Chapter. 7
Product & Service Costing
Process Systems vs. Job-Order system
Lesson Objectives
After studying this chapter, you should be able to;
1. Explain product and service costing
2. Briefly differentiate Job-order and process costing
3. Understand the characteristics of process costing
4. Explain equivalent units
5. Understand production report
6. Discuss production for service organisations
7. Understand JIT manufacturing
8. Discuss FIFO inventory method in process costing
Product & Service Costing
One of the most fundamental cost objects is the output produced
by individual businesses. The two types of output are tangible
products and services (intangible products)
■ Tangible products are goods produced by converting raw materials
through the use of direct labor and capital inputs such as plant, land,
and machinery.
■ Services are tasks or activities performed for a customer or an
activity performed by a customer using an organization’s products
or facilities. Services are also produced using materials, labor, and
capital inputs.
Job-order & Process Production
Job-order Production;
Process Production;
1. The production is uniquely
numbered and produced
through the job# assigned
accordingly.
1. The production is of the same
kind of item that goes through
different processes before
becoming finished product
2. Direct material, direct labour
and factory overhead are
combined for each job-order
accordingly and converted to
finished products
2. Direct material, direct labour and
factory overhead are combined
for at once that become work in
process.
The same work in process can go
through another process with
different direct labor and
overheads that converts the item
into another WIP or finished
product
3. The cost incurred for one job#
are different for other job#
An Operational Process System
A process model for a brewery firm (SP)
Mixing
•
•
•
•
Selecting
Sifting
Measuring
Blending
Canning/Bottling
• Loading
• Monitoring
• Costing
Packing
•
•
•
•
•
Loading
Counting
Capping
Packaging
Separating
Characteristics of Process Costing
 Homogeneous units pass through a series of similar processes.
 Each unit in each process receives a similar amount of
manufacturing costs.
 Manufacturing costs are accumulated by a process for a given
period of time.
 There is a work-in-process account for each process.
 Manufacturing cost flows and the associated journal entries are
generally similar to job-order costing.
 The departmental production report is the key source document for
tracking manufacturing activity and costs.
Equivalent Units
■ Equivalent unit of production is an expression of the amount of
work done by a manufacturer on units of output that are partially
completed (WIP) at the end of an accounting period.
■ Equivalent units are expressed in percentage and, thus, computed
accordingly
■ Basically the fully completed units and the partially completed
units are expressed in terms of fully completed units.
■ Equivalent units are used in the production cost reports for the
producing departments of manufacturers using a process costing
system.
■ The cost calculations per equivalent unit of production are
recognized under two cost flow assumptions: weighted-average
and FIFO.
The Flow of Process & Costs
A simple example of process and costs flow;
■ Flow of inventory and costs from each process.
■ The accounting entry are treated accordingly.
1. Work-in-Process—Mixing
xx
Cost of Production
xx
To record manufacturing costs incurred in mixing.
2. Work-in-Process—Canning
xx
Work-in-process - Mixing
Materials
Payroll (DL)
Overhead Control
To record manufacturing costs incurred in canning.
xx
xx
xx
xx
3. Work-in-Process—Packing
Work-in-Process—Canning
To transfer goods to packing.
xx
xx
Production Report
■ The production cost report summarizes the production and
cost activity within a department for a reporting period.
■ It is simply a formal summary of the 4 steps performed to
assign costs to units transferred out and units in ending workin-process (WIP) inventory.
1. Summarize Physical units (FG) and Equivalent
Units
2. Summarize the cost (beginning WIP & cost
incurred during period)
3. Calculation of cost per Equivalent Unit
4. Assign costs to units transferred out & units in
WIP inventory
Service Organisations – Production
Service businesses they do have the production cost but no inventory
Services do not consider work in process inventories, because they use a
process costing approach.
Consider the teeth-cleaning process offered a dentists.
The production costs and the number of cleanings (patients served) for the
month of March are given below:
Direct materials
Hygienist salary
Overhead
Total production cost
K 400
3,500
2,100
K6,000
Number of cleanings
300
Unit cost = K6,000/300 = K20 per cleaning
JIT Manufacturing
Advancement in manufacturing management approaches
technology has allowed firms to increase quality, reduce
inventories, eliminate waste, and reduce costs.
Hence, the approach of just-in-time (JIT) has been very effective in
all production activities.
Businesses that practice JIT also use work cells to produce products.
■ JIT attempts to produce a product only when it is needed and
only in the quantities estimated from demand or customer orders
■ Parts and materials arrive just in time to be used in production for
required quantities only.
■ JIT manufacturing focuses on continual improvement by
reducing inventory costs and increases the emphasis on quality
control.
FIFO Costing Method
Principles of FIFO Costing
■ Under the FIFO costing method, the equivalent units and
manufacturing costs in beginning work in process are
excluded from the current-period unit cost calculation.
■ Thus, FIFO recognizes that the work and costs carried over
from the previous period rightfully belong to that period.
Equivalent Units of Production
The weighted-average method . . .
1. Makes no distinction between work done in prior or
current periods.
2. Blends together units and costs from prior and
current periods.
3. Equivalent units = Units transferred out + equivalent
units in ending Work in Process Inventory.
Compute and Apply Costs
The formula for computing the cost
per equivalent unit is:
Cost per
equivalent =
unit
Cost of beginning
Work in Process +
Inventory
Cost added during
the period
Equivalent units of production
Summary
■ A processing cost system is used when nearly identical units
are mass produced.
■ Organizations that produce tangible products are the
manufacturing organizations whereas, service organisations
produce intangible products
■ Services are also produced using materials, labor, and
capital inputs.
■ A process is a series of activities (operations) that are linked
to perform and achieve a specific objective. Thus, process
costing is a linked production processes to give a specific
final products.
■ Equivalent units of output are the complete units that could
have been produced given the total amount of productive
effort expended for the period under consideration.
End of Lecture