1. Process Costing and Hybrid Product-Costing Systems
Chapter 4
Process Costing and Hybrid
Product-Costing Systems
Chapter 4: Process Costing and Hybrid Product-Costing Systems
McGraw-Hill/Irwin
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2. Learning Objective 1
Learning Objective 1. List and explain the similarities and important differences between job-order and process costing.
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3. Comparison of Job-Order Costing and Process Costing
Used for production of small, identical, low cost items.
Mass produced in automated continuous production process.
Costs cannot be directly traced to each unit of product.
This chapter covers process-costing systems. Process costing is used in repetitive production environments, where large numbers of identical or very similar products are manufactured in a continuous flow. (LO1)
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4. Comparison of Job-Order Costing and Process Costing
Typical process cost applications:
Petrochemical refinery
Paint manufacturer
Paper mill
Industries using process costing include paper, petroleum, chemicals, textiles, food processing, lumber, and electronics. (LO1)
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5. Comparison of Job-Order Costing and Process Costing
Costs accumulated by the job.
Work in process has a job-cost sheet for each job.
Many unique, high cost jobs.
Jobs built to customer order.
Process costing
Costs accumulated by department or process.
Work in process has a production report for each batch of products.
A few identical, low cost products.
Units continuously produced for inventory in automated process.
In many ways, job-order costing and process costing are similar. Both product-costing systems have the same ultimate purpose—assignment of production costs to units of output. Moreover, the flow of costs through the manufacturing accounts is the same in the two systems. (LO1)
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6. Differences Between Job-Order and Process Costing
The work-in-process account consists of individual jobs in a job-order cost system.
Direct Material
Finished Goods
Direct Labor
Jobs
In job-order costing, costs are accumulated by job order and recorded on job-cost records. The cost of each unit in a particular job order is found by dividing the total cost of the job order by the number of units in the job. (LO1)
Manufacturing Overhead
Cost of Goods Sold
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7. Differences Between Job-Order and Process Costing
The work-in-process account consists of individual products in a process-cost system.
Direct Material
Direct Labor & Overhead (Conversion)
Finished Goods
Products
In process costing, costs are accumulated by department, rather than by job order or batch. The cost per unit is found by dividing the total costs incurred by the units produced. (LO1)
Cost of Goods Sold
When direct labor is a relatively small amount compared to material and overhead, it is often combined with overhead.
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8. Learning Objective 2
Learning Objective 2. Prepare journal entries to record the flow of costs in a process-costing system with sequential production departments.
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9. Process Cost Flows
In a single production department situation, direct-material, direct-labor, and manufacturing-overhead costs are added to a Work-in-Process Inventory account. As goods are finished, costs are transferred to Finished-Goods Inventory. During the period when goods are sold, the product costs are transferred to Cost of Goods Sold. (LO2)
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10. Process Cost Flows
In the two-department case, when goods are finished in the first production department, costs accumulated in the Work-in-Process Inventory account for production department A are transferred to the Work-in-Process Inventory account for production department B. (LO2)
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11. Learning Objective 3
Learning Objective 3. Prepare a table of equivalent units under weighted-average process costing.
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12. Equivalent Units: A Key Concept
Costs are accumulated for a period of time for products in work-in-process inventory.
Products in work-in-process inventory at the beginning and end of the period are only partially complete.
Equivalent units is a concept expressing these partially completed products as a smaller number of fully completed products.
The term equivalent units is used in process costing to refer to the amount of manufacturing activity that has been applied to a batch of physical units. (LO3)
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13. Equivalent Units Example
Two half completed products are equivalent to one completed product. + = l
For example, two units which are 50 percent complete are equivalent to one unit that is 100 percent complete. Likewise, 10,000 units that are 70 percent complete is 7,000 equivalent units. (LO3)
So, 10,000 units that are 70% complete are equivalent to 7,000 complete units.
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14. Equivalent Units Question 1
For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 30% 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
Jones started 15,000 units and transferred 10,000 units to finished goods. The remaining 5,000 units were 30 percent complete. How many equivalent units did Jones have for the period? (LO3)
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15. Equivalent Units Question 1
For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 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
The 5,000 units that are 30 percent complete are equivalent to 1,500 units. Add that to the 10,000 units that are 100 percent complete for a total of 11,500 equivalent units. (LO3)
10,000 units + (5,000 units × .30) = 11,500 equivalent units
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16. Equivalent Units Question 2
Jones incurred $27,600 in production costs for the 11,500 equivalent units. What was Jones’s cost per equivalent unit for the period?
a. $1.84
b. $2.40
c. $2.76
d. $2.90
The production costs incurred for the period were $27,600. What is the cost per equivalent unit? (LO3)
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17. Equivalent Units Question 2
Jones incurred $27,600 in production costs for the 11,500 equivalent units. What was Jones’s cost per equivalent unit for the period?
a. $1.84
b. $2.76
c. $2.40
d. $2.90
$27,600 ÷ 11,500 equivalent units
= $2.40 per equivalent unit
The production costs are divided by the number of equivalent units to arrive at the cost per equivalent unit. (LO3)
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18. Calculating and Using Equivalent Units of Production
To calculate the direct materials and conversion costs per equivalent unit for the period:
Materials cost per equivalent unit
Materials cost for the period Materials equivalent units for the period =
Direct material is usually placed into production at beginning of the production process. In contrast, direct labor and manufacturing overhead, called conversion costs, usually are incurred uniformly throughout the process. When an accounting period ends, the partially completed goods that remain in process generally are at different stages of completion with respect to material and conversion activity. The most important feature of process costing is that the costs of direct material and conversion are assigned to equivalent units rather than to physical units. (LO3)
Conversion cost per equivalent unit
Conversion cost for the period Conversion equivalent units for the period =
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19. Departmental Production Report
Analysis of physical flow of units.
Calculation of equivalent units.
Computation of unit costs.
Analysis of total costs.
Production Report
The key document in a typical process-costing system is the departmental production report, prepared for each production department at the end of each accounting period. The departmental production report summarizes the flow of production quantities through the department, and it shows the amount of production cost transferred out of the department’s Work-in-Process Inventory account during the period. There are four steps used in preparing a departmental production report:
1. Analysis of physical flow of units.
2. Calculation of equivalent units.
3. Computation of unit costs.
4. Analysis of total costs.
(LO3)
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20. Equivalent Units of Production – Weighted-Average Method
The weighted-average method . . .
Makes no distinction between work done in the prior period and work done in the current period.
Blends together units and costs from the prior period and the current period.
The FIFO method is a more complex method and is rarely used in practice.
The method of process costing that we will focus on in this chapter is called the weighted-average method. This method is almost always used in practice by companies using process costing. There is another process-costing method called the first-in, first-out, or FIFO, method. (LO3)
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21. Production Report Example
MVP Sports Equipment Company makes baseball gloves in two departments, Cutting and Stitching.
MVP uses weighted-average process costing.
Material is added at the beginning of the Cutting Department, while conversion is incurred uniformly throughout the process.
Using the following information for the month of March, let’s prepare a production report for the Cutting Department.
The MVP Sports Equipment Company manufactures baseball gloves. Two production departments are used in sequence: the Cutting Department and the Stitching Department. In the Cutting Department, direct material is placed into production at the beginning of the process. Direct-labor and manufacturing overhead costs are incurred uniformly throughout the process. The predetermined overhead rate used in the Cutting Department is 125 percent of direct-labor cost. (LO3)
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22. Production Report Example
Work in process, March 1: 20,000 units Cost Materials: 100% complete. $ 50,000 Conversion: 10% complete. 7,200 Units started into production in March: 30,000 units Units completed and transferred out in March: 40,000 units Work in process, March 31: 10,000 units Materials 100% complete. Conversion 50% complete. Costs incurred during March Materials cost 90,000 Conversion costs: Direct labor $ 86,000 Applied manufacturing overhead 107,500 Total conversion costs 193,500 Total costs to account for $ 340,700
This slide presents a summary of the activity and costs in the Cutting Department during March. The direct-material and conversion costs for the March 1 work in process consist of costs that were incurred during February. These costs were assigned to the units remaining in process at the end of February. Materials costs of $90,000 and conversion costs of $193,500 were added during the month of March. The beginning work in process and the costs added during March equal the total costs to be accounted for. (LO3)
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23. Production Report Example
Analysis of Physical Flow of Units
The first step is to prepare a table summarizing the physical flow of production units during March. (LO3)
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24. Production Report Example
Calculation of Equivalent Units
Beginning inventory % is not used in weighted-average method.
50% of 10,000 units
The second step is to calculate the equivalent units of direct material and conversion activity. The table of equivalent units, displayed on this slide, is based on the table of physical flows prepared in step 1. The Cutting Department completed its work on 40,000 physical units. Thus, it represents 40,000 equivalent units for both direct material and conversion. The 10,000 units in the Cutting Department’s ending work-in-process inventory are 50 percent complete with respect to conversion. Therefore, the ending work-in-process inventory represents 5,000 equivalent units of conversion activity (10,000 physical units x 50% complete). (LO3)
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25. Production Report Example
Calculation of Equivalent Units
100% of 10,000 units, all material added at beginning
With respect to direct material, the 10,000 units in the Cutting Department’s ending work-in-process inventory are 100 percent complete. Therefore, the ending work-in-process inventory represents 10,000 equivalent units of direct material. (LO3)
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26. Learning Objective 4
Learning Objective 4. Compute the cost per equivalent unit under the weighted-average method of process costing.
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27. Production Report Example
Computation of unit costs
$140,000 ÷ 50,000 equivalent units
$200,700 ÷ 45,000 equivalent units
$ $4.46
The third step in the process-costing procedure is calculating the cost per equivalent unit for both direct material and conversion activity. The cost per equivalent unit for direct material is computed by dividing the total direct-material cost, including the cost of the beginning work in process and the cost incurred during March, by the total equivalent units (from step 2). The same procedure is used for conversion costs. (LO4)
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28. Learning Objective 5
Learning Objective 5. Analyze the total production costs for a department under the weighted-average method of process costing.
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29. Production Report Example
Analysis of total costs
The final step is to determine the total cost to be transferred out of the Cutting Department’s Work-in-Process Inventory account and into the Stitching Department’s Work-in-Process Inventory account. The cost per equivalent unit, $7.26, was calculated in step 3. The number of units transferred is multiplied by the total cost per equivalent unit. (LO5)
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30. Production Report Example
Analysis of total costs
The direct material equivalent units is multiplied by the direct materials cost per equivalent unit. The conversion equivalent units is multiplied by the conversion cost per equivalent unit. These two amounts are added together. (LO5)
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31. Production Report Example
Analysis of total costs
The sum of these costs is added to the cost of goods completed and transferred. Now all costs on the production report have been accounted for. These calculations are used as the basis for the journal entries to transfer the cost of goods completed and transferred out to the Stitching Department. (LO5)
All costs accounted for
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32. Learning Objective 6
Learning Objective 6. Prepare a departmental production report under weighted-average process costing.
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33. We have now completed all four steps necessary to prepare a production report. The report simply combines the tables prepared in Learning Objectives 3, 4, and 5. The report provides a convenient summary of all of the process-costing calculations made under the weighted-average method. This method is called the weighted-average method because the cost per equivalent unit, for both direct material and conversion activity, is computed as a weighted average of the costs incurred during two different accounting periods. (LO6)
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34. Actual Costing vs. Normal Costing Manufacturing overhead is applied
Actual costs of manufacturing overhead are entered in Work-in-Process Inventory
Manufacturing overhead is applied
to Work-in-Process Inventory using a predetermined overhead rate
Both actual and normal costing can be used in conjunction with a process costing system. Our illustration used a predetermined overhead rate based on direct-labor cost, which is normal costing. (LO6)
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35. Departmental Production Report
Analysis of physical flow of units.
Calculation of equivalent units.
Computation of unit costs.
Analysis of total costs.
The four-step process is summarized on this slide. In our illustration, production requires two sequential production operations: cutting and stitching. Although the process-costing procedures for the second department are similar to those illustrated for the first, there is one additional complication. The cost of goods completed and transferred out of the Cutting Department must remain assigned to the partially completed product units as they undergo further processing in the Stitching Department. Note that process-costing procedures for subsequent production departments are covered in the appendix at the end of this chapter, which may be studied now. (LO6)
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36. Learning Objective 7
Learning Objective 7. Describe how an operation costing system accumulates and assigns the costs of direct-material and conversion activity in a batch manufacturing process.
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37. Operation Costing
Operation costing employs some aspects of both job-order and process costing.
Job-order Operation Costing Process Costing (Products produced in batches) Costing
Job-order and process costing represent the polar extremes of product-costing systems. But some production processes exhibit characteristics of both job-order and process costing environments. These production processes often are referred to as batch manufacturing processes. Such processes are characterized by high-volume production of several product lines that differ in some important ways but are nearly identical in others. Since batch manufacturing operations have characteristics of both job-order costing and process-costing environments, a hybrid product-costing system is required. One common approach is called operation costing. (LO7)
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38. Operation Costing
Operation costing employs some aspects of both job-order and process costing.
Job-order Operation Costing Process Costing (Products produced in batches) Costing
Material costs are charged to batches as in job-order costing.
Conversion costs are assigned to batches as in process costing.
This product-costing system is used when conversion activities are very similar across product lines, but the direct materials differ significantly. Conversion costs are accumulated by department, and process costing methods are used to assign these costs to products. In contrast, direct-material costs are accumulated by job order or batch, and job-order costing is used to assign material costs to products. (LO7)
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39. I’m ready to process some leisure time.
End of Chapter 4
I’m ready to process some leisure time.
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