Financial & Managerial
Accounting 2002e
Belverd E. Needles, Jr.
Marian Powers
Susan Crosson
----------Multimedia Slides by:
Harry Hooper
Santa Fe Community College
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1
Chapter 18
Costing Systems:
Process Costing
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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.
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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.
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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.
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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.
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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.
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7
Uses of Product Costing Information in the Management Cycle
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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.
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9
Executing Stage

During the executing stage, actual costs can
be computed.
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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.
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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.
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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.
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13
Patterns of Product Flows
OBJECTIVE 2
Relate the patterns of product flows in a
process costing environment to the process
cost flow approaches.
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14
Product Flows in a Process Costing System for Winemaking
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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.
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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.
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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.
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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.
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19
Discussion
Q. What are two costing approaches associated
with a process environment?
A. 1. The FIFO costing approach.
2. The average costing approach.
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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.
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21
Cost Flows and Product Unit Cost in a Process Costing System for
Winemaking
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22
Cost Flows

The main difference between job order
costing and process costing is the way in
which costs are assigned to products.
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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.
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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.
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25
Work in Process Inventory
 There
is one Work in Process Inventory
account for each process or department in
the production process.
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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.
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27
The Process Cost Report
OBJECTIVE 4
Define and compute equivalent production
(units).
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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.
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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).
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30
Computation of Equivalent Production
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31
The Process Costing System
OBJECTIVE 5
Prepare a process cost report.
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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.
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The Schedule of
Equivalent Production
 The
schedule of equivalent production
includes unit figures for two elements.

Materials.

Conversion costs.
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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
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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.
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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.
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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
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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.
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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.
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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.
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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.
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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.
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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
+
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$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.
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45
Discussion
Q. Unit figures for what two elements are
included in the schedule of equivalent
production?
A. 1. Materials.
2. Conversion costs.
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46
Using Product Costing
Information to Evaluate
Performance
OBJECTIVE 6
Evaluate operating performance using
information about product cost.
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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.
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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.
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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.
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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.
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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.
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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.
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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)
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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)
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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
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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
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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
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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.
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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.
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60
AND FINALLY . . .
5. Apply activity-based costing to a process
costing system.
6. Evaluate operating performance using a
product costing system.
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61