Management Accounting
2010
Second semester
Takayuki Asada
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Chapter3 Process Costing
After reading this chapter, you will be able to:
Describe how products flow through departments and how
costs flows through accounts
Discuss the concepts of an equivalent unit
Caluculate the cost per equivalent unit
Calculate the cost of goods completed and the ending work in
process balance in a processing department.
Describe a production cost report.
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１． Introduction
Stancy Brannen who had graduated from State University with a
degree in mechanical engineering and now she was nearing the
end of her first day on the job(factory tour) at Kent.
She found herself wondering how the cost of products was determined.
“Bill (he is plant manager) ,can you give me a rough idea of how
you calculated product costs? She asked. “I noticed ,for
example,that to end up with a gallon of wood preseravative ready
to ship, we perform both mixing and packaging operations.with
labor,material,and overhead added in these separate
operations ,is assigning costs to wood preservative a difficult job?”
The type of product costing system used at Kent Chemical Company is
a process costing at Kent Chemical.
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2.Difference Between Job-order and
Process Costing Sytems
We discuss the topic of cost management systems.
Historically, there are two types of costing systems,job
order costing and process costing .
In a job-order system,each unique product or batch is a
“ job” for which the company needs cost information.
Therefore,it is necessary to trace manufacturing costs to
specific jobs.
When jobs are completed,the cost of the jobs is removed
from Work In Process and included in Finished Goods
and included in Cost of Goods Sold.
Process Costing is essentially a system of averaging.
Dividing production costs by the total number of
homogeneous items produced results in an average unit
cost.
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Illustration 3-1 presents a comparison of job-order and process costing
systems, The reminder of the chapter describes process costing sysetms in
mode detail.
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3.Product and Cost Flows
Here ,we discuss the flow of products through departments and the flow of
costs through accounts in process costing companies.
1)Product flows through departments
Generally,identifying the stage when materials enter the production process is
easy. In the mixing departmentmthe chemical materials are added at the start
of the process. Determiing exactly when labor and overhead are added to the
process is more difficult. Labor and overhead are often grouped together and
referred to as conversion costs.
Illustration 3-2 shows how items flow through the two processing department
and how costs are incurred.
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2)Cost flows through accounts
The product costs accumulated in a process costing system are essentially
the same costs considered in job-order costing: direct material, direct
labor,and manufacturing overhead.
A processing department may have a cost called transferred-in cost. This is
the cost incurred in one processing department that is transferred to the
next processing department.
3)The following entries illustrates the flow of costs between
processing departments.
Direct Material
(April/25/011) Work in Process,Mixing 142,000
Raw Materials
142,000
Direct Labor
(April/25/011) Work in Process,Mixing 62,200
Wages Payable
62,200
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4)Manufacturing Overhead
to assign overhead to products in a process costing system,a
company may use either actual overhead costs or a
predetermined overhead rate.
Suppose that at the start of the year,the mixing department
estimates it will incur $2,160,000 of overhead cost and
$720,000 of direct labor cost. Using direct labor as an
allocation base,the department calcurates a predetermined
overhead rate of $3 for each dollar of direct labor cost.
Assuming $62,200 of direct labor cost was incurred in the month
of April,$186,600 of overhead would be assigned to Work in
Process that month.($62,200 × 3=$ 186,600)
(April 26,011)Work in Process,Mixing
186,600
Manufacturing Overhead
186,600
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(April 27,011) Work in Process,Packaging
360,000
Work in Process,Mixing
336,000
When one processing department completes its work,the items are
transferred to the next department along with their ralated cost.
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4.Calucurating Unit Cost
This section shows how to calucurate an average unit cost in a
process costing system. First,we must explain an essential
concept in process costing.—the concept of an equivalent unit.
For example,if 100 units in work in process are 50 percent
completed,then they are equivalent to 50 completed
units(100×50%),as shown in illustaration 3-4.
The number of equivalent units in work in Process may be
different for material and conversion costs.
Illustration 3-5 show the comparison between different
equivalent units of materials and conversion costs
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1) Cost Per Equivalent unit
The average unit cost in a process costing system is referred to as
a cost per equivalent unit.
The numerator contain the cost in beginning WORK in
Process(WIP) plus the cost incurred in the current period.
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5. Caluculating and applying cost per Equivalent unit:
Mixing department example
Nex t,we consider cost per equivalent unit calculation for the Mixing
department fo Kent Chemical Company.
Ilustration 3-6 Caluculation of cost per equivalent unit,mixing
department
Cost
Material
Labor
Overhead
Total
Beginning WIP
Cost incurred during April
$18,000
142,000
$7,800
62,200
23,400
186,600
$49,200
390,800
Total Cost
160,000
70,000
210,000
440,000
60,000
20,000
60,000
10,000
60,000
10,000
80,000
70,000
70,000
$2
+ $1
Units
Units completed
Equivalent units,ending
WIP
Total units
Cost per equivalent unit
(total cost + total units)
+$ 1
=
$6
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1)Cost transferred out
Recall that 60,000 gallons were completed by the Mixing
Department during April and transferred to the Packaging
Departments. We know that the unit cost is $6. Therefore
,$360,000 of cost (60,000 gallons × $6) is related to the units
Completed and transferred out.
The entry at the end of April to record the transfer was presented
ealier and is repeated here:
(April 27,011) work in process,packaging
360,000
work in process,mixing
360,000
2)Ending work in process
The ending balance in work in process in the mixing department
is $80,000.This balance is made up of 20,000 equivalent units
for material at $2 per equivalent unit,10,000 equivalent units
for labor at $1,and 10,000 equivalent units for overhead at $3.
Ending Balance in Work in Process,Mixing
------------------------------------------------------------------------------------Matrerial(20,000 equiv.,units at $2.)
$40,000
Labor (10,000 equiv. units at $1.)
$10,000
Overhead(10,000 equiv. units at $3.)
$30,000
total
$ 80,000
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6. Production Cost Report
A production cost report is an end-of-the month report for a process costing
system that provides a reconciliation of units and a reconciliation of costs as
well as the details of the cost per equivalent unit calculations.
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7.Basic steps in process costing: A summary
Here is a summary of the basic steps presented earlier. As you can see ,each of
the steps is performed when the production cost report is prepared.
Step 1.Account for the number of physical units. The number of units at the
start of the period plus the number of units started during the period
should equal the number of units completed plus the number of units in
ending work in Process.
Step2.Caluculate the cost per equivalent unit for material ,labor and overhead.
Remember that cost includes both beginning cost and cost incurred during
the periods. The number of equivalent units includes both the number of
units completed and the number of equivalent units in ending work in
Progress.
Step 3. Assign cost to items completed and items in ending Work in Process.
The cost of items completed is simply the product of the total costs per
equivalent unit and the number of units completed. The cost of items in
Work in Process is the sum of the products of equivalent units in process
and cost per equivalent unit for material,labor and overhead.
Step4. Account for the amount of product cost. The cost of beginning inventory
plus the cost incurred during the period should equal the amount of cost
assigned to completed items plus the amount of cost assigned to items in
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ending Work in Process.
8. Kent Chemical Revisted :Answering Stancy’s question
A key issue that always has to be addressed regarding process
costing is the situation that arises at the end of a production
period when not all of the product in the manufacturing.
Essentially,material ,labor ,and overhead cost are accumulated
in each processing department. In each department,the cost
per equivalent unit is caluculated for material,labor and
overhead. The costs per equivalent unit are used to
determine the cost of items completed and the cost of ending
Work In Process.
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9.Dealing with Transferred-In cost :Packaging department
example
The Chapter focuses on how direct and indirect costs are treated in
two of the most well-known traditional product costing systems
： job order and process costing systems
Both costing systems are identify materials and labor costs directly
with jobs or products, and also assign the remainder of costs to jobs
or products on the basis of predetermined cost driver rates.
If you used to calculate the unit of product based on process costing
or job-order costing systems, the simple driver for costing each
product is sometimes to show the systematic different results of each
product figures of cost when you would try to compare a cost based
on ABC with the traditional product costing systems.
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10.Process Costing and incremental analysis
Recall from chapter 1 that whenever we make a decision,we
need to perform incremental analysis. That is,we need to the
determine the change in revenue and the change in
cost,assuming a particular decision alternative is selected. If
the net change is positive ,the decision alternative is “good”
since it will have a positive impact on firm profit.
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