PROCESS COST ACCOUNTING University of Louisiana at Lafayette Managerial Accounting Weygandt • Kieso • Kimmel CHAPTER 3 PROCESS COST ACCOUNTING Prepared by Dan R. Ward Suzanne P. Ward University of Louisiana at Lafayette John Wiley & Sons, Inc. © 2005

PROCESS COST ACCOUNTING CHAPTER 3 PROCESS COST ACCOUNTING Study Objectives Understand who uses process cost systems. Explain the similarities and differences between job order and process cost systems. Explain the flow of costs in a process cost system. Make the journal entries to assign manufacturing costs in a process cost system.

Study Objectives: Continued Compute equivalent units. Explain the four steps necessary to prepare a production cost report. Prepare a production cost report.

NATURE OF PROCESS COST SYSTEMS USES OF PROCESS COST SYSTEMS Study Objective 1 Used to apply costs to similar products that are mass produced in a continuous fashion. Examples include the production of cereal, paint, and soft drinks.

NATURE OF PROCESS COST SYSTEMS USES OF PROCESS COST SYSTEMS Costs in a job order cost system are assigned to a specific job. Examples include Building a customized home Making a motion picture Making specialized machine

NATURE OF PROCESS COST SYSTEMS USES OF PROCESS COST SYSTEMS Comparison of Process Cost and Job Order Cost

NATURE OF PROCESS COST SYSTEMS SIMILARITIES AND DIFFERENCES Study Objective 2 In job order cost systems: Costs are assigned to each job. The products have unique characteristics. In process cost systems: Costs are tracked through a series of connected manufacturing processes or departments. The products are uniform or relatively homogeneous and produced in a large volume.

NATURE OF PROCESS COST SYSTEMS SIMILARITIES AND DIFFERENES

NATURE OF PROCESS COST SYSTEMS SIMILARITIES BETWEEN SYSTEMS Job order and process cost systems are similar in 3 ways: Same manufacturing cost elements Direct Materials, Direct Labor, and Manufacturing Overhead. Similar accumulation of costs Debit raw materials costs to Raw Material Inventory Debit factory labor costs to Factory Labor Debit manufacturing overhead costs Manufacturing Overhead. Same accounts for flow of costs Work in Process, Finished Goods Inventory, and Cost of Goods Sold; however, the methods of assigning the costs differ significantly.

NATURE OF PROCESS COST SYSTEMS DIFFERENCES BETWEEN SYSTEMS Job order and process cost systems differ in 4 ways:

NATURE OF PROCESS COST SYSTEMS PROCESS COST FLOW Study Objective 3 Example – Tyler Company Manufacturing of automatic can openers consists of two processes: Machining – raw materials are shaped, honed, drilled Assembly – parts assembled and packaged Materials, labor, and manufacturing overhead added in both departments.

NATURE OF PROCESS COST SYSTEMS PROCESS COST FLOW

NATURE OF PROCESS COST SYSTEMS ASSIGNMENT OF MANUFACTURING COSTS Study Objective 4 Accumulation of materials and labor costs is the same as in job order costing. Debit Raw Materials Inventory for all purchases of raw materials Debit Factory Labor for all factory labor incurred However, assignment of the three manufacturing cost elements to Work in Process is different.

NATURE OF PROCESS COST SYSTEMS ASSIGNMENT OF MANUFACTURING COSTS Materials Costs A process cost system requires fewer materials requisitions than a job order cost system. Materials are used for processes not specific jobs. Requisitions are for larger quantities of materials. The entry to record the materials used:

NATURE OF PROCESS COST SYSTEMS ASSIGNMENT OF MANUFACTURING COSTS Factory Labor Costs Time tickets used in both systems. All labor costs incurred within a production department are a cost of processing. The entry to assign these costs:

NATURE OF PROCESS COST SYSTEMS ASSIGNMENT OF MANUFACTURING COSTS Manufacturing Overhead Costs Objective of assigning overhead - allocate overhead to departments on an objective and equitable basis. Use the activity that “drives” or causes the costs Machine time used - primary driver in continuous manufacturing operations - widely used The entry to allocate overhead to the two processes:

NATURE OF PROCESS COST SYSTEMS ASSIGNMENT OF MANUFACTURING COSTS Entries to Transfer Costs Through System Monthly entry to transfer goods to next department: Entry to transfer completed goods to Finished Goods: Entry to record Cost of Goods Sold at the time of sale:

Let’s Review Which of the following items is not a characteristic of a process cost system? Once production begins, it continues until the finished product emerges. The focus is on continually producing homogenous products. When the finished product emerges, all units have precisely the same amount of materials, labor, and overhead. The products produced are heterogeneous in nature.

Let’s Review Which of the following items is not a characteristic of a process cost system? Once production begins, it continues until the finished product emerges. The focus is on continually producing homogenous products. When the finished product emerges, all units have precisely the same amount of materials, labor, and overhead. The products produced are heterogeneous in nature.

EQUIVALENT UNITS Study Objective 5 A measure of the work done during the period, expressed in fully completed units Used to determine the cost per unit of the completed product

Equivalent Units of Part-time Students Full-time Equivalent Students EQUIVALENT UNITS Example Compute the cost of instruction at XYZ College per full-time equivalent student based on the following information: Total cost of instruction is $9,000,000 Student population consists of 900 full-time and 1,000 part-time students Part-time students take 60% of the classes of a full- time student Full-time Students Equivalent Units of Part-time Students Full-time Equivalent Students + = 900 + (60% x 1,000) = 1,500

EQUIVALENT UNITS Example - Continued Cost of instruction per full-time equivalent student equals total cost of instruction divided by number of full-time equivalent students $9,000,000 / 1,500 = $6,000

EQUIVALENT UNITS WEIGHTED-AVERAGE METHOD Considers the degree of completion (weighting) of units completed and transferred out and units in ending work in process Most widely used method Beginning work in process not part of computation of equivalent units Units Completed and Transferred Out Equivalent Units of Ending Work in Process Equivalent Units of production + = + =

EQUIVALENT UNITS WEIGHTED-AVERAGE METHOD - REFINEMENTS Generally, two equivalent unit computations are required: One for materials One for conversion costs Units Completed and Transferred Out-Materials Equivalent Units of Ending Work in Process-Materials Equivalent Units of Production-Materials + = Equivalent Units of Ending Work in Process- Conversion Costs Equivalent Units of Production-Conversion Costs Units Completed and Transferred Out- Conversion Costs + =

EQUIVALENT UNITS - Refinements WEIGHTED-AVERAGE METHOD - Example The Kellogg Company uses 3 departments (Mixing, Baking, and Freezing/Packaging) to produce waffles. Physical units for Mixing Department: Beginning work in process 100,000 Started into production during period 800,000 Transferred out to Baking Department 700,000 Ending work in process 200,000

EQUIVALENT UNITS - Refinements WEIGHTED-AVERAGE METHOD Example - Continued Mixing Department Raw Materials Information All ingredients (materials) are added at the beginning of the mixing process. All units, regardless of degree of completion, are 100% complete as to materials. Equivalent Units for Materials: Units Transferred Out 700,000 100% Complete 700,000 Ending Work in Process 200,000 100% Complete 200,000 Total Equivalent Units 900,000

EQUIVALENT UNITS - Refinements WEIGHTED-AVERAGE METHOD Example - Continued Mixing Department Conversion Cost Information Conversion costs - sum of labor costs and overhead costs Incurred uniformly throughout the mixing process. Beginning work in process - 70% complete as to conversion costs. Ending work in process - 60% complete as to conversion costs Equivalent Units for Conversion Costs: Units Transferred Out 700,000 100% Complete 700,000 Ending Work in Process 200,000 60% Complete 120,000 Total Equivalent Units 820,000

PRODUCTION COST REPORT Study Objective 6 Key document used to understand activities Prepared for each department and shows: Production quantity Cost data Four preparation steps Compute physical unit flow Compute equivalent units of production Compute unit production costs Prepare a cost reconciliation schedule

FLOW OF COSTS IN PROCESS SYSTEM Example – Production of Waffles

COMPREHENSIVE EXAMPLE OF PROCESS COSTING Basic Information

COMPREHENSIVE EXAMPLE Continued Step 1: Compute Physical Unit Flow Physical units actual units to be accounted for during a period, regardless of work performed. Total units to be accounted for units started (or transferred) into production during period + units in production at beginning of period. Total units accounted for units transferred out during period + units in production at end of period.

COMPREHENSIVE EXAMPLE Continued Step 1: Compute Physical Unit Flow - Continued

COMPREHENSIVE EXAMPLE - Continued Step 2: Compute Equivalent Units of Production Measure of a department’s productivity. Two computations required: one for materials and one for conversion costs. Beginning work in process is ignored.

COMPREHENSIVE EXAMPLE - Continued Step 3: Compute Unit Production Costs Costs expressed in terms of equivalent units of production When equivalent units of production are different for materials and for conversion costs, three unit costs are computed: materials conversion total manufacturing

COMPREHENSIVE EXAMPLE - Continued Step 3: Compute Unit Production Costs - Continued Materials Direct Materials Cost in Beginning Work in Process $ 50,000 Direct Materials Added to Production during Month 400,000 Total Materials Cost $450,000 The computation of unit materials cost:

COMPREHENSIVE EXAMPLE - Continued Step 3: Compute Unit Production Costs - Continued Conversion Costs Conversion Costs in Beginning Work in Process $ 35,000 Conversion Costs Added to Production during Month 170,000 Total Conversion Costs $205,000 The computation of unit conversion cost:

COMPREHENSIVE EXAMPLE - Continued Step 3: Compute Unit Production Costs - Continued Total Manufacturing Cost Per Unit The computation of unit total manufacturing cost:

COMPREHENSIVE EXAMPLE - Continued Step 4: Prepare a Cost Reconciliation Schedule Determines cost of goods transferred to the next department Assigns total costs to units transferred out and to ending work in process Shows that total costs accounted for equal total costs to be accounted for

COMPREHENSIVE EXAMPLE - Continued Step 4: Prepare a Cost Reconciliation Schedule - Continued Costs charged to Mixing Department Cost of beginning Work in Process $ 85,000 Costs started into production during period 570,000 Total costs to be accounted for $655,000

THE COST OF PRODUCTION REPORT Study Objective 7

THE COST OF PRODUCTION REPORT Study Objective 7 An internal document for management Shows production quantity and cost data for a department Presents results of the four steps in system Uses of Cost of Production Report: Basis for evaluating productivity of each department Helps assess reasonableness of unit costs and total costs Aids in judging whether planned objectives are met

Summary of Study Objectives Understand who uses process cost systems. Used by companies that mass-produce similar products in a continuous fashion Explain the similarities and the differences between job order cost and process cost systems. Similarities: Both systems track the same cost elements: Direct Materials, Direct Labor, and Manufacturing Overhead Costs are accumulated in the same accounts: Raw Materials Inventory, Factory Labor, and Manufacturing Overhead Accumulated costs are assigned to the same accounts: Work in Process, Finished Goods, and Cost of Goods Sold

Summary of Study Objectives Continued - Differences: Number of Work in Process Accounts In a job order cost system – one account In a process cost system – multiple accounts Documents used to track costs In a job order cost system – job cost sheets In a process cost system – production cost report Point at which costs are totaled In a job order cost system – when job is completed In a process cost system – at the end of a period of time Unit cost computations In a job order cost system – the total cost per job divided by the number of units produced in the job In a process cost system – the total manufacturing costs for the period divided by the units produced during the period

Summary of Study Objectives Explain the flow of costs in a process cost system. Costs for materials, labor, and overhead are assigned to work in process accounts for various departments Costs of completed units are transferred from one department to another as units move through the manufacturing process Costs of completed work is transferred to Finished Goods Inventory When inventory is sold, costs are transferred to Cost of Goods Sold

Summary of Study Objectives Make the journal entries to assign manufacturing costs in a process cost system. Debit Work in Process for each processing department Credit Raw Materials Inventory, Factory Labor, and Manufacturing Overhead Debit Work in Process for receiving department Credit Work in Process for department whose work is finished Debit Finished Goods Inventory Credit Work in Process for department which completed work on units Debit Cost of Goods Sold when units are sold Credit Finished Goods Inventory

Summary of Study Objectives Compute equivalent units. Measure work done during a period expressed in fully completed units Sum of units completed and transferred out plus equivalent units of ending work in process Explain the four steps necessary to prepare a production cost report. Compute physical flow (units to be accounted for) Compute equivalent units of production Compute unit production costs (in terms of equivalent units) Prepare a cost reconciliation schedule (total cost accounted for equals total cost to be accounted for)

Summary of Study Objectives Prepare a production cost report. Contains both quantity and cost data Four sections in the report: number of physical units equivalent unit computations unit costs cost reconciliation schedule

Let’s Review In the RYZ Company, there are zero units in beginning work in process, 7,000 units started into production, and 500 units in ending work in process 20% completed. The physical units to be accounted for are: 7,000 7,360 7,600 7,340

Let’s Review In the RYZ Company, there are zero units in beginning work in process, 7,000 units started into production, and 500 units in ending work in process 20% completed. The physical units to be accounted for are: 7,000 7,360 7,600 7,340

APPENDIX: EQUIVALENT UNITS FIFO METHOD Study Objective 8 Computes equivalent units on a first-in, first-out basis. Corresponds to actual physical flow of goods. Assumes that beginning work in process is completed before new work is started. Sum of work performed to: Finish beginning work in process Complete units started during the period, called units started and completed Start, but only partially complete, ending work in process

APPENDIX: EQUIVALENT UNITS FIFO METHOD - Example Assembly Department of Shutters Inc. Units to be accounted for consist of 8,100 units completed and transferred out and 400 units in ending work in process

APPENDIX: EQUIVALENT UNITS FIFO METHOD - Example The Assembly Department of Shutters Inc. The 7,600 units started and completed during the month are the units transferred out minus the units in beginning work in process (8,100 – 500)

COMPREHENSIVE EXAMPLE - FIFO Basic Information

COMPREHENSIVE EXAMPLE - FIFO Continued Step 1: Compute Physical Unit Flow Expanded to include transferred out units Reports beginning work in process and units started and completed

COMPREHENSIVE EXAMPLE - FIFO Continued Step 2: Compute Equivalent Units of Production Materials: Added at beginning of process No additional materials cost to complete beginning work in process 100% of material costs incurred on ending work in process

COMPREHENSIVE EXAMPLE - FIFO Continued Step 2: Compute Equivalent Units of Production - Continued Conversion Costs:

COMPREHENSIVE EXAMPLE - FIFO Continued Step 3: Compute Unit Production Costs Costs expressed in terms of equivalent units of production Based entirely on production costs incurred during the period. Costs in beginning work in process are ignored When equivalent units of production are different for materials and for conversion costs, three unit costs computed: materials, conversion, and total manufacturing

COMPREHENSIVE EXAMPLE - FIFO Continued Step 3: Compute Unit Production Costs - Continued Production costs incurred during current period: Direct Materials $400,000 Conversion Costs 170,000 Total Costs $570,000 Computation of unit costs:

COMPREHENSIVE EXAMPLE - FIFO Continued Step 4: Prepare a Cost Reconciliation Schedule Assigns total costs to units transferred out and to ending work in process First goods to be completed are units in beginning work in process Cost of the beginning work in process is always assigned to the goods transferred to the next department (or to finished goods) Ending work in process includes only production costs incurred in the current period

COMPREHENSIVE EXAMPLE - FIFO Continued Shows that total costs accounted for equal total costs to be accounted for Costs charged to Mixing Department Cost of beginning Work in Process $ 85,000 Costs started into production during period 570,000 Total costs to be accounted for $655,000 The cost reconciliation assigns the $655,000 to Units transferred out to the Baking Department, and Units in ending Work in Process

COMPREHENSIVE EXAMPLE - FIFO Continued

FIFO AND WEIGHTED AVERAGE The weighted-average method has one major advantage: Simple to understand and to apply When prices do not fluctuate significantly, the weighted- average method is very similar to the FIFO method. Conceptually, the FIFO method is superior because Current performance is measured using only costs incurred in the current period and The FIFO method provides current cost information which leads to more accurate pricing strategies

Summary of Study Objective For Appendix Compute equivalent units using the FIFO method Sum of the work performed to (1) Finish the units of beginning work in process inventory (2) Complete units started into production during the period, and (3) Start, but only partially complete, units in ending work in process inventory

COPYRIGHT Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.