Financial & Managerial Accounting 2002e Belverd E. Needles, Jr. Marian Powers Susan Crosson ----------Multimedia Slides by: Harry Hooper Santa Fe Community College Copyright © by Houghton Mifflin Company. All rights reserved. 1 Chapter 18 Costing Systems: Process Costing Copyright © by Houghton Mifflin Company. All rights reserved. 2 LEARNING OBJECTIVES 1. Describe the process costing system, discuss its role in the management cycle, and identify the reasons for its use. 2. Relate the patterns of product flows in a process costing environment to the process cost flow methods. 3. Explain the role of the Work in Process Inventory account(s) in a process costing system. Copyright © by Houghton Mifflin Company. All rights reserved. 3 LEARNING OBJECTIVES 4. Define and compute equivalent production (units). 5. Prepare a process cost report. 6. Evaluate operating performance using information about product cost. Copyright © by Houghton Mifflin Company. All rights reserved. 4 SUPPLEMENTAL OBJECTIVE 7. Compute equivalent units, product unit cost, and the ending Work in Process Inventory balance in a process costing system that uses the average costing method. Copyright © by Houghton Mifflin Company. All rights reserved. 5 The Process Costing System OBJECTIVE 1 Describe the process costing system, discuss its role in the management cycle, and identify the reasons for its use. Copyright © by Houghton Mifflin Company. All rights reserved. 6 A process costing system is a product costing system used by companies that produce large amounts of similar products or liquids, or companies that have a continuous production flow. Copyright © by Houghton Mifflin Company. All rights reserved. 7 Uses of Product Costing Information in the Management Cycle Copyright © by Houghton Mifflin Company. All rights reserved. 8 Planning Stage During the planning stage, managers: Determine reasonable selling prices. Determine how much products or services should cost to deliver. Forecast Create future costs. budgets. Copyright © by Houghton Mifflin Company. All rights reserved. 9 Executing Stage During the executing stage, actual costs can be computed. Copyright © by Houghton Mifflin Company. All rights reserved. 10 Reviewing Stage Information gathered during the reviewing stage allows managers to: Evaluate performance by comparing budgeted costs to actual costs. Analyze reasons for problems. Recommend changes. Copyright © by Houghton Mifflin Company. All rights reserved. 11 Reporting Stage During the reporting stage, management accountants prepare reports that help managers: Value the period’s inventory on the balance sheet and cost of goods sold on the income statement. Determine whether the goals for product or service costs are being achieved. Copyright © by Houghton Mifflin Company. All rights reserved. 12 Discussion Q. At what point in the management cycle do managers make decisions about the reasonable selling prices for products? A. The planning stage. Copyright © by Houghton Mifflin Company. All rights reserved. 13 Patterns of Product Flows OBJECTIVE 2 Relate the patterns of product flows in a process costing environment to the process cost flow approaches. Copyright © by Houghton Mifflin Company. All rights reserved. 14 Product Flows in a Process Costing System for Winemaking Copyright © by Houghton Mifflin Company. All rights reserved. 15 Product Flows During production in a process costing environment, products flow through several departments or processes. A company may use a number of separate processes to manufacture many different components, which will become direct materials. Copyright © by Houghton Mifflin Company. All rights reserved. 16 Cost Flow Methods In process costing, costs are accumulated by department and are passed to each subsequent department as the product is made. The accumulated costs may be assigned to products using either the FIFO costing approach or the average costing approach. Copyright © by Houghton Mifflin Company. All rights reserved. 17 FIFO Costing Approach The FIFO costing approach is a costing method in which the cost flow follows the logical product flow. The costs assigned to the first products made are the first costs transferred from one department to the next department. Copyright © by Houghton Mifflin Company. All rights reserved. 18 Average Costing Approach The average costing approach assigns an average cost to all products made during an accounting period. Cost assignment is not linked to the physical product flow. Copyright © by Houghton Mifflin Company. All rights reserved. 19 Discussion Q. What are two costing approaches associated with a process environment? A. 1. The FIFO costing approach. 2. The average costing approach. Copyright © by Houghton Mifflin Company. All rights reserved. 20 Cost Flows Through the Work in Process Inventory Accounts OBJECTIVE 3 Explain the role of the Work in Process Inventory account(s) in a process costing system. Copyright © by Houghton Mifflin Company. All rights reserved. 21 Cost Flows and Product Unit Cost in a Process Costing System for Winemaking Copyright © by Houghton Mifflin Company. All rights reserved. 22 Cost Flows The main difference between job order costing and process costing is the way in which costs are assigned to products. Copyright © by Houghton Mifflin Company. All rights reserved. 23 Cost Flows In a job order costing system, costs are traced to specific jobs and products. In a process costing system, an averaging technique is used. Copyright © by Houghton Mifflin Company. All rights reserved. 24 Process Costing System All products worked on during a specific time period are used for computing unit cost. Total costs of direct materials, direct labor, and manufacturing overhead accumulated in the Work in Process Inventory account are divided by the equivalent units for products worked on during the period. Copyright © by Houghton Mifflin Company. All rights reserved. 25 Work in Process Inventory There is one Work in Process Inventory account for each process or department in the production process. Copyright © by Houghton Mifflin Company. All rights reserved. 26 Discussion Q. What is the main difference between job order costing and process costing? A. In a job order costing system, costs are traced to jobs or products. In a process costing system, an averaging technique is used. Copyright © by Houghton Mifflin Company. All rights reserved. 27 The Process Cost Report OBJECTIVE 4 Define and compute equivalent production (units). Copyright © by Houghton Mifflin Company. All rights reserved. 28 Equivalent Production Equivalent production is a measure of the number of equivalent whole units produced in a period of time. Partly completed units are restated in terms of equivalent whole units. Copyright © by Houghton Mifflin Company. All rights reserved. 29 Equivalent Units Equivalent units under the FIFO costing approach are the sum of several elements. Units started and completed during the period. Units in ending work in process times their percentage of completion. Units in beginning work in process (one minus their percentage of completion). Copyright © by Houghton Mifflin Company. All rights reserved. 30 Computation of Equivalent Production Copyright © by Houghton Mifflin Company. All rights reserved. 31 The Process Costing System OBJECTIVE 5 Prepare a process cost report. Copyright © by Houghton Mifflin Company. All rights reserved. 32 The Process Cost Report A process cost report helps managers track and analyze costs in a process costing system. The process cost report consists of three schedules: 1. The schedule of equivalent production. 2. The unit cost analysis schedule. 3. The cost summary schedule. Copyright © by Houghton Mifflin Company. All rights reserved. 33 The Schedule of Equivalent Production The schedule of equivalent production includes unit figures for two elements. Materials. Conversion costs. Copyright © by Houghton Mifflin Company. All rights reserved. 34 Step 1: Schedule of Equivalent Production: With Beginning Inventory Kernan Computer Products Company Schedule of Equivalent Production - Cables For the Month Ended February 28, 20xx Equivalent Units Units Stage of Completion Beginning inventory - units started last period but completed in this period Units to Be Accounted For Direct Materials Costs 6,200 (Direct materials costs 100% complete) (Conversion costs 60% complete) Units started and completed in this period Ending inventory - units started but not completed in this period 2,480 52,500 52,500 52,500 5,000 (Direct materials costs 100% complete) (Conversion costs 60% complete) Totals Conversion Costs 5,000 63,700 Copyright © by Houghton Mifflin Company. All rights reserved. 57,500 2,250 57,230 35 Unit Costs Unit costs are found by using a unit cost analysis schedule. 1.Direct materials costs for units in beginning inventory and direct materials costs of the current period are added. 2.The same procedure is followed for conversion costs. Copyright © by Houghton Mifflin Company. All rights reserved. 36 Unit Costs 3. The unit cost for direct materials is found by dividing the direct materials costs for the current period by the equivalent unit amount for direct materials. 4. The same procedure is followed for conversion costs. 5. The unit costs for direct materials and conversion costs are added to yield the total cost for the period. Copyright © by Houghton Mifflin Company. All rights reserved. 37 Step 2: Unit Cost Determination Kernan Computer Products Company Unit Cost Analysis Schedule - Computer Mice For the Month Ended February 28, 2003 Total Cost Analysis Direct materials cost Conversion costs Totals Costs from Beginning Inventory Current Period Costs Total Costs to Be Accounted For $20,150 21,390 $41,540 $189,750 320,488 $510,238 $209,900 341,878 $551,778 Computation of Equivalent Unit Costs Costs from Current Period Direct materials costs Conversion costs $189,750 320,488 Totals $510,238 Equivalent + Units 57,500 57,500 Copyright © by Houghton Mifflin Company. All rights reserved. Cost per Equivalent = Unit $ 3.30 5.60 $ 8.90 38 Cost Summary Schedule: Part 1 The first part of the cost summary schedule is used to compute the costs assigned to units completed and transferred out during the period. Copyright © by Houghton Mifflin Company. All rights reserved. 39 Cost Summary Schedule: Part 1 1. The cost of producing the units in the beginning inventory is determined by adding the costs transferred in from the preceding period and the conversion costs needed to complete the units during the current period. Copyright © by Houghton Mifflin Company. All rights reserved. 40 Cost Summary Schedule: Part 1 2. That amount is added to the total cost of producing all units started and completed during the period. The result is the total cost to be transferred to the Finished Goods Inventory account. Copyright © by Houghton Mifflin Company. All rights reserved. 41 Cost Summary Schedule: Part 2 The second part of the cost summary schedule assigns costs to units still in process at the end of the period. Copyright © by Houghton Mifflin Company. All rights reserved. 42 Cost Summary Schedule: Part 2 1. Unit costs for direct materials and conversion costs are multiplied by their respective equivalent units. 2. The total equals the balance in the Work in Process Inventory account at the end of the period. Copyright © by Houghton Mifflin Company. All rights reserved. 43 Step 3: Cost Summary Schedule Kernan Computer Products Company Cost Summary Schedule - Computer Mice For the Month Ended February 28, 2003 Cost of Goods Transferred to Finished Goods Inventory Beginning inventory Costs from preceding period Costs to complete this period Direct materials costs: none Conversion costs: 2,480 units x $5.60 Subtotal Cost of Ending Total Costs Work in to Be Process Accounted Inventory For $ 41,540 ---13,888 $ 55,428 Units started and completed 52,500 units x $8.90 467,250 Ending inventory Direct materials costs: 5,000 units x $3.30 Conversion costs: 2,250 units x $5.60 Totals $522,678 $16,500 12,600 + Copyright © by Houghton Mifflin Company. All rights reserved. $29,100 = $551,778 44 Process Costing for Two or More Production Departments When a company has more than one production department, it must have a Work in Process Inventory account for each department. Costs transferred from one department to another are treated as direct material costs by the receiving department. A separate process cost report is prepared for each department. Copyright © by Houghton Mifflin Company. All rights reserved. 45 Discussion Q. Unit figures for what two elements are included in the schedule of equivalent production? A. 1. Materials. 2. Conversion costs. Copyright © by Houghton Mifflin Company. All rights reserved. 46 Using Product Costing Information to Evaluate Performance OBJECTIVE 6 Evaluate operating performance using information about product cost. Copyright © by Houghton Mifflin Company. All rights reserved. 47 Operating Performance Both the job order and the process costing systems supply information that managers can use to evaluate the operating performance of an organization. Copyright © by Houghton Mifflin Company. All rights reserved. 48 Measurements Measurements can help managers analyze operating efficiency. 1. Cost trends of a product or product line. 2. Units produced per time period. 3. Materials usage per unit produced. Copyright © by Houghton Mifflin Company. All rights reserved. 49 Measurements 4. Labor cost per unit produced. 5. Special order needs of customers. 6. Cost effectiveness comparisons of shifting to a more advanced production process. Copyright © by Houghton Mifflin Company. All rights reserved. 50 Discussion Q. What are the measurements that can help managers analyze operating efficiency? A. 1. Cost trends. 2. Units produced. 3. Materials usage. 4. Labor cost. 5. Special orders. Copyright © by Houghton Mifflin Company. All rights reserved. 51 Costing Systems: Process Costing SUPPLEMENTAL OBJECTIVE 7 Compute equivalent units, product unit cost, and the ending Work in Process Inventory balance in a process costing system that uses the average costing method. Copyright © by Houghton Mifflin Company. All rights reserved. 52 Process Costing: Average Costing No Beginning Work in Process Inventory Same as FIFO method. With Beginning Work in Process Inventory All units in beginning inventory are treated as if they were started and completed in the current period. Copyright © by Houghton Mifflin Company. All rights reserved. 53 Process Costing: Average Costing Equivalent Unit Calculations 1. Units in Beginning Inventory 2. 3. = Number of Units x 100% Units started and completed = Number of Units x 100% Units in Ending Inventory = Number of Units x Percentage of Completion (for Materials Costs and Conversion Costs) Copyright © by Houghton Mifflin Company. All rights reserved. 54 Process Costing: Average Costing Cost per Unit = Costs in Beginning Inventory + Costs of the Current Period Equivalent Units Total (for Materials Unit Cost and Conversion Unit Cost) Copyright © by Houghton Mifflin Company. All rights reserved. 55 Step 1: Schedule of Equivalent Production: With Beginning Inventory Kernan Computer Products Company Schedule of Equivalent Production - Computer Mice For the Month Ended February 28, 2003 Equivalent Units Units Stage of Completion Beginning inventory - units started last period but completed in this period Units to Be Accounted For Direct Materials Costs 6,200 Conversion Costs 2,480 (Direct materials costs 100% complete) (Conversion costs 60% complete) Units started and completed in this period Ending inventory - units started but not completed in this period 52,500 52,500 5,000 (Direct materials costs 100% complete) (Conversion costs 45% complete) Totals 52,500 5,000 63,700 Copyright © by Houghton Mifflin Company. All rights reserved. 57,500 2,250 60,950 56 Step 2: Unit Cost Determination Kernan Computer Products Company Unit Cost Analysis Schedule - Computer Mice For the Month Ended February 28, 2003 Total Cost Analysis Direct materials cost Conversion costs Totals Computation of Equivalent Unit Costs Costs from Beginning Inventory Current Period Costs Total Costs to Be Accounted For $20,150 21,390 $41,540 $189,750 320,488 $510,238 $209,900 341,878 $551,778 Cost per Equivalent Total Costs to Equivalent Be Accounted For + Units = Unit Direct materials costs Conversion costs $209,900 341,878 Totals $551,778 63,700 60,950 $ 3.30* 5.61* $ 8.91 *Rounding Copyright © by Houghton Mifflin Company. All rights reserved. 57 Step 3: Cost Summary Schedule Kernan Computer Products Company Cost Summary Schedule - Computer Mice For the Month Ended February 28, 2003 Cost of Goods Transferred to Finished Goods Inventory Beginning inventory 6,200 units x $8.91 per unit Cost of Ending Total Costs Work in to Be Process Accounted Inventory For $ 55,242 Units started and completed 52,500 units x $8.91 467,775 Ending inventory Direct materials costs: 5,000 units x $3.30 Conversion costs: 2,250 units x $5.61 Totals $523,017 $16,500 12,623* + $29,123* = $552,140* *Rounding Difference Copyright © by Houghton Mifflin Company. All rights reserved. 58 OK, LET’S REVIEW . . . 1. Describe the process costing system, discuss its role in the management cycle, and identify the reasons for its use. 2. Relate the patterns of product flows in a process costing environment to the process cost flow methods. 3. Explain the role of the Work in Process Inventory account(s) in a process costing system. Copyright © by Houghton Mifflin Company. All rights reserved. 59 CONTINUING OUR REVIEW . . . 4. Prepare a process cost report: (a) use a schedule of equivalent production to compute equivalent units of production, (b) use a unit cost analysis schedule to compute product unit cost for a specific time period, and (c) complete a cost summary schedule that assigns costs to units completed and transferred out during the period, and compute the ending balance in the Work in Process Inventory account. Copyright © by Houghton Mifflin Company. All rights reserved. 60 AND FINALLY . . . 5. Apply activity-based costing to a process costing system. 6. Evaluate operating performance using a product costing system. Copyright © by Houghton Mifflin Company. All rights reserved. 61