Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 Process Costing Chapter Eleven

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Identify the types of firms or operations for which a process costing system is most suitable Explain and calculate equivalent units produced Describe the five steps in process costing Demonstrate the weighted-average method of process costing Demonstrate the FIFO method of process costing Learning Objectives

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Apply process costing to a firm with multiple departments Prepare journal entries to record the flow of costs in a process cost system Explain how process cost systems are implemented and enhanced in practice Account for spoilage in process costing Learning Objectives (continued)

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Process costing: a product costing system that accumulates costs according to processes or departments Accumulated costs are spread over output of the period Used when outputs are standardized/ homogeneous Examples: chemicals, oil refining, textiles, paints, flour, canneries, rubber, steel, glass, cement, and sporting goods Process Costing

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Prepared each period (e.g., each month) for each department Each department has its own WIP Inventory account The production cost report summarizes: –The number of physical and equivalent units –Costs incurred during the period –Cost per equivalent unit for each cost element (e.g., DL, DM, factory overhead) –Costs assigned to units completed and to units in ending WIP inventory Production Cost Report

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Equivalent units: –A measure of output for the period Example: 2 units 50% complete = 1 unit fully complete –An expression of partially completed units in terms of fully completed units Cost/equivalent unit = costs in each department for the period by the “number of equivalent units” produced during the period –Definition of numerator and denominator depends on whether FIFO or weighted-average method is used Production Cost Report (continued)

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Some Cost Issues Because of the relatively small DL content in many process industries, factory overhead and DL costs are often combined into a separate cost element and called conversion costs Many firms incur conversion costs uniformly throughout the production process DM costs can be added at discrete points of manufacturing or continuously over production (in the latter case, DM for equivalent-unit purposes will be calculated using the same proportion as conversion costs)

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Flow of Costs in Process Costing

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Completing the Production Cost Report: 5 Steps  Account for the physical units  Calculate equivalent units for each manufacturing cost element (FIFO or weighted-average method)  Determine total costs for each manufacturing cost element (FIFO or weighted-average method)  Compute cost per equivalent unit for each manufacturing cost element  Assign total manufacturing costs to units completed and ending WIP Inventory

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Weighted-Average vs. FIFO? The weighted average method includes all costs (i.e., beginning WIP inventory + current period manufacturing costs) in calculating cost per equivalent unit for each cost element the unit cost –Thus, prior period and current period costs are averaged The FIFO method includes in calculating the unit cost only costs incurred and work effort performed during the current period –Thus, FIFO costs represent the current period’s cost per equivalent unit for each manufacturing cost element

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Process Costing Example HSU Toy Company has two production departments, molding and finishing. Molding places direct materials into production at the beginning of the process. Direct labor and factory overhead costs are incurred gradually throughout the process with different proportions. The molding department’s units of production and costs for the month of June are provided.

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Process Costing Example (continued)

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 1: Account for Physical Product Flow

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 2: Calculate Equivalent Units for Each Cost Element

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 3: Determine Total Cost for Each Cost Element “Total Costs for Each Manufacturing Cost Element” = Numerator in cost per equivalent unit calculation (and is different for FIFO vs. Weighted-Average method)

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 4: Calculate Cost per Equivalent Unit for Each Cost Element

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 5: Cost Assignment

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies FIFO Example: Step 1

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 2, Alternative 1: Calculate FIFO Equivalent Units

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 2, Alternative 2: Calculate FIFO Equivalent Units

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 3: Calculate FIFO (i.e., Current Period) Costs

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 4: Calculate FIFO Costs per Equivalent Unit

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 5, Part 1: Assign Costs to Units Completed from Beginning WIP Inventory

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Step 5, Part 2: Assign Costs to Units Started & Completed and Account for Total Costs

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Weighted-Average vs. FIFO Weighted- Average FIFO Handling of partially completed beginning WIP No separate treatment Separates the units in the beginning WIP (and their costs) from the units started and completed during the period Ease of calculation and appropriateness Easier; best in situations where WIP is small and prices/costs are stable More difficult; best in situations where prices/costs fluctuate; better for “control” purposes

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Process Costing with Multiple Departments As a product passes from one department to another, the accumulated cost passes from department to department Transferred-in costs, or prior department costs, are costs of work performed in earlier departments that are transferred into the present department These costs are treated like an additional cost element

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Implementation and Enhancement of Process Costing Sometimes process-based manufacturers have very different products going through different processes, making process costing by itself inadequate Activity-based costing (ABC) is an important enhancement to process costing when product and process variety arises Process costing also lacks the ability to identify the most profitable product mix--to remedy this shortcoming we might use: –The contribution methods (Chapter 9) –The theory of constraints (Chapter 10)

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Spoilage in Process Costing There are two options to account for normal spoilage: –Count the number of spoiled units, prepare a separate equivalent unit computation with the cost per unit of the spoiled goods, and then allocate the cost of spoilage to the good units produced –Omit the spoiled units in computing the equivalent units of production; the spoilage cost is thus included as part of total manufacturing costs

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Process costing is a product costing system that accumulates costs according to processes or departments and assigns them to a large number of nearly identical products The typical firm that uses process costing employs a standardized production process (often mass production) to manufacture homogeneous products Process costing is used in industries such as chemicals, oil refining, textiles, paints, flour, canneries, rubber, steel, glass, cement, and sporting goods Chapter Summary

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Chapter Summary (continued) Each period, each department prepares a production cost report Five steps in preparing a production cost report: –Analyze the physical flow of units –Calculate equivalent units for each manufacturing cost element (FIFO or Weighted-average method) –Determine total costs for each manufacturing cost element (FIFO or Weighted-average method) –Compute cost per equivalent unit for each manufacturing cost element –Allocate total manufacturing costs for the period to units completed and to ending WIP

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Chapter Summary (continued) The weighted average method includes all costs in calculating unit costs, including both costs incurred during the period and those in the beginning WIP inventory (i.e., those costs brought forward from last period into the current period) –Thus, prior period and current period costs are averaged

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Chapter Summary (continued) The FIFO method includes in calculating equivalent unit cost only costs incurred and work effort performed during the current period; thus, the FIFO costs can be considered “current period manufacturing costs per equivalent unit” for each cost element –For cost assignment purposes, the cost of units from the beginning WIP inventory will include a combination of last period’s costs + the current period’s (FIFO) cost to complete the units –Units that are both started and completed during the period are assigned the current period costs per equivalent unit –Ending inventory is assigned the current (FIFO) period’s costs

Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies Chapter Summary (continued) Transferred-in costs, or prior department costs, are costs of work performed in an earlier department that are transferred into the present department –These costs are treated like an additional cost element Activity-based costing (ABC), the contribution methods, and the theory of constraints are important enhancements to a process costing system There are two options when accounting for spoilage: –Calculate the cost per spoiled unit and allocate it to the good units –Omit the spoiled units from the computation