Process Costing Chapter 04 Introduction to Managerial Accounting Chapter 4: Process Costing Managers need to assign costs to products to facilitate external financial reporting and internal decision making. This chapter illustrates an absorption costing approach to calculating product costs known as process costing. Introduction to Managerial Accounting Brewer, Garrison,Noreen Power Points from website - adapted by Cynthia Fortin, CPA, CMA http://highered.mheducation.com/sites/0078025419/student_view0/chapter4/powerpoint_presentations.html

Similarities Between Job-Order and Process Costing Material, labor, and overhead costs assigned to products to compute unit product costs. Same manufacturing accounts. Same flow of costs 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.

Quick Check  Process costing is used for products that are: a. Different and produced continuously. b. Similar and produced continuously. c. Individual units produced to customer specifications. d. Purchased from vendors. Can you identify the most likely circumstances where a process costing system may be used?

Quick Check  Process costing is used for products that are: a. Different and produced continuously. b. Similar and produced continuously. c. Individual units produced to customer specifications. d. Purchased from vendors. Can you identify the most likely circumstances where a process costing system may be used?

Differences

Manufacturing Overhead Job-Order Costing Direct Materials Work in Process Finished Goods Direct Labor Cost of Goods Sold The flow of costs through the manufacturing accounts is basically the same for process and job-order costing. Direct materials, direct labor, and manufacturing overhead are added to Work in Process. When work in process is completed, the costs are transferred to Finished Goods. When finished goods are sold, the costs are transferred to Cost of Goods Sold. Manufacturing Overhead

Manufacturing Overhead Comparing Job-Order Costs are traced and applied to individual jobs in a job-order cost system. Direct Materials Jobs Finished Goods Direct Labor There is a key fundamental difference between process and job-order costing systems. Job-order costing systems trace and apply manufacturing costs to jobs. One Work in Process account is often used to accumulate costs for all jobs. The individual job cost sheets serve as a subsidiary ledger. Manufacturing Overhead Cost of Goods Sold

Process Costing Processing Department Costs are traced and applied to departments in a process cost system. Direct Materials Processing Department Finished Goods Direct Labor In a process costing system, costs are traced to departments that process the goods. In some companies there may be several processing departments that goods must pass through to become finished goods. A separate Work in Process account is maintained for each processing department. Material, labor, and overhead costs transferred from one department’s Work in Process account to another department’s Work in Process account are called transferred-in costs. Manufacturing Overhead Cost of Goods Sold

Sequential processing departments

T-Account Views of Process Cost Flows Megan's Classic Cream Soda, a company that has two processing departments—Formulating and Bottling. Formulating Department ingredients are checked for quality (Raw material: water, sugar, carbon dioxide and flavours) mixed and injected with carbon dioxide to create bulk cream soda. Bottling Department (Raw material: bottles, caps and packing) bottles are checked for defects, filled with cream soda, capped, visually inspected again for defects, packed for shipping. 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 Formulating Raw Materials Direct Materials Direct Materials Work in Process Bottling 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. To record materials used in each department

Process Cost Flows: The Flow of Labor Costs Salaries and Wages Payable Work in Process Formulating Direct Materials Direct Labor Direct Labor Work in Process Bottling 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 To record labor costs in each department

Process Cost Flows: The Flow of Manufacturing Overhead Costs Work in Process Formulating Direct Materials Manufacturing Overhead Direct Labor Actual Overhead Overhead Applied to Work in Process Applied Overhead Work in Process Bottling 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 To record applied mfg overhead in each department

Process Cost Flows: Transfers from WIP-Formulating to WIP Bottling Work in Process Formulating Work in Process Bottling Direct Materials Transferred to Bottling Transferred from Formulating 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.

Process Cost Flows: Transfers from WIP Bottling to Finished Goods Work in Process Bottling Finished Goods Direct Materials Cost of Goods Manufactured Cost of Goods Manufactured Direct Labor Applied Overhead Transferred from Formulating 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 goods manufactured.

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

Equivalent units After materials, labor, and overhead costs have been accumulated in a department, the department's output must be determined so that unit product costs can be computed. W.I.P. has partially completed units which will be translated into an equivalent number of completed units.

Equivalent Units – The Basic Idea Two half-completed products are equivalent to one complete product. + = 1 The basic idea behind equivalent units is quite easy to understand, but the computation of equivalent can become complex. Here we can say the two half-completed units of production are equal to one complete unit. Using this logic, we can say that 10,000 units that are 70% complete are equivalent, or the same as, 7,000 complete units. So, 10,000 units 70% complete are equivalent to 7,000 complete units.

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?

Equivalent Units of Production 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. Equivalent units = Units transferred out + equivalent units in ending Work in Process Inventory. When we use the weighted-average method we make no distinction between work done in the prior period and work done in the current period. We blend together the units and costs from both the prior and current period. We determine the cost per equivalent unit by dividing costs for the period by the equivalent units of production. The equivalent units of production for a department are the number of units transferred to the next department (or finished goods) plus the equivalent units in the department’s ending Work in Process Inventory.

Compute and Apply Costs The formula for computing the cost per equivalent unit is: Cost per equivalent unit = Cost of beginning Work in Process Inventory Cost added during the period Equivalent units of production + We calculate the cost per equivalent unit by adding together the cost of beginning Work in Process Inventory and the cost added during the period. We divide the total dollar amount by the number of equivalent units we previously calculated.

Treatment of Direct Labor Direct Materials Direct labor costs may be small in comparison to other product costs in process cost systems. Manufacturing Overhead Dollar Amount Direct Labor In today’s economy, direct labor costs are becoming small when compared to materials and overhead costs. Automation is one of the causes for this shift. Type of Product Cost

Treatment of Direct Labor Direct Materials Direct labor and manufacturing overhead may be combined into one classification of product cost called conversion costs. Conversion Direct Labor Dollar Amount Direct Labor As a consequence of the change in volume of direct labor costs, many companies combine labor and overhead costs and refer to the total as conversion costs. That is, these are the costs incurred to convert the direct materials into a finished good. We will make extensive use of the notion of direct materials and conversion costs in the remainder of this chapter. Manufacturing Overhead Type of Product Cost

Double Diamond Skis Production Process

Shaping and Milling Dept. Data for May operations

Skis process.docx