PowerPoint Authors: Jon A. Booker, Ph.D., CPA, CIA Charles W. Caldwell, D.B.A., CMA Susan Coomer Galbreath, Ph.D., CPA Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin Chapter 4 System Design: Process Costing

Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product cost. Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods. The flow of costs through the manufacturing accounts is basically the same in both systems. Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product cost. Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods. The flow of costs through the manufacturing accounts is basically the same in both systems. Similarities Between Job-Order and Process Costing 4-2

Process costing is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs are worked on each period. Process costing systems accumulate costs by department. Job-order costing systems accumulate costs by individual jobs. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet. Process costing is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs are worked on each period. Process costing systems accumulate costs by department. Job-order costing systems accumulate costs by individual jobs. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet. Differences Between Job-Order and Process Costing 4-3

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. 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. Quick Check 4-4

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. 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. Quick Check 4-5

Processing Departments Any location in an organization where materials, labor, or overhead are added to the product. The activities performed in a processing department are performed uniformly on all units of production. Furthermore, the output of a processing department must be homogeneous. 4-6

Learning Objective 1 Record the flow of materials, labor, and overhead through a process costing system. 4-7

Finished Goods Cost of Goods Sold Work in Process Direct Materials Direct Labor Manufacturing Overhead Flow of Materials, Labor, and Overhead Costs 4-8

Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead JobsJobs Costs are traced and applied to individual jobs in a job-order cost system. Direct Materials Flow of Materials, Labor, and Overhead Costs 4-9

Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead ProcessingDepartmentProcessingDepartment Costs are traced and applied to departments in a process cost system. Direct Materials Flow of Materials, Labor, and Overhead Costs 4-10

For purposes of this example, assume there are two processing departments – Departments A and B. We will use T-accounts and journal entries. T-Account and Journal Entry Views of Process Cost Flows 4-11

Raw Materials Work in Process Department B Work in Process Department A Direct Materials The Flow of Raw Materials ( in T-Account form) 4-12

The Flow of Raw Materials ( in journal entry form) 4-13

Work in Process Department B Work in Process Department A Salaries and Wages Payable Direct Materials Direct Labor The Flow of Labor Costs ( in T-Account form) 4-14

The Flow of Labor Costs ( in journal entry form) 4-15

Work in Process Department B Work in Process Department A Manufacturing Overhead Overhead Applied to Work in Process Applied Overhead Direct Labor Direct Materials Direct Labor Direct Materials Actual Overhead The Flow of Manufacturing Overhead Costs ( in T-Account form) 4-16

The Flow of Manufacturing Overhead Costs ( in journal entry form) 4-17

Work in Process Department B Work in Process Department A Direct Materials Direct Labor Applied Overhead Direct Materials Direct Labor Applied Overhead Transferred to Dept. B Transferred from Dept. A Partially Completed Units Transferred ( in T-Account form) 4-18

Partially Completed Units Transferred ( in journal entry form) 4-19

Finished Goods Work in Process Department B Cost of Goods Manufactured Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Cost of Goods Manufactured Transfer of Cost of Completed Units ( in T-Account form) 4-20

Transfer of Cost of Completed Units ( in journal entry form) 4-21

Finished Goods Cost of Goods Sold Work in Process Department B Cost of Goods Manufactured Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Cost of Goods Sold Cost of Goods Manufactured Cost of Finished Goods Sold ( in T-Account form) 4-22

Cost of Finished Goods Sold ( in journal entry form) 4-23

Equivalent Units of Production Equivalent units are the product of the number of partially completed units and the percentage of completion of those units. We need to calculate equivalent units because a department usually has some partially completed units in its beginning and ending inventory. 4-24

Two half completed products are equivalent to one completed product. So, 10,000 units 70% complete are equivalent to 7,000 complete units. + = 1 Equivalent Units – The Basic Idea 4-25

For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process that are 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 For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process that are 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 Quick Check 4-26

For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process that are 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 For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process that are 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 Quick Check 4-27

Calculating Equivalent Units Equivalent units can be calculated two ways:  The First-In, First-Out Method – FIFO is covered in the appendix available on the web.  The Weighted-Average Method – This method will be covered in the main portion of the chapter. Equivalent units can be calculated two ways:  The First-In, First-Out Method – FIFO is covered in the appendix available on the web.  The Weighted-Average Method – This method will be covered in the main portion of the chapter. 4-28

Learning Objective 2 Compute the equivalent units of production using the weighted-average method. 4-29

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. 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. Characteristics of the Weighted Average Method 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. 4-30

Direct labor costs may be small in comparison to other product costs in process costing systems. Direct labor costs may be small in comparison to other product costs in process costing systems. Direct Materials Type of Product Cost Dollar Amount Direct Labor Conversion Treatment of Direct Labor 4-31

Type of Product Cost Dollar Amount Conversion Direct labor and manufacturing overhead may be combined into one product cost called conversion. Direct Materials Treatment of Direct Labor Direct labor costs may be small in comparison to other product costs in process costing systems. Direct labor costs may be small in comparison to other product costs in process costing systems. 4-32

Smith Company reported the following activity in the Assembly Department for the month of June: Weighted-Average – An Example 4-33

The first step in calculating the equivalent units is to identify the units completed and transferred out of Assembly Department in June (5,400 units) Weighted-Average – An Example 4-34

The second step is to identify the equivalent units of production in ending work in process with respect to materials for the month (540 units) and adding this to the 5,400 units from step one. Weighted-Average – An Example 4-35

The third step is to identify the equivalent units of production in ending Work in Process with respect to conversion for the month (270 units) and adding this to the 5,400 units from step one. Weighted-Average – An Example 4-36

Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in Work in Process Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in Work in Process Weighted-Average – An Example 4-37

Ending Work in Process 900 Units 60% Complete 6,000 Units Started 5,400 Units Completed 5,100 Units Started and Completed Materials 5,400 Units Completed 540 Equivalent Units 900 × 60% 5,940 Equivalent units of production Beginning Work in Process 300 Units 40% Complete Weighted-Average – An Example 4-38

6,000 Units Started 5,400 Units Completed 270 Equivalent Units 900 × 30% 5,670 Equivalent units of production Beginning Work in Process 300 Units 20% Complete Ending Work in Process 900 Units 30% Complete Conversion 5,100 Units Started and Completed Weighted-Average – An Example 4-39

Learning Objective 3 Compute the cost per equivalent unit using the weighted-average method. 4-40

Beginning Work in Process Inventory: 400 units Materials: 40% complete $6,119 Conversion: 20% complete $3,920 Production started during June 6,000 units Production completed during June 5,400 units Costs added to production in June Materials cost $ 118,621 Conversion cost $ 81,130 Ending Work in Process Inventory: 900 units Materials: 60% complete Conversion: 30% complete Compute and Apply Costs 4-41

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 + Compute and Apply Costs 4-42

Here is a schedule with the cost and equivalent unit information. Compute and Apply Costs 4-43

Here is a schedule with the cost and equivalent unit information. $124,740 ÷ 5,940 units = $21.00 $85,050 ÷ 5,670 units = $15.00 Cost per equivalent unit = $ $15.00 = $36.00 Compute and Apply Costs 4-44

Learning Objective 4 Assign costs to units using the weighted-average method. 4-45

Applying Costs 4-46

Applying Costs 4-47

Applying Costs 4-48

Computing the Cost of Units Transferred Out 4-49

Computing the Cost of Units Transferred Out 4-50

Computing the Cost of Units Transferred Out 4-51

Learning Objective 5 Prepare a cost reconciliation report. 4-52

Reconciling Costs 4-53

Reconciling Costs 4-54

PowerPoint Authors: Jon A. Booker, Ph.D., CPA, CIA Charles W. Caldwell, D.B.A., CMA Susan Coomer Galbreath, Ph.D., CPA Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin Appendix 4A FIFO Method 4-55

FIFO vs. Weighted-Average Method The FIFO method (generally considered more accurate that the weighted-average method) differs from the weighted-average method in two ways: 1.The computation of equivalent units. 2.The way in which the costs of beginning inventory are treated. 1.The computation of equivalent units. 2.The way in which the costs of beginning inventory are treated. 4-56

Learning Objective 6 Compute the equivalent units of production using the FIFO method. 4-57

Equivalent Units – FIFO Method Let’s revisit the Smith Company example. Here is information concerning the Assembly Department for the month of June. 4-58

Equivalent Units – FIFO Method Step 1: Determine equivalent units needed to complete beginning Work in Process inventory. 4-59

Equivalent Units – FIFO Method Step 2: Determine units started and completed during the period. 4-60

Equivalent Units – FIFO Method Step 3: Add the equivalent units in ending Work in Process inventory. 4-61

Beginning Work in Process 300 Units 40% Complete Ending Work in Process 900 Units 60% Complete 6,000 Units Started 5,100 Units Started and Completed FIFO Example MaterialsMaterials 5,100 Units Completed 540 Equivalent Units 900 × 60% 5,820 Equivalent units of production 180 Equivalent Units 300 × 60% 4-62

Beginning Work in Process 300 Units 20% Complete Ending Work in Process 900 Units 30% Complete 6,000 Units Started 5,100 Units Started and Completed FIFO Example ConversionConversion 5,100 Units Completed 270 Equivalent Units 900 × 30% 5,610 Equivalent units of production 240 Equivalent Units 300 × 80% 4-63

Equivalent Units: Weighted- Average vs. FIFO As shown below, the equivalent units in beginning inventory are subtracted from the equivalent units of production per the weighted-average method to obtain the equivalent units of production under the FIFO method. 4-64

Learning Objective 7 Compute the cost per equivalent unit using the FIFO method. 4-65

Beginning Work in Process: 400 units Materials: 40% complete $6,119 Conversion: 20% complete $3,920 Production started during June6,000 units Production completed during June5,400 units Costs added to production in June: Materials cost $ 118,621 Conversion cost $ 81,130 Ending Work in Process: 900 units Materials: 60% complete Conversion: 30% complete Cost per Equivalent Unit - FIFO Let’s revisit the Smith Company Assembly Department for the month of June to prepare our production report. 4-66

Cost per Equivalent Unit - FIFO The formula for computing the cost per equivalent unit under FIFO method is: Cost per equivalent unit = Cost added during the period Equivalent units of production 4-67

Cost per Equivalent Unit - FIFO Total cost per equivalent unit = $ $ = $ $118,600 ÷ 5,820 $81,130 ÷ 5,

Learning Objective 8 Assign costs to units using the FIFO method. 4-69

Applying Costs - FIFO Step 1: Record the equivalent units of production in ending Work in Process inventory. 900 units × 60% 900 units × 30% 4-70

Applying Costs - FIFO Step 2: Record the cost per equivalent unit. 4-71

Applying Costs - FIFO Step 3: Compute the cost of ending Work in Process inventory. 540 × $ ×

Cost of Units Transferred Out Step 1: Record the cost in beginning Work in Process inventory. 4-73

Cost of Units Transferred Out Step 2: Compute the cost to complete the units in beginning Work in Process inventory. 4-74

Cost of Units Transferred Out Step 3: Compute the cost of units started and completed this period. 4-75

Cost of Units Transferred Out Step 4: Compute the total cost of units transferred out. 4-76

Learning Objective 9 Prepare a cost reconciliation report using the FIFO method. 4-77

Reconciling Costs 4-78

Reconciling Costs 4-79

A Comparison of Costing Methods In a lean production environment, FIFO and weighted-average methods yield similar unit costs. When considering cost control, FIFO is superior to weighted-average because it does not mix costs of the current period with costs of the prior period. 4-80

End of Chapter