Chapter 6 Process Costing Key Topics: Cost flows in mass production Steps in preparing process cost reports (FIFO and weighted average) Equivalent units Applying costs Spoilage in process costing Uses, Uncertainties, and limitations Chapter 6

Process Costing Process product-costing systems are used for costing inventories or services when they are mass-produced, identical units. These products differ from the custom-made or unique goods that are assigned costs under a job costing system Chapter 6

Mass Production Many goods are produced using a continuous process. Examples: Chapter 6

Overview of Process Costing Systems Chapter 6

Steps for Preparing a Process Costing Report: 1. Summarize total costs to account for. 2. Summarize total physical and equivalent units. 3. Compute cost per equivalent unit. 4. Account for cost of units completed and cost of ending WIP. Chapter 6

What Are Equivalent Units, and How Do They Relate to the Production Process? Measure the resources used in partially completed units relative to the resources needed to complete the units. Equivalent Units Depend on the Pattern of Cost Flow: Direct Materials: * Added at the beginning of the process * Added during the process Conversion Costs: * Incurred uniformly throughout the process * Incurred non-uniformly Chapter 6

How Is the Weighted Average Method Used in Process Costing? Costs from beginning WIP (performed last period) are averaged with costs incurred during the current period and then allocated to all units completed and ending WIP. Chapter 6

Summaries of Physical Units and Total Costs for Weighted Average Calculations (Assuming direct materials are added at the beginning of the process) Chapter 6

Calculation of Equivalent Units Under the Weighted Average Method Chapter 6

Beg. WIP Costs + Costs Added This Period Calculation of Cost Per Equivalent Unit Under the Weighted Average Method Beg. WIP Costs + Costs Added This Period Weighted Average Equivalent Units Chapter 6

Equivalent Unit Costs Weighted Average: Direct materials = $6,000+$30,500 =$3.0417 12,000 Conversion costs=$4,200+$76,680=$7.0947 11,400 Total cost per equivalent unit = $10.1364 Chapter 6

Weighted Average Process Cost Report Chapter 6

Summaries of Physical Units and Total Costs for FIFO Calculations (Assuming direct materials are added at the beginning of the process) Chapter 6

Calculation of Equivalent Units Under the FIFO Method Chapter 6

First-in, First-out (FIFO) Method The current period’s costs are used to allocate cost to work performed this period Chapter 6

Calculation of Cost Per Equivalent Unit Current Period Cost Equivalent Units for Work Performed this Period Chapter 6

Equivalent Units Costs FIFO: Direct materials = $30,500 = $3.05 10,000 Conversion costs=76,680 = $7.10 10,800 Total cost per equivalent unit = $10.15 Chapter 6

FIFO Process Cost Report Chapter 6

How Is Process Costing Performed for Multiple Production Departments Transferred-in Costs: Costs of processing performed in a previous department Transferred-in costs are pooled separately from other costs Chapter 6

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How Are Spoilage Costs Handled in Process Costing? Normal Spoilage: Defective units that arise as part of regular operations Abnormal Spoilage: Spoilage that is not part of everyday operations Chapter 6

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Use Process Cost Information to: Measure costs of products mass-produced products Assign costs to inventory and cost of goods sold for financial statements and income tax returns Monitor operations and costs Develop estimates of future costs for decision making Analyze the costs and benefits of quality improvements Identify potential areas for process improvements Chapter 6

Uncertainties and Measurement Errors in Process Costing Actual cost flows might not be known: * When are direct materials added? * When are conversion costs incurred? * How complete are the units in ending work in process? * What amount of spoilage is normal? Chapter 6