MANAGERIAL ACCOUNTING Eighth Canadian Edition GARRISON, CHESLEY, CARROLL, WEBB Prepared by: Robert G. Ducharme, MAcc, CA University of Waterloo, School.

MANAGERIAL ACCOUNTING Eighth Canadian Edition GARRISON, CHESLEY, CARROLL, WEBB
Prepared by: Robert G. Ducharme, MAcc, CA University of Waterloo, School of Accounting and Finance

Systems Design: Process Costing
4-2 Systems Design: Process Costing Chapter Four Managers need to assign costs to products to facilitate external financial reporting and internal decision making. This chapter illustrates an absorption costing approach to calculating product costs known as process costing.

Similarities Between Job-Order and Process Costing
4-3 Similarities Between Job-Order and Process Costing Both systems assign material, labour 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. Job-order and process costing are similar in that they both deal with assigning materials, labour and overhead to products as a way to calculate the unit product cost. Both systems use raw materials inventory, work in process inventory, and finished goods inventory. The flow of costs is similar, but not exactly the same, in the two systems.

Differences Between Job-Order and Process Costing
4-4 Differences Between Job-Order and Process Costing 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 accumulated costs by individual jobs. Process costing systems use department production reports to accumulate costs. Job-order costing systems use job cost sheets to accumulate costs. 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 best suited for the production of a single product that is continuously produced for a long period of time. Recall the mixing and bottling of Coca-Cola from Chapter Three. Job-order costing is best suited when jobs are produced as discrete projects. For example, building a house. Process costing accumulates costs by department, while job-order costing accumulates costs by individual jobs. Process costing uses a fundamental document called a department production report, while job-order costing uses the job cost sheet. In process costing unit cost is computed by department, while in job-order systems unit cost is computed by job. While there are similarities between the two systems, there are also significant differences.

Quick Check  Process costing is used for products that are:
4-5 Quick Check  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. Can you identify the most likely circumstances where a process costing system may be used?

Quick Check  Process costing is used for products that are:
4-6 Quick Check  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. Can you identify the most likely circumstances where a process costing system may be used?

Processing Departments
4-7 Processing Departments Any unit in an organization where materials, labour 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. A processing department is any location in an organization where materials, labour, or overhead are added to the product. The output from a processing department is homogeneous, that is, they all appear the same.

4-8 Learning Objective 1 Record the flow of materials, labour, and overhead through a process cost system. Learning objective number 1 is to record the flow of materials, labour, and overhead through a process cost system.

Comparing Job-Order and Process Costing
4-9 Comparing Job-Order and Process Costing Direct Materials Work in Process Finished Goods Direct Labour In all manufacturing systems, direct material, direct labour, and manufacturing overhead are charged to Work in Process Inventory. As we complete the production process, goods are transferred to the Finished Goods Inventory. Finally, when we sell the finished goods, we transfer the cost to cost of goods sold. Cost of Goods Sold ManufacturingOverhead

4-10 Comparing Job-Order and Process Costing Costs are traced and applied to individual jobs in a job-order cost system. Direct Materials Jobs Finished Goods Direct Labour In a job-order cost system costs are traced to individual jobs. All of the jobs in process make up the company’s Work in Process Inventory. ManufacturingOverhead Cost of Goods Sold

4-11 Comparing Job-Order and Process Costing Costs are traced and applied to departments in a process cost system. Direct Materials Processing Department Finished Goods Direct Labour In a process costing systems, costs are traced to departments that process the goods. In some companies there may be several processing departments that goods must pass through to become finished goods. Material, labour and overhead costs transferred from one department’s Work in Process account to another department’s Work in Process account are called transferred-in costs. ManufacturingOverhead Cost of Goods Sold

T-Account and Journal Entry Views of Cost Flows
4-12 T-Account and Journal Entry Views of Cost Flows For purposes of this example, assume there are two processing departments – Departments A and B. We will use T-accounts and journal entries. Let’s look at the flow of costs through the tee accounts and related journal entries for a manufacturing process that has two departments – Department A and Department B.

Process Cost Flows (in T-account form)
4-13 Process Cost Flows (in T-account form) Work in Process Department A Raw Materials Direct Materials Direct Materials Work in Process Department B Part I Direct materials can be requisitioned for use in both Department A and Department B. These direct materials are likely to be different in nature. Direct material costs are debited to the appropriate departmental Work in Process account depending upon where the materials were added to the production process. The Raw Materials account is credited for the corresponding amounts.

Process Cost Flows (in journal entry form)
4-14 Process Cost Flows (in journal entry form) The journal entry that shows the requisition of direct materials for use in Processing Departments A and B, is to debit the processing department of the direct materials requisitioned and credit Raw Materials Inventory. Notice that the direct materials are placed into a separate work in process account for each processing department.

4-15 Process Cost Flows (in T-account form) Work in Process Department A Wages Payable Direct Materials Direct Labour Direct Labour Work in Process Department B Direct labour is transferred from the wages payable account into the work in process account of departments A and B depending upon where the individual employee worked. Direct labour costs are debited to the appropriate departmental Work in Process account depending upon where the labour was added to the production process. Salaries and Wages Payable is credited for the corresponding amounts. Direct Materials

Process Costing (in journal entry form)
4-16 Process Costing (in journal entry form) Here is the journal entry to place the direct labour into the work in process inventory of departments A and B.

4-17 Process Cost Flows (in T-account form) Work in Process Department A Direct Materials Manufacturing Overhead Direct Labour Actual Overhead Overhead Applied to Work in Process Applied Overhead Work in Process Department B Manufacturing overhead is applied to each processing department based on a predetermined rate for each department. The predetermined rate does not have to be based on the same cost driver for each processing department. Manufacturing overhead costs are debited to the respective departmental Work in Process accounts. Manufacturing Overhead is credited by the corresponding amounts. Direct Materials Direct Labour Applied Overhead

Process Costing (In journal entry form)
4-18 Process Costing (In journal entry form) This is the journal entry we use to apply overhead to the work in process inventory of each of the processing departments.

4-19 Process Cost Flows (in T-account form) Work in Process Department A Work in Process Department B Direct Materials Transferred to Dept. B Transferred from Dept. A Direct Materials Direct Labour Direct Labour Applied Overhead Applied Overhead The cost of units complete as to processing in Department A are transferred into Department B for additional work. Department B has incurred additional costs to work on units that were in process at the beginning of the period. The transferred-in costs from Department A are added to the manufacturing costs incurred in Department B.

4-20 Process Costing (in journal entry form) To transfer the costs, we debit the work in process inventory in Department B, and credit, or reduce, the work in process inventory in Department A.

4-21 Process Cost Flows (in T-account form) Work in Process Department B Finished Goods Direct Materials Cost of Goods Manufactured Cost of Goods Manufactured Direct Labour Applied Overhead Transferred from Dept. A Here we see the transfer of completed goods our of Work in Process – Department B and into Finished Goods Inventory. The costs transferred represent the cost of good manufactured.

4-22 Process Costing (in journal entry form) The necessary journal entry is to debit finished goods inventory and credit work in process inventory in Department B to transfer finished production.

Process Cost Flows (in journal entry form)
4-23 Process Cost Flows (in journal entry form) Work in Process Department B Finished Goods Direct Materials Cost of Goods Manufactured Cost of Goods Manufactured Cost of Goods Sold Direct Labour Applied Overhead Transferred from Dept. A Once we sell finished goods, we debit cost of goods sold and credit finished goods inventory. Cost of Goods Sold Cost of Goods Sold

4-24 Process Costing (in journal entry form) If we assume the company uses the perpetual inventory system, two entries are required to record a sale. The first entry is to record the sale and account receivable. The second entry is to transfer the finished goods sold to cost of goods sold. Sales are recorded at selling price and cost of good sold is recorded at cost. The difference between the two is the gross margin on the sale.

4-25 Learning Objective 2 Compute the equivalent units of production using the weighted-average method. Learning objective number 2 is to compute the equivalent units of production using the weighted average method.

Equivalent Units of Production
4-26 Equivalent Units of Production Equivalent units are the product of the number of partially completed units and the percentage completion of those units. Partially completed units complicate the determination of a department’s output for a given period and the unit cost that should be assigned to that output. Equivalent units need to be calculated because a department usually has some partially completed units in its beginning and ending inventory. These partially completed units complicate the determination of a department’s output for a given period and the unit cost that should be assigned to that output. We need to calculate equivalent units because a department usually has some partially completed units in its beginning and ending inventory.

Equivalent Units – The Basic Idea
4-27 Equivalent Units – The Basic Idea Two half completed products are equivalent to one completed product. + = 1 The basic idea behind equivalent units is quite easy to understand, but the computation of equivalent can become complex. Here we can say the two half- completed units of production are equal to one completed unit. Using this logic, we can say that 10,000 units that are 70% complete are equivalent, or the same as, 7,000 complete units. So, 10,000 units 70% complete are equivalent to 7,000 complete units.

4-28 Quick Check  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 Read the information carefully and determine how many equivalent units of production were manufactured during the period.

4-29 Quick Check  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 correct answer is 11,500 equivalent units. How did you do? 10,000 units + (5,000 units × 0.30) = 11,500 equivalent units

Calculating Equivalent Units
4-30 Calculating Equivalent Units Equivalent units can be calculated two ways: The First-In, First-Out Method – FIFO is covered in the appendix to this chapter. The Weighted-Average Method – This method will be covered in the main portion of the chapter. Equivalent units may be calculated using the FIFO method or the weighted-average method. For the bulk of this chapter we will use the weighted-average method. We cover the FIFO method in the appendix to this chapter.

Equivalent Units of Production Weighted-Average Method
4-31 Equivalent Units of Production Weighted-Average Method 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. Determines equivalent units of production for a department by adding together the number of units transferred out plus the equivalent units in ending work in process inventory. When we use the weighted-average method we make no distinction between work done in the prior period and work done in the current period. We blend together the units and costs from both the prior and current period. We determine the cost per equivalent unit by dividing costs for the period by the equivalent units of production. 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.

Treatment of Direct Labour
4-32 Treatment of Direct Labour Direct Materials Direct labour costs may be small in comparison to other product costs in process cost systems. Conversion Dollar Amount Direct Labour In today’s economy, direct labour costs are becoming small when compared to materials and overhead costs. Automation is one of the causes for this shift. Type of Product Cost

Treatment of Direct Labour
4-33 Treatment of Direct Labour Direct Materials Direct labour costs may be small in comparison to other product costs in process cost systems. Conversion Dollar Amount As a consequence of the change in volume of direct labour costs, many companies combine labour and overhead costs and refer to the total as conversion costs. That is, these are the costs incurred to convert the direct materials into a finished good. We will make extensive use of the notion of direct materials and conversion costs in the remainder of this chapter. Type of Product Cost Direct labour and manufacturing overhead may be combined into one product cost called conversion.

Weighted-Average Example
4-34 Weighted-Average Example Double Diamond Skis reported the following activity in Shaping and Milling Department for the month of May: Let’s look at an example of calculating the cost per equivalent unit for the shaping and milling department of Double Diamond Skis. The shaping and milling department is only one of the company’s processing departments. Notice that Department A started the month of May with 200 units that are 55% complete as to materials and 30% complete as to conversion (direct labour and overhead). During the month the Department started 5,000 units into production. 4,800 units were transferred out to the next department during the month of May. At the end of May, the department had 400 units, 40% complete as to materials and 25% complete as to conversion. Since the Department began the month with two hundred units and started five thousand units into production, we have fifty-two hundred units to account for. Of these fifty-two hundred units, forty-eight hundred were transferred out and four hundred remain in work in process inventory.

4-35 Weighted-Average Example The first step in calculating the equivalent units is to identify the units completed and transferred out of the Department in May (4,800 units) The first step in calculating the equivalent units is to identity the units completed and transferred out. In the case of the shaping and milling department, there were 4,800 units completed and transferred out. We know these units are 100% complete as to materials and conversion.

4-36 Weighted-Average Example The second step is to identify the equivalent units of production in ending work in process with respect to materials for the month (160 units) and add this to the 4,800 units from step one. The second step is to calculate the equivalent units as to materials in ending inventory. We know there are 400 units in ending inventory that are 40% complete as to materials. So we know that there are 160 equivalent units as to materials in ending working in process inventory. For materials we add the units completed and transferred out to the equivalent units as to materials, for total units as to materials of five thousand nine hundred forty units.

4-37 Weighted-Average Example The third step is to identify the equivalent units of production in ending work in process with respect to conversion for the month (100 units) and add this to the 4,800 units from step one. The third step is to calculate the equivalent units in ending inventory as to conversion. We know there are 400 units in ending work in process inventory that are 25% complete as to conversion. So there are 100 equivalent units as to conversion in ending inventory. For conversion, we add the units completed and transferred out to the equivalent units as to conversion to arrive at a total equivalent units as to conversion of five thousand six hundred seventy units. We always follow these three steps when using the weighted-average method.

4-38 Weighted-Average Example Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in work in process We can restate the three-step process more quickly by saying that, when using the weighted-average method, equivalent units of production will always be equal to the units completed and transferred out plus the equivalent units remaining in work in process inventory. Some of you may prefer the three-step approach while others may prefer the short-cut approach.

4-39 Weighted-Average Example Materials 5,000 Units Started Beginning Work in Process 200 Units 55% Complete Ending Work in Process 400 Units 40% Complete 4,800 Units Started and Completed Here is a visual showing the computation of equivalent units as to materials. The equivalent units of production equals the units completed and transferred out (4,800 units) plus the equivalent units remaining in work in process (160 units for materials and 100 units for conversion). 4,800 Units Completed 400 × 40% 160 Equivalent Units 4,960 Equivalent units of production

4-40 Weighted-Average Example Conversion 5,000 Units Started Ending Work in Process 400 Units 25% Complete Beginning Work in Process 200 Units 30% Complete 4,800 Units Started and Completed Here is a similar visual for conversion costs. Again, the key to understanding the visual is units started and completed this period. 4,800 Units Completed 400 × 25% 100 Equivalent Units 4,900 Equivalent units of production

4-41 Learning Objective 3 Compute the cost per equivalent unit using the weighted-average method. Learning objective number 3 is to compute the cost per equivalent unit using the weighted-average method.

Compute and Apply Costs
4-42 Compute and Apply Costs Beginning work in process: units Materials: % complete $ 9,600 Conversion: 30% complete 5,575 Production started during May 5,000 units Production completed during May 4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost ,900 Ending work in process units Materials: 40% complete Conversion: 25% complete Assume the following additional facts with respect to Double Diamond Skis’ Shaping and Milling Department. The department started the month of May with two hundred units, fifty-five percent complete as to materials and thirty percent complete as to conversion (labour and overhead). During May, five thousand units were started into production and forty-eight hundred units were completed and transferred out. You can see the costs associated with materials and conversion. At the end of May, there were four hundred units in ending working in process inventory, forty percent complete as to materials and twenty five percent complete as to conversion. Let’s prepare the Production Report for May. Remember, we start with the first section that computes the equivalent units as to materials and conversion.

4-43 Compute and Apply Costs 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 + We calculate the cost per equivalent unit by adding together the cost of beginning work in process inventory and the cost added during the period. We divide the total dollar amount by the number of equivalent units we previously calculated.

4-44 Compute and Apply Costs Here is a schedule with the cost and equivalent unit information. We begin by adding the costs in beginning inventory to the costs incurred during the current period. The sum of the cost of materials and conversion equal the total cost to be accounted for during the period. Notice that we have 4,960 equivalent units as to materials, and 4,900 equivalent units as to conversion. Let’s look at the calculation of cost per equivalent unit.

4-45 Compute and Apply Costs Here is a schedule with the cost and equivalent unit information. Part I We have a total cost of $378,200 and 4,960 equivalent units, so the cost per equivalent unit is $76.25 for materials. Part II With total costs of $356,475 and total equivalent units of 4,900, we have an average cost per equivalent unit of $72.75 for conversion. Part III So, the total cost of materials and conversion is $ per equivalent unit. We add our materials and conversion cost per equivalent unit to get a total cost per equivalent unit during May of one hundred forty-nine dollars. This completes the second section of the Production Report. The last section is the cost reconciliation. $356,475 ÷ 4,900 units = $72.75 $378,200 ÷ 4,960 units = $76.25

Assign costs to units using the weighted-average method.
4-46 Learning Objective 4 Assign costs to units using the weighted-average method. Learning objective number 4 is to assign costs to units using the weighted-average method.

4-47 Applying Costs Let’s start the process of computing the cost of ending work in process inventory. The first step is to record the equivalent units of production in ending work in process inventory (160 units for materials and 100 units for conversion).

4-48 Applying Costs The second step is to record the cost per equivalent unit ($76.25 for materials and $72.75 for conversion).

4-49 Applying Costs The third step is to compute the cost of ending work in process inventory ($12,200 for materials, $7,275 for conversion, and $19,475 in total).

Computing the Cost of Units Transferred Out
4-50 Computing the Cost of Units Transferred Out Now, let’s Compute the cost of units transferred The first step is to record the units transferred out to the next department (4,800 units for materials and conversion).

4-51 Computing the Cost of Units Transferred Out The second step is to record the cost per equivalent unit ($76.25 for materials and $72.75 for conversion).

4-52 Computing the Cost of Units Transferred Out The third step is to compute the cost of units transferred out ($366,000 for materials, $349,200 for conversion and $715,200 in total).

4-53 Reconciling Costs Next, we must reconcile the costs. The first step is to record the cost of beginning work in process as shown on slide 39 ($15,175). The second step is to record the costs added to production during the period as shown on slide 39 ($719,500). The third step is to sum these two costs ($734,675).

4-54 Reconciling Costs Computing the costs accounted for: The first step is to record the previously computed cost of ending working process inventory ($19,475). The second step is to record the previously computed cost of units transferred out ($715,200). The third step is to sum these two costs ($734,675). Notice the two totals agree indicating that all costs have been accounted for.

4-55 Operation Costing Operation costing is a hybrid of job-order and process costing because it possesses attributes of both approaches. Job-order Costing Operation Costing (Products produced in batches) Process Costing Operation costing is similar to job-order costing. For example, a shoe manufacturer may charge each batch of shoes for its own specific material costs (e.g., shoes made with expensive leather would be charged accordingly, as would shoes made with inexpensive synthetic materials). It is also similar to process costing, the shoe manufacturer may accumulate the labour and overhead costs by department and assign the same conversion cost per unit to each shoe regardless of the shoe style. Material Costs charged to batches as in job-order costing. Conversion costs assigned to batches as in process costing. Operation costing is commonly used when batches of many different products pass through the same processing department.

4-56 FIFO Method Appendix 4A Appendix 4A – FIFO Method.

FIFO vs. Weighted-Average Method
4-57 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: The computation of equivalent units. The way in which the costs of beginning inventory are treated in the cost reconciliation report. FIFO is considered a more accurate measure of cost than weighted-average. It is important to be careful with your handling of beginning work in process inventory when using the FIFO method. While the calculations in weighted-average and FIFO appear to be similar, there are significant differences between the two methods. We will be using our previous example material to illustrate the FIFO method.

Compute the equivalent units of production using the FIFO method.
4-58 Learning Objective 5 Compute the equivalent units of production using the FIFO method. Learning objective number 5 is to compute the equivalent units of production using the FIFO method.

Equivalent Units – FIFO Method
4-59 Equivalent Units – FIFO Method Let’s revisit the Double Diamond Skis example. Assume the following activity is reported in Shaping and Milling Department for May: Recall this basic information from the Double Diamond Skis. We completed the calculation of equivalent units for the company using the weighted-average method. Now, we will use the same information to determine equivalent units under FIFO.

4-60 Equivalent Units – FIFO Method Step 1: Determine equivalent units needed to complete beginning inventory. The first step in the accounting process is to determine the equivalent units needed to complete beginning inventory (90 units for materials and 140 units for conversion).

4-61 Equivalent Units – FIFO Method Step 2: Determine units started and completed during the period. The second step is to add the units started and completed during the period (4,600 units for materials and conversion).

4-62 Equivalent Units – FIFO Method Step 3: Add the equivalent units in ending work in process inventory. The third step is to add the equivalent units in ending working in process inventory (160 units for materials and 100 units for conversion). This calculation results in 4,850 and 4,840 equivalent units of materials

Materials FIFO Example 5,000 Units Started 90 Equivalent Units
4-63 FIFO Example Materials 5,000 Units Started Beginning Work in Process 200 Units 55% Complete Ending Work in Process 400 Units 40% Complete 4,600 Units Started and Completed Here is a visual showing the computation of equivalent units as to materials. The equivalent units of production equals the units completed and transferred out (4,800 units) plus the equivalent units remaining in work in process (160 units for materials and 100 units for conversion). 200 × 45% 90 Equivalent Units 4,600 Units Completed 400 × 40% 160 Equivalent Units 4,850 Equivalent units of production

Conversion FIFO Example 5,000 Units Started 140 Equivalent Units
4-64 FIFO Example Conversion 5,000 Units Started Beginning Work in Process 200 Units 30% Complete Ending Work in Process 400 Units 25% Complete 4,600 Units Started and Completed Here is a visual showing the computation of equivalent units as to materials. The equivalent units of production equals the units completed and transferred out (4,800 units) plus the equivalent units remaining in work in process (160 units for materials and 100 units for conversion). 200 × 70% 140 Equivalent Units 4,600 Units Completed 400 × 25% 100 Equivalent Units 4,840 Equivalent units of production

Equivalent Units: Weighted Average vs. FIFO
4-65 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. The FIFO method removes the equivalent units that were already in beginning inventory from the equivalent units as defined using the weighted-average method. Thus, the FIFO method isolates the equivalent units due to work performed during the current period. This can be illustrated using the Double Diamond Skis example The equivalent units of material produced per the weighted-average method (4,960 units) minus the equivalent units of material in beginning inventory (110 units) equals the equivalent units of production per the FIFO method (4,850 units). The equivalent units of conversion per the weighted-average method (4,900 units) minus the equivalent units of conversion in beginning inventory (60 units) equals the equivalent units of production per the FIFO method (4,840 units).

Compute the cost per equivalent unit using the FIFO method.
4-66 Learning Objective 6 Compute the cost per equivalent unit using the FIFO method. Learning objective number 6 is to compute the cost per equivalent unit using the FIFO method.

Cost per Equivalent Unit - FIFO
4-67 Cost per Equivalent Unit - FIFO Let’s revisit the Double Diamond Skis Shaping and Milling Department for the Month of May to prepare our production report. Beginning work in process: units Materials: % complete $ 9,600 Conversion: 30% complete 5,575 $15, 175 Production started during May 5,000 units Production completed during May 4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost ,900 Ending work in process: units Materials: 40% complete Conversion: 25% complete Let’s return to our Double Diamond Skis information and apply FIFO to our production report. The information on your screen is the same as we used earlier in this chapter.

4-68 Cost per Equivalent Unit - FIFO The formula for computing the cost per equivalent unit under FIFO method is as follows: Cost per equivalent unit = Cost added during the period Equivalent units of production We calculate the cost per equivalent unit by dividing costs added during the period by the equivalent units we previously calculated.

4-69 Cost per Equivalent Unit - FIFO We begin our production report by determining the total number of units to account for and computing the number of equivalent units. On May 1st work in process inventory contained two hundred units and we started 5,000 units into production. Total units to account for is 5,200.

Assign costs to units using the FIFO method.
4-70 Learning Objective 7 Assign costs to units using the FIFO method. Learning objective number 7 is to assign costs to units using the FIFO method.

4-71 Applying Costs - FIFO Step 1: Record the equivalent units of production in ending work in process inventory. Let’s compute the cost of ending work in process inventory. The first step is to record the equivalent units of production in ending work in process inventory (160 units for materials and 100 units for conversion).

Step 2: Record the cost per equivalent unit.
4-72 Applying Costs - FIFO Step 2: Record the cost per equivalent unit. The second step is to record the cost per equivalent unit ($76.00 for materials and $72.50 for conversion).

Step 3: Compute the cost of ending work in process inventory.
4-73 Applying Costs - FIFO Step 3: Compute the cost of ending work in process inventory. The third step is to compute the cost of ending work in process inventory ($12,160 for materials, $7,250 for conversion, and $19,410 in total).

Cost of Units Transferred Out
4-74 Cost of Units Transferred Out Step 1: Record the cost in beginning work in process inventory. Now, we will compute the cost of units transferred out. The first component of the computation is to record the cost in beginning work in process inventory ($9,600 for materials, $5,575 for conversion, and $15,175 in total)

4-75 Cost of Units Transferred Out Step 2: Compute the cost to complete the units in beginning work in process inventory. The second component of the computation is to compute the cost to complete the units in beginning work in process inventory. Begin by recording the equivalent units of production required to complete the units in beginning inventory (90 units for materials and 140 units for conversion). Next, record the cost per equivalent unit ($76.00 for materials and $72.50 for conversion), Finally, compute the cost to complete the units in beginning work in process inventory ($6,840 for materials, $10,150 for conversion, and a total of $16,990)

4-76 Cost of Units Transferred Out Step 3: Compute the cost of units started and completed this period. The third component of the computation is to compute the cost of units started and completed this period. The first step is to record the units started and completed this period (4,600 units for materials and conversion). The second step is to record the cost per equivalent unit ($76.00 for materials and $72.50 for conversion). The third step is to compute the cost of units started and completed during this period ($349,600 for materials, $333,500 for conversion, and $683,100 in total).

4-77 Cost of Units Transferred Out Step 4: Compute the total cost of units transferred out. The final computation is to compute the total cost of units transferred out ($715,265).

4-78 Reconciling Costs When computing the costs to be accounted for, the first step is to record the cost of beginning work in process as shown on slide 61 ($15,175). The second step is to record the costs added to production during the period as shown on slide 61 ($719,500). The third step is to sum these two costs ($734,675).

4-79 Reconciling Costs When computing the costs accounted for, begin by recording the cost of ending working process inventory ($19,410). Next, record the cost of units transferred out ($715,265). Finally, sum these two costs ($734,675). Notice the two totals agree indicating that all costs have been accounted for.

A Comparison of Costing Methods
4-80 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. In most situations, the weighted-average and FIFO methods will produce very similar unit costs, particularly in a lean production environment. From a cost control standpoint, the FIFO method is superior to the weighted-average method because it does not mix costs of the current period with costs of the prior period.

Service Department Allocations
4-81 Service Department Allocations Appendix 4B Appendix 4B – Service Department Allocations. In this appendix we will look at the allocation of service department costs to operating departments.

Operating Departments
4-82 Operating Departments An operating department carries out the central purpose of the organization The Accounting Department at your University. An Assembly Department at General Motors. Operating departments carry out the central purpose of the organization. Examples of operating departments include: The Surgery Department at Mt. Sinai Hospital The Geography Department at the University of Washington The production departments at Mitsubishi

4-83 Service Departments A service department does not directly engage in operating activities. The Accounting Department at Macys The Human Resources Department at Walgreens. Service departments do not directly engage in operating activities. They provide services or assistance to the operating departments. Examples of service department include: Cafeteria Internal Auditing Human Resources Accounting.

Interdepartmental Services
4-84 Interdepartmental Services Service Department Operating Department Costs of the service department become overhead costs to the operating department The overhead costs of operating departments frequently include allocations of costs from service departments. To the extent service department costs are classified as production costs, they should be included in unit product costs and thus must be allocated to operating departments in a process costing system.

Allocation Approaches
4-85 Allocation Approaches Direct Method  Step-Down Method  Three approaches are used to allocate service department costs to other departments—the direct method, the step-down method, and the reciprocal method. Reciprocal Method 

Reciprocal Services Service Department 1 Service Department 2
4-86 Reciprocal Services Service Department 1 Service Department 2 When service departments provide services to each other we call them reciprocal services. Keep in mind that many service departments provide services to each other, as well as to operating departments. Services provided between service departments are known as interdepartmental or reciprocal services.

4-87 Learning Objective 8 Allocate service department costs to operating departments using the direct method. Learning objective number 8 is to allocate service department costs to operating departments using the direct method.

Direct Method Service Department (Cafeteria) Operating Department
4-88 Direct Method Service Department (Cafeteria) Operating Department (Machining) Interactions between service departments are ignored and all costs are allocated directly to operating departments. Service Department (Custodial) Operating Department (Assembly) The direct method is the simplest of the three cost allocation methods because it ignores the services provided by a service department to other service departments. Interactions between service departments are ignored and all costs of each service department are allocated directly to operating departments.

4-89 Direct Method In the example shown on your screen, a company has two service departments, Cafeteria and Custodial, and two operating departments, Machining and Assembly. Cafeteria costs are allocated to the operating departments based on the number of employees in each department. Custodial costs are allocated to each operating department based on the number of square feet in each operating department.

4-90 Direct Method How much of the Cafeteria and Custodial costs should be allocated to each operating department using the direct method of cost allocation? How much of the Cafeteria and Custodial costs should be allocated to each operating department using the direct method of cost allocation?

4-91 Direct Method Using the direct method of cost allocation, it doesn’t matter which service department we allocate first. We will start with cafeteria. The total number of employees in the allocation base is 50, 20 for Machining plus 30 for Assembly. Recall that we ignore the number of employees in Custodial as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Machining, the allocation percentage is 40%, obtained by dividing 20 employees by 50 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Machining we multiply 40% times $360,000 and get $144,000. Quantities of the allocation base attributed to the service departments are ignored. $360,000 × 20 = $144,000 Allocation base: Number of employees

4-92 Direct Method Next, let’s allocate Cafeteria costs to Assembly. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Assembly, the allocation percentage is 60%, obtained by dividing 30 employees by 50 employees. To allocate Cafeteria costs to Assembly we multiply 60% times $360,000 and get $216,000. $360,000 × 30 = $216,000 Allocation base: Number of employees

4-93 Direct Method Now let’s allocate Custodial costs. The total number of square feet in the allocation base is 75,000, 25,000 for Machining plus 50,000 for Assembly. Recall that we ignore the square feet in Cafeteria as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the square feet in an operating department by the total number of square feet in the allocation base. For Machining, the allocation percentage is 33-1/3%, obtained by dividing 25,000 square feet by 75,000 square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Machining we multiply 33-1/3% times $90,000 and get $30,000. $90,000 × 25,000 25, ,000 = $30,000 Allocation base: Square feet occupied

4-94 Direct Method Next, let’s allocate Custodial costs to Assembly. The total number of square feet in the allocation base is 75,000, 25,000 for Machining plus 50,000 for Assembly. The allocation percentage is calculated by dividing the square feet in an operating department by the total number of square feet in the allocation base. For Assembly, the allocation percentage is 66-2/3%, obtained by dividing 50,000 square feet by 75,000 square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Assembly we multiply 66-2/3% times $ and get $60,000. The sum of the costs assigned to Assembly ($60,000) and Machining ($30,000) is equal to the total costs assigned from the Custodial Department ($90,000). 50,000 25, ,000 $90,000 × = $60,000 Allocation base: Square feet occupied

4-95 Learning Objective 9 To allocate service department costs to operating departments using the step-down method. Learning objective number 9 is to allocate service department costs to operating departments using the step-down method.

Step Method Service Department (Cafeteria) Operating Department
4-96 Step Method Service Department (Cafeteria) Operating Department (Machining) Once a service department’s costs are allocated, other service department costs are not allocated back to it. Service Department (Custodial) Operating Department (Assembly) The step method provides for the allocation of a service department’s costs to other service departments, as well as to operating departments. It is a sequential allocation procedure, and the sequence usually begins with the service department that provides the greatest amount of service to other service departments. Once a service department’s costs have been allocated to other departments, other service department costs are not allocated back to it.

4-97 Step Method There are three key points to understand regarding the step method:  In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.  Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.  Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments. There are three key points to understand regarding the step method:  In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.  Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.  Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments.

4-98 Step Method We will use the same data used in the direct method example. We will use the same information shown on your screen for the step-method example. There are two service departments, Cafeteria and Custodial, and two operating departments, Machining and Assembly. Cafeteria costs are allocated to the operating departments based on the number of employees in each department. Custodial costs are allocated to each operating department based on the number of square feet in each operating department.

4-99 Step Method How much of the Cafeteria and Custodial costs should be allocated to each operating department using the step method of cost allocation? We will allocate Cafeteria first since it is larger and provides more service to Custodial than Custodial provides to Cafeteria. Allocate Cafeteria costs first since it provides more service than Custodial.

4-100 Step Method $360,000 × 10 = $60,000 The total number of employees in the allocation base is 60, 10 for Custodial plus 20 for Machining plus 30 for Assembly. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Custodial, the allocation percentage is 16-2/3%, obtained by dividing 10 employees by 60 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Custodial, we multiply 16-2/3% times $360,000 and get $60,000. Allocation base: Number of employees

4-101 Step Method $360,000 × 20 = $120,000 Next, let’s allocate Cafeteria costs to Machining. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Machining, the allocation percentage is 33-1/3%, obtained by dividing 20 employees by 60 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Machining, we multiply 33-1/3% times $360,000 and get $120,000. Allocation base: Number of employees

4-102 Step Method $360,000 × 30 = $180,000 Next, let’s allocate Cafeteria costs to Assembly. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Assembly, the allocation percentage is 50%, obtained by dividing 30 employees by 60 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Assembly, we multiply 50% times $360,000 and get $180,000. The sum of the assigned costs ($60,000 + $120,000 + $180,000) equals the total Cafeteria Department costs of $360,000. Allocation base: Number of employees

4-103 Step Method New total = $90,000 original Custodial cost plus $60,000 allocated from the Cafeteria. Now, we can allocate Custodial costs. The costs in Custodial are now $150,000. This amount includes the department’s own costs of $90,000 plus the $60,000 allocated from Cafeteria. None of the $150,000 will be allocated back to Cafeteria. How much of the Custodial costs should be allocated to each operating department using the step method of cost allocation?

4-104 Step Method $150,000 × 25,000 25, ,000 = $50,000 The total number of square feet in the allocation base is 75,000, 25,000 for Machining plus 50,000 for Assembly. The allocation percentage is calculated by dividing the square feet in a department by the total number of square feet in the allocation base. For Machining, the allocation percentage is 33-1/3%, obtained by dividing t25,000 square feet by 75,000 square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Machining we multiply 33-1/3% times $150,000 and get $50,000. Allocation base: Square feet occupied

4-105 Step Method $150,000 × 50,000 25, ,000 = $100,000 Next, let’s allocate Custodial costs to Assembly. The total number of square feet in the allocation base is 75,000, 25,000 for Machining plus 50,000 for Assembly. The allocation percentage is calculated by dividing the square feet in an operating department by the total number of square feet in the allocation base. For Assembly, the allocation percentage is 66-2/3%, obtained by dividing 50,000 square feet by 75,000 square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Assembly we multiply 66-2/3% times $150,000 and get $100,000. The sum of the costs assigned to Assembly ($100,000) and Machining ($50,000) is equal to the total costs assigned from the Custodial Department ($150,000). Allocation base: Square feet occupied

4-106 Learning Objective 10 To allocate service department costs to operating departments using the reciprocal method. Learning objective number 10 is to allocate service department costs to operating departments using the reciprocal method.

4-107 Reciprocal Method Service Department (Cafeteria) Operating Department (Machining) Interdepartmental services are given full recognition rather than partial recognition as with the step method. Service Department (Custodial) Operating Department (Assembly) The reciprocal method gives full recognition to interdepartmental services. While the step method only allocates forward – never backwards – the reciprocal method allocates service department costs in both directions. Reciprocal allocation requires the use of simultaneous linear equations and is beyond the scope of our discussion. The reciprocal method is rarely used in practice because of it complexity and because the results are usually close to the step method results. Because of its mathematical complexity, the reciprocal method is rarely used.

Quick Check Data for Direct and Step Methods
4-108 Quick Check Data for Direct and Step Methods The direct method of allocation is used. Allocation bases: Business school administration costs (ADMIN): Number of employees Business Administration computer services (BACS): Number of personal computers On your screen, you see information for a series of questions. The first cost allocation questions use the direct method. You will probably want to refer back to this screen as you work through the questions.

4-109 Quick Check  How much cost will be allocated from Administration to Accounting? a. $ 36,000 b. $144,000 c. $180,000 d. $ 27,000 Here’s your first question using the direct method of service department cost allocation.

4-110 Quick Check  How much cost will be allocated from Administration to Accounting? a. $ 36,000 b. $144,000 c. $180,000 d. $ 27,000 The total number of employees in the allocation base is one hundred, twenty in Accounting plus eighty others. Recall that we ignore the number of employees in BACS as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Accounting, the allocation percentage is 20%, obtained by dividing 20 employees by 100 employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to Accounting we multiply 20% times $180,000 and get $36,000. $180,000 × 20 = $36,000

4-111 Quick Check  How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? a. $ 52,500 b. $135,000 c. $270,000 d. $ 49,500 Here’s your second question using the direct method of service department cost allocation.

4-112 Quick Check  How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? a. $ 52,500 b. $135,000 c. $270,000 d. $ 49,500 $90,000 × 18 = $13,500 We will allocate BACS costs to Accounting and add the result to the answer for the previous question. BACS is allocated on the basis of the number of personal computers in each operating department. The total number of personal computers in the allocation base is 120, 18 for Accounting plus 102 others. The allocation percentage is calculated by dividing the number of personal computers in an operating department by the total number of personal computers in the allocation base. For Accounting, the allocation percentage is 15%, obtained by dividing 18 personal computers by 120 personal computers. To allocate BACS costs to Accounting, we multiply 15% times $90,000 and get $13,500. The total amount allocated to Accounting is the sum of $36,000 and $13,500 for a total of $49,500.

Quick Check Data The step method of allocation is used.
4-113 Quick Check Data The step method of allocation is used. Allocation bases: Business school administration costs (ADMIN): Number of employees Business administration computer services (BACS): Number of personal computers Now we will look at a question where we will use the step method of service department cost allocation. The information on your screen for this question is the same information that we used for the direct method questions.

4-114 Quick Check  How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? a. $35,250 b. $49,072 c. $18,000 d. $26,333 Here’s your question using the step method of service department cost allocation.

4-115 Quick Check  How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? a. $35,250 b. $49,072 c. $18,000 d. $26,333 ADMIN provides more service than BACS so we allocate it first. The total number of employees in the allocation base is 105, 5 for BACS, plus 20 for Accounting, plus 80 others. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Accounting, the allocation percentage is found by dividing 20 employees by 105 employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to Accounting we multiply the allocation percentage times $180,000 and get $34,286. We must also allocate ADMIN costs to BACS. The allocation percentage is found by dividing 5 employees by 105 employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to BACS, we multiply the allocation percentage times $180,000 and get $8,571. The new amount to be allocated from BACS is the original $90,000 plus $8,571, for a total of $98,571. Now we can allocate BACS costs to Accounting. For BACS, the allocation percentage of 15% is found by dividing 18 computers by 120 computers. Next we multiply the allocation percentage times the service department cost. To allocate BACS costs to Accounting, we multiply 15% times $98,571 and get $14,786. The total amount allocated to Accounting is $49,072.

4-116 End of Chapter 4 End of chapter 4.

MANAGERIAL ACCOUNTING Eighth Canadian Edition GARRISON, CHESLEY, CARROLL, WEBB Prepared by: Robert G. Ducharme, MAcc, CA University of Waterloo, School.

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MANAGERIAL ACCOUNTING Eighth Canadian Edition GARRISON, CHESLEY, CARROLL, WEBB Prepared by: Robert G. Ducharme, MAcc, CA University of Waterloo, School.

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