1. Chapter 6: Process Costing
Cornerstones of Managerial Accounting, 4e
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2. Characteristics of Process Manufacturing1
Characteristics of Process Manufacturing
Since each product within a product line passing through the processes would receive similar ‘‘doses’’ of materials, labor, and overhead, costs are accumulated by process.
Process costing works well whenever relatively homogeneous products pass through a series of processes and receive similar amounts of manufacturing costs.
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3. 1
Types of Processes
Sequential processing requires that units pass through one process before they can be worked on in the next process in the sequence.
Parallel processing is another processing pattern that requires two or more sequential processes to produce a finished good.
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4. Types of Processes (continued)1
Types of Processes (continued)
Partially completed units (e.g., two subcomponents) can be worked on simultaneously in different processes and then brought together in a final process for completion.
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5. 1
What’s In Common?
Regardless of which processing pattern exists within a firm, all units produced share a common property.
Units are homogeneous and subjected to the same operations for a given process and each unit produced in a period should receive the same unit cost.
Understanding how unit costs are computed requires an understanding of the manufacturing cost flows that take place in a process-costing firm.
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6. How Costs Flow through the Accounts in Process Costing1
How Costs Flow through the Accounts in Process Costing
The manufacturing cost flows for a process-costing system are generally the same as those for a job-order system.
As raw materials are purchased, the cost of these materials flows into a raw materials inventory account. Similarly, raw materials, direct labor, and applied overhead costs flow into a work-in-process (WIP) account.
When goods are completed, the cost of the completed goods is transferred from WIP to the finished goods account.
Finally, as goods are sold, the cost of the finished goods is transferred to the cost of goods sold account.
The journal entries generally parallel those described in a job-order costing system.
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7. How Costs Flow through the Accounts in Process Costing (continued)1
How Costs Flow through the Accounts in Process Costing (continued)
Although job-order and process cost flows are generally similar, some differences exist.
In process costing, each producing department has its own WIP account. As goods are completed in one department, they are transferred to the next department.
The costs attached to the goods transferred out are also transferred to the next department.
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8. Accumulating Costs in the Production Report1
Accumulating Costs in the Production Report
In process costing, costs are accumulated by department for a period of time.
The production report is the document that summarizes the manufacturing activity that takes place in a process department for a given period of time.
A production report contains information on costs transferred in from prior departments as well as costs
added in the department such as direct
materials, direct labor, and overhead;
similar to the job-order cost sheet,
it is subsidiary to the WIP account.
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
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9. Accumulating Costs in the Production Report (continued)1
Accumulating Costs in the Production Report (continued)
A production report is divided into the following sections
and subdivisions:
A production report traces the flow of units through a department, identifies the costs charged to the department, shows the computation of unit costs, and reveals the disposition of the department’s costs for the reporting period.
Unit information section: The unit information section has two major subdivisions:
• units to account for
• units accounted for
Cost information section: The cost information section has two major subdivisions:
• costs to account for
• costs accounted for
Unit ^^^^^^^^Cost
^^^^^^^^
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10. The Impact of Work-In-Process Inventories on Process Costing2
The Impact of Work-In-Process Inventories on Process Costing
Conceptually, calculating the unit cost is easy—just divide total cost by the number of units produced. However, the presence of WIP inventories causes two problems:
Defining the units produced can be difficult, given that some units produced during a period are complete, while those in ending inventory are not. This is handled through the concept of equivalent units of production.
How should the costs and work of beginning work-in-process (BWIP) be treated? Should they be counted with the current period work and costs or treated separately? Two methods have been developed to solve this problem: the weighted average method and the FIFO method.
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11. Equivalent Units of Production2
Equivalent Units of Production
By definition, EWIP is not complete.
Thus, a unit completed and transferred out during the period is not identical (or equivalent) to one in EWIP inventory, and the cost attached to the two units should not be the same.
In computing the unit cost, the output of the period must be defined, a significant issue for process costing.
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12. Equivalent Units of Production (continued)2
Equivalent Units of Production (continued)
The solution is to calculate equivalent units of output.
Equivalent units of output are the complete units that could have been produced given the total amount of manufacturing effort expended for the period under consideration.
Determining equivalent units of output for transferred-out units is easy; a unit would not be transferred out unless it was complete.
Thus, every transferred-out unit is an equivalent unit.
Units remaining in EWIP inventory, however, are not complete.
Thus, someone in production must ‘‘eyeball’’ EWIP to estimate its degree of completion.
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13. Two Methods of Treating Beginning Work-in-Process Inventory2
Two Methods of Treating Beginning Work-in-Process Inventory
In computing a current-period unit cost for a department, two approaches have evolved for dealing with the prior-period output and prior-period costs found in BWIP:
The weighted average costing method and
The FIFO costing method.
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14. The Weighted Average Costing Method2
The Weighted Average Costing Method
The weighted average costing method combines beginning inventory costs and work done with current-period costs and work to calculate this period’s unit cost.
In essence, the costs and work carried over from the prior period are counted as if they belong to the current period.
Thus, beginning inventory work and costs are pooled with current work and costs, and an average unit cost is computed and applied to both units transferred out and units remaining in ending inventory.
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15. The FIFO Costing Method2
The FIFO costing method separates work and costs of the equivalent units in beginning inventory from work and costs of the equivalent units produced during the current period.
Only current work and costs are used to calculate this period’s unit cost.
It is assumed that units from beginning inventory are completed first and transferred out.
The costs of these units include the costs of the work done in the prior period as well as the current period costs necessary to complete the units.
Units started in the current period are divided into two categories:
units started and completed and
units started but not finished (EWIP).
Units in both of these categories are valued using the current period’s cost per equivalent unit.
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16. Weighted Average Costing3
Weighted Average Costing
The weighted average costing method treats beginning inventory costs and the accompanying equivalent output as if they belong to the current period.
This is done for costs by adding the manufacturing costs in BWIP to the manufacturing costs incurred during the current period.
The total cost is treated as if it were the current period’s total manufacturing cost.
Similarly, beginning inventory output and current period output are merged in the calculation of equivalent units.
Under the weighted average method, equivalent units of output are computed by adding units completed to equivalent units in EWIP.
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17. Five Steps in Preparing a Production Report3
Five Steps in Preparing a Production Report
The production report is subsidiary to the WIP account for a department.
The following five steps describe the general pattern of a process-costing production report:
physical flow analysis
calculation of equivalent units
computation of unit cost
valuation of inventories (goods transferred out and EWIP)
cost reconciliation
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18. Evaluation of the Weighted Average Method3
Evaluation of the Weighted Average Method
Advantages
Disadvantages
Unit cost computations are simplified:
Units in BWIP are treated as those of the current period and all equivalent units belong to the same category when it comes to calculating unit costs.
Inaccuracies in computing unit costs for current period output and for units in BWIP:
If the unit cost in a process is relatively stable from one period to the next, the weighted average method is reasonably accurate. However, if the price of manufacturing inputs increases significantly from one period to the next, the unit cost of current output is understated, and the unit cost of BWIP units is overstated.
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19. Multiple Departments 4
In process manufacturing, some departments receive partially completed goods from prior departments.
The usual approach is to treat transferred-in goods as a separate material category when calculating equivalent units.
Thus, the department receiving transferred-in goods would have three input categories:
one for the transferred-in materials
one for materials added
one for conversion costs
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20. Appendix: Production Report- First-In, First-Out Costing5
Under the FIFO costing method, the equivalent units and manufacturing costs in BWIP are excluded from the current period unit cost calculation.
This method recognizes that the work and costs carried over from the prior period legitimately belong to that period.
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21. 5
Differences between the First-In, First-Out and Weighted Average Methods
FIFO
Weighted Average
More Accurate: If changes occur in the prices of the manufacturing inputs from one period to the next.
Better cost control
Better pricing decisions
Most firms use this method due to simplicity.
FIFO has little advantage over weighted average, if unit costs are calculated for short periods.
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