1. 17 Costing Systems: Process Costing
C H A P T E R
Costing Systems:
Process Costing
Financial and Managerial Accounting
10e
Needles
Powers
Crosson
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2. Concepts Underlying the Process Costing System
A process costing system first measures the costs of direct materials, direct labor, and overhead for each process, department, or work cell and then assigns those costs to the products produced during a particular period.
Such a system is used for cost measurement by companies that make large amounts of similar products or liquid products or that have continuous production runs of identical products.
In this system, costs are measured and recognized by production processes, not by jobs.
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3. Patterns of Product Flows and Cost Flow Methods
In a process costing environment, products flow through several processes, departments, or work cells and may undergo many different operations.
Take for example the simple linear production flow of how milk is produced in a series of three processing steps, or departments.
Each department has its own Work in Process Inventory account to accumulate the direct materials, direct labor, and overhead costs associated with it.
The product unit cost of a bottle of milk is the sum of the cost elements in all three departments divided by the number of bottles of milk produced.
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4. Patterns of Product Flows and Cost Flow Methods
To measure and recognize product costs using process costing requires the preparation of a process cost report for each process, department, or work cell as product-related costs flow through the production process.
Managers assign these costs to the units that have been transferred out of the process and to the units that are still a part of the work in process, using a cost allocation method.
In the first-in, first-out (FIFO) costing method, the cost flow follows the logical physical flow of production—that is, the costs assigned to the first materials processed are the first costs transferred out when those materials flow to the next process, department, or work cell.
The average costing method assigns an average cost to all products made during a period. This method uses total cost averages and does not try to match cost flow with the physical flow of production.
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5. Cost Flows Through the Work in Process Inventory Accounts
A process costing system has a separate Work in Process Inventory account for each process, department, or work cell.
As products move from one process, department, or work cell to the next, the costs of the direct materials, direct labor, and overhead associated with them flow to the next Work in Process inventory account.
Once the products are completed, packaged, and ready for sale, their costs are transferred to the Finished Goods Inventory account.
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6. Computing Equivalent Production
A process costing system does not associate costs with particular job orders. Instead, it assigns the costs incurred in a process, department, or work cell to the units in production during a period by computing an average cost per unit of effort.
Unit cost for the period is computed as follows:
(Direct Materials + Direct Labor + Overhead)
÷ Number of Units = Unit Cost
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7. Computing Equivalent Production
Equivalent production (or equivalent units) applies a percentage-of-completion factor to partially completed units to calculate the equivalent number of whole units produced during a period for each type of input (direct materials, direct labor, and overhead).
The number of equivalent units produced is (1) the sum of total units started and completed during the period and (2) an amount representing the work done on partially completed products in both the beginning and ending work in process inventories.
The costs of direct labor and overhead are often incurred uniformly throughout the production process, so it is convenient to combine them when calculating equivalent units. These combined costs are called conversion costs (or processing costs).
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8. Accounting for Units
Managers must account for the physical flow of products through their areas (Step 1) before they can compute equivalent production for the accounting period (Step 2).
Assume the following for Milk Products in February:
The beginning work in process inventory consists of 6,200 partially completed units (60 percent processed in the previous period).
During the period, the 6,200 units in beginning inventory were completed, and 57,500 units were started into production.
Of the 57,500 units started during the period, 52,500 units were completed. The other 5,000 units remain in work in process inventory and are 45 percent complete.
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9. Step 1: Account for Physical Units
In Step 1, Milk Product’s department manager computes the total units to be accounted for by adding the 6,200 units in beginning inventory to the 57,500 units started into production during this period.
Step 1 continues accounting for physical units. The 6,200 units in beginning inventory that were completed during the period, the 52,500 units that were started and finished in the period, and the 5,000 units remaining in the department at the end of the period are summed, and the total is listed as “units accounted for.” (Note that “units accounted for” must equal the “units to be accounted for” in Step 1.)
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10. Step 2: Account for Equivalent Units (slide 1 of 2)
Beginning Inventory
Because all direct materials are added at the beginning of the production process, the 6,200 partially completed units that began February as work in process were already 100 percent complete in regard to direct materials.
They were 60 percent complete in regard to conversion costs on February 1. The remaining 40 percent of their conversion costs were incurred during the month. Thus, the current equivalent production for their conversion costs is 2,480 (6,200 units X 40%).
Units Started and Completed During the Period
All the costs of the 52,500 units started and completed during February were incurred during this period. Thus, the full amount of 52,500 is entered as equivalent units for both direct materials costs and conversion costs.
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11. Step 2: Account for Equivalent Units (slide 2 of 2)
Ending Inventory
Because the materials for the 5,000 drinks still in process at the end of February were added when the drinks went into production during the month, the full amount of 5,000 is entered as the equivalent units for direct materials costs.
However, these drinks are only 45 percent complete in terms of conversion costs. Thus, the equivalent production for their conversion costs is 2,250 (5,000 units X 45%).
Totals
Step 2 is completed by summing all the physical units to be accounted for (63,700), all equivalent units for direct materials costs (57,500), and all equivalent units for conversion costs (57,230).
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12. Step 3: Account for Costs
All costs for the period are accumulated in the Total Costs column.
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13. Step 4: Compute Cost per Equivalent Unit
Compute the current cost per current equivalent unit for direct materials and for conversion costs.
Note that the equivalent units are taken from Step 2. Prior period costs attached to units in beginning inventory are not included in these computations because the FIFO costing method uses a separate costing analysis for each accounting period.
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14. Step 5: Assign Costs to Cost of Goods Manufactured and Ending Inventory (slide 1 of 2)
Cost of Goods Manufactured and Transferred Out
Step 5 shows that the costs transferred out to the Finished Goods Inventory account include the $41,540 in direct materials and conversion costs for completing the 6,200 units in beginning inventory.
Step 2 shows that 2,480 equivalent units of conversion costs were required to complete these 6,200 units. Because the equivalent unit conversion cost for February is $5.60, the cost to complete the units carried over from January is $13,888 (2,480 units X $5.60).
Each of the 52,500 units started and completed in February cost $8.90 to produce. Thus, 52,500 units X $8.90 = $467,250.
The cost assigned to the work completed during the period and transferred to Finished Goods is $522,678 ($41,540 + $13, $467,250).
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15. Step 5: Assign Costs to Cost of Goods Manufactured and Ending Inventory (slide 2 of 2)
All costs remaining in Work in Process Inventory after the cost of goods manufactured has been transferred out represent the cost of the drinks still in production at the end of February. The balance in the ending Work in Process Inventory is computed as follows:
(5,000 units x $3.30 per unit) + (2,250 x $5.60 per unit) = $29,100
Remember that the total costs in Steps 3 and 5 must always
be the same number. If they are not, look for omission of any costs, calculation errors, or rounding differences.
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16. Process Costing for Two or More Production Departments
A company that has more than one production process or department must have a Work in Process Inventory account for each process or department.
When products flow from the first department to the second department, their costs flow from the first department’s Work in Process Inventory account to the second department’s Work in Process Inventory account.
The costs transferred into the second department’s Work in Process Inventory account are treated in the same way as the cost of direct materials added at the beginning of the production process.
At the end of the period, a separate process cost report is prepared for each department.
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17. Preparing a Process Cost Report Using the Average Costing Method
When a process cost report uses the average costing method cost flows do not follow the logical physical flow of production as they do with the FIFO method.
Instead, the costs in beginning inventory are combined with current period costs to compute an average product unit cost.
Preparing a process cost report using the average costing method includes the same five steps as using the FIFO method, but the procedures for completing the steps differ.
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18. Step 1: Account for Physical Units
Step 1 of a process cost report accounts for the physical units in a production process, department, or work cell during a period.
Units to be accounted for equals the physical units in beginning inventory plus the physical units started during the period.
In Step 1, Milk Products’ department manager computes the total units to be accounted for as follows:
6,200 units + 57,500 units = 63,700 units
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19. Step 2: Account for Equivalent Units (slide 1 of 2)
Units Completed and Transferred Out
The average costing method treats both the direct materials costs and the conversion costs of the 58,700 units completed in February (6,200 units from beginning inventory + 52,500 started this period) as if they were incurred in the current period. Thus, the full amount of 58,700 is entered as the equivalent units for these costs.
Ending Inventory
Because all direct materials are added at the beginning of the production process, the full amount of 5,000 is entered as the equivalent units for direct materials costs.
Because the 5,000 units in ending inventory are only 45 percent complete in terms of conversion costs, the amount of equivalent units is computed as follows: 5,000 units x 45% = 2,250 units
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20. Step 2: Account for Equivalent Units (slide 2 of 2)
Totals
When the average costing method is used, Step 2 in a process cost report is completed by summing all the physical units to be accounted for, all equivalent units for direct materials costs, and all equivalent units for conversion costs.
Milk Products accounted for 63,700 physical units. Equivalent units for direct materials costs totaled 63,700, and equivalent units for conversion cots totaled 60,950.
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21. Step 3: Account for Costs
All direct materials costs and conversion costs for beginning inventory and the current period are accumulated in the Total Costs column.
The total of $551,778 consists of $209,900 in direct materials costs and $341,878 in conversion costs.
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22. Step 4: Compute Cost per Equivalent Unit
Step 4 computes the cost per equivalent.
Note that the cost per equivalent unit for both direct materials and conversion costs has been rounded to the nearest cent.
Note also that the average costing and FIFO costing methods use different numerators and denominators in Step 4. Average costing divides total cost by total equivalent units, whereas FIFO divides current costs by current equivalent units.
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23. Cost of Goods Manufactured and Transferred Out
Step 5: Assign Costs to Cost of Goods Manufactured and Ending Inventory (slide 1 of 2)
Cost of Goods Manufactured and Transferred Out
The costs of the units completed and transferred out are assigned by multiplying the equivalent units for direct materials and conversion costs (accounted for in Step 2) by their respective cost per equivalent unit (computed in Step 4) and then totaling these assigned values.
Because the costs per equivalent unit were rounded in Step 4, a rounding difference of $362 has been deducted from the total cost. The $522,655 of transferred costs will go to the Finished Goods Inventory account, since the goods are ready for sale.
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24. Step 5: Assign Costs to Cost of Goods Manufactured and Ending Inventory (slide 2 of 2)
The costs of the units in ending work in process inventory are assigned in the same way as the costs of cost of goods manufactured and transferred out. Thus, the total of costs assigned to ending inventory is computed as follows:
(5,000 x $3.30) + (2,250 x $5.61) = $29,123
The $29,123 (rounded) will appear as the ending balance in the Work in Process Inventory account.
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25. The Management Process and the Process Costing System
The ways managers use process costing throughout the management process are:
Plan
Perform
Evaluate
Communicate
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