Chapter Six Process Costing COPYRIGHT © 2012 Nelson Education Ltd.

Learning Objectives Describe the basic characteristics and cost flows associated with process manufacturing Define equivalent units and explain their role in process costing. Explain the differences between the weighted average method and the FIFO method of accounting for process costs Prepare a departmental production report using the weighted average method Explain how non-uniform inputs and multiple processing departments affect process costing (Appendix) Prepare a departmental production report using the FIFO method

OBJECTIVE  1 Describe the basic characteristics and cost flows associated with process manufacturing

Characteristics of Process Manufacturing Process costing works well whenever relatively homogeneous products pass through a series of processes and they receive similar amount of manufacturing costs Example Industries: Chemicals Food Tire manufacturers Large manufacturing plants

Sequential processing Types of Processes Sequential processing Requires that units pass through one process before they can be worked on in later processes Parallel processing Partially completed units can be worked on simultaneously in different processes and then brought together in a final process for completion

Raw Materials Cost Flow Manufacturing cost flows are same as those for a job-order system Raw Materials As raw materials are purchased, cost of these materials flow into a raw materials account Materials purchases

Cost Flows Into Work In Process Finished Goods Completed Goods + Materials + Completed Goods + Direct labour + Overhead Completed goods are transferred out of Work-In-Process and into Finished Goods Materials, labour and overhead flow into the Work-In-Process account

Cost Flows Into Work In Process Finished Goods Cost of Goods Sold Sold Goods + Completed Goods + Sold Goods Goods that are sold are transferred out of Finished Goods and into Cost of Goods Sold

Example: Cornerstone 6-1 How to Calculate Cost Flows Without Work-In-Process (WIP) Information: Healthblend produces 2,000 bottles of multivitamins with the following costs: Picking Dept. Encapsulating Dept. Bottling Dept. Direct materials $1,700 $1,000 $800 Direct labour 50 60 300 Applied overhead 450 500 600 Required: Calculate the costs transferred out of each department Prepare journal entries that reflect these cost transfers

Costs Transferred Out Picking Dept. Encapsulating Dept. Bottling Dept. Direct materials $1,700 $1,000 $ 800 Direct labour 50 60 300 Applied overhead 450 500 600 Costs added $2,200 $1,560 $1,700 Costs transferred in 2,200 3,760 Costs transferred out $2,200 $3,760 $5,460

Journal Entries Work in Process (Encapsulating) $2,200 Work in Process (Picking) $2,200 Work in Process (Bottling) $3,760 Work in Process (Encapsulating) $3,760 Finished Goods $5,460 Work in Process (Bottling) $5,460

Transferred-In Costs Transferred-In Costs are costs transferred from a prior process to a subsequent process From the viewpoint of the subsequent process, transferred-in costs are a type of raw material cost

Production Report Units to Account For Units Accounted For Summary of manufacturing activity of a process department for a given period of time Unit Information section Cost Information section Units to Account For Units Accounted For Unit Information Section has two major subdivisions

Production Report Costs to Account For Costs Accounted For Unit Information section Cost Information section Costs to Account For Costs Accounted For Cost Information Section has two major subdivisions

OBJECTIVE  2 Define equivalent units and explain their role in process costing. Explain the differences between the weighted average method and the FIFO method of accounting for process costs

Equivalent Units Example Assume that Department A had the following data for October: Units in BWIP --- Units completed 1,000 Units in EWIP (25% complete) 600 If we say 1000, we ignore the ending work in process. 1600? Then we ignore the fact that the units in ending work in process are only partially completed. Total manufacturing costs $11,500 What is the output for this department? 1000 units? 1600 units?

Equivalent Units of Output Total number of complete units that could have been produced given the total manufacturing effort used during the period Dilemma Some units are physically complete Some units are not complete Dilemma Some units are physically complete called units completed when complete, units are transferred out Some units are not complete remain in Work-In-Process degree of completion must be determined 6-17

Example: Cornerstone 6-2 How to Calculate Equivalent Units of Production: No Beginning Work-In-Process Information: October Data: 1,000 units completed 600 units 25 percent complete Required: Calculate the equivalent units for October

Equivalent Units Equivalent Units Units Completed 1,000 Units in Ending WIP × 25% complete 150 1,150

Example: Cornerstone 6-3 How To Measure Output and Assign Costs: No Beginning Work-In-Process Information: Manufacturing Costs for the period 11,500 Units Transferred Out 1,000 Units in Ending Work In Process (25% Complete) 600 Required: Calculate the unit cost Calculate the cost of goods transferred out and the cost of ending work-in-process (EWIP)

Calculating Unit Cost $10 Cost per equivalent unit Manufacturing costs = Number of Equivalent Units $11,500 Cost per equivalent unit = 1,150 Cost per equivalent unit = $10

Cost of Goods Transferred Out Units Transferred Out Cost of goods transferred out Unit Cost = × $10 × 1,000 units Cost of goods transferred out = $10,000

Cost of Ending Work-In-Process (EWIP) Unit Cost Units in EWIP = × $10 × 150 Cost of ending work in process = $1,500 Things get more complicated if there are units in work-in-process at the beginning of the period

Beginning Work In Process Work done on these beginning inventory units Represents prior period costs How should these costs figure into the computation of current period unit costs? Weighted Average method FIFO method

Weighted Average Method Combines Beginning inventory costs Current period costs Calculates Unit Cost for the period By averaging Unit cost is used to compute costs for: Goods transferred out Goods remaining in work-in-process

FIFO Method Separates work and costs for 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

OBJECTIVE  3 Prepare a departmental production report using the weighted average method

Preparing a Weighted Average Production Report Step 1: Physical Flow Analysis Trace the physical units of production Two amounts are computed Units Started and Completed (Units Completed minus Units in BWIP) Units Started (Add Units Started and Completed plus EWIP)

Preparing a Weighted Average Production Report Step 2: Calculation of Equivalent Units Adding together Units Completed Units in Ending Work In Process × Fraction Complete Beginning Inventory Included in the units completed Treats beginning inventory as if it was started and completed the current period

Preparing a Weighted Average Production Report Step 3: Computation of Unit Cost Manufacturing Costs ÷ Equivalent Unit Costs include: Prior period costs associated with beginning work-in-process Current period manufacturing costs

Preparing a Weighted Average Production Report Step 4: Valuation of Inventories Computing cost of goods transferred out Multiplying Unit cost (computed in step #3) Units completed (computed in step #1) Computing cost of ending work in process Equivalent units (computed in step #2)

Cornerstones 6-4, 6-5, and 6-6 will walk us through an example Preparing a Weighted Average Production Report Step 5: Cost Reconciliation Checks to see if: Costs to account for Beginning Work In Process + Costs incurred during the period Equal Costs assigned to inventory Transferred out + Ending Work-In-Process Cornerstones 6-4, 6-5, and 6-6 will walk us through an example

Example: Cornerstone 6-4 How to Measure Output and Assign Costs: Weighted Average Information: Production: Units in process, July 1, 75% complete 20,000 litres Units completed and transferred out 50,000 litres Units in process, July 31, 25% complete 10,000 litres Costs: Work in process, July 1 $3,525 Costs added during July $10,125

Example Required: Calculate an output measure for July Assign costs to units transferred out and ending work in process using the weighted average method

Measuring Output 50,000 units completed this period Add Units in Beginning WIP to the Units Started and Completed Started & Completed BWIP 20,000 + 30,000 50,000 units completed this period

Measuring Output Add equivalent units in Ending WIP Units Completed EWIP 50,000 + 10,000 units (25% complete) 50,000 + 2,500 52,500 equivalent units manufactured this period

Assigning Costs Compute Unit Cost Work in process, July 1 $ 3,525 $ 3,525 Costs added during July 10,125 Total costs assigned $13,650 Unit cost = $13,650/52,500 equivalent units Unit cost $0.26 per equivalent unit =

All the manufacturing costs have been assigned Assigning Costs Assign Costs to Units Transferred Out (50,000 units × $0.26) $13,000 Ending WIP (2,500 equiv. units × $0.26) 650 Total Costs Assigned $13,650 All the manufacturing costs have been assigned

Example: Cornerstone 6-5 How to Prepare a Physical Flow Schedule Information: Production: Units in process, July 1, 75% complete 20,000 litres Units completed and transferred out 50,000 litres Units in process, July 31, 25% complete 10,000 litres Required: Prepare a physical flow schedule

Physical Flow Schedule Units to account for: Units in beginning work in process (75% complete) 20,000 Units started during the period This needs to be computed 6-40

Units Started and Completed Units completed – Units, BWIP = Units started and completed = 50,000 – 20,000 Units started and completed = 30,000

Units started and completed = + Units, EWIP Units started = 30,000 + 10,000 Units started = 40,000

Physical Flow Schedule Units to account for: Units in beginning work in process (75% complete) 20,000 Units started during the period 40,000 Total units to account for 60,000

Physical Flow Schedule continued Units accounted for: Units completed and transferred out: Started and completed 30,000 From beginning work in process 20,000 50,000 Units in ending work in process (25% complete) 10,000 Total units accounted for 60,000 All the units “to be accounted for” have been “accounted for”

Now we need to calculate the unit cost Example Calculation of Equivalent Units Units completed 50,000 10,000 × 25% Add: Units in ending work in process × fraction complete 2,500 Equivalent units of output 52,500 Now we need to calculate the unit cost 50,000:This is the beginning work in process + the started and completed units. +2,500 = 52,500 (Now we need to calculate the unit cost)

Example Computation of Unit Cost Work in process, July 1 $ 3,525 $ 3,525 Costs added during July 10,125 Total manufacturing costs for July $13,650 Unit cost = $13,650/52,500 Unit cost = $0.26 per equivalent unit

Example Cost Reconciliation 50,000 units × $0.26 Total manufacturing costs assigned to inventories are as follows: Goods transferred out $13,000 Goods in ending work in process 650 It reconciles!! Costs assigned = Costs to account for Total costs accounted for $13,650 2,500 units × $0.26

Example: Cornerstone 6-6 How to Prepare a Production Report: Weighted Average Method Information: Calculations in Cornerstones 6-4 & 6-5 Required: Prepare a production report

Production Report for July 2011 Healthblend Company Picking Department Production Report for July 2011 Unit Information Physical Flow Units To Account For: Units Accounted For: Units in Beg. WIP 20,000 Units completed 50,000 Units started 40,000 Units in End. WIP 10,000 Total units to account for Total units accounted for 60,000 60,000 Equivalent Units Units completed 50,000 Units in EWIP 2,500 Total equivalent units 52,500

Production Report for July 2011 Healthblend Company Picking Department Production Report for July 2011 (Continued) Cost Information Costs to account for: Beginning Work In Process $ 3,525 Incurred during the period 10,125 Total costs to account for $13,650 Cost per equivalent unit $ 0.26

Production Report for July 2011 Healthblend Company Picking Department Production Report for July 2011 (Continued) Transferred Out Ending WIP Total Costs accounted for: Goods transferred out $13,000 --- $13,000 Goods in Ending WIP --- $650 650 Total costs accounted for $13,000 $650 $13,650

Evaluation of the Weighted Average Method Major benefit of this method is the simplicity Main disadvantage is reduced accuracy in computing unit costs If greater accuracy is desired, a company should use the FIFO method to determine unit costs

OBJECTIVE  4 Explain how nonuniform inputs and multiple processing departments affect process costing

Nonuniform Application of Manufacturing Inputs In the prior example Materials, labour and overhead were applied uniformly throughout the process But often materials is not added uniformly Instead it is added at the beginning and ending of the process This leads to separate completion percentages for materials and conversion costs Separate equivalent units, unit costs and category costs are computed for materials and conversion costs

Example: Cornerstone 6-7 How to Calculate Equivalent Units, Unit Costs, and Value Inventories with Nonuniform Inputs Information: Production: Units in process, Sept 1, 50% complete* 10,000 Units completed and transferred out 60,000 Units in process, Sept 30, 40% complete* 20,000 * Percentage complete as to conversion costs

Information continued: Example Information continued: Costs: Work in process, Sept 1: Materials* $ 1,600 Conversion costs 200 Total $ 1,800 Current costs: Materials* $12,000 Conversion costs 3,200 Total $15,200 * Materials are added at the beginning of the process

Example Required: Calculate equivalent units Calculate unit cost Calculate the valuation of the inventories

Example Calculation of Equivalent Units Materials Conversion Units completed 60,000 60,000 Add: Units in ending work in process × fraction complete 20,000 8,000 20,000 × 40% These units have 40% of their labour and overhead 20,000 × 100% Since these units have all their materials

Calculation of Equivalent Units Example Calculation of Equivalent Units Materials Conversion Units completed 60,000 60,000 Add: Units in ending work in process × fraction complete 20,000 8,000 Equivalent units of output 80,000 68,000

Calculation of Unit Cost Example Calculation of Unit Cost Unit materials cost = ($1,600 + $12,000)/80,000 Unit materials cost = $0.17 Unit conversion cost = ($200 + $3,200)/68,000 Unit conversion cost = $0.05 Total unit cost = $0.17 + $0.05 Total unit cost = $0.22

Valuation of Ending Work in Process and Goods Transferred Out Example Valuation of Ending Work in Process and Goods Transferred Out Cost of ending work in process: Materials $0.17 × 20,000 $3,400 Conversion $0.05 × 8,000 400 Total cost $3,800 Valuation of goods transferred out: Cost of goods transferred out $13,200 $0.22 × 60,000

Multiple Departments Some departments receive partially completed goods from prior departments Usual approach is to treat transferred-in goods as a separate material category Cost of this material is the cost of the goods transferred out as computed in the prior department

Example: Cornerstone 6-8 How to Calculate the Physical Flow Schedule, Equivalent Units, Unit Costs, and Transferred-In Goods Information: For September, Healthblend’s encapsulating dept had: 15,000 units in beginning inventory With transferred-in costs of $3,000 70,000 units completed during the month Picking department Completed and transferred-out 60,000 units at a cost of $13,200

Example Required: Prepare a physical flow schedule with transferred-in goods Calculate equivalent units for the transferred-in category Calculate unit cost for the transferred-in category

Physical Flow Schedule Example Physical Flow Schedule Units to account for: Units in beginning work in process 15,000 Units transferred in during Sept. 60,000 Total units to account for 75,000 6-65

Physical Flow Schedule Example Physical Flow Schedule Units accounted for: Units completed and transferred out: Started and completed 55,000 From beginning work in process 15,000 Units in ending work in process 5,000 Total units accounted for 75,000

Example Equivalent Units for the transferred-in category Units completed 70,000 Add: Units in ending work in process × fraction complete 5,000 × 100% since these units have all their materials 5,000 Equivalent units of output 70,000

Example Calculation of Unit Cost for the Transferred-in Category = ($13,200 + $3,000)/75,000 Unit cost = $16,200 / 75,000 Unit cost = $0.216

Prepare a departmental production report using the FIFO method OBJECTIVE  5 Appendix: Prepare a departmental production report using the FIFO method

Production Report FIFO Costing Separates the cost of BWIP from cost of current period Review: Cornerstone 6-9, How to calculate output and cost assignments: FIFO method, page 264; and Cornerstone 6-10, How to prepare a production report: FIFO method, page 267 This leads to separate completion percentages for materials and conversion costs