Management Accounting 28th February 2011 Process Costing Management Accounting 28th February 2011

Process Costing Is used mainly when a company makes one item continuously Unlike Job Order Costing where each JOB is costed on a separate JOB CARD Both systems have the same basic purpose, to assign the costs of production to the COST OBJECT(S) Please read and understand Pg 153 differences between Job and Process Costing and ask any questions you may have

Cost Flows Raw Materials (RM) Work In Progress (WIP) Finished Goods (FG)

Raw Materials Raw Materials or Inventory are the objects which go into making the COST OBJECT before any conversion process has taken place In our example of a Chair the Raw Materials would be the stock of Wood, Nails and Glue before it is requisitioned for a job Or the example on Page 153 is of Potatoes before they are transformed into Potato Chips

Work In Progress Work in Progress is the materials as they are being transformed into the final product In our example of a chair this is the Nails, Wood and Glue as they are being put together Or in the example on Pg 153 it refers to the Potatoes as they are Cut, Cooked and Packaged

Finished Goods Finished Goods are the completed product which has not yet been sold In Our Example this would be the completed chair In the example on Pg 153 it is the packaged Potato Chips

What Happens during each of these stages? Raw Materials are our Direct Materials before any Direct Labour has been applied Work in Progress are the Direct Material as the Direct Labour is being applied Finished Goods are the completed products RM, WIP and FG are one way of understanding how costs accumulate during the Production Process

Direct Material and Direct Labour Production Process Finished Goods All Costs assigned Total Costs include all Direct Materials, Labour and Allocated Overheads Work In Progress Direct Material and Direct Labour Goods not complete so Overheads not allocated fully, only according to Conversion % Raw Materials Direct Materials No Direct Labour

Cost Accumulation Costs accumulate as the Production Process moves forward Costs can therefore be calculated depending on what stage they are in the Production Process This has the advantage of more accurately assigning costs and controlling wastage

System Design Process Costing Systems are designed along exactly the same lines as Job Costing as materials, labour and overheads are allocated depending on the % of the conversion process completed Therefore if Work in Progress has to be written off at some stage of production we have a more accurate record of the costs of wastage This is particularly useful in systems of continuous production (Think of Plastic Bottles)

How we measure costs in a Process Costing System Step One – Determine Equivalent Units Step Two – Compute Costs Step Three - Apply Costs

2 Methods for Determining EQUIVILENT UNITS FIFO (First In First Out) Weighted Average Method For simplicities sake we will be using the Weighted Average Method

Weighted Average Method – Step One You will be looking at a defined period of time, in this example one week Find Beginning Work in Progress (WIP) for the period Find Units Started into production during the period Find Units Completed in the period Find ending (WIP)

March 2011 Pressing Department % Complete Beginning WIP Units Started into Production Units Completed Ending WIP Units Materials Conversion 300 6000 5000 600

Step Two Find the % of Materials which have been utilised for each of these classifications Assume that Units Completed have a utilisation rate for Materials of 100% (ALL THE MATERIALS FOR THIS PROCESS HAVE BEEN USED)

March 2011 Pressing Department % Complete Beginning WIP Units Started into Production Units Completed Ending WIP Units Materials Conversion 300 6000 5000 600 55% n/a 100% 40%

Step Three Find the Conversion Rate (this is how far the units have moved through the production process) Assume that the Conversion Rate for Units Completed is always 100% (These units have used all the direct materials/Labour and Overheads that they are going to at this point of the process)

March 2011 Pressing Department % Complete Beginning WIP Units Started into Production Units Completed Ending WIP Units Materials Conversion 400 6000 5000 600 55% n/a 100% 40% 35% 50%

Step 4 – Determining the Equivalent Units Find units completed Weight the Ending WIP according to the % utilisation of Materials and Conversion Do not worry about beginning WIP as this forms a part of the Units completed in the period

Equivalent Units Units Completed = 5000 Ending WIP Materials 600 x 40% (0.4) =240 Conversion 600 x 50% (0.5) = 300 OR Pressing March 2011 Materials Conversion Units Transferred 5000 Ending WIP - Materials (600 x 0.4) 240 - Conversion (600 x 0.5) 300 Equivalent Units of Production 5240 5300

The Next Step – Compute and Apply Costs Costs are computed and applied for Starting WIP, Units Completed in the Period and Ending WIP and Weighted according to EQUVILENT UNITS You will generally be given costs

Starting WIP Starting WIP Units In Process 400 Stage Completion (Materials) 55% Stage Completion (Conversion) 35% Costs in the Beginning Inventory $ - Materials Cost 8000 - Conversions Costs 4000 Total Costs 12000

Units Started In Production WIP 6000 Units Completed 5000 Costs Added During Process $ - Materials Cost 100,000 - Conversions Costs Total Costs 200,000

Ending WIP Starting WIP Units In Process 600 Stage Completion (Materials) 40% Stage Completion (Conversion) 50%

Cost Per Equivalent Unit Cost of beginning WIP Inventory + Cost Added during the period Equivalent Units of Production

Equivalent Costs Materials Conversion Cost of Beginning WIP Inventory 8000 4000 Cost Added During the Period 100,000 Total Cost 108000 104000 Equivalent Units of Production 5240 5300 Cost Per Equivalent Unit 20.61 19.62

Applying the Costs The Equivalent Cost Per Unit is used to value WIP that is moving through the processes We must ensure that we know the Ending WIP value as well as its % use of conversion and materials as this is what the next Process costing in the following period will be based upon

Back to the Example Find the proportion of units left in the process by both Material and conversion percentage Multiply these by the respective costs

Cost of WIP and Finished Goods Material Conversion Total Ending WIP 240 300 Cost Per Equivilent Unit 20.61 19.62 Cost of Ending WIP 4946.4 5886 10832.4 Units Completed 5000 Cost Of Finished Goods 103050 98100 201150

Seminar Problem A Process Costing for the following information

Production Information for the Period Cost Information For the Period Milling Dept Units Materials Conversion Begining WIP 200 30% 40% Units Started in Period 1000 Units Completed 900 100% Ending WIP 300 35% Cost Information For the Period $ - Materials 500 - Conversion 350 Total Begining WIP 850 2500 1750 Total Finished Goods 4250

Step One – Find Equivalent Units of Production Refer to Page 159

Equivilent Units Of Production Materials Conversion Units Transfered (FG) 1000 Ending WIP 105 120 Totals 1105 1120

Step Two – Cost Per Equivalent Unit Refer to page 160

Cost of Begining WIP 500 350 Costs Added In the Period 2500 1750 Total Costs 3000 2100 Equivilent Units 1105 1120 Cost per Equivilent Unit ($) 2.71 1.88

Apply costs Refer to Page 161

Apply Costs Materials Conversion Total Ending WIP 105 120 Cost Per Equivilent Unit 2.71 1.88 Cost of Ending WIP 285.07 225.00 510.07 Finished Goods Units Completed 1000 Cost per Equivilent Unit Cost of Units Transfered Out 2710 1880 4590

Apply Costs Materials Conversion Total Ending WIP 105 120 Cost Per Equivilent Unit 2.71 1.88 Cost of Ending WIP 285.07 225.00 510.07 Finished Goods Units Completed 1000 Cost per Equivilent Unit Cost of Units Transfered Out 2710 1880 4590 Reconciliation   5100.00 Cost of Begining WIP 850 Cost of Finished Goods 4250 Total Costs to Account for 5100