Hilton Maher Selto

8 Process-Costing Systems McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

8-3 Process Costing is a costing system that assigns costs equally to homogeneous units within a particular time period. This is an appropriate system to use when: Units do not differ from each other. Unit cycle time is relatively short. The production process is continuous. This is an appropriate system to use when: Units do not differ from each other. Unit cycle time is relatively short. The production process is continuous. Process Costing System Design

8-4 Process Costing at Monterrey Bay Abalone Human and physical resources Cultivation process activities Grow-out process activities Market-size abalone Finished Goods Inventory

8-5 Process Costing: The Basics Costs will be accumulated by process. They will not be traced to individual units of product. Direct Materials Conversion Costs Raw material directly traceable to the process. Labor and overhead directly traceable to the process.

8-6 Process Costing: The Basics Direct Materials (DM) Conversion Costs (CC) +

8-7 Process Costing: The Basics  Determine total Direct Material costs  Compute DM Cost per Unit  Determine total Conversion Costs  Compute CC Cost per Unit  Add Steps 2 and 4 to get Total Cost per Unit  COGS = Step 5 × Units Sold  Ending Inventory = Step 5 × Units Not Sold  Determine total Direct Material costs  Compute DM Cost per Unit  Determine total Conversion Costs  Compute CC Cost per Unit  Add Steps 2 and 4 to get Total Cost per Unit  COGS = Step 5 × Units Sold  Ending Inventory = Step 5 × Units Not Sold

8-8 Example 1: All Units Fully Completed (No WIP) Toothpick, Inc. is a new company that makes toothpicks from damaged antique furniture. The product sells at a premium and is in high demand. During June, they purchased 8,000 pounds of wood scraps costing $67,000. They spent $6,500 on labor. Toothpick, Inc. incurred other process overhead (insurance, rent, benefits, etc.) of $6,000. They produced and sold 250,000 toothpicks during June. There were no units in beginning or ending WIP inventory. Compute the cost per toothpick produced. Toothpick, Inc. is a new company that makes toothpicks from damaged antique furniture. The product sells at a premium and is in high demand. During June, they purchased 8,000 pounds of wood scraps costing $67,000. They spent $6,500 on labor. Toothpick, Inc. incurred other process overhead (insurance, rent, benefits, etc.) of $6,000. They produced and sold 250,000 toothpicks during June. There were no units in beginning or ending WIP inventory. Compute the cost per toothpick produced.

8-9? Example 1: All Units Fully Completed (No WIP) Direct Materials (DM) Conversion Costs (CC) +

8-10 Some Units Not Fully Complete (Ending WIP) In many cases, there will be some units at the end of the month still in the process. With a continuous process, it would be unrealistic to expect every unit to be complete at the end of each month We must compute EQUIVALENT UNITS of Production for the items still in Ending WIP.

8-11 Some Units Not Fully Complete (Ending WIP) We have to compute EQUIVALENT UNITS in Ending WIP for both Direct Materials and for Conversion Costs. For example, two half full glasses are equivalent to 1 full glass.

8-12 Total EQUIVALENT UNITS = EU in Ending WIP + Units Completed and Transferred to Finished Goods. Some Units Not Fully Complete (Ending WIP)

8-13 Some Units Not Fully Complete (Ending WIP)  Summarize the flow of physical units.  Compute the number of equivalent units.  Summarize the total costs to account for (for both DM and CC)  Compute costs per equivalent unit.  Assign costs to COGS and to ending WIP.  Summarize the flow of physical units.  Compute the number of equivalent units.  Summarize the total costs to account for (for both DM and CC)  Compute costs per equivalent unit.  Assign costs to COGS and to ending WIP.

8-14 For July, Toothpick purchased 9,000 pounds of wood scraps for $72,000. They spent $7,500 on labor and had other process overhead of $7,404. Toothpick started 300,000 units in July, completing and selling 260,000 units. Ending WIP had 40,000 toothpicks. Beginning WIP was zero. The ending WIP was 100% complete with respect to material, but only 40% of the conversion work has been done. Compute the cost per toothpick produced. Also, compute the Ending WIP Inventory and COGS. For July, Toothpick purchased 9,000 pounds of wood scraps for $72,000. They spent $7,500 on labor and had other process overhead of $7,404. Toothpick started 300,000 units in July, completing and selling 260,000 units. Ending WIP had 40,000 toothpicks. Beginning WIP was zero. The ending WIP was 100% complete with respect to material, but only 40% of the conversion work has been done. Compute the cost per toothpick produced. Also, compute the Ending WIP Inventory and COGS. Example 2: Some Units Not Fully Complete (Ending WIP)

8-15 Example 2: Some Units Not Fully Complete (Ending WIP) 100% complete for materials 100% complete for conversion 100% complete for materials 100% complete for conversion 100% complete for materials 40% complete for conversion 100% complete for materials 40% complete for conversion..

8-16 Example 2: Some Units Not Fully Complete (Ending WIP)..

8-17 Example 2: Some Units Not Fully Complete (Ending WIP)

8-18 Example 2: Some Units Not Fully Complete (Ending WIP)

8-19 Example 2: Some Units Not Fully Complete (Ending WIP)

8-20 Example 2: Some Units Not Fully Complete (Ending WIP). Ending WIP = $9,600 + $864 = $10,464

8-21 Primary question to be answered: Which units were completed first during the period? (How you answer this question will affect the Total EU for the period.) Primary question to be answered: Which units were completed first during the period? (How you answer this question will affect the Total EU for the period.) Beginning & Ending WIP When there is Beginning WIP, the determination of equivalent units becomes somewhat more complicated.

8-22 Beginning & Ending WIP Weighted Average vs. FIFO Weighted- Average All units and costs are considered together to determine average cost per EU, regardless of whether the costs were incurred last period or currently. Weighted- Average All units and costs are considered together to determine average cost per EU, regardless of whether the costs were incurred last period or currently. FIFO Costs are accounted for by layer. Cost per EU for this period is computed separately from the Cost per EU for last period. FIFO Costs are accounted for by layer. Cost per EU for this period is computed separately from the Cost per EU for last period.

8-23 Beginning & Ending WIP Weighted- Average All units and costs are considered together to determine average cost per EU, regardless of whether the costs were incurred last period or currently. Weighted- Average All units and costs are considered together to determine average cost per EU, regardless of whether the costs were incurred last period or currently. Weighted- Average is the most commonly used method. Weighted Average vs. FIFO

8-24 Example: Weighted-Average For August, Toothpick purchased 9,500 pounds of wood scraps for $75,000. They spent $8,000 on labor and had other process overhead of $7,000. Toothpick started 320,000 units in July, completing 335,000 units. Ending WIP had 25,000 toothpicks. Beginning WIP was 40,000 units. The ending WIP was 100% complete for material, and 70% complete for conversion. Beginning WIP was 100% for material and 40% complete for conversion. Compute the cost per toothpick produced. Also, compute the Ending WIP Inventory and COGS. For August, Toothpick purchased 9,500 pounds of wood scraps for $75,000. They spent $8,000 on labor and had other process overhead of $7,000. Toothpick started 320,000 units in July, completing 335,000 units. Ending WIP had 25,000 toothpicks. Beginning WIP was 40,000 units. The ending WIP was 100% complete for material, and 70% complete for conversion. Beginning WIP was 100% for material and 40% complete for conversion. Compute the cost per toothpick produced. Also, compute the Ending WIP Inventory and COGS.

8-25 Example: Weighted-Average 100% complete for materials 40% complete for conversion 100% complete for materials 40% complete for conversion 100% complete for materials 70% complete for conversion 100% complete for materials 70% complete for conversion..

8-26 Example: Weighted-Average

8-27 Example: Weighted-Average

8-28 Example: Weighted-Average Step 2: Total Equivalent Units

8-29 Example: Weighted-Average

8-30 Example: Weighted-Average Ending WIP = $5,875 + $789 = $6,664

8-31 Recognizing Spoilage Spoilage represents the amount of resources that go into the process, but DO NOT result in finished product. Managers face key problems related to spoilage: 1. Identifying whether it exists. 2. Determining whether it can be eliminated. 3. Deciding whether eliminating it is worthwhile. Spoilage represents the amount of resources that go into the process, but DO NOT result in finished product. Managers face key problems related to spoilage: 1. Identifying whether it exists. 2. Determining whether it can be eliminated. 3. Deciding whether eliminating it is worthwhile.

8-32 Recognizing Spoilage Spoilage represents the amount of resources that go into the process, but DO NOT result in finished product. The 5-step approach discussed earlier can be modified by including Spoilage as an additional type of input and adjusting the formulas accordingly. Spoilage represents the amount of resources that go into the process, but DO NOT result in finished product. The 5-step approach discussed earlier can be modified by including Spoilage as an additional type of input and adjusting the formulas accordingly.. This now includes Finished Goods AND Spoilage.

8-33 Recognizing Spoilage

8-34 Recognizing Spoilage Steps 3 & 4 are not affected by Spoilage. Spoilage is added as an additional line item in Step 5.

8-35 I get the feeling I’m in over my head! End of Chapter 8