Process Costing ACCTG 404 ACCTG 404 Huddart

Costing Systems Job Order Costing Process Costing Each job is unique Product costs are easy to trace to a specific job/product Product is mass-produced Impossible to trace product costs to a specific can

Process Costing: Basic Operational and Cost Concepts 1 A process system is characterized by a large number of homogeneous products passing through a series of processes Each process is responsible for one or more operations that bring a product one step closer to completion A process is a series of activities that are linked to perform a specific objective In each process, materials labor and overhead inputs may be needed and, upon completion of that process, are transferred to another process until complete, when they are transferred to finished goods.

Process Costing: Reflects Actual Manufacturing Flows An Operational Process System: Antihistamine Manufacturing Blending Encapsulating Bottling Selecting Sifting Measuring Mixing Loading Filling Sealing Drying Loading Counting Capping Packing

Process Costing: Reflects Actual Manufacturing Flows manufacturing costs Direct Materials Direct Labor Applied Overhead Job 205 Jobs 206 Jobs 207 Finished Goods Job Order Costing: manufacturing costs Direct Materials Direct Labor Applied Overhead Blending Dept. Encapsulating Dept. Bottling Dept. Finished Goods Process Costing: ACCTG 404 - Lansford - Spring 2014

Similarities Between Job-Order and Process Costing Both systems assign material, labor, and overhead costs to products and they provide a mechanism for computing unit product costs. Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods. The flow of costs through the manufacturing accounts is basically the same in both systems. Job-order and process costing are similar in that they both deal with assigning materials, labor, and overhead to products as a way to calculate the unit product cost. Both systems use Raw Materials Inventory, Work in Process Inventory, and Finished Goods Inventory. The flow of costs is similar, but not exactly the same, in the two systems.

Differences Between Job-Order and Process Costing Is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs having different production requirements are worked on each period. Systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet. Process costing is best suited for the production of a single product that is continuously produced for a long period of time. Recall the mixing and bottling of Coca-Cola from Chapter Three. Job-order costing is best suited when jobs are produced as discrete projects. For example, building a house. Process costing accumulates costs by department, while job-order costing accumulates costs by individual jobs. Process costing uses a fundamental document called a department production report, while job-order costing uses the job cost sheet. In process costing unit cost is computed by department, while in job-order systems unit cost is computed by job. While there are similarities between the two systems, there are also significant differences.

Processing Departments Definition: Any unit in an organization where materials, labor, or overhead are added to the product. The activities performed in a processing department are performed uniformly on all units of production. Furthermore, the output of a processing department must be homogeneous. Products in a process costing environment typically flow in a sequence from one department to another. A processing department is any unit in an organization where materials, labor, or overhead are added to the product. The output from a processing department is homogeneous, that is, they all appear the same. Products in a process costing environment typically flow in a sequence from one department to another.

Example of Accounting with Process Costing For purposes of this example, assume there are two processing departments: Departments A and B. We will use T-accounts. Let’s look at the flow of process costs through the t-accounts and related journal entries for a manufacturing company that has two departments – Department A and Department B.

Process Cost Flows: The Flow of Raw Materials Work in Process Department A Raw Materials Direct Materials Direct Materials Work in Process Department B Direct materials can be requisitioned for use in both Department A and Department B. These direct materials are likely to be different in nature. Direct material costs are debited to the appropriate departmental Work in Process account depending upon where the materials were added to the production process. The Raw Materials Inventory account is credited for the corresponding amounts.

Process Cost Flows: The Flow of Labor Costs Salaries and Wages Payable Work in Process Department A Direct Materials Direct Labor Direct Labor Work in Process Department B Direct labor is transferred from the Salaries and Wages Payable account into the work in process account of Departments A and B depending upon where the individual employee worked. Direct labor costs are debited to the appropriate departmental Work in Process account depending upon where the labor was added to the production process. Salaries and Wages Payable is credited for the corresponding amounts. Direct Materials

Process Cost Flows: The Flow of Manufacturing Overhead Costs Work in Process Department A Direct Materials Manufacturing Overhead Direct Labor Actual Overhead Overhead Applied to Work in Process Applied Overhead Work in Process Department B Manufacturing overhead is applied to each processing department based on a predetermined rate for each department. The predetermined rate does not have to be based on the same cost driver for each processing department. Manufacturing overhead costs are debited to the respective departmental Work in Process accounts. Manufacturing overhead is credited by the corresponding amounts. Direct Materials Direct Labor Applied Overhead

Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept. B Work in Process Department A Work in Process Department B Direct Materials Transferred to Dept. B Transferred from Dept. A Direct Materials Direct Labor Direct Labor Applied Overhead Applied Overhead The cost of units complete as to processing in Department A are transferred into Department B for additional work. Department B has incurred additional costs to work on units that were in process at the beginning of the period. The transferred-in costs from Department A are added to the manufacturing costs incurred in Department B. Department A Department B

Process Cost Flows: Transfers from WIP-Dept. B to Finished Goods Work in Process Department B Finished Goods Direct Materials Cost of Goods Manufactured Cost of Goods Manufactured Direct Labor Applied Overhead Transferred from Dept. A Here we see the transfer of completed goods from Work in Process – Department B into Finished Goods Inventory. The costs transferred represent the cost of good manufactured.

Process Cost Flows: Transfers from Finished Goods to COGS Work in Process Department B Finished Goods Direct Materials Cost of Goods Manufactured Cost of Goods Manufactured Cost of Goods Sold Direct Labor Applied Overhead Transferred from Dept. A Once we sell finished goods, we debit Cost of Goods Sold and credit Finished Goods Inventory. Cost of Goods Sold Cost of Goods Sold

Process Costing Process costing is the averaging technique to assign costs to the units produced Process costing is complicated by work-in-process inventory (and “spoilage”) Unit Cost = Production Costs Production Quantity

# of physical units × % of completion = Equivalent Units Two units that are 50% complete have required the same inputs and effort as one unit that is 100% complete. So these two physical units are one equivalent unit. # of physical units × % of completion = Equivalent Units

ACCTG 404 - Lansford - Spring 2014 Equivalent Units Number of same or similar units that could have been produced given the amount of work actually performed on both complete and partially completed units. Includes units: started last period and finished this period started and finished this period started this period and not finished ACCTG 404 - Lansford - Spring 2014

Quick Check For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 30 percent complete. How many equivalent units of production did Jones have for the period? a. 10,000 b. 11,500 c. 13,500 d. 15,000 Read the information carefully and determine how many equivalent units of production were manufactured during the period.

Quick Check For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 30 percent complete. How many equivalent units of production did Jones have for the period? a. 10,000 b. 11,500 c. 13,500 d. 15,000 10,000 units + (5,000 units × 0.30) = 11,500 equivalent units The correct answer is 11,500 equivalent units. How did you do?

Process Costing Methods Weighted Average Method combine beginning work- in-process current period production FIFO Method separate beginning work- in-process current period production ACCTG 404 - Lansford - Spring 2014

Equivalent Units: Beginning Must Equal Ending Balances Beginning Inventory in Equivalent Units + Equivalent Units of current output = Ending inventory in Equivalent Units Units transferred out ACCTG 404 - Lansford - Spring 2014

Six Step in Process Costing We’ll start with an example using the weighted-average method. The weighted-average method . . . Makes no distinction between work done in prior or current periods. Blends together units and costs from prior and current periods. Determines equivalent units of production for a department by adding together the number of units transferred out plus the equivalent units in ending Work in Process Inventory. ACCTG 404 - Lansford - Spring 2014

Step 1: Units to Account For Beginning WIP 25,000 Started 510,000 Units to account for 535,000 ACCTG 404 - Lansford - Spring 2014

Step 2: Units Accounted For Beginning WIP 25,000 Started 510,000 Units to account for 535,000 must be equal Finished and transferred 523,000 Ending WIP 12,000 Units accounted for 535,000 ACCTG 404 - Lansford - Spring 2014

Weighted Average Method Step 3: Compute Equivalent Units DM CC Beginning WIP inventory 25,000 25,000 Started and completed 498,000 498,000 Ending WIP inventory 12,000 9,600* Equivalent units 535,000 532,600 *(ending units × % complete) 12,000 × 80% = 9,600 ACCTG 404 - Lansford - Spring 2014

Weighted Average Method Step 4: Costs to Account For DM CC Total Beginning WIP $ 42,650 $ 17,152 $ 59,802 Current costs $433,500 $339,690 $ 773,190 To account for $476,150 $356,842 $832,992 ACCTG 404 - Lansford - Spring 2014

Weighted Average Method Step 5: Cost per Equivalent Unit DM CC Total Beginning WIP $ 42,650 $ 17,152 $ 59,802 Current costs 433,500 339,690 773,190 To account for $476,150 $356,842 $832,992 Divide by EU 535,000 532,600 Cost per EUP $.89 $.67 $1.56 ACCTG 404 - Lansford - Spring 2014

Weighted Average Method Step 6: Assign Costs to Inventories Transferred (523,000 × $1.56) $815,880 Ending WIP Inventory Direct Materials (12,000 × $.89) $10,680 Conversion (9,600 × $.67) 6,432 17,112 Cost accounted for $832,992* *must agree with costs to account for Transferred Out Ending WIP ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Process Costing: FIFO Under the FIFO costing method, the equivalent units and manufacturing costs in beginning work in process are excluded from the current period unit cost calculation. Thus, FIFO recognizes that the work and costs carried over from the prior period legitimately belong to that prior period. ACCTG 404 - Lansford - Spring 2014

Process Costing Methods Weighted Average Beginning WIP 100% Started and finished 100% Ending WIP % completed FIFO Beginning WIP % completed Started and finished 100% Ending WIP % completed the difference ACCTG 404 - Lansford - Spring 2014

Process Costing: FIFO Method Let’s re-do the same problem using the FIFO method. Note that the biggest difference between FIFO and weighted-average is the way equivalent units is computed. ACCTG 404 - Lansford - Spring 2014

Process Costing: FIFO Method FIFO emphasizes current period costs and production Steps 1 and 2 are the same (so no need to re-do here) Step 3: Compute Equivalent Units DM CC Beginning WIP 0 15,000* Started and completed 498,000 498,000 Ending WIP Inventory 12,000 9,600 Equivalent units 510,000 522,600 * (beginning units × % completed in current period) 25,000 × (1 – 40%) = 15,000 ACCTG 404 - Lansford - Spring 2014

Process Costing – FIFO Method Step 4 is the nearly same – except only use current costs Step 5: Cost per Equivalent Unit DM CC Total Current costs $433,500 $339,690 773,190 Divide by EU 510,000 522,600 Cost per EUP $.85 $.65 $1.50 ACCTG 404 - Lansford - Spring 2014

Step 6: Assign Costs to Inventories - FIFO Transferred Beginning WIP Inventory $59,802 Cost to complete Conversion (15,000 × $.65) 9,750 $69,552 Started and completed (498,000 × $1.50) 747,000 Ending WIP Direct Materials (12,000 × $.85) $10,200 Conversion (9,600 × $.65) 6,240 16,440 Cost accounted for $832,992* *must agree with costs to account for Transferred Out Ending WIP ACCTG 404 - Lansford - Spring 2014

Process Costing Comparison Weighted Average EU DM 535,000 EU CC 532,600 Cost per unit DM $ .89 Cost per unit CC .67 Total $1.56 Transferred Out $815,880 Ending WIP 17,112 Total $832,992 FIFO EU DM 510,000 EU CC 522,600 Cost per unit DM $ .85 Cost per unit CC .65 Total $1.50 Transferred Out $816,552 Ending WIP 16,440 Total $832,992 ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Practice Problem Consider the following data for the Assembly Division of Fenton Watches, Inc.: The Assembly Division uses the weighted-average method of process costing. Compute equivalent units for direct materials and conversion costs. Show physical units in the first column of your schedule. ACCTG 404 - Lansford - Spring 2014

STEP 3: Compute Output in Equivalent Units Under the weighted-average method, equivalent units are calculated as the equivalent units of work done to date. The equivalent units of work effort performed for the Assembly Division for direct materials and conversion costs are: STEPS 1&2: Summarize Output in Physical Units STEP 3: Compute Output in Equivalent Units ACCTG 404 - Lansford - Spring 2014

Practice Problem STEP 4: Summarize Total Costs to Account For Now summarize total costs to account for, calculate cost per equivalent unit for direct materials and conversion costs, and assign total costs to units completed (and transferred out) and to units in ending work in process. STEP 4: Summarize Total Costs to Account For STEP 5: Compute Cost per Equivalent Unit STEP 6: Assign Total Costs to Units Completed and to Units in Ending Work in Process ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Practice Problem FIFO method. Suppose the Assembly Division at Fenton Watches, Inc., uses the FIFO method of process costing instead of the weighted-average method. Compute equivalent units for direct materials and conversion costs. Show physical units in the first column of your schedule. STEPS 1&2: Summarize Output in Physical Units STEP 3: Compute Equivalent Units done in current period ACCTG 404 - Lansford - Spring 2014

Process Costing - FIFO STEP 4: Summarize Total Costs to Account For DM CC Total Current costs $3,220,000 $1,392,000 $4,612,000 Divide by EUP 460 464 Cost per EUP $7,000 $3,000 $10,000 STEP 5: Compute Cost per Equivalent Unit ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Process Costing - FIFO STEP 6: Assign Total Costs to Units Completed and to Units in Ending Work in Process Transferred Beginning WIP Inventory $584,400 Cost to complete DM (8 × $7,000) 56,000 Conversion (48 × $3,000) 144,000 $ 784,400 Started and completed (380 × $10,000) 3,800,000 Ending WIP Direct Materials (72 × $7,000) $504,000 Conversion (36 × $3,000) 108,000 612,000 Cost accounted for $5,196,400* *must agree with costs to account for Transferred Out Ending WIP ACCTG 404 - Lansford - Spring 2014

Would process costing likely be used by this watcher maker? ACCTG 404 - Lansford - Spring 2014

Multiple Departments & Spoilage Costs add some additional complexities ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Spoilage Normal spoilage – is uncontrollable and expected in day to day operations. Part of product costs. Abnormal spoilage – exceeds expected losses and is charged as a period expense. ACCTG 404 - Lansford - Spring 2014

Equivalent Units: Beginning Must Equal Ending Balances Beginning Inventory in Equivalent units + Equivalent units of current output = Ending inventory in equivalent units Units transferred out Normal spoilage + Abnormal spoilage ACCTG 404 - Lansford - Spring 2014

Process Costing with Multiple Departments As a product passes from one department to another, the accumulated cost passes from department to department Transferred-in costs, or prior department costs, are costs of work performed in earlier departments that are transferred into the present department These costs are treated like an additional cost element ACCTG 404 - Lansford - Spring 2014

Spoilage in Process Costing There are two options to account for normal spoilage: Count the number of spoiled units, prepare a separate equivalent unit computation with the cost per unit of the spoiled goods, and then allocate the cost of spoilage to the good units produced Omit the spoiled units in computing the equivalent units of production; the spoilage cost is thus included as part of total manufacturing costs We will focus on the first option. Let’s walk through a problem that includes spoilage ACCTG 404 - Lansford - Spring 2014

Weighted-Average Method Production Quality Information Steps 1 & 2: Step 3: Flow of Costs   Calculate Equiv. Units Physical Units Completion Percentage Direct Materials Conversion Costs Input Work-in-process, May 1 2,000 Direct materials 100% Conversion 75% Number started 8,000 Total to account for 10,000 Output Number completed 7,000 Normal spoilage (10%) 700 Abnormal spoilage 300 Work-in-process, May 31 80% 1,600 Total accounted for Total equivalent units 9,600 Weighted-Average Method ACCTG 404 - Lansford - Spring 2014

Weighted-Average Method Unit Cost Determination Step 4: Determine Total Costs   Direct Materials Conversion Costs Total Work-in-process, May 1 $100,000 $80,000 $180,000 Costs added during period 300,000 405,000 705,000 Total costs to account for $400,000 $485,000 $885,000 Step 5: Compute Costs per Equivalent Unit Divide by number of equivalent units 10,000 9,600 Equivalent unit costs $40.00 $50.521 $90.521 ACCTG 404 - Lansford - Spring 2014

Weighted-Average Method Cost Assignment Step 6: Assign Total Manufacturing Costs Completed & Tran. Out Ending WIP   Total Goods Completed and Transferred out [(Goods units 7,000 + Normal spoilage 700) x $90.521] $697,011 Abnormal Spoilage (300 x $90.521) 27,156 Work-in-process, May 31 Direct Materials (2,000 x $40.000) $80,000 80,000 Conversion (1,600 x $50.521) $80,833 80,833 Total Costs accounted for $160,833 $885,000 ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Prepare the Production Cost Report for May, using the weighted-average method. Compute the equivalent units of DM and CC Compute equivalent unit cost per unit Compute the cost summary of Finished goods (good production and normal spoilage) Abnormal spoilage Ending WIP ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Whole Equivalent Units QUANTITY RECAP: PHYSICAL UNITS Units Materials Conversion Beginning WIP 5,000 100% 25% Units started 26,000 TOTAL IN Process 31,000 Units Finished or Transferred-out 25,000 Normal spoilage 750 Abnormal spoilage Ending WIP 4,500 80% TOTAL OUT Process EQUIVALENT UNITS: WEIGHTED-AVERAGE Materials 31,000 (= eq units in Beg WIP + units started & completed + eq spoiled units + eq units in End WIP) Conversion 30,100 COST ADDED Materials Conversion Total Beginning WIP $45,600 $8,125 $53,725 Current Costs $228,400 $45,500 $273,900 $274,000 $53,625 $327,625 Weighted-average Cost per EU $8.839 $1.782 $10.620 ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Cost Summary: Weighted-Average Method: Finished Goods 25,000 units Good production (@ $10.620) $265,507 Normal spoilage (750 × $10.620) $7,965 $273,472 Abnormal Spoilage 750 (750 x $10.62) Ending WIP 4,500 Materials (4,500 × $8.839) $39,774 Conversion (4,500 x 0.8 × $1.782) $6,414 $46,188 Total Cost Accounted For $327,625 ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 On March 31, Morgan Company recorded the following information in the Assembly Department’s Work in Process account: Assume that the BB and EB WIP units are 70% and 80% complete for both materials and conversion, respectively. There is no spoilage. Using FIFO, what is the total cost assigned to ending work in process? Units DM Cost CC Cost Beginning balance 14,000 $60,000 $25,000 Costs incurred this period 80,000 $229,852 $57,745 Completed and transferred to Packaging 90,000 Ending balance 4,000 ACCTG 404 - Lansford - Spring 2014

Solution 1. Physical Units to Account For 14,000 + 80,000 = 94,000 2. Physical Units Accounted For 90,000 + 4,000 = 94,000 ACCTG 404 - Lansford - Spring 2014

3. Equivalent Units of Production Solution 3. Equivalent Units of Production DM CC BB WIP 14,000 × (1-.7) 14,000 × (1-.7) S&C (90,000-14,000) (90,000-14,000) EB WIP 4,000×.80 4,000×.80 83,400 83,400 ACCTG 404 - Lansford - Spring 2014

5. Cost per Equivalent Unit of Production Solution 4. Costs to Account For Costs incurred this period: DM $229,852 CC $ 57,745 5. Cost per Equivalent Unit of Production DM EUP = $229,852 ÷ 83,400 = $2.76 CC EUP = $57,745 ÷ 83,400 = $0.69 ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Solution 6. Costs to Assignment to Ending WIP: (3,200 × $2.76) + (3,200 × $0.69) = $11,040 ACCTG 404 - Lansford - Spring 2014

What If There Are Two Different Types of Direct Materials Used Sometimes a manufacturing process requires more than one stage or type of direct material In these situations, you may have one type of direct material added at a different time than the other direct materials To account for this, simply account for each type of direct material separately An example follows: ACCTG 404 - Lansford - Spring 2014

Superior Brands, Inc., manufactures a medium-quality rubber cement product in two departments. Cost and production data for the first department for June:   Work-in-process inventory, June 1 Conversion 40% complete 15,000 units Work-in-process inventory, June 30 65% 25,000 Started into production 80,000 Completed and transferred out ? Costs: Direct materials $72,500.00 $12,937.50 Costs added in June Material A $260,000.00 Material B $403,750.00 $461,437.50 ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Material A is added at the beginning of work in the first department. Material B is also added in the first department but not until units of product are 50% complete with regard to conversion activity. Conversion costs are incurred uniformly during the process. There is no spoilage. The company uses FIFO. Stage of completion of beginning WIP inventory with respect to material A = 100% Stage of completion of ending WIP inventory with respect to material A = Stage of processing at which material B is added = 50% 1. Calculate equivalent units produced with respect to material A, material B, and conversion costs. 2. Calculate the cost per equivalent unit for material A, material B, and conversion costs. 3. Calculate the cost of the units transferred out during the period. 4. Calculate the cost of the ending WIP inventory ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Quantity Schedule: Input Work-in-process inventory, 6/1 15,000 Units Started 80,000 Total units to account for 95,000 Output Units completed 70,000 Work-in-process inventory, 6/30 25,000 Total units account for ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Equivalent Units-FIFO Method Material A Units completed 70,000 Work-in-process inventory, 6/30 100% 25,000 Total 95,000 Less: EU in WIP inventory,6/1 (15,000) Total equivalent units 80,000 Material B 0% Conversion 65% 16,250 86,250 40% (6,000) 80,250 Costs per equivalent unit: Costs Material A Material B Conversion Costs incurred in June $260,000 $403,750 $461,438 Divided by FIFO eq units 80,000 95,000 80,250 FIFO cost per equivalent unit $3.25 $4.25 $5.75 ACCTG 404 - Lansford - Spring 2014

ACCTG 404 - Lansford - Spring 2014 Accounting for Total Costs: Cost of units from beginning WIP inventory: WIP inventory, June 1 $85,438 Cost to finish Beginning WIP: Material B $63,750 Conversion $51,750 $115,500 Total cost of units from beginning WIP inventory $200,938 Cost of units started and completed $728,750 Cost of units transferred out $929,688 Cost of ending WIP inventory Material A $81,250 $106,250 $93,438 Total cost of ending WIP Inventory $280,938 ACCTG 404 - Lansford - Spring 2014

A Comparison of Process Costing Methods In a lean production environment, FIFO and weighted-average methods yield similar unit costs. When considering cost control, FIFO is superior to weighted-average because it does not mix costs of the current period with costs of the prior period. In most situations, the weighted-average and FIFO methods will produce very similar unit costs, particularly in a lean production environment. From a cost control standpoint, the FIFO method is superior to the weighted-average method because it does not mix costs of the current period with costs of the prior period.