STRATEGIC COST MANAGEMENT
LESSON 1: PROCESS COSTING
 It is a system of accumulating cost of product by departments or cost
center. Commonly used by companies where a large number of product
are being continuously process until completed and transferred to
finished goods.
 OBJECTIVES:
1. To determine the manufacturing costs allocated in every
department to calculate the unit per cost of the product for profit
determination and inventory costing procedures.
2. To determine the total cost of the units still in process and the
costs of the units completed.
TAKE NOTE: Process Cost system is used when products are manufactured by
mass production while Job-Order Cost system is most suitable when single
product or batch of product is manufactured according to customer’s
preference.
The following similarities between process costing and job-order cost system:



Manufacturing cost element – both track and record the three elements:
Direct Materials, Direct Labor, and Manufacturing Overhead
Accumulation costs:
a) All raw materials purchased – Debited to Material Account
b) All direct labor – Debited to Factory Payroll Account
c) All actual manufacturing overhead costs – Debited to
Manufacturing Overhead Control Account
Flow of costs – the accumulated manufacturing costs are assigned to the
same account in both costing system: Work in process, Finished Goods, and
Cost of Goods Sold.
Differences:
Number in Work in Process
accounts
Process Costing
Multiple work in process
accounts
are used for each
used
production
department
Point at which total costs id At the end of the each
month while
determined
the units are being
processed
The unit cost is equal to the
total
manufacturing costs for the
Unit cost computation
period
divided by the units
produced during
the period
Job-Order Cost System
One work in process
account is used
Total costs are computed
when the
job is completed
The unit cost is determined
by
dividing the total cost per
job by the
units produced.
ACCUMULATION OF COSTS BY DEPARTMENT
 Units in completed in one department are transferred to the next
department accompanied by their corresponding costs.
 Completed unit of the one department becomes the raw materials of
the one department until the units are converted into finished
products.
 The output of Department 1 becomes the input of Department 2, which
receives the units produced as well as its production costs.
 Upon the completion of the process in Department 2, the cost of units
completed consists of the cost received from Department 1 and cost
incurred in Department 2.

The cost of unit increases as it progresses from one department to the
next.
ASSIGNEMENT OF MANUFACTURING COSTS
 Normal Costing - direct materials and direct labor are applied at actual
cost while manufacturing overhead is applied at predetermined rate.
 Standard Costing – direct materials, direct labor and manufacturing
overhead are applied at standard cost or estimated cost.
TYPES OF PROCESSES
 Sequential processing – (series of producing department) it requires
that units pass through process before one process they can be worked
on in the next process in the sequence.

Parallel processing – (two sub-components) that requires two or more
sequential processes to produce a finished goods.
PROCESS COSTING SYSTEM
Direct Materials – usually direct materials are added to the first
department, but they may also be added in the subsequent departments.
Work in process, Depatment
xxx
1
xxx
Work in process, Department
xxx
2
Work in process, Department
3
Materials
xx
x
Direct Labor – the distributions of direct labor to the departments are:
Work in process, Depatment 1
xxx
Work in process, Department 2
xxx
Work in process, Department 3
xxx
Factory Payroll
xxx
Manufacturing Overhead – are applied using a predetermined application
rate.
Work in process, Depatment 1 xxx
Work in process, Department 2 xxx
Work in process, Department 3 xxx
xxx
Applied Manufacturing Overhead
Transfer to Next Department
Work in process, Department
2
Work in Process, Department 1
xxx
xxx
Transfer to Finished Goods - the units completed in the last department
and transferred to stockroom awaiting sale:
Finished Goods
xxx
Work in process, Department
xxx
3
Transferred-in costs – are costs transferred from a prior process
department to a subsequent process department. For subsequent process
department, transferred-in costs are a type of raw material costs.
ACCUMULATING COSTS IN
PRODUCTION REPORT Production
Report



The document that summarizes the manufacturing activity that takes
place in a prior process department for a given period of time.
It is prepared by the cost accountant for each department at the end of
the month.
It provides information about the physical units produced in a
department and their associated manufacturing costs.


It is the document used by the management to understand and
evaluate the operations of a department because it shows the flow of
units as well as the flow of costs related to the department.
It is divided into the following sections and subdivisions:
 Unit information section
a) Units to account for = Units in BWIP + Units started
during the period
b) Units accounted to = Units started and transferred out +
Units in EWIP
 Cost information section
a) Costs to account for = Goods transferred out + Goods in
EWIP
b) Cost accounted for = BWIP + Incurred during the month
EQUIVALENT UNITS IN PRODUCTION
 It is the measure of work done during the month, express in fully
completed units. The stage of completion at the end of the month is
based on past experiences.
 Normally, not all units are completed during the period. There are still
in process at different stages of completion at the end of the month. All
these units must be converted to equivalent unit of production by
multiplying the number of units in process the percentage of
completion.
 This procedure is necessary for the purpose of computing the unit cost.
METHODS:
WEIGHTED AVERAGE METHOD
 Total Manufacturing Cost = BWIP costs + costs incurred during the
period
 Equivalents units = Units completed + units in EWIP
 Unit Cost = Total Manufacturing Costs / Equivalents
units during the period Evaluation of Weighted Average
Method
 By treating units in BWIP as belonging to the current period, all
equivalent units belong to the same category when it comes to
calculating unit cost.
 Unit cost computation are simplified
 If the unit cost in a process is relatively stable from one period to the
next, the weighted average method is reasonably accurate.
 If the price of manufacturing inputs increases significantly from one
period to the next, the unit cost of current output is understated, and
the unit cost of BWIP units is overstated.
STEPS:
1. Physical Flow Analysis Schedule
Units to account for:
Units in BWIP
Units started during the period
Units accounted to:
Units started and transferred out:
Started and completed
From beginning work in process
xxx
xxx
Units in EWIP
xx
x
xx
x
xx
x
xx
x
xx
x
xx
x
2. Prepare a schedule for equivalents units
Equivalent Units
Materials
xxx
xxx
Labor
xxx
xxx
Overhead
xxx
xxx
xxx
xxx
xxx
Materi
als
Labor
Overhead
Total
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Units Completed
Add: Units in EWIP x
percentage
Total Equivalent Units
3. Compute the cost per
equivalents
Cost to account for:
BWIP
EWIP
Total Cost to account xxx
for
Cost per equivalent
unit =
Total Cost to account xxx
for /
Total Equivalent Units
xxx
xxx
xxx
xxx
xxx
xxx
4. Compute the cost of goods transferred out and the cost of EWIP
Cost of Goods Transferred out = Units completed (see step 2) x Total
Cost per Equivalent
Cost of EWIP = Units in EWIP (see step 2) multiply by the
corresponding cost per equivalent unit in step 3
5. Prepare the Cost Reconciliation
Cost to account for = BWIP costs + Incurred during the period
Cost accounted for = Cost of units transferred out (see step 4) +
Cost of EWIP (see step 4) FIFO METHOD




The equivalent units of work in BWIP from the prior period are not
counted in calculating this period’s equivalent units. Thus, it is
excluded in calculating the unit cost.
Unit cost = cost of the period / output of the period
The cost of units transferred out is the sum of three different items:
o Costs incurred in the prior period
found in BWIP o Cost of completing
the BWIP incurred this period o Cost
of the units started and completed this
period
Cost of EWIP = unit cost x equivalents in EWIP
STEPS:
1) Physical Flow Analysis (see step 1 under Weighted Average)
2) Prepare a schedule of equivalent units
Materials Labor
Units started
xxx
xxx
Add: Units in BWIP x % (yung
xxx
xxx
kailangan pa para
ma-complete si 100%)
Add: Units in EWIP x % (yung na
xxx
xxx
completed na)
Total Equivalent Units of
xxx
xxx
Output
3) Compute the cost per equivalent
unit
Materials Labor
Overhead
Cost incurred during the xxx
xxx
xxx
period
Divide by: Total
xxx
xxx
xxx
equivalent units
of output
Cost per equivalent unit xxx
xxx
xxx
Overhead
xxx
xxx
xxx
xxx
Total
xxx
xxx
xxx
4) Compute the cost of goods transferred out
and cost of EWIP Cost of Goods Transferred
Out:
Units started and Completed = units started (see step 2) x total cost per
equivalent unit (see step 3)
Add: Units in BWIP (see step 2) multiply by the corresponding cost per
equivalent unit (see step 3)
Add: BWIP costs
Cost of EWIP
Units in EWIP (see step 2) multiply by the corresponding cost per
equivalent unit (see step 3)
5) Prepare the cost
reconciliation Cost to
account for
BWIP costs
Cost incurred during the period
Cost accounted for
Units in BWIP (see step 4)
Units started and completed (see step 4)
Units in EWIP (see step 4)
LESSON 2: ALLOCATION FOR JOINT AND BY-PRODUCTS
Joint Products - are individual products, each with significant sales values,
which are produced simultaneously from the same raw materials and/or
manufacturing process.
• Manufacturing of joint products has a split-off point (point of
separation) in which separate products emerge, which can be sold as is
or processed further. Cost incurred after split-off point do not cause
allocation problems since they can be identified with the specific
products
• None of the joint products is significantly greater in value than other
joint products. This characteristic distinguishes joint products from byproducts.
• Joint products require simultaneous common processing. Processing of
one of the joint products results in the processing of all the other joint
products at the same time.
Joint cost – common cost consist of direct materials, direct labor and
manufacturing overhead incurred from the start of the process up to the
point of separation (split off point). These costs are indivisible, because they
cannot be identified to any of the products being simultaneously produced.
Additional processing costs – are cost incurred by each product, after
emerged from the same raw material. Additional processing costs consist
also of additional materials, direct labor and manufacturing overhead
incurred after the split off point.
METHODS:
Physical measure method, such as weight or volume
• The physical measure in unit (the gallon) is easy because the products
are measured in gallons
• The joint costs is easily allocated between two products
• Unit costs of all the products are the same, because they were
computed by dividing the total cost by the total units
• No consideration is given to relative sales value, special processing or
handling required, the content of the product, or other special
characteristics
• Not all costs are directly related to physical units
Product 1
Product 2
Physical Measures
Productio
Total Production
n
Ratio
Production / Total Production
100%
Total
Allocated Joint
Total Manufacturing Costs x Ratio
Manufacturing
Cost
Cost
Joint cost per
Allocated Joint Cost / Production
piece
Income Statement – Physical
Measures Method
Product
Product 2
1
Revenues
Sales x selling price
Total Revenues
Cost of Goods
Allocated Joint Cost LESS cost of ending Total Cost of
Goods
Sold
inventory*
Sold
*ending inventory x joint cost per piece
Gross Profit
Gross Profit Rate
Revenues – Cost of Goods Sold
Gross Profit / Revenues
Total Revenues –
Total Cost of
Goods
Sold
Total Gross Profit
/
Total Revenues
Sales value at split-off point method (relative sales value), set to yield a
uniform rate of gross profit.
• This method allocates joint costs to joint products on the basis of their
relative sales value at the split-off point. This method uses the sales
value of the entire production of the accounting period because joint
costs are incurred on all units produced, not just on those sold in the
current period.
•
x Joint cost = Allocated Joint Costs
Costs are allocated to products in proportion to their expected revenues.
The cost-allocation base (total sales value at split-off point) is
expressed in terms of a common denominator (the amount of
revenues) that is systematically recorded in the accounting system.
• This method needs the market selling prices for all products at the
split-off point.
• This method always yield the same rate of gross profit for the
products when there are no beginning inventories and all products
are sold at split-off point.
• This method is straightforward.
Product
Product 2
1
Sales Value at
Tota Sales Value
Production x selling price
Split-off
l
at
Point
Split-off Point
Ratio
Sales Value at Split-off point / Total
100
Sales Value at
%
Split-off
point
Allocated Joint
Tota Manufacturin
Total Manufacturing Costs x Ratio
Cost
l
g
Cost
Joint cost per piece
Allocated Joint Cost / production
•
Income Statement – Sales Value at Split-off Point Method
Product
Product 2
1
Revenues
Sales x selling price
Total Revenues
Cost of Goods Sold Allocated Joint Cost less cost of ending Total Cost of
Goods
inventory*
Sold
*ending inventory x joint cost per piece
Gross Profit
Revenues – Cost of Goods Sold
Total Gross Profit
Total Gross Profit /
Gross Profit Rate
Gross Profit / Revenues
Total Revenues
Adjusted sales value method (net realizable value), considering additional
processing costs.
• If the joint products must be processed further before sale, the sales
value at split-off point method of allocation does not measure the true
value of the production at the point of separation.
• The additional processing costs must be deducted from the sales value
before the cost allocation is made.
•
•
•
•
•
•
x Joint Costs = Allocated Joint Cost
This method is usually used only when sales value at split-off point of
one or more products is not known
The allocations are very similar to those made when the sales value at
split-off point is used.
The procedures involved are simple and relatively easy to apply.
The costs usually present the true picture of the values at the point of
separation of the products.
The cost allocations are still derived from the selling or market price,
which may have a little or no relationship to the actual cost.
NEW PRODUCT 1 NEW PRODUCT 2
Product 1 – was
Product 2 – was
further
further
processed to
processed to
Adjusted Sales
Value at
split-off Point
Ratio
Allocated Joint
Cost
Joint Cost per
piece
produce
produce
another product
another product
Sales before cost
LESS separable
allocation
cost or
incremental cost
Total Adjusted
sales
Value at Split-off
Point
Adjusted Sales Value at Split-off Point / 100%
Total
Adjusted Sales Value at Split-off Point
Total
Total Manufacturing Cost x Ratio
Manufacturing
Cost
Allocated Joint Cost PLUS separable
cost or
incremental cost DIVIDE BY pieces
produced
Income Statement – Adjusted Sales Value Method
NEW PRODUCT 1 NEW PRODUCT 2
Product 1 – was
Product 2 – was
further
further
processed to
processed to
produce
produce
another product
another product
Revenues
Sales x selling price
Allocated Joint Cost
Cost of Goods Sold Add: Separable Cost or Incremental
Cost
Cost of Goods Available for Sale
Less: Ending Inventory*
*ending inventory x joint cost per piece
Gross Profit
Revenues – Cost of Goods Sold
Gross Profit Rate
Gross Profit / Revenues
Total Revenues
Total Cost of
Goods
Sold
Total Gross Profit
Total Gross Profit /
Total Revenues
Which method of allocating joint costs should be used?
• Used sales value method at split-off method when selling price is
available (even if further processing is done.) Reason for using sales
value at split-off point methods are:
• It measures the value of the joint product immediately at the end
of the joint process
• It does not require information on the process steps after split-off
point, if there is further processing
• It serves as a meaningful basis to allocate joint costs to products,
which are revenues
• It is simple to apply
By-products
• By-products are those products of limited sales value produced
simultaneously with products of greater sales value, known as the
main or principal products. Main products are usually produced in
much greater quantity than by-products.
• By-products, like joint or main products are produced from the same
raw materials and or common manufacturing process
• By-products are generally secondary importance in production cost
allocation methods differ from those used for joint products
METHODS:
1) Method A – this method is used when by-products are considered of
minor importance and does not require additional processing costs.
Net revenue (sales value less selling costs) may be treated as:
• Addition to revenue from the sale of the main product or as other
income, and all manufacturing costs are applied to the main
product
• Reduction from the cost of the main product.
By-products recognized when sold
Net Revenue treated as Additional Revenue or Other Income
• This method makes no journal entries until sale of the by-product
occurs.
•
Revenue (proceeds) of the by-product are reported in the income
statement either as revenues group with other sales or as other
income. From data given, the journal entry to
record the sale of the by-product is as follows:
Accounts Receivable/Cash
xxx
Sales
xxx
•
•
•
No cost is assigned or allocated to the by-product.
The sale of the by-product has no effect on the cost of the
main product.
The procedure is simple and practical and requires no
computations of the cost of the by-product.
Net Revenue Treated as Cost Reduction
 If the net revenue from the sale of the by-product is treated as
a reduction from the cost of the main product, the following
entry to record the sale of by-product would made:
Accounts Receivable/Cash
xx
x
Work in process
xxx
Income Statement under Method A
As Addition to
Revenue from
Sales of Main Product
Main Product: Sales x
selling price
Revenues:
PLUS By-product: Sales x
selling
price (net of selling
costs)
Total Manufacturing Costs
– Main
Cost of Goods
Product ending
Sold
inventory*
Gross Profit
Gross Profit
Rates
Cost of Main Product
ending
inventory = Net
Manufacturing
Costs/Production x
Ending
Inventory
Revenues – Cost
Goods Sold
Gross Profit/Revenues
As Cost Reduction from
Cost of
Main Product
Main Product: Sales x
selling price
Total Manufacturing Costs –
Byproduct revenues – Main
Product
ending inventory*
Cost of Main Product
ending
inventory = Net
Manufacturing
Costs/Production x Ending
Inventory
Revenues – Cost of Goods
Sold
Gross Profit/Revenues
2) Method B – By-products are recognized when produced.
• This method is used when by-products are considered important
and therefore require additional processing costs.
• Two basic accounting methods can be used when by-products are
recognized when production is completed:
By-product is Recorded at its Net Realizable Value (NRV) :


The net realizable value of the completed by-product
(estimated sales value less estimated additional costs and
selling costs) is charged to By-product inventory and deducted
from the total manufacturing costs. No part of joint costs is
allocated to the by-product.
The method recognizes by-products in the financial
statements at the time production is completed,
Inventory – By-product (production x
xxx
selling price)
Work in process – Main Product
xxx
Income Statement under Method B – Net Realizable Value
Main Product
Revenues
Sales x selling price
Cost of Goods
Sold
Gross Profit
Gross Profit
Rate
Total Manufacturing Costs
Less: Net Realizable Value of
By-product
Net manufacturing Costs
Less: Main Product Inventory (ending inventory x
unit cost*)
Unit Cost = Net Manufacturing Costs / Production
Revenues – Cost of Goods Sold
Gross Profit / Revenues
Joint cost allocated to by-product inventory (reversal cost
method)
 Part of the joint costs is allocated to the by-product using the
Normal Net Profit or Reversal Cost Method. By-products are
also with any additional processing costs after separation.

Under this method, the cost to be allocated to the by-product
is computed so that the by-product will yield the normal
percentage of profit on sales that the company makes, on the
average.

The estimated cost of the by-product is computed by working back
from the estimated sales value, as shown in the following
computation:
Estimated Sales Price of Completed By-product (production
x selling price)
Less: Estimated Selling Expense (production x selling
expense per pack)
Estimated Normal Net Profit (estimated sales
price of completed by product x percentage of
normal net profit)
Total Estimated Manufacturing Costs
Less: Estimated Additional Processing Costs
Estimated Manufacturing Cost before Separation
Once the cost of the by-product is determined, journal entries relating
to by-product are recorded as follows:
 Charged cost before separation applicable to by-product:
Work in process, By-product
xx
x
Work in process
xxx


When additional processing costs are incurred:
Work in process, By-product
Materials
Conversion Costs
When by-product is completed:
Inventory, By-product
Work in process, Byproduct
Income Statement under Method B – Reversal
Cost Method
Main Product
Revenues
Sales x selling price
Joint Cost before separation
(is
considered as Total
Manufacturing
Cost because additional
Cost of Goods
processing
Sold
cost after separation is only
applicable to by-product) ending
inventory*
*Total Manufacturing Costs /
Gross Profit
Gross Profit
Rate
Production x ending
inventory
Revenues – Cost of Goods
Sold
Gross Profit / Revenues
xxx
xxx
xxx
xxx
xxx
By-Product
Sales x selling Price
Joint Cost before separation
Add: Additional processing
cost after
separation
Total Manufacturing Cost
Less: Ending inventory*
*Total Manufacturing Cost /
Production
x ending inventory
Revenues – Cost of Goods
Sold
Gross Profit / Revenues
Analysis of Joint cost allocated to by-product inventory
(reversal cost method)
•
•
•
This method assigned both the joint costs and costs incurred after
separation to the by-product. The transfer of the joint costs reduces
the cost of the main product.
This method is complicated and often difficult to apply, because all
costs to sell the by-products should be used in the computation and
it is impossible to determine the normal selling costs that are
applicable. Thus, the incremental selling costs related specifically to
the by-product are usually used.
The computations are made from estimates that the results may not
be sufficiently reliable. Therefore, if the amount of the by-product is
minimal, it may not be necessary to use this method because of the
time and effort required compared to the benefits received.