Process Costing and Hybrid Product- Costing Systems Chapter 4 Process Costing and Hybrid Product- Costing Systems

Comparison of Job-Order Costing and Process Costing Used for production of small, identical, low cost items. Mass produced in automated continuous production process. Costs cannot be directly traced to each unit of product. Learning Objective 1 This chapter covers process-costing systems. Process costing is used in repetitive production environments, where large numbers of identical or very similar products are manufactured in a continuous flow. (LO1) Industries using process costing include paper, petroleum, chemicals, textiles, food processing, lumber, and electronics. (LO1)

Comparison of Job-Order Costing and Process Costing Costs accumulated by the job. Work in process has a job-cost sheet for each job. Many unique, high cost jobs. Jobs built to customer order. Process costing Costs accumulated by department or process. Work in process has a production report for each batch of products. A few identical, low cost products. Units continuously produced for inventory in automated process. In many ways, job-order costing and process costing are similar. Both product-costing systems have the same ultimate purpose—assignment of production costs to units of output. Moreover, the flow of costs through the manufacturing accounts is the same in the two systems. (LO1) In job-order costing, costs are accumulated by job order and recorded on job-cost records. The cost of each unit in a particular job order is found by dividing the total cost of the job order by the number of units in the job. (LO1) In process costing, costs are accumulated by department, rather than by job order or batch. The cost per unit is found by averaging the total costs incurred over the units produced. (LO1)

Process Cost Flows Learning Objective 2 In a single production department situation, direct-material, direct-labor, and manufacturing-overhead costs are added to a Work-in-Process Inventory account. As goods are finished, costs are transferred to Finished-Goods Inventory. During the period when goods are sold, the product costs are transferred to Cost of Goods Sold. (LO2)

Process Cost Flows In the two-department case, when goods are finished in the first production department, costs accumulated in the Work-in-Process Inventory account for production department A are transferred to the Work-in-Process Inventory account for production department B. (LO2)

Equivalent Units: A Key Concept Costs are accumulated for a period of time for products in work-in-process inventory. Products in work-in-process inventory at the beginning and end of the period are only partially complete. Equivalent units is a concept expressing these partially completed products as a smaller number of fully completed products. Learning Objective 3 The term equivalent units is used in process costing to refer to the amount of manufacturing activity that has been applied to a batch of physical units. (LO3) For example, if two units are 50 percent complete, that is equivalent to 1 unit that is 100 percent complete. Likewise, 10,000 units that are 70 percent complete is 7,000 equivalent units. (LO3)

Calculating and Using Equivalent Units of Production To calculate the cost per equivalent unit for the period: Cost per equivalent unit Costs for the period Equivalent units for the period = The cost per equivalent unit is the costs for the period divided by the equivalent units produced for the period. (LO3)

Calculating and Using Equivalent Units of Production To calculate the direct materials and conversion costs per equivalent unit for the period: Materials cost per equivalent unit Materials cost for the period Materials equivalent units for the period = Direct material is usually placed into production at one or more discrete points in the process. In contrast, direct labor and manufacturing overhead, called conversion costs, usually are incurred continuously throughout the process. When an accounting period ends, the partially completed goods that remain in process generally are at different stages of completion with respect to material and conversion activity. The most important feature of process costing is that the costs of direct material and conversion are assigned to equivalent units rather than to physical units. (LO3) Materials cost per equivalent unit Materials cost for the period Materials equivalent units for the period =

Departmental Production Report Analysis of physical flow of units. Calculation of equivalent units. Computation of unit costs. Analysis of total costs. Production Report The key document in a typical process-costing system is the departmental production report, prepared for each production department at the end of every accounting period. The departmental production report summarizes the flow of production quantities through the department, and it shows the amount of production cost transferred out of the department’s Work-in-Process Inventory account during the period. There are four steps are used in preparing a departmental production report: 1. Analysis of physical flow of units. 2. Calculation of equivalent units. 3. Computation of unit costs. 4. Analysis of total costs. (LO3)

Equivalent Units of Production – Weighted-Average Method The weighted-average method . . . Makes no distinction between work done in the prior period and work done in the current period. Blends together units and costs from the prior period and the current period. The FIFO method is a more complex method and is rarely used in practice. The method of process costing that we will focus on in this chapter is called the weighted-average method. This method is almost always used in practice by companies using process costing. There is another process-costing method called the first-in, first-out, or FIFO, method. (LO3)

Computation of Unit Costs $140,000 ÷ 50,000 equivalent units Learning Objective 4 The third step in the process-costing procedure is calculating the cost per equivalent unit for both direct material and conversion activity. The cost per equivalent unit for direct material is computed by dividing the total direct-material cost, including the cost of the beginning work in process and the cost incurred during March, by the total equivalent units (from step 2). The same procedure is used for conversion costs. (LO3) $200,700 ÷ 45,000 equivalent units $2.80 + $4.46

Analysis of Total Costs Slide 1 of 3 Learning Objective 5 The final step is to determine the total cost to be transferred out of the Cutting Department’s Work-in-Process Inventory account and into the Stitching Department’s Work-in-Process Inventory account. The cost per equivalent unit, $7.26, was calculated in step 3. The number of units transferred is multiplied by the cost per equivalent unit. (LO4) The direct material equivalent units is multiplied by the direct materials cost per equivalent unit. The conversion equivalent units is multiplied by the conversion cost per equivalent unit. These two amounts are added together. (LO4) The sum of these costs is added to the cost of goods completed and transferred. Now all costs on the production report have been accounted for. These calculations are used as the basis for the journal entries to transfer the cost of goods completed and transferred out to the Stitching Department. (LO4) All costs accounted for

Learning Objective 6 We have now completed all four steps necessary to prepare a production report. The report simply combines the tables prepared in Learning Objectives 3, 4 and 5. The report provides a convenient summary of all of the process-costing calculations made under the weighted-average method. This method is called the weighted-average method because the cost per equivalent unit, for both direct material and conversion activity, is computed as a weighted average of the costs incurred during two different accounting periods. Both actual and normal costing can be used in conjunction with a process costing system. Our illustration used a predetermined overhead rate based on direct-labor cost, which is normal costing. In our illustration, production requires two sequential production operations: cutting and stitching. Although the process-costing procedures for the second department are similar to those illustrated for the first, there is one additional complication. The cost of goods completed Department must remain assigned to the partially completed product units as they undergo further processing in the Stitching and transferred out of the Cutting Department. Process-costing procedures for subsequent production departments are covered in the appendix at the end of this chapter, which may be studied now. (LO6)

Departmental Production Report Analysis of physical flow of units. Calculation of equivalent units. Computation of unit costs. Analysis of total costs. In our illustration, production requires two sequential production operations: cutting and stitching. Although the process-costing procedures for the second department are similar to those illustrated for the first, there is one additional complication. The cost of goods completed and transferred out of the Cutting Department must remain assigned to the partially completed product units as they undergo further processing in the Stitching Department. Process-costing procedures for subsequent production departments are covered in Learning Objective 8. (LO6)

Operation Costing Operation costing employs some aspects of both job-order and process costing. Job-order Operation Costing Process Costing (Products produced in batches) Costing Material Costs charged to batches as in job-order costing. Conversion costs assigned to batches as in process costing. Learning Objective 7 Job-order and process costing represent the polar extremes of product-costing systems. But some production processes exhibit characteristics of both job-order and process costing environments. These production processes often are referred to as batch manufacturing processes. Such processes are characterized by high-volume production of several product lines that differ in some important ways but are nearly identical in others. Since batch manufacturing operations have characteristics of both job-order costing and process-costing environments, a hybrid product-costing system is required. One common approach is called operation costing. (LO7) This product-costing system is used when conversion activities are very similar across product lines, but the direct materials differ significantly. Conversion costs are accumulated by department, and process costing methods are used to assign these costs to products. In contrast, direct-material costs are accumulated by job order or batch, and job-order costing is used to assign material costs to products. (LO7)