CHAPTER 16
Process Costing
LEARNING OBJECTIVES
1.
UNDERSTAND WHO USES PROCESS COST SYSTEMS.
2.
EXPLAIN THE SIMILARITIES AND DIFFERENCES
BETWEEN JOB ORDER COST AND PROCESS COST SYSTEMS.
3.
EXPLAIN THE FLOW OF COSTS IN A PROCESS COST SYSTEM.
4.
MAKE THE JOURNAL ENTRIES TO ASSIGN MANUFACTURING
COSTS IN A PROCESS COST SYSTEM.
5.
COMPUTE EQUIVALENT UNITS.
6.
EXPLAIN THE FOUR STEPS NECESSARY TO PREPARE A
PRODUCTION COST REPORT.
7.
PREPARE A PRODUCTION COST REPORT.
*8.
COMPUTE EQUIVALENT UNITS USING THE FIFO METHOD.
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CHAPTER REVIEW
Process Manufacturing and Accounting
1.
(L.O. 1) Process cost systems are used to apply costs to similar products that are mass
produced in a continuous fashion, such as the production of ice cream, steel or soft drinks. In
comparison, costs in a job order cost system are assigned to a specific job, such as the
construction of a customized home, the making of a motion picture, or the manufacturing of a
specialized machine.
2.
(L.O. 2) Job order cost and process cost systems are similar in that (a) both use the same three
manufacturing cost elements of direct materials, direct labor, and manufacturing overhead;
(b) both accumulate costs of raw materials by debiting Raw Materials Inventory, factory labor by
debiting Factory Labor, and manufacturing overhead costs by debiting Manufacturing Overhead;
and (c) both assign costs to the same accounts of Work in Process, Finished Goods Inventory,
and Cost of Goods Sold.
3.
The major differences between a job order cost system and a process cost system are as follows:
Job Order
Cost System
One for each job
Process
Cost System
One for each process
Documents used
Job cost sheets
Production cost reports
Determination of
total manufacturing
costs
Each job
Each period
Unit-cost
computations
Cost of each job
÷ Units produced
for the job
Total manufacturing costs
÷ Equivalent units produced
during the period
Feature
Work in process
accounts
Process Cost Flow
4.
(L.O. 3) In the Tyler Company example in the text book, manufacturing consists of two
processes: machining and assembly. In the Machining Department, the raw materials are shaped,
honed, and drilled. In the Assembly Department, the parts are assembled and packaged.
5.
Materials, labor, and manufacturing overhead can be added in both the Machining and Assembly
Departments. When the Machining Department finishes its work, the cost of the partially
completed units is transferred to the Assembly Department. In the Assembly Department, the
goods are finished and the cost is then transferred to the finished goods inventory. Upon sale, the
cost of the goods sold is removed from the finished goods inventory.
16-2
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Assignment of Manufacturing Costs
6.
(L.O. 4) All raw materials issued for production are a materials cost to the producing department.
Materials requisition slips may be used in a process cost system, but fewer requisitions are
generally required than in a job order cost system, because the materials are used for processes
rather than for specific jobs. In the case of the Tyler Company, the entry to record the materials
used is:
Work in Process—Machining ..........................................
Work in Process—Assembly...........................................
Raw Materials Inventory.........................................
7.
XXXX
XXXX
XXXX
The basis for allocating the overhead costs to the production departments in an objective and
equitable manner is the activity that “drives” or causes the costs. A primary driver of overhead
costs in continuous manufacturing operations is machine time used, not direct labor. Thus,
machine hours are widely used in allocating manufacturing overhead costs. In the case of the
Tyler Company, the entry to allocate overhead is:
Work in Process—Machining ..........................................
Work in Process—Assembly...........................................
Manufacturing Overhead........................................
9.
XXXX
Time tickets may be used in determining the cost of labor assignable to the production
departments. The labor cost chargeable to a process can be obtained from the payroll register or
departmental payroll summaries. All labor costs incurred within a producing department are a cost
of processing he raw materials. In the case of the Tyler Company, the entry to assign the labor
costs is:
Work in Process—Machining ..........................................
Work in Process—Assembly...........................................
Factory Labor.........................................................
8.
XXXX
XXXX
XXXX
XXXX
XXXX
At the end of the period, the following transfer entries are needed for the Tyler Company to
transfer units to the Assembly department from the Machining department; to transfer from the
Assembly department to Finished Goods; and, to transfer from Finished Goods to Cost of Goods
Sold:
Work in Process—Assembly...........................................
Work in Process—Machining .................................
XXXX
Finished Goods Inventory ...............................................
Work in Process—Assembly ..................................
XXXX
Cost of Goods Sold ........................................................
Finished Goods Inventory ......................................
XXXX
XXXX
XXXX
XXXX
Equivalent Units
10.
(L.O. 5) A major step in process cost accounting is the calculation of equivalent units. Equivalent
units of production measure the work done during the period, expressed in fully completed
units. This concept is used to determine the cost per unit of completed product.
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11.
The formula to compute equivalent units of production under the weighted-average method is as
follows:
Units Completed and
+
Transferred Out
Equivalent Units of
Ending Work in
Process
=
Equivalent Units of
Production
12.
The method of computing equivalent units here is referred to as the weighted-average method. It
considers the degree of completion (weighting) of the units completed and transferred out and the
units in ending work in process. A lesser used method, called the FIFO method, is discussed in
the appendix to this chapter.
13.
To illustrate the computation of equivalent units using the weighted-average method, assume that
materials are entered at the beginning of the process, conversion costs include both labor and
overhead costs, and the following information is provided for the Processing Department of Silva
Company:
Work in process, Beg.
Started into production
Total units
Units transferred out
Work in process, End.
Total units
14.
Percentage Complete
Materials
Conversion Costs
100%
80%
Physical Units
2,500
4,500
7,000
6,000
1,000
7,000
100%
60%
The two equivalent unit computations are as follows:
Units transferred out
Work in process, End
1,000 X 100%
1,000 X 60%
Total equivalent units
Equivalent Units
Conversion
Materials
Costs
6,000
6,000
1,000
7,000
600
6,600
Production Cost Report
15.
16-4
(L.O. 6) A production cost report is the key document used by management to understand the
activities in a department because it shows the production quantity and cost data related to that
department. In order to be ready to complete a production cost report, the company must perform
four steps:
a. Compute the physical unit flow.
b. Compute the equivalent units of production.
c. Compute unit production costs.
d. Prepare a cost reconciliation schedule.
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16.
The computation of physical units involves:
a. adding the units started (or transferred) into production during the period to the units in
process at the beginning of the period to determine the total units to be accounted for; and
b. accounting for these units by determining the output for the periodwhich consists of units
transferred out during the period and units in process at the end of the period.
In the example above, the total units to be accounted for and the units accounted for are both
equal to 7,000 units for the Silva Company.
17.
In computing unit costs, production costs are expressed in terms of equivalent units of production.
When equivalent units are different for materials and conversion costs, the formulas for computing
unit costs are as follows:
Total Materials
÷
Cost
18.
Equivalent Units
of Materials
=
Unit Materials
Cost
Total Conversion
Costs
÷
Equivalent Units
of Conversion Costs
=
Unit Conversion
Cost
Unit Materials
Cost
+
Unit Conversion
Cost
=
Total Manufacturing
Cost per Unit
The cost reconciliation schedule shows that the total costs accounted for equal the total costs
to be accounted for as follows:
Costs to be accounted for
Transferred out ..........................................
Work in process, End
Materials................................................
Conversion costs ...................................
Total costs ....................................................
19.
$XXXX
$XXXX
XXXX
XXXX
$XXXX
(L.O. 7) Assume the Processing Department of Silva Company has the following additional cost
information:
Work in process, Beg.
Direct materials: 100% complete .......................
Conversion costs: 80% complete ......................
Cost of work in process, Beg. ...................................
$ 24,000
19,620
$ 43,620
Costs incurred during production
Direct materials .................................................
Conversion costs ...............................................
Costs incurred ..........................................................
$200,000
150,000
$350,000
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20.
Silva Company’s Processing Department Production Cost Report at the end of the period is as
follows:
Processing Department
Production Cost Report
For the Period Ended
Physical
Units
QUANTITIES
Units to be accounted for
Work in process, Beg.
Started into production
Total units
Units accounted for
Transferred out
Work in process, End.
Total units
Equivalent Units
Conversion
Materials
Costs
2,500
4,500
7,000
6,000
1,000
7,000
6,000
1,000
7,000
Materials
COSTS
Unit costs
Costs during the period
Equivalent units
Unit costs [(a) ÷ (b)]
(a) $224,000
(b)
7,000
$32.00
6,000
600 (1,000 X 60%)
6,600
Conversion
Costs
$169,620
6,600
$25.70
Costs to be accounted for
Work in process, Beg.
Started into production
Total costs
Total
$393,620
$57.70
$ 43,620
350,000
$393,620
Cost Reconciliation Schedule
Costs accounted for
Transferred out (6,000 X $57.70)
Work in process, End.
Materials (1,000 X $32.00)
Conversion costs (600 X $25.70)
Total costs
$346,200
$32,000
15,420
47,420
$393,620
Operations Costing
21.
16-6
Companies often use a combination of a process cost and a job order cost system, called
operations costing. Operations costing is similar to process costing in that standardized
methods are used to manufacture the product. At the same time, the product may have some
customized, individual features that require the use of a job order cost system.
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Equivalent Units Using the FIFO Method
*22. (L.O. 8) To illustrate the computation of equivalent units using the FIFO method, assume that
materials are entered at the beginning of the process and the following information is provided for
the Processing Department of Silva Company:
Work in process, Beg.
Started into production
Total units
Units transferred out
Work in process, End.
Total units
Physical Units
2,500
4,500
7,000
6,000
1,000
7,000
Percentage Complete
Materials
Conversion Costs
100%
80%
100%
60%
*23. The equivalent units for material costs of the Processing Department under the FIFO method are
computed as follows:
Production Data
Work in process, Beg.
Started and finished
Work in process, End.
Total
Processing Department
Work Added
Physical Units
This Period
2,500
0
3,500
100%
1,000
100%
7,000
Equivalent
Units
3,500
1,000
4,500
*24. The equivalent units for conversion costs of the Processing Department under the FIFO method
are computed as follows:
Production Data
Work in process, Beg.
Started and completed
Work in process, End.
Total
Processing Department
Work Added
Physical Units
This Period
2,500
20%
3,500
100%
1,000
60%
7,000
Equivalent
Units
500
3,500
600
4,600
Production Cost Report Using the FIFO Method
*25. Assume the Processing Department of Silva Company has the following additional cost
information:
Work in process, Beg.
Direct materials: 100% complete .......................................
Conversion costs: 80% complete .......................................
Cost of work in process, Beg. ..............................................
$ 24,000
19,620
$ 43,620
Costs incurred during the production
Direct materials..................................................................
Conversion costs ...............................................................
Costs incurred .....................................................................
$200,000
150,000
$350,000
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*26. Silva Company’s Processing Department Production Cost Report at the end of the period using
the FIFO method is as follows:
Processing Department
Production Cost Report
For the Period Ended
Physical
Units
QUANTITIES
Units to be accounted for
Work in process, Beg.
Started into production
Total units
Units accounted for
Completed and transferred out
Work in process, Beg.
Started and completed
Work in process, End.
Total units
Equivalent Units
Conversion
Materials
Costs
2,500
4,500
7,000
2,500
3,500
1,000
7,000
COSTS
Unit costs
Costs during the period
Equivalent units
Unit costs [(a)/(b)]
(a)
(b)
0
3,500
1,000
4,500
500
3,500
600
4,600
Materials
Conversion
Costs
$200,000
4,500
$44.444
$150,000
4,600
$ 32.609
Costs to be accounted for
Work in process, Beg.
Started into production
Total costs
Units started and completed (3,500 X $77.053)
Total costs transferred out
Work in process, End
Materials (1,000 X $44.444)
Conversion costs (600 X $32.609)
$77.053
$ 43,620
16,305
59,925
269,686
329,611
$44,444
19,565
Total costs
Copyright © 2013 John Wiley & Sons, Inc.
$350,000
$ 43,620
350,000
$393,620
Cost Reconciliation Schedule
Costs accounted for
Transferred out
Work in process,
Costs to complete beg. work in process
Conversion costs (500 X $32.609)
Total costs
16-8
Total
64,009
$393,620
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LECTURE OUTLINE
A.
Uses of Process Cost Systems.
1. Process cost systems are used to apply costs to similar products that
are mass-produced in a continuous fashion.
2. Once production begins, it continues until the finished product emerges,
and each unit of finished product is like every other unit.
B.
Similarities and Differences Between Job Order Cost and Process Cost
Systems.
1. In a process cost system, costs are tracked through a series of connected
manufacturing processes or departments, rather than by individual jobs
as in a job order cost system.
2. Companies use process cost systems when they produce a large volume
of relatively homogeneous products.
3. Job order cost and process cost systems are similar in three ways:
a.
Both systems track the same manufacturing cost elements—direct
materials, direct labor, and manufacturing overhead.
b.
Both accumulate costs in the same accounts—Raw Materials Inventory, Factory Labor, and Manufacturing Overhead.
c.
Both assign accumulated costs to the same accounts—Work in
Process, Finished Goods Inventory, and Cost of Goods Sold.
4. There are four main differences between the two cost systems:
a.
In a job order cost system, only one work in process account is used
while separate accounts are maintained for each department or
manufacturing process in a process cost system.
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C.
b.
In a job order cost system, costs are charged to individual jobs and
summarized in a job cost sheet; in a process cost system, costs are
summarized in a production cost report for each department.
c.
Costs are totaled at the completion of a job in a job cost system but
at the end of a time period (i.e. a month or year) in a process cost
system.
d.
In a job cost system, the unit cost is the total cost per job ÷ by the units
produced. In a process cost system, the unit cost is total manufacturing costs for the period ÷ by the units produced during the
period.
Process Cost Flow.
1. The company can add materials, labor, and manufacturing overhead in
each production department.
2. The costs of units completed are transferred from one department to
another as those units move through the manufacturing process.
3. The costs of completed work are transferred to Finished Goods Inventory.
4. When inventory is sold, costs are transferred to Cost of Goods Sold.
D.
Assigning manufacturing costs.
1. The accumulation of the costs of materials, labor, and manufacturing
overhead is the same in a process cost system as in a job order cost
system.
2. Entries to assign the costs of raw materials, factory labor, and overhead
consist of a debit to Work in Process for each department and a credit to
Raw Materials Inventory, Factory Labor, and Manufacturing Overhead.
16-10
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3. The assignment of the three manufacturing cost elements to Work in
Process in a process cost system is different from a job order cost system.
a.
All raw materials issued for production are a materials cost to the
producing department. A process cost system may use materials
requisition slips, but fewer requisitions are generally required than
in a job order system, because the materials are used for processes
rather than specific jobs.
b.
Companies may use time tickets to determine the cost of factory
labor assignable to production departments. Since labor costs are
assigned to a process rather than a job, the labor cost chargeable
to a process can be obtained from the payroll register or departmental
payroll summaries.
c.
The objective in assigning overhead in a process cost system is to
allocate the overhead costs to the production departments on an
objective and equitable basis. A primary driver of overhead costs
in continuous manufacturing operations is machine time used, not
direct labor. Companies widely use machine hours in allocating
manufacturing overhead costs.
4. The entry to record units completed and transferred to the warehouse is
a debit to Finished Goods Inventory and a credit to Work in Process.
5. The entry to record the sale of goods is a debit to Cost of Goods Sold
and a credit to Finished Goods Inventory.
MANAGEMENT INSIGHT
Some companies continue to assign manufacturing overhead on the basis of
direct labor despite the fact that there is no cause-and-effect relationship between
labor and overhead. In such cases, the overhead rates may be misleading.
What is the result if a company uses the wrong “cost driver” to assign manufacturing overhead?
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Answer: Incorrect application of manufacturing overhead will result in some
products receiving too much overhead and others receiving too little.
E.
Equivalent Units.
1. Equivalent units of production measure the work done during the period,
expressed in fully completed units.
2. Companies use this measure to determine the cost per unit of
completed product.
3. Equivalent units of production are the sum of:
a.
Units completed and transferred out.
b.
Equivalent units of ending work in process.
4. The weighted-average method is most commonly used to compute
equivalent units of production.
5. This method considers the degree of completion (weighting) of the units
completed and transferred out and the ending work in process.
6. In computing equivalent units, the beginning work in process is not part
of the equivalent-units-of-production formula.
7. For the example company in the textbook, the company needs to make
two equivalent unit computations: one for materials, and the other for
conversion costs (labor plus overhead costs). This is necessary because
ending work in process is fully complete as to materials, but only partially
complete as to conversion costs.
MANAGEMENT INSIGHT
In recent years more companies have been remanufacturing a wide variety of
products including cell phones, car parts, and medical equipment. Rising
commodity prices and regulations requiring that certain electronic items be recycled
has fueled this trend.
16-12
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In what ways might the relative composition (materials, labor, and overhead) of a
remanufactured product’s cost differ from that of a newly made product?
Answer: We would expect that the materials costs would be substantially
reduced since the bulk of the physical product is being reused. The
labor component might increase, and the level of automation might
decrease, since remanufacturing a product requires identification and
replacement of malfunctioning components. This process might not be
as easily automated as the production of a new product.
F.
Production Cost Report.
1. In order to complete a production cost report, the company must perform
four steps:
a.
Compute the physical unit flow.
b.
Compute the equivalent units of production.
c.
Compute unit production costs.
d.
Prepare a cost reconciliation schedule.
2. The first step in completing a production cost report requires computing
physical unit flow.
a.
The physical units are computed by adding the units started (or
transferred) into production during the period to the units in process
at the beginning of the period. This amount is called the total units
to be accounted for.
b.
These units then are accounted for by the output of the period, which
consists of units transferred out during the period and any units in
process at the end of the period.
3. The second step in completing a production cost report requires computing
equivalent units of production.
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a.
Each processing department adds materials at the beginning of the
process, and incurs conversion costs uniformly during the process.
b.
Two computations of equivalent units are required—one for materials
and one for conversion costs.
4. The third step in completing a production cost report requires computing
unit production costs.
a.
Unit production costs are costs expressed in terms of equivalent units
of production.
b.
When equivalent units of production are different for materials and
conversion costs, companies compute three unit costs: (1) materials,
(2) conversion, and (3) total manufacturing.
c.
Total manufacturing cost per unit is computed as the sum of unit
materials cost + unit conversion cost.
5. The fourth step in completing a production cost report requires preparing
a cost reconciliation schedule.
G.
a.
The company prepares a cost reconciliation schedule to assign total
costs to (1) units transferred out to the next department and (2)
ending work in process.
b.
The total manufacturing cost per unit is used in costing the units
completed and transferred out.
c.
The cost reconciliation schedule shows that the total costs accounted for equal the total costs to be accounted for.
Preparing the Production Cost Report.
1. The production cost report contains both quantity and cost data for a
production department.
16-14
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a.
This report is an internal document for management that shows
production quantity and cost data for a production department.
b.
There are four steps in preparing a production cost report:
(1) Prepare a physical unit schedule.
(2) Compute equivalent units.
(3) Compute unit costs.
(4) Prepare a cost reconciliation schedule.
c.
Production cost reports provide a basis for evaluating the productivity
of a department. Managers can use the cost data to assess whether
unit costs and total costs are reasonable.
*H. Equivalent Units Under FIFO.
1. Under the FIFO method, companies compute equivalent units on a firstin, first-out basis.
2. Companies assume that the beginning work in process is completed
before new work is started under the FIFO method.
3. Equivalent units are the sum of the work performed to:
a.
Finish the units of beginning work in process inventory.
b.
Complete the units started into production during the period (units
started and completed).
c.
Start, but only partially complete, the units in ending work in
process inventory.
4. The units started and completed during the current period are the units
transferred out minus the units in beginning work in process.
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5. Companies often expand the physical units schedule to ensure reporting
of the beginning work in process and the units started and completed.
6. As with the weighted-average method, once companies determine the
physical flow of units, they need to compute the equivalent units of
production.
a.
When companies add materials at the beginning of the process, no
additional materials costs are required to complete the beginning
work in process. However, sometimes companies add materials
evenly throughout the process. When this occurs, computations for
materials would mirror those for conversion costs.
b.
Equivalent units for materials are the sum of:
(1) Units started and finished.
(2) Equivalent units of ending work in process.
c.
Equivalent units for conversion costs are the sum of:
(1) Equivalent units to complete beginning work in process.
(2) Units started and finished.
(3) Equivalent units of ending work in process.
7. The unit production costs are based entirely on the production costs
incurred during the month. The costs in the beginning work in process
are ignored because they were incurred on work done in the preceding
month.
8. In preparing a cost reconciliation schedule under the FIFO method:
16-16
a.
The cost of the beginning work in process is always assigned to the
goods transferred to the next department (or finished goods, if
processing is complete).
b.
The ending work in process will be assigned only the production
costs incurred in the current period.
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9. The weighted-average method of computing equivalent units is simple to
understand and apply. It will be very similar to the FIFO method when
prices do not fluctuate significantly from period to period.
10. Conceptually, the FIFO method is superior to the weighted-average
method because it measures current performance using only costs
incurred in the current period. It provides current cost information, which
the company can use to establish more accurate pricing strategies for
goods manufactured and sold in the current period.
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20 MINUTE QUIZ
Circle the correct answer.
True/False
1. Costs are assigned to each specific job in a process cost system.
True
False
2. In a process cost system, total costs are determined at the end of a period of time, such
as a month.
True
False
3. In a process cost system, the unit cost is total manufacturing costs divided by the
equivalent units produced during the period.
True
False
4. The accumulation of the costs of materials, labor, and manufacturing overhead is the
same in a process cost system as in a job order cost system.
True
False
5. More materials requisitions are generally required in a process cost system than in a job
order cost system.
True
False
6. Equivalent units of production equals units completed and transferred out + units in
beginning work in process.
True
False
7. Two equivalent unit computations are necessary—one for materials and the other for
conversion costs.
True
False
8. The first step in preparing a production cost report is to compute the equivalent units of
production.
True
False
9. The cost reconciliation schedule shows that the total costs accounted for equal the total
costs to be accounted for.
True
False
*10. Units in work in process at the beginning of the period are included in units “started and
completed” under the FIFO method.
True
16-18
False
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Multiple Choice
1.
Which of the following is not a step in preparing a production cost report?
a. Prepare a cost reconciliation schedule.
b. Compute equivalent units of production.
c. Compute the physical unit flow.
d. Assign costs to particular jobs.
2.
A department has no beginning work in process, has started 80,000 units and completed
50,000 units. Its ending work in process is 30,000 units, 60% complete as to conversion
costs and fully complete as to materials. Its equivalent units for conversion costs are
a. 50,000.
b. 80,000.
c. 68,000.
d. 44,000.
3.
In process costing, the computation of unit production costs requires
a. the accumulation of material and conversion costs in work in process for each
department or process.
b. the computation of equivalent units for material and conversion costs.
c. both a and b.
d. neither a nor b.
4.
Which of the following is not included in a production cost report?
a. Costs accounted for.
b. Entries to assign cost.
c. Units accounted for.
d. Units to be accounted for.
5.
Unit costs for materials and conversion costs amount to $4 and $5 respectively. The
ending work in process costs for 8,000 units (100% complete as to material and 70%
complete as to conversion costs) amount to
a. $60,000.
b. $72,000.
c. $44,000.
d. $40,000.
Copyright © 2013 John Wiley & Sons, Inc.
Kimmel, Accounting, 5/e, Instructor’s Manual
(For Instructor Use Only) 16-19
ANSWERS TO QUIZ
True/False
1.
2.
3.
4.
5.
False
True
True
True
False
6.
7.
8.
9.
*10.
False
True
False
True
False
Multiple Choice
1.
2.
3.
4.
5.
16-20
d.
c.
c.
b.
a.
Copyright © 2013 John Wiley & Sons, Inc.
Kimmel, Accounting, 5/e, Instructor’s Manual
(For Instructor Use Only)