Cornerstones of Managerial Accounting, 5e © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Chapter 6: Process Costing Cornerstones of Managerial Accounting, 5e © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Characteristics of Process Manufacturing Each product within a line passing through the processes would receive similar ‘‘doses’’ of materials, labor, and overhead costs. Process costing works well whenever homogeneous products pass through a series of processes and receive similar amounts of manufacturing costs. LO-1 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Types of Processes Sequential processing requires that units pass through one process before they can be worked on in the next process in the sequence. Parallel processing is another processing pattern that requires two or more sequential processes to produce a finished good. LO-1 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Types of Processes (cont.) Partially completed units (e.g., two subcomponents) can be worked on simultaneously in different processes and then brought together in a final process for completion. LO-1 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 5

What’s In Common? No matter which processing pattern exists within a firm, all units produced share a common property. Units are homogeneous and subjected to the same operations for a given process and each unit produced in a period should receive the same unit cost. Understanding how unit costs are computed requires insight of the manufacturing cost flows that take place in a process-costing firm. LO-1 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 6

How Costs Flow through the Accounts in Process Costing The manufacturing cost flows for a process-costing system are the same as those for a job-order system. As raw materials are purchased, the cost of these materials flows into a raw materials inventory account. Similarly, raw materials, direct labor, and applied overhead costs flow into a work-in-process (WIP) account. LO-1 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 7

How Costs Flow through the Accounts in Process Costing (cont.) When goods are completed, the cost of the completed goods is transferred from WIP to the finished goods account. Finally, as goods are sold, the cost of the finished goods is transferred to the cost of goods sold account. The journal entries generally parallel those described in a job-order costing system. LO-1 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 8

How Costs Flow through the Accounts in Process Costing (cont.) Although job-order and process cost flows are generally similar, some differences exist. In process costing, each producing department has its own WIP account. As goods are completed in one department, they are transferred to the next department. The costs attached to the goods transferred out are also transferred to the next department. LO-1 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 9

How Costs Flow through the Accounts in Process Costing (cont.) © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 10

Accumulating Costs in the Production Report In process costing, costs are accumulated by department for a period of time. The production report is the document that summarizes the manufacturing activity that takes place in a process department for a given period of time. LO-1 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 11

Accumulating Costs in the Production Report (cont.) A production report contains information on costs transferred in from prior departments as well as costs Added in the department such as direct materials, direct labor, and overhead Similar to the job-order cost sheet A subsidiary to the WIP account LO-1 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 12

Accumulating Costs in the Production Report (cont.) A production report traces the flow of units through a department, identifies the costs charged to the department, shows the computation of unit costs, and reveals the disposition of the department’s costs for the reporting period. Unit information section: The unit information section has two major subdivisions: • units to account for • units accounted for Cost information section: The cost information section has two major subdivisions: • costs to account for • costs accounted for Unit ^^^^^^^^Cost ^^^^^^^^ LO-1 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 13

The Impact of Work-In-Process Inventories on Process Costing Calculating the unit cost is easy—just divide total cost by the number of units produced. The presence of WIP inventories causes problems: Defining the units produced can be difficult, given that some units produced during a period are complete, while those in ending inventory are not. This is handled through the concept of equivalent units of production. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 14

The Impact of Work-In-Process Inventories on Process Costing (cont.) How should the costs and work of beginning work-in-process (BWIP) be treated? Should they be counted with the current period work and costs or treated separately? Two methods have been developed to solve this problem: the weighted average method and the FIFO method. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 15

Equivalent Units of Production By definition, EWIP is not complete. Thus, a unit completed and transferred out during the period is not identical (or equivalent) to one in EWIP inventory, and the cost attached to the two units should not be the same. In computing the unit cost, the output of the period must be defined, a significant issue for process costing. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 16

Equivalent Units of Production (cont.) The solution is to calculate equivalent units of output. Equivalent units of output are the complete units that could have been produced given the total amount of manufacturing effort expended for the period under consideration. Determining equivalent units of output for transferred-out units is easy; a unit would not be transferred out unless it was complete. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 17

Equivalent Units of Production (cont.) Every transferred-out unit is an equivalent unit. Units remaining in EWIP inventory are not complete. Someone in production must ‘‘eyeball’’ EWIP to estimate its degree of completion. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 18

Two Methods of Treating Beginning Work-in-Process Inventory In computing a current-period unit cost for a department, two approaches have evolved for dealing with the prior-period output and prior-period costs found in BWIP: The weighted average costing method and The FIFO costing method. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 19

The Weighted Average Costing Method The weighted average costing method combines beginning inventory costs and work done with current-period costs and work to calculate this period’s unit cost. Costs and work carried over from the prior period are counted as if they belong to the current period. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 20

The Weighted Average Costing Method (cont.) Beginning inventory work and costs are pooled with current work and costs, and an average unit cost is computed and applied to both units transferred out and units remaining in ending inventory. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 21

The FIFO Costing Method The FIFO costing method separates work and costs of the equivalent units in beginning inventory from work and costs of the equivalent units produced during the current period. Only current work and costs are used to calculate this period’s unit cost. It is assumed that units from beginning inventory are completed first and transferred out. The costs of these units include the costs of the work done in the prior period as well as the current period costs necessary to complete the units. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 22

The FIFO Costing Method Units started in the current period are divided into two categories: units started and completed and units started but not finished (EWIP). Units in both of these categories are valued using the current period’s cost per equivalent unit. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 23

Weighted Average Costing The weighted average costing method treats beginning inventory costs and the accompanying equivalent output as if they belong to the current period. This is done by adding the manufacturing costs in BWIP to the manufacturing costs incurred during the current period. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 24

Weighted Average Costing (cont.) The total cost is treated as if it were the current period’s total manufacturing cost. Beginning inventory output and current period output are merged in the calculation of equivalent units. Under the weighted average method, equivalent units of output are computed by adding units completed to equivalent units in EWIP. LO-2 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 25

Five Steps in Preparing a Production Report The production report is subsidiary to the WIP account for a department. The following five steps describe the general pattern of a process-costing production report: physical flow analysis calculation of equivalent units computation of unit cost valuation of inventories (goods transferred out and EWIP) cost reconciliation LO-3 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 26

Evaluation of the Weighted Average Method Advantages Disadvantages Unit cost computations are simplified Units in BWIP are treated as those of the current period and all equivalent units belong to the same category to calculate unit costs. Inaccuracies in computing unit costs for current period output and for units in BWIP If the unit cost in a process is stable from one period to the next, the weighted average method is accurate. If the price of manufacturing inputs increases from one period to the next, the unit cost of current output is understated, and the unit cost of BWIP units is overstated. LO-3 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 27

Multiple Departments In process manufacturing, some departments receive partially completed goods from prior departments. Treat transferred-in goods as a separate material category when calculating equivalent units LO-4 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 28

Multiple Departments (cont.) The department receiving transferred-in goods would have three input categories: one for the transferred-in materials one for materials added one for conversion costs LO-4 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 29

Appendix: Production Report- First-In, First-Out Costing Under the FIFO costing method, the equivalent units and manufacturing costs in BWIP are excluded from the current period unit cost calculation. This method recognizes that the work and costs carried over from the prior period belong to that period. LO-5 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 30

Differences in First-In, First-Out and Weighted Average Methods FIFO Weighted Average More Accurate: If changes occur in the prices of the manufacturing inputs from one period to the next. Better cost control Better pricing decisions Most firms use this method due to simplicity. FIFO has little advantage over weighted average, if unit costs are calculated for short periods. LO-5 © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 31