Business 1 Becker Professional Education | CPA Exam Review VII. PROCESS COSTING (cost accumulation system) Process costing is a method of product costing that averages costs and applies them to a large number of homogeneous items. PA S S K E Y Computation of how each segment of the process should compute cost of goods transferred out and the cost of goods remaining in work-in-process (inventory) is the central product costing issue in process costing environments. Five steps are normally followed to resolve this issue: 1. Summarize the flow of physical units (beginning with the Production Report). 2. Calculate "equivalent unit" output. 3. Accumulate the total costs to be accounted for (Production Report). 4. Calculate the unit costs based on total costs and equivalent units. 5. Apply the average costs to the units completed and the units remaining in ending work-in-process inventory. A. Units and Costs Collected on a Production Report Costs incurred for a period as well as all units produced during that period are accumulated on a production report that accounts for the physical flow of units. The report includes the beginning inventory, the number of units started, the number of units completed, and the number of units remaining in inventory. 1. Unit (Quantity) Accounting The number of units accounted for must equal the number of units charged to the department (or separate process). 2. Cost Accounting The amount of costs accounted for must also equal the amount of costs charged to the department (or separate process). PA S S K E Y The determination of the components of inventory cost can be confusing; however, with the use of the "BASE" mnemonic, it all gets a little easier! The following shows how the components "fit" together with the flow of activity: Inventory: Raw Materials Inventory: Work-in-Process Inventory: Finished Goods B Beginning inventory of raw materials B Beginning inventory of work-in-process B Beginning inventory of finished goods A Add: Purchases of raw materials Raw materials available for use S Subtract: Raw materials used E Ending inventory of raw materials A Add: Raw materials used plus direct labor and overhead used Work-in-process inventory available to be finished S Subtract: Inventory transferred to finished goods E Ending inventory of work-in-process © 2012 DeVry/Becker Educational Development Corp. All rights reserved. A Add: Inventory transferred from work-in-process Finished goods inventory available for sale S Subtract: Cost of goods sold E Ending inventory of finished goods B1-45 Business 1 Becker Professional Education| CPA Exam Review E X A M P L E — P R O D U C T I O N R E P O R T I L L U S T R AT E D Quantities Charged to dept: In process, beginning 5,000 Transferred in 20,000 Total units charged to department 25,000 Units accounted for: Transferred out 15,000 In process, end 10,000 Total units accounted for 25,000 Costs Charged to dept: $ 12,000 In process, beginning During the period 85,000 Total units charged to department $97,000 Costs accounted for: Transferred out $ 60,000 In process, end 37,000 Total costs accounted for B. $97,000 Equivalent Units Costs must be attached to the completed units as well as to the units that are partially complete at the end of each period. This calculation is made by taking into account the partially completed units and by making use of equivalent units. PA S S K E Y Accounting for the physical flow of units is an important step in process costing. Remember, however, that the pure physical flow of units will be different from the equivalent units of production. 1. Equivalent Unit Defined An equivalent unit of direct material, direct labor, or conversion costs (direct labor plus factory overhead) is equal to the amount of direct material, direct labor, or conversion costs necessary to complete one unit of production. EXAMPLE 10,000 actual units of DM, DL, or OH in process that are 75% complete would represent 7,500 equivalent units of (DM, DL, or OH) production. B1-46 © 2012 DeVry/Becker Educational Development Corp. All rights reserved. Becker Professional Education | CPA Exam Review 2. Business 1 Process Costing Assumptions a. Transfers In are 100% Complete Transfers in from departments are always considered 100% complete. The transfer in costs of direct material from a previous department are treated as direct materials (DM), even though they are called "transfer in" costs or "previous department" costs. b. Timing of Addition of Direct Material (1) Addition at the Beginning or During a Process Direct material added at the beginning of or during a second or later process may either be 100% complete or "partially complete," depending on how much work has been done on that component of the process. (2) Addition at the End of a Process Any material added at the (very) end of a process will not be in work-inprocess inventory at the month end. C. Costing Issues 1. Calculations of Average Unit Costs The calculation of average unit costs and the application of those costs to various segments of the process is complicated by a number of issues. a. Averaging of Costs from Prior Month's WIP Frequently, costs from the previous month's work-in-process inventory are different from costs of the current month. These costs must be averaged. b. Cost Flow Assumptions Cost averaging computations depend upon FIFO and/or weighted (or moving) average cost flow assumptions. These computations require a well-labeled account analysis format for each unit of direct material, direct labor, or overhead. D. Specific Cost Flow Assumptions 1. Calculation Using First-In First-Out (FIFO) Under FIFO accounting, the ending inventory is priced at the cost of manufacturing during the period, assuming that the beginning inventory was completed during the period. a. Equivalent Unit Components The equivalent units are composed of three separate elements: (1) Completion of units on hand at the beginning of the period (2) Units started and completed during the period (Units completed - Beginning WIP) (3) Units partially complete at the end of the period b. Cost Components Current costs incurred during the period are allocated to the equivalent units produced during the period. © 2012 DeVry/Becker Educational Development Corp. All rights reserved. B1-47 Business 1 Becker Professional Education| CPA Exam Review 2. Calculation Using Weighted-Average The weighted-average cost method averages the cost of production during the period with the costs in the beginning work-in-process inventory. a. Equivalent Unit Components The equivalent units are composed of two elements: (1) Units completed during the month (regardless of when the work was done) (2) Units partially complete at the end of the period b. Cost Components Total costs include both the costs of beginning inventory and current costs are allocated to equivalent units to arrive at a weighted-average unit cost. EXAMPLE—EQUIVALENT UNITS OF PRODUC TION Assume the following information: Work-in-process, beginning 100 units, 25% complete Units completed and transferred out 600 units Work-in-process, ending 200 units, 40% complete Weighted-Average Equivalent Units of Production Units completed and transferred out (always 100%) 600 Work-in-process, ending 200 units × 40% 80 Equivalent units of production 680 FIFO Equivalent Units of Production Work-in-process, beginning 100 units × 75% (to complete) 75 Units started and completed this period Units completed and transferred out Units in beginning inventory 600 (100)500 Work-in-process, ending 200 units × 40% 80 Equivalent units of production 655 B1-48 © 2012 DeVry/Becker Educational Development Corp. All rights reserved. Business 1 Becker Professional Education | CPA Exam Review 3. Comparison of FIFO and Weighted-Average a. Unit Components Equivalent unit calculation under FIFO consists of three elements representing current period production, whereas the calculation under the weighted-average method consists of only two elements that embrace units completed and are available in beginning inventory. b. Cost Components FIFO represents only costs incurred in the current period. The weighted-average approach includes both current period units plus prior period units. PA S S K E Y Equivalent units of production may be computed using either First In First Out (FIFO) or weightedaverage assumptions. The FIFO approach specifically accounts for work to be completed, while the weighted-average approach blends the units as follows: 1. Weighted-average (2 steps) a. Units completed XXX b. Ending WIP × % completed XXX + Equivalent units XXX 2. FIFO (3 steps) a. Beginning WIP × % to be completed XXX b. Units completed—Beginning WIP + XXX c. Ending WIP × % completed + XXX Equivalent units XXX PA S S K E Y Cost per equivalent unit is computed by dividing total costs by equivalent units. FIFO anticipates using only current costs, while the weighted-average approach uses both beginning inventory and current costs as follows: 1.Weighted-average WeightedBeginning cost + Current cost = average Equivalent units 2.FIFO FIFO = Current cost only Equivalent units © 2012 DeVry/Becker Educational Development Corp. All rights reserved. B1-49 Business 1 Becker Professional Education| CPA Exam Review EXAMPLe Comprehensive Example of Process Costing under FIFO and Weighted-Average The following problem illustrates process costing using both the FIFO and weighted-average approaches. Note that separate unit costs for materials and conversion (direct labor and manufacturing overhead) must be determined. Comprehensive Example Process Costing Under FIFO and Weighted-Average May 20X1 FACT PATTERN Percent Complete Materials 1 Units in process, May 1 Materials Conversion 100% 40% 4,000 2 Units started and completed in May Materials Conversion 100% 100% 10,000 3 Units in process, May 31 Materials Conversion 100% 80% 2,000 Total 4,000 10,000 2,000 4 Costs associated with May 1 WIP Materials Conversion $ 1,000 5 Costs associated with May production Materials Conversion $24,000 6 Total Costs Conversion $ 3,000 $ 1,000 3,000 $49,000 24,000 49,000 $77,000 Requirements Complete a Production Report for Units and Costs Complete Equivalent Units using FIFO and Weighted-Average Complete Unit Cost of Production using FIFO and Weighted-Average B1-50 © 2012 DeVry/Becker Educational Development Corp. All rights reserved. Business 1 Becker Professional Education | CPA Exam Review E X A M P L e ( continued ) COMPUTE A PRODUCTION REPORT First In First Out Materials Weighted-Average Conversion Materials Conversion Quantities 1 Units in process, May 1 Units transferred in Total units charged to department 4,000 12,000 16,000 4,000 11,600 15,600 4,000 12,000 16,000 4,000 11,600 15,600 2 Units transferred out 3 Units in process, May 31 Total units accounted for 14,000 2,000 16,000 14,000 1,600 15,600 14,000 2,000 16,000 14,000 1,600 15,600 $ 1,000 24,000 $25,000 $ 3,000 49,000 $52,000 $ 1,000 24,000 $25,000 $ 3,000 49,000 $52,000 $21,000 4,000 $25,000 $46,400 5,600 $52,000 $21,875 3,125 $25,000 $46,667 5,333 $52,000 Costs 4 Costs in WIP, May 1 5 Costs during May Total costs charged to department Costs transferred out (plug) Costs of WIP at May 31 (EU x Cost per EU) Total costs accounted for COMPUTE EQUIVALENT UNITS OF PRODUCTION First In First Out Materials 1 Units in process, May 1 2 Units started and completed in May 3 Units in process, May 31 COMPUTE EQUIVALENT COST PER UNIT Equivalent cost per unit E. Conversion 2,400 10,000 1,600 4,000 10,000 2,000 4,000 10,000 1,600 12,000 14,000 16,000 15,600 16,000 15,600 (4,000) 12,000 (1,600) 14,000 – 49,000 $ 1,000 24,000 $ 3,000 49,000 $24,000 $49,000 $25,000 $52,000 $ $ $ 1.56 $ 3.33 Alternative FIFO Computation Total Units accounted for Equivalent Units from prior periods included in beginning inventory Equivalent units Total Costs Materials 10,000 2,000 Total Units COMPUTE UNIT COST OF PRODUCTION 4 Costs in WIP, May 1 5 Costs during May Weighted-Average Conversion $ – 24,000 2.00 $ 3.50 Spoilage (or shrinkage) Spoilage (or shrinkage) is generally taken care of automatically because the equivalent units added for the month are generally less than the actual units added during the month due to problems with the production process. © 2012 DeVry/Becker Educational Development Corp. All rights reserved. B1-51