during May
5,000 units
4,800 units
Costs added to production in May
Materials cost
Conversion cost
$ 368,600
350,900
Ending work in process
400 units
Materials:
40% complete
Conversion: 25% complete
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Cost per Equivalent Unit - FIFO
The formula for computing the cost per
equivalent unit under FIFO method is:
Cost per
equivalent =
unit
McGraw-Hill /Irwin
Cost added during the period
Equivalent units of production
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Cost per Equivalent Unit - FIFO
Total
Cost
Costs added in the Shaping
and Milling Department
Equivalent units
$ 719,500
Materials
Conversion
$ 368,600
4,850
$ 350,900
4,840
$ 76.00
Cost per equivalent unit
Total cost per equivalent unit = $76.00 + $72.50 = $148.50
McGraw-Hill /Irwin
$
72.50
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 7
Assign costs to units
using the FIFO method.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of Ending
Work in Process Inventory
Step 1: Record the equivalent units of production
in ending work in process inventory.
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Materials
Conversion
Total
Ending work in process inventory:
Equivalent units of production
160
100
Cost per equivalent unit
$
76.25
$
72.75
Cost of ending work in process inventory
$
12,200
$
7,275
$
19,475
Units completed and transferred out:
Units transferred to the next department
Cost per equivalent unit
Cost of units transferred out
McGraw-Hill /Irwin
$
$
4,800
76.25
366,000
$
$
4,800
72.75
349,200
$
715,200
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of Ending
Work in Process Inventory
Step 2: Record the cost per equivalent unit.
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Materials
Conversion
Total
Ending work in process inventory:
Equivalent units of production
160
100
Cost per equivalent unit
$
76.00
$
72.50
Cost of ending work in process inventory
$
12,160
$
7,250
$
19,410
Units completed and transferred out:
Units transferred to the next department
Cost per equivalent unit
Cost of units transferred out
McGraw-Hill /Irwin
$
$
4,800
76.25
366,000
$
$
4,800
72.75
349,200
$
715,200
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of Ending
Work in Process Inventory
Step 3: Compute the cost of ending
work in process inventory.
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Materials
Conversion
Total
Ending work in process inventory:
Equivalent units of production
160
100
Cost per equivalent unit
$
76.00
$
72.50
$
19,410
Cost of ending work in process inventory
$
12,160
$
7,250
Units completed and transferred out:
Units transferred to the next department
Cost per equivalent unit
Cost of units transferred out
McGraw-Hill /Irwin
$
$
4,800
76.25
366,000
$
$
4,800
72.75
349,200
$
715,200
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of
Units Transferred Out
Step 1: Record the cost in beginning
work in process inventory.
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Conversion
Materials
Units transferred out:
5,575
$
9,600
$
Cost in beginning work in process (WIP)
Cost to complete beginning WIP:
140
90
Equivalent units to complete
72.50
$
76.00
$
Cost per equivalent unit
10,150
$
6,840
$
Cost to complete beginning WIP
Cost of units started and completed in May
4,600
4,600
Units started and completed in May
72.50
$
76.00
$
Cost per equivalent unit
333,500
$
$ 349,600
Cost of units started and completed in May
Cost of units transferred out
McGraw-Hill /Irwin
Total
$
15,175
$
16,990
$
$
683,100
715,265
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of
Units Transferred Out
Step 2: Determine the cost to complete the units
in beginning work in process inventory.
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Conversion
Materials
Units transferred out:
5,575
$
9,600
$
Cost in beginning work in process (WIP)
Cost to complete beginning WIP:
140
90
Equivalent units to complete
72.50
$
76.00
$
Cost per equivalent unit
10,150
$
6,840
$
Cost to complete beginning WIP
Cost of units started and completed in May
4,600
4,600
Units started and completed in May
72.50
$
76.00
$
Cost per equivalent unit
333,500
$
$ 349,600
Cost of units started and completed in May
Cost of units transferred out
McGraw-Hill /Irwin
Total
$
15,175
$
16,990
$
$
683,100
715,265
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of
Units Transferred Out
Step 3: Determine the cost of units started
and completed this period.
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Total
Conversion
Materials
Units transferred out:
15,175
$
5,575
$
9,600
$
Cost in beginning work in process (WIP)
Cost to complete beginning WIP:
140
90
Equivalent units to complete
72.50
$
76.00
$
Cost per equivalent unit
10,150
$
6,840
$
Cost to complete beginning WIP
16,990
$
Cost of units started and completed in May
4,600
4,600
Units started and completed in May
72.50
$
76.00
$
Cost per equivalent unit
$ 683,100
333,500
$
$ 349,600
Cost of units started and completed in May
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Computing the Cost of
Units Transferred Out
Step 4: Determine the total cost of units transferred out.
Shaping and Milling Department
Cost of Ending Work in Process Inventory and the Units Transferred Out
Conversion
Materials
Units transferred out:
5,575
$
9,600
$
Cost in beginning work in process (WIP)
Cost to complete beginning WIP:
140
90
Equivalent units to complete
72.50
$
76.00
$
Cost per equivalent unit
10,150
$
6,840
$
Cost to complete beginning WIP
Cost of units started and completed in May
4,600
4,600
Units started and completed in May
72.50
$
76.00
$
Cost per equivalent unit
333,500
$
$ 349,600
Cost of units started and completed in May
Cost of units transferred out
McGraw-Hill /Irwin
Total
$
15,175
$
16,990
$
$
683,100
715,265
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Reconciling Costs
Shaping and Milling Department
Cost Reconciliation
Costs to be accounted for:
Cost of beginning work in process inventory
Costs added to production during the period
Total cost to be accounted for
Cost accounted for as follows:
Cost of ending work in process inventory
Cost of units transferred out
Total cost accounted for
McGraw-Hill /Irwin
$
15,175
719,500
$ 734,675
$
19,475
715,200
$ 734,675
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Reconciling Costs
Shaping and Milling Department
Cost Reconciliation
Costs to be accounted for:
Cost of beginning work in process inventory
Costs added to production during the period
Total cost to be accounted for
Cost accounted for as follows:
Cost of ending work in process inventory
Cost of units transferred out
Total cost accounted for
McGraw-Hill /Irwin
$
15,175
719,500
$ 734,675
$
19,410
715,265
$ 734,675
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
A Comparison of Costing Methods
In a lean production environment, FIFO and
weighted-average methods yield similar
unit costs.
When considering cost control, FIFO is superior
to weighted-average because it does not mix
costs of the current period with costs of the
prior period.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
End of Chapter 4
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.