Managerial Accounting
Balakrishnan | Sivaramakrishnan | Sprinkle | Carty | Ferraro
Chapter 15: Process Costing
Prepared by Debbie Musil, Kwantlen Polytechnic University
What is Process Costing?
• Many production environments have a
“continuous” flow
− Paper, cereal manufacturing, bottling soft
drinks, pharmaceuticals, garment
manufacturing, electronics assembly
• Two main features
− Units in the same batch might be at different
levels of completion (in different inventory
accounts)
− Not possible to track costs of individual units in
a batch
• We can only track costs at the level of the batch /
department
LO1: Explain the mechanics of process costing
Problem
• How to determine inventory values?
−
−
−
−
Some
Some
Some
Some
units might have been finished and sold
units might be finished but not sold
might still be in process
might not have started into production
• We allocate costs (for each batch) among COGM
and WIP
− Divide by number of units in COGM to value the layer of
inventory
• Can then calculate COGS
− Using “average values” OK because the items are similar
• Process costing focuses on the allocation
LO1: Explain the mechanics of process costing
Example
• Begin with basic setting
− Continue to add detail as we progress
• Data
−
−
−
−
Began with 0 inventory
Started 180,000 units
Completed 155,000 units
Incurred $6,880,000 of cost
• What is the value of Cost of Goods
Manufactured (COGM) and ending WIP
inventory?
LO1: Explain the mechanics of process costing
Easy Solution
• We can allocate based on number of units
− $6,880,000 × (25,000/180,000) = $955,555 to WIP
− $6,880,000 × (155,000/180.000) = $5,924,444 to COGM
• This allocation is probably wrong!
− Each unit (whether in WIP or completed) is valued at
$6,880,000/180,000 = $15.22 per unit
− But, we will work some more (and incur more costs) to
finish the units in WIP
− The value of the units cannot both be $15.22 currently.
LO1: Explain the mechanics of process costing
Equivalent Units
• Process Costing Systems solve the problem by
computing equivalent units
• Physical units × % completion = Equivalent
units
− 100 physical units × 20% complete = 20 Eq. units
− 500 physical units × 40% complete = 200 Eq. units
• We use equivalent units (rather than physical
units) as the allocation basis
− Convenient to use a 5-step template to organize
the allocation process.
LO1: Explain the mechanics of process costing
Five-step Template Applied
LO1: Explain the mechanics of process costing
Refining the Allocation
• Split the costs into smaller pools
− Different costs might have different completion rates
− Materials might be added as a lump amount at the start
of process
− Labour and overhead (conversion) might be incurred
uniformly
• The same unit in WIP could therefore be
− 100% complete for materials, 20% complete for
conversion
• In our example, suppose:
− We added all materials at start and ending WIP was 20%
complete for conversion costs
− Let $6,880,000 = $4,320,000 for materials and $2,560,000
for conversion
LO2: Apply process costing to settings with many pools and beginning inventory
Refining the Allocation:
Solution
• Do the allocations separately!
• Create a separate column (in Steps 2-5) for
each kind of input
− Number of columns = number of cost pools
• Thus, we will have:
− One column for materials
− One column for conversion costs
• We can do allocation separately and then
add up
LO2: Apply process costing to settings with many pools and beginning inventory
LO2: Apply process costing to settings with many pools and beginning inventory
Materials Issued at Different
Points
• Real world systems might have many columns for
many cost pools
− Raw materials for a belt (e.g., leather strips) can be
added in the beginning
− Some components (e.g., studs) can be added in the
middle
− Yet more pieces (e.g., buckles) might be added at the
end
− We might also separate out different types of overhead
• The underlying mechanics remain unaltered
• We also can refine the allocation for the product
going through many processes
LO2: Apply process costing to settings with many pools and beginning inventory
LO2: Apply process costing to settings with many pools and beginning inventory
Opening Inventory
• We often have to deal with inventory left over
from the prior period
− This inventory might have different costs
− Need inventory cost flow assumption
− Weighted Average Method is most sensible and
common
• Weighted average method
− Does not distinguish between units in opening
inventory and those started this period
− Does not distinguish (i.e. add together) the costs
from opening inventory and the current period
LO2: Apply process costing to settings with many pools and beginning inventory
Example
• Chen began June with 25,000 units
− The ending inventory for May
− Valued at $561,250 for materials and $80,000 for
labor
• Added more 175,000 units
− Incurred $4,038,750 for materials, $2,830,000 for
labor and $323,750 for packing
• Ended with 15,000 units
− 90% complete for labor
• Materials added at beginning, labor incurred uniformly
and packing added at end of process
• What is the value of COGM and Ending WIP?
LO2: Apply process costing to settings with many pools and beginning inventory
LO2: Apply process costing to settings with many pools and beginning inventory
Standard Process Costing
• Many firms take advantage of large production
volumes to use the same rate each accounting
period
− Product cost does not change across periods
− Permits variance analysis (see Chapter 8) for
exercising operational control
• Method
− Same template as before
− Use standard rates instead of calculating actual
rates as we did before
LO3: Perform process costing using standard costs
LO3: Perform process costing using standard costs
Can Integrate with Variances
• Standard process costing lets us calculate variances
− We know that Chen spent $4,041,000 on materials in May
− The standard cost of the work done was $4,005,000
− Thus, we can calculate the variance as $36,000 U =
$4,041,000 - $4,005,000.
• We can extend the idea to settings with opening
inventory
− Be careful in considering cost of work done during the
period
Cost of
work done
this period
=
Cost of
Cost of
goods
+ ending
completed
inventory
-
Cost of
opening
inventory
− Compare with actual expenditure for the period
LO3: Perform process costing using standard costs
LO2: Apply process costing to settings with many pools and beginning inventory
Exercise 15.31
Mechanics of process costing, steps 1 and 2 (LO1).
Orange Computers began June with zero units of its portable music player in
work-in-process inventory. During June, Orange started 250,000 units into
production, completing 175,000 units by month’s end. Production personnel
estimate that the 75,000 units still in process on June 30 are 100% complete
with respect to materials and 40% complete with respect to conversion costs.
Required:
Complete steps 1 and 2 of Orange’s process-costing report for June.
Exercise 15.31 (Continued)
Complete steps 1 and 2 of Orange’s process-costing report for June.
Using the information provided, we have:
Total
Step 1: Track Physical Flow
Beginning inventory - June 1
Detail for each cost pool
Materials
Conversion
0
Started during June
250,000
Total physical units to account for
250,000
Step 2: Compute Equivalent Units
Units completed during June
175,000
175,000
(100% of 175,000)
175,000
(100% of 175,000)
Units in process on June 30
75,000
75,000
(100% of 75,000)
30,000
(0.40 × 75,000)
250,000
250,000
205,000
Total physical units accounted for
Exercise 15.31 (Concluded)
Complete steps 1 and 2 of Orange’s process-costing report for June.
Notice that the percentage of completion varies between materials
and conversion costs. Thus, the number of equivalent units also
varies. For materials, each unit in WIP is equivalent to a finished unit
as it has consumed all of the requisite materials. In contrast, each unit
is only 0.40 of a finished unit in terms of conversion costs, because
the unit in WIP is only 40% complete with respect to conversion costs.
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