Chapter 18 Process Costing

Chapter 18 Learning Objectives Describe the flow of costs through a process costing system Calculate equivalent units of production for direct materials and conversion costs © 2018 Pearson Education, Inc.

Chapter 18 Learning Objectives Prepare a production cost report for the first department using the weighted-average method Prepare a production cost report for subsequent departments using the weighted-average method © 2018 Pearson Education, Inc.

Chapter 18 Learning Objectives Prepare journal entries for a process costing system Use a production cost report to make decisions Prepare a production cost report using the first-in, first-out method (Appendix 18A) © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 1 Describe the flow of costs through a process costing system © 2018 Pearson Education, Inc.

HOW DO COSTS FLOW THROUGH A PROCESS COSTING SYSTEM? Job order costing system Allocates costs by job Used by companies that manufacture unique products or provide specialized services Process costing system Allocates costs by process Used by companies that manufacture identical units Focuses on a process, one of the steps in manufacturing production Job order costing is an accounting system that accumulates costs by job. It is used by companies that manufacture unique products or provide specialized services. In contrast, other companies use a process costing system. A process is one of a series of steps in manufacturing production. A process costing system is an accounting system that accumulates costs by process. It is used by companies that manufacture identical units through a series of uniform production steps or processes. © 2018 Pearson Education, Inc.

Job Order Costing Versus Process Costing Both job order and process costing systems track the product costs of direct materials, direct labor, and manufacturing overhead through the three inventory accounts on the balance sheet: Raw Materials Inventory, Work-in-Process Inventory, and Finished Goods Inventory. The primary differences between job costing and process costing are how and when costs are recorded in Work-in-Process Inventory. Job order costing has one Work-in-Process Inventory account, with a subsidiary ledger containing individual job cost records for each job. Costs are transferred to Finished Goods Inventory when the jobs are completed. Process costing has a separate Work-in-Process Inventory account for each process or department. © 2018 Pearson Education, Inc.

Flow of Costs Through a Process Costing System Exhibit 18-2 illustrates Puzzle Me’s manufacturing operations. Puzzle Me, a fictitious jigsaw puzzle manufacturing company, divides its manufacturing operations into two processes: assembly and cutting. The Assembly Department applies the glue to the cardboard and then presses a picture onto the cardboard. The Cutting Department cuts the cardboard into puzzle pieces and packages the puzzles in a box. The box is then moved to the finished goods storage. The jigsaw puzzles accumulate production costs during each process. The company then assigns these costs to the puzzles passing through that process. At Puzzle Me, each process is a separate department. © 2018 Pearson Education, Inc.

Flow of Costs Through a Process Costing System Suppose the company’s production costs incurred to make 50,000 puzzles and the costs per puzzle are as follows: At any moment, some puzzles are in the assembly process and others are in the cutting process. Computing the puzzles’ cost becomes more complicated when the units are at different places in the production cycle. © 2018 Pearson Education, Inc.

Flow of Costs Through a Process Costing System Companies use process costing to determine the per unit cost in order to: Control costs Set sales prices Calculate account balances for Work-in-Process Inventory Finished Goods Inventory Cost of Goods Sold Companies use process costing to determine the per unit cost in order to control costs, set sales prices, and calculate account balances for Work-in-Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Exhibit 18-3 compares cost flows in a job order costing system for Smart Touch Learning and a process costing system for Puzzle Me. Panel A shows that a job order costing system has a single Work-in-Process Inventory supported by an individual job cost record for each job. Panel B summarizes the flow of costs for a process costing system. Costs flow through the Work-in-Process Inventory Assembly account before going to the Work-in-Process Inventory Cutting account before going into the Finished Goods Inventory. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 2 Calculate equivalent units of production for direct materials and conversion costs © 2018 Pearson Education, Inc.

WHAT ARE EQUIVALENT UNITS OF PRODUCTION, AND HOW ARE THEY CALCULATED? Companies may have products still in process at the end of the accounting period. The total production costs incurred in each process must be split between the following: The units that have been completed in that process and transferred to the next process. The units not completed and remaining in Work-in-Process Inventory. Companies may have products still in process at the end of the accounting period. The total production costs incurred in each process must be split between the units that have been completed in that process and transferred to the next process, and the units not completed and remaining in Work-in-Process Inventory. © 2018 Pearson Education, Inc.

WHAT ARE EQUIVALENT UNITS OF PRODUCTION, AND HOW ARE THEY CALCULATED? Exhibit 18-4 illustrates the point that all costs must be accounted for. They must either remain in the department or be transferred to the next department.   © 2018 Pearson Education, Inc.

Equivalent Units of Production Equivalent units of production (EUP) Measures the amount of materials added to or work done on partially completed units during a period Expressed in terms of fully complete units of output Conversion costs are the sum of direct labor and manufacturing overhead costs and represent the cost to convert direct materials into finished goods. Equivalent units of production (EUP) is used to measure the amount of materials added to or work done on partially completed units and is expressed in terms of fully complete units. © 2018 Pearson Education, Inc.

Equivalent Units of Production Assume Puzzle Me has 40,000 units that the Assembly Department completed and transferred out. Therefore, for units complete and transferred out the equivalent units would be 40,000 units (40,000 units * 100% complete) for both direct materials and conversion costs. Assume Puzzle Me has 40,000 units that the Assembly Department completed and transferred out. Therefore, the equivalent units would be 40,000 units (40,000 units * 100% complete) for both direct materials and conversion costs. © 2018 Pearson Education, Inc.

Equivalent Units of Production Puzzle Me has 10,000 units in ending Work-in-Process Inventory that are 100% complete with respect to direct materials cost and 25% completed with respect to conversion costs. The equivalent units in ending Work-in-Process Inventory in terms of direct materials: The equivalent units in ending Work-in-Process Inventory in terms of conversion costs: Puzzle Me ended the accounting period with 10,000 units in the Assembly Department’s Work-in-Process Inventory. The 10,000 units were 100% complete for direct materials and 25% complete for conversion. Expressed in terms of equivalent units of production, the 10,000 partially completed units are equal to 10,000 EUP for direct materials and 2,500 EUP for conversion costs. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 3 Prepare a production cost report for the first department using the weighted-average method © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED FOR THE FIRST DEPARTMENT? For a comprehensive example of a process costing system, let’s look at Puzzle Me. Exhibit 18-5 illustrates the two major production processes.   In the first process, the Assembly Department applies glue to the cardboard and then presses a picture onto the cardboard. Then the Cutting Department cuts the board into puzzle pieces and packages the puzzles in a box. The box is then moved to finished goods storage. The production process uses materials, machines, and labor in both departments, and there are two work-in-process inventory accounts: one for the Assembly Department and one for the Cutting Department. We are going to complete a lot of calculations in this chapter. As you work through the computations, keep the picture in Exhibit 18-4 in mind so you don’t confuse inputs with outputs. The inputs are the materials, labor, and overhead. The outputs are the completed puzzles. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED FOR THE FIRST DEPARTMENT? A production cost report shows the calculations for the physical flows and the cost flows of the products. Preparing this report involves four steps: Summarize the flow of physical units. Compute output in terms of equivalent units of production. Compute the cost per equivalent unit of production. Assign costs to units completed and units in process. A production cost report must be completed for each department. The production cost reports show the calculations for the physical flows and the cost flows of the products.   There are four steps in preparing a production cost report. The first step is to summarize the flow of physical units. The next step is to compute output in terms of equivalent units of production. The third step is to compute the cost per equivalent unit of production. The last step is to assign costs to units completed and units in process. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED FOR THE FIRST DEPARTMENT? Two unique terms are used on the production cost report: To account for includes the amount in process at the beginning of the period plus the amount started or added during the period. Accounted for shows what happened to the amounts to account for. They are either still in process or completed and transferred out. Two unique terms are used on a production cost report. To account for includes the amount in process at the beginning of the period plus the amount started or added during the period. Accounted for shows what happened to the amounts to account for. They are either still in process or completed and transferred out.   These terms are used for both units and costs. To account for and accounted for must always be equal. © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department The Assembly Department applies glue to the cardboard and then presses a picture onto the cardboard. Operations for this department include two inputs: The direct materials (glue and cardboard) are added at the beginning of the process. The conversion costs are added evenly throughout the process. The Assembly Department applies glue to the cardboard and then presses a picture onto the cardboard. Operations for this department include two inputs: The direct materials (glue and cardboard) are added at the beginning of the process. The conversion costs are added evenly throughout the process. © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department Step 1: Summarize the Flow of Physical Units The physical units are the actual units that the company will account for during the period. The Assembly Department had 8,000 units in process on July 1 and started 42,000 units during the month. The Assembly Department had 8,000 units in process on July 1 and started 42,000 units during the month. Therefore, to account for is 50,000 physical units. The Assembly Department completed the assembly process on 40,000 of the 50,000 units to account for and transferred those units to the Cutting Department. Therefore, the remaining 10,000 units must still be in process, and we have accounted for all units. © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department To account for equals accounted for, so we are ready to record this information on the production cost report. Exhibit 18-6 shows units to account for and units accounted for. Notice that we are completing the UNITS section of the report. At this point, we are not yet assigning costs to units. © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department Step 2: Compute Output in Terms of Equivalent Units of Production The Assembly Department adds all direct materials at the beginning of the process. Equivalent Units of Production for Direct Materials: The Assembly Department worked on 50,000 puzzle boards during July. We have already determined that 40,000 puzzle boards are completed and have been transferred to the next department. If they are completed and transferred out, then they are 100% complete for both direct materials and conversion costs in this department. Another 10,000 puzzle boards are only 25% complete. Equivalent units of production for direct materials total 50,000 because all the direct materials have been added to all 50,000 units worked on during July. Because the direct materials are added at the beginning of the process, if the units are started, then 100% of the materials have been added. © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department Step 2: Compute Output in Terms of Equivalent Units of Production The Assembly Department incurs conversion costs evenly throughout the process. Equivalent Units of Production for Conversion Costs: The Assembly Department worked on 50,000 puzzle boards during July. We have already determined that 40,000 puzzle boards are completed and have been transferred to the next department. If they are completed and transferred out, then they are 100% complete for both direct materials and conversion costs in this department. Another 10,000 puzzle boards are only 25% complete. Conversion costs are 100% complete for the 40,000 puzzle boards completed and transferred out to the Cutting Department, but only 25% of the conversion work has been done on the 10,000 puzzle boards in ending Work-in-Process Inventory. © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department Exhibit 18-7 shows how we use the information from Step 2 to update the production cost report. © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department Step 3: Compute the Cost per Equivalent Unit of Production The Assembly Department has to account for costs associated with the following: Work done last month on the 8,000 partially completed units (beginning work-in-process) Work done this month to complete the 8,000 partially completed units Work done this month on the 42,000 units that were started into production The Assembly Department has to account for costs associated with the following: Work done last month on the 8,000 partially completed units (beginning work-in-process) Work done this month to complete the 8,000 partially completed units Work done this month on the 42,000 units that were started into production © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department Step 3: Compute the Cost per Equivalent Unit of Production The weighted-average method combines the beginning work-in-process costs and the costs added during the period into one cost pool. A cost pool is an accumulation of individual costs. The total costs to be accounted for include direct materials and conversion costs and will be calculated as beginning work-in-process costs plus costs added during the period. The weighted-average method combines the beginning work-in-process costs and the costs added during the period into one cost pool. A cost pool is an accumulation of individual costs. The total costs to be accounted for include direct materials and conversion costs and will be calculated as beginning work-in-process costs plus costs added during the period. © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department Step 3: Compute the Cost per Equivalent Unit of Production To calculate the cost per equivalent unit of production, divide the total costs by the equivalent units of production. Computations are required for both direct materials and conversion costs. © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department Step 3: Compute the Cost per Equivalent Unit of Production The Assembly Department has $208,000 of costs to account for: $140,000 in direct materials costs and $68,000 in conversion costs. In Step 2, we computed equivalent units of production for direct materials as 50,000 EUP and conversion costs as 42,500 EUP. Because the equivalent units of production differ, we must compute a separate cost per equivalent unit of production for direct materials and for conversion costs. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Exhibit 18-8 shows the costs per equivalent unit added to the production cost report. © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department Step 4: Assign Costs to Units Completed and Units in Process The costs must be divided between two outputs: The 40,000 completed puzzle boards that have been transferred out to the Cutting Department. The 10,000 partially completed puzzle boards remaining in the Assembly Department’s ending Work-in-Process Inventory. This is accomplished by multiplying the cost per equivalent unit of production (Step 3) by the equivalent units of production (Step 2). To assign the costs of the two inputs to the two outputs, this step must be repeated four times, to assign: Direct materials costs to: Completed units In process units Conversion costs to: © 2018 Pearson Education, Inc.

Production Cost Report—First Process—Assembly Department Step 4: Assign Costs to Units Completed and Units in Process We have accomplished our goal of splitting the $208,000 total cost between the completed units and the in process units and can record these costs on the production cost report. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Exhibit 18-9 shows the completed production cost report for the Assembly Department. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 4 Prepare a production cost report for subsequent departments using the weighted-average method © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department The Cutting Department receives the puzzle boards from the Assembly Department and cuts the boards into puzzle pieces before inserting the pieces into the box at the end of the process. Glued puzzle boards with pictures are transferred in from the Assembly Department at the beginning of the Cutting Department’s process. The Cutting Department’s conversion costs are added evenly throughout the process. The Cutting Department’s direct materials are added at the end of the process. The Cutting Department receives the puzzle boards from the Assembly Department and cuts the boards into puzzle pieces before inserting the pieces into the box at the end of the process. Operations for this department include three inputs: Glued puzzle boards with pictures are transferred in from the Assembly Department at the beginning of the Cutting Department’s process. The Cutting Department’s conversion costs are added evenly throughout the process. The Cutting Department’s direct materials (boxes) are added at the end of the process. © 2018 Pearson Education, Inc.

Production Cost Report— Second Process— Cutting Department Transferred in costs are costs that were incurred in a previous process and brought into a later process as part of the product’s cost. Keep in mind that direct materials in the Cutting Department refers to the boxes added in that department and not to the materials (cardboard, pictures, and glue) added in the Assembly Department. The costs of the materials from the Assembly Department that are transferred into the Cutting Department are called transferred in costs. Likewise, conversion costs in the Cutting Department refers to the direct labor and manufacturing overhead costs incurred only in the Cutting Department. The conversion costs incurred in the Assembly Department are also transferred in costs for the Cutting Department. The data show that Puzzle Me’s Cutting Department started the July period with 5,000 puzzle boards partially completed through work done in the Cutting Department in June. During July, the Cutting Department started work on 40,000 additional puzzle boards that were received from the Assembly Department. © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department Step 1: Summarize the Flow of Physical Units The Cutting Department has 5,000 units in process on July 1 and receives 40,000 units during the month from the Assembly Department. The Cutting Department completes the cutting and boxing process on 38,000 of the 45,000 units to account for and transfers those units to Finished Goods Inventory. Step 1: Summarize the Flow of Physical Units The Cutting Department had 5,000 units in process on July 1 and received 40,000 units during the month from the Assembly Department. Therefore, to account for is 45,000 units. The Cutting Department completed the cutting and boxing process on 38,000 units of the 45,000 units to account for and transferred those units to Finished Goods Inventory. Therefore, 7,000 units must still be in process and we have accounted for all units. © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department To account for equals accounted for, so we are ready to record this information on the production cost report. Exhibit 18-10 shows the units to account for and units accounted for. Notice that because this is a subsequent department, we must account for units that are transferred in. We show this by having a Transferred In column on the production cost report. © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department Step 2: Compute Output in Terms of Equivalent Units of Production The Cutting Department starts with the units transferred in from the Assembly Department. The equivalent units of production for transferred in are always 100%. Equivalent Units of Production for Transferred In: The Cutting Department is the second department in the process system; it receives units from the Assembly Department. These units are the transferred in units. The equivalent units of production for transferred in are always 100%. © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department Step 2: Compute Output in Terms of Equivalent Units of Production The Cutting Department adds direct materials at the end of the process. Equivalent Units of Production for Direct Materials: Equivalent units of production for direct materials total 38,000 for the completed units because they are 100% complete. However, the units that are in process do not yet have any direct materials added in this department because the box is added at the end of the process. Because they are still in process, the box has not yet been added. © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department Step 2: Compute Output in Terms of Equivalent Units of Production The Cutting Department incurs conversion costs evenly throughout the process. Equivalent Units of Production for Conversion Costs: Conversion costs are complete for the 38,000 puzzles completed and transferred out to Finished Goods Inventory, but only 30% of the conversion work has been done on the 7,000 puzzle boards in ending Work-in-Process Inventory. © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department Exhibit 18-11 shows the production cost report, including the information from Step 2. © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department Step 3: Compute the Cost per Equivalent Unit of Production The Cutting Department has three inputs and therefore must make three calculations for cost per equivalent unit of production. The formulas to compute the cost per equivalent unit of production are the same as used for the Assembly Department; we just need to add the calculation for the transferred in costs. The Cutting Department has three inputs and therefore must make three calculations for cost per equivalent unit of production. © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department Step 3: Compute the Cost per Equivalent Unit of Production The Cutting Department has $233,040 of costs to account for, as illustrated in Exhibit 18-12. The beginning balances and the additional costs incurred were given in the original data. The amount transferred in from the Assembly Department, $176,000, is the amount calculated on the production cost report for the Assembly Department for July as the amount completed and transferred out in the costs accounted for section. Our next task is to split these costs between the 38,000 completed puzzles transferred out to Finished Goods Inventory and the 7,000 partially complete puzzle boards that remain in the Cutting Department’s ending Work-in-Process Inventory. © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department Step 3: Compute the Cost per Equivalent Unit of Production In Step 2, we computed equivalent units of production for transferred in as 45,000 EUP, direct materials as 38,000 EUP, and conversion costs as 40,100 EUP. Because the equivalent units of production differ, we must compute a separate cost per unit for each input. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. These calculations from Step 3 are added to the production cost report, as shown in Exhibit 18-13. © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department Step 4: Assign Costs to Units Completed and Units in Process The $233,040 total costs accounted for by the Cutting Department should be assigned to the following: The 38,000 completed puzzles that have been transferred out to Finished Goods Inventory The 7,000 partially completed puzzle boards remaining in the Cutting Department’s ending Work-in-Process Inventory We assign costs to units completed and units in process by multiplying the cost per equivalent unit of production by the equivalent units of production. To assign the costs of the three inputs to the two outputs, this step must be completed six times, to assign: Transferred in costs to: Completed units In process units Direct materials cost to: Conversion costs to: © 2018 Pearson Education, Inc.

Production Cost Report—Second Process—Cutting Department Step 4: Assign Costs to Units Completed and Units in Process This slide shows the assignment of the costs to units completed and units in process. Once we have accomplished our goal of splitting the $233,040 total cost between the completed units and the in process units, we can record these costs on the production cost report. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. The completed report for the Cutting Department is shown in Exhibit 18-14. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 5 Prepare journal entries for a process costing system © 2018 Pearson Education, Inc.

WHAT JOURNAL ENTRIES ARE REQUIRED IN A PROCESS COSTING SYSTEM? Costs flow through the process costing system in four steps: Accumulate Assign Allocate Adjust Costs flow from one Work-in-Process Inventory account to the next and eventually to Finished Goods Inventory and Cost of Goods Sold. As costs flow through the process costing system, we go through a four-step process of accumulating, assigning, allocating, and adjusting. This is the same process illustrated in the previous chapter for job order costing. Remember that the primary differences between the two costing systems are how costs are accumulated and when costs are assigned. In a process costing system, costs are accumulated in the following accounts: Raw Materials Inventory, the various Work-in-Process Inventory accounts, and Manufacturing Overhead. © 2018 Pearson Education, Inc.

Transaction 1—Raw Materials Purchased During July, the company purchases materials on account for $175,000. The journal entries for process costing are similar to those for job costing. When inventory is purchased on account, the Raw Materials Inventory account is a debit, and Accounts Payable is a credit. © 2018 Pearson Education, Inc.

Transaction 2—Raw Materials Used in Production During July, Puzzle Me assigns direct materials to the two production departments: $130,200 to the Assembly Department and $19,000 to the Cutting Department; $2,000 in indirect materials is accumulated in Manufacturing Overhead. Direct materials are used in production in both the Assembly Department and the Cutting Department. In addition, indirect materials are used. The Work-in-Process Inventory accounts for each department are increased with a debit for the direct materials that are used. Manufacturing Overhead is increased with a debit for the indirect materials used. Raw Materials Inventory is decreased for the total of all materials used. © 2018 Pearson Education, Inc.

Transaction 3—Labor Costs Incurred During the month, Puzzle Me assigns $22,090 in direct labor costs to the Assembly Department and $3,840 in direct labor costs to the Cutting Department. $1,500 in indirect labor costs are accumulated in Manufacturing Overhead. Direct labor is used in production in both the Assembly Department and the Cutting Department. In addition, indirect labor is used. The Work-in-Process Inventory accounts for each department are increased with a debit for the direct labor that is incurred. Manufacturing Overhead is increased with a debit for the indirect labor incurred. Wages Payable is increased for the total of all labor incurred. © 2018 Pearson Education, Inc.

Transaction 4—Additional Manufacturing Costs Incurred Puzzle Me incurs $30,000 in machinery depreciation and $19,000 in indirect costs that were paid in cash. These costs are accumulated in the Manufacturing Overhead account. Additional manufacturing overhead is incurred for depreciation and rent and utilities. Depreciation is recorded with a debit to Manufacturing Overhead and a credit to Accumulated Depreciation. Rent and utilities are recorded with a debit to Manufacturing Overhead and a credit to Cash. © 2018 Pearson Education, Inc.

Transaction 5—Allocation of Manufacturing Overhead Puzzle Me uses a predetermined overhead allocation rate to allocate indirect costs to the departments: $42,000 to the Assembly Department and $11,000 to the Cutting Department. To allocate the manufacturing overhead, Puzzle Me debits the Work-in-Process Inventory account for each department and credits Manufacturing Overhead. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Transaction 6—Transfer from the Assembly Department to the Cutting Department At the end of July, when the production cost report for the Assembly Department is prepared, Puzzle Me assigns $176,000 to the 40,000 units transferred from the Assembly Department to the Cutting Department. The Cutting Department’s Work-in-Process Inventory account is increased, and the Assembly Department’s Work-in-Process Inventory account is decreased. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Transaction 7—Transfer from Cutting Department to Finished Goods Inventory At the end of July, when the production cost report for the Cutting Department is prepared, Puzzle Me assigns $201,400 to the 38,000 units transferred from the Cutting Department to Finished Goods Inventory. This is the cost of goods manufactured. At the end of the month, when the production cost report for the Cutting Department is prepared, the cost of the units transferred from the Cutting Department to Finished Goods Inventory is recorded. Finished Goods Inventory is increased, and the Cutting Department’s Work-in-Process Inventory account is decreased. This is the cost of goods manufactured. © 2018 Pearson Education, Inc.

Transaction 8—Puzzles Sold During July, Puzzle Me sells 35,000 puzzles. The total production cost of manufacturing a puzzle is $5.30. The cost of 35,000 puzzles is $185,500 (35,000 puzzles × $5.30 per puzzle). The puzzles are sold on account for $8.00 each, which is a total of $280,000 (35,000 puzzles × $8.00 per puzzle). The sale of 35,000 puzzles increases Accounts Receivable and Sales Revenue. It also increases Cost of Goods Sold and decreases Finished Goods Inventory. © 2018 Pearson Education, Inc.

Transaction 9—Adjust Manufacturing Overhead The actual manufacturing overhead costs incurred are $50,500. The amount of manufacturing overhead allocated to the two departments is $53,000. The T-account for Manufacturing Overhead shows that the amount of manufacturing overhead allocated is $500 more than the actual costs incurred. This means the overhead is overallocated. © 2018 Pearson Education, Inc.

Transaction 9—Adjust Manufacturing Overhead The adjusting entry for overallocated or underallocated manufacturing overhead is usually prepared at the end of the year. We are showing it here at the end of the month so we can illustrate all journal entries for a process costing system. This means manufacturing overhead is overallocated by $500, requiring an adjustment at the end of the period. © 2018 Pearson Education, Inc.

WHAT JOURNAL ENTRIES ARE REQUIRED IN A PROCESS COSTING SYSTEM? This slide illustrates the key accounts after posting. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 6 Use a production cost report to make decisions © 2018 Pearson Education, Inc.

HOW CAN THE PRODUCTION COST REPORT BE USED TO MAKE DECISIONS? Controlling costs Evaluating performance Pricing products Identifying the most profitable products Preparing the financial statements Managers use the production cost report to make decisions for their companies. Controlling costs: Puzzle Me uses product cost data to look for ways to reduce costs. This may include changing suppliers to reduce the cost of raw materials or changing a component in the production process to reduce direct materials costs. To reduce labor costs, a manager may need employees with different skill levels paid at different hourly rates. Perhaps more skilled employees would require a higher pay rate but be more efficient. The increase in cost per labor hour may be more than offset by the increased productivity of the workers. Evaluating performance: Managers are often rewarded based on how well they meet the budget. Puzzle Me compares the actual direct materials and conversion costs with expected amounts. If actual costs are too high, managers look for ways to cut. If actual costs are less than expected, the managers may receive a bonus. Pricing products: Puzzle Me also uses product cost data to set the price for the product. Puzzle Me’s selling price must be high enough to cover the manufacturing cost of each puzzle plus marketing and distribution costs. Identifying the most profitable products: Selling price and cost data help managers figure out which products are most profitable. They can then promote these products to help increase profits. Preparing the financial statements: Finally, the production cost report aids in preparing the financial statements. It provides inventory data for the balance sheet and cost of goods sold for the income statement. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 7 Prepare a production cost report using the first-in, first-out method (Appendix 18A) © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Equivalent unit of production cost methods: Weighted-average method First-in, first-out The first-in, first-out method (for Process Costing) determines the cost of equivalent units by accounting for beginning inventory separately. The chapter illustrates how to complete the production cost reports for Puzzle Me using the weighted-average method. In the weighted-average method, the costs from the beginning balance in Work-in-Process Inventory are combined with the current period cost when determining the cost per equivalent units of production. Another method for assigning production costs is the first-in, first-out method. The first-in, first-out method (for Process Costing) determines the cost of equivalent units of production by accounting for beginning inventory costs separately from current period costs. It assumes that the first units started are the first units completed and sold. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? The data related to Puzzle Me’s Assembly Department is shown to the left. We can use the same four-step procedure to complete the production cost report for the Assembly Department for July using the FIFO method: 1. Summarize the flow of physical units. 2. Compute output in terms of equivalent units of production. 3. Compute the cost per equivalent unit of production. 4. Assign costs to units completed and units in process. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Step 1: Summarize the Flow of Physical Units The Assembly Department has 8,000 units in process on July 1 and starts 42,000 units during the month. Therefore, to account for is 50,000 units. This is the same as in the weighted-average method. The Assembly Department has 8,000 units in process on July 1 and starts 42,000 units during the month. Therefore, to account for is 50,000 units. This is the same as in the weighted-average method. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Step 1: Summarize the Flow of Physical Units If 40,000 units are completed and transferred, this includes the 8,000 units in beginning inventory plus another 32,000 units started in July. We must account for 50,000 units. If 40,000 are transferred out, then that leaves 10,000 still in process at the end of July. Using the FIFO method creates three groups of units to be accounted for: Units in beginning inventory started in June and completed in July Units started in July and completed in July Units started in July but not completed in July (These units are still in process at the end of July and will be completed in August.) The information for the Assembly Department shows 8,000 units in beginning inventory and 40,000 units transferred out. If 40,000 units are completed and transferred, this includes the 8,000 units in beginning inventory plus another 32,000 units started in July. Remember, FIFO stands for first-in, first-out. Therefore, it is assumed that the first units in (those in beginning inventory) are the first units out. We must account for 50,000 units. If 40,000 units are transferred out, then that leaves 10,000 still in process at the end of July. We have now accounted for all units. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Step 1: Summarize the Flow of Physical Units Exhibit 18A-1 illustrates the three groups of units accounted for. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Exhibit 18A-2 shows the units to account for and units accounted for. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Step 2: Compute Output in Terms of Equivalent Units of Production The Assembly Department adds direct materials at the beginning of the process. Equivalent Units of Production for Direct Materials: In the FIFO method, costs from the previous period are not merged with the costs from the current period. Therefore, the EUP calculation is for the current period. The Assembly Department adds direct materials at the beginning of the process, and conversion costs are incurred evenly throughout the process. Thus, we must compute equivalent units of production separately for direct materials and conversion costs. Because Puzzle Me adds materials at the beginning of the process, no additional direct materials are added to complete the beginning work-in-process units. The completed units and ending WIP are 100% complete for direct materials. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Step 2: Compute Output in Terms of Equivalent Units of Production The Assembly Department incurs conversion costs evenly throughout the process. Equivalent Units of Production for Conversion Costs: In the FIFO method, costs from the previous period are not merged with the costs from the current period. Therefore, the EUP calculation is for the current period. The Assembly Department adds direct materials at the beginning of the process, and conversion costs are incurred evenly throughout the process. Thus, we must compute equivalent units of production separately for direct materials and conversion costs. This is the section where the difference between the weighted-average and FIFO methods is most obvious. Beginning WIP―The 8,000 units in process at the beginning of July were 60% complete. That means 60% of the work was done in June. We are concerned with the work completed in July. If 60% of the work was done in June and the units were completed in July, then 40% of the work was done in July (100% – 60% = 40%). Therefore, the EUP for these units is 8,000 units × 40% = 3,200 EUP. Started and Completed―For the 32,000 units started and completed in July, all (100%) of the work done on the units started and completed was done in July, so the equivalent units of production are 32,000 units × 100% = 32,000 EUP. In Process―Only 25% of the conversion work has been done on the 10,000 puzzle boards in ending Work-in-Process Inventory. Equivalent units of production are 10,000 units × 25% = 2,500 EUP. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Step 2: Compute Output in Terms of Equivalent Units of Production Exhibit 18A-3 illustrates the timing of the incurrence of conversion costs. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Exhibit 18A-4 shows the production cost report with the EUP calculations added. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Step 3: Compute the Cost per Equivalent Unit of Production The Assembly Department has $208,000 of costs to account for. The Assembly Department has two inputs and therefore must make two calculations for cost per equivalent unit of production. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Step 3: Compute the Cost per Equivalent Unit of Production Our next task is to split these costs between the 40,000 completed puzzle boards transferred out to the Cutting Department and the 10,000 partially complete puzzle boards that remain in the Assembly Department’s ending Work-in-Process Inventory. In Step 2, we computed equivalent units of production for direct materials as 42,000 EUP and conversion costs as 37,700 EUP. Because the equivalent units of production differ, we must compute a separate cost per unit for each input. Also, the numerator for each calculation is the cost incurred in the current period, not total costs, because of the FIFO method. We need to calculate the cost per EUP for the current period. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. The costs to account for calculations are added to the production cost report, as shown in Exhibit 18A-6. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? Step 4: Assign Costs to Units Completed and Units in Process The $208,000 total costs must be assigned to: The 8,000 puzzle boards from beginning inventory that have now been completed and transferred to the Cutting Department. The 32,000 started and completed puzzle boards that have also been transferred to Cutting Department. The 10,000 partially completed puzzle boards remaining in the Assembly Department’s ending Work-in-Process Inventory. We assign costs to units completed and units in process by multiplying the cost per equivalent unit of production by the equivalent units of production. To assign the costs of the two inputs to the three groups of outputs, this step must be repeated six times, to assign: Direct materials cost to: Complete beginning units Started and completed units In process units Conversion costs to: process Complete beginning units In units In addition, the costs in beginning WIP must be added to the above calculations for costs incurred in the current period. © 2018 Pearson Education, Inc.

HOW IS A PRODUCTION COST REPORT PREPARED USING THE FIFO METHOD? We have accomplished our goal of splitting the $208,000 total cost between the completed units and the in process units and can record these costs on the production cost report. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. The completed production cost report is shown in Exhibit 18A-7. Notice that the cost per unit for the units that were in beginning WIP is $2.39 ($19,150 / 8,000 units) and the cost per unit for the units started and completed in July is $4.80 ($153,600 / 32,000 units). This indicates that costs varied from June to July. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Exhibit 18A-8 shows the completed production cost report for July for the Assembly Department using the weighted-average method. This is a duplicate of Exhibit 18-9 from the chapter. Compare it to Exhibit 18A-7. © 2018 Pearson Education, Inc.

Comparison of Weighted-Average and FIFO Methods Notice the differences in the completed and transferred out costs and ending work-in-process costs under each method. The total costs are the same, regardless of which method is used. The difference between the two methods relates to how the total costs of $208,000 is split between completed and transferred out and ending work-in-process. If a business operates in an industry that experiences significant cost changes, it would be to its benefit to use the FIFO method. The FIFO method would create better month-to-month cost comparisons. This would be especially evident when there are substantial quantities of units in process at the end of the period. The more detailed cost information obtained from the FIFO method would allow managers to make better pricing and product mix decisions. If a business operates in an industry that does not experience significant cost changes, the weighted-average method would be appropriate. This method is easier to use, and the additional benefit derived from more detailed calculations would not outweigh the cost of obtaining them. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc.