1. Process Costing and Analysis
Chapter 16
Process Costing and Analysis
This chapter focuses on how to measure and account for costs in process operations. We explain process production, describe how to assign costs to processes, and compute cost per equivalent unit for a process.

2. Conceptual Learning Objectives
C1: Explain process operations and the way they differ from job order operations.
C2: Define equivalent units and explain their use in process cost accounting.
C3: Explain the four steps in accounting for production activity in a period.
C4: Define a process cost summary and describe its purposes.
C5: Appendix 16A: Explain and illustrate the four steps in accounting for production activity using FIFO. NOT COVERED
In this chapter, you will learn the following conceptual objectives:
C1: Explain process operations and the way they differ from job order operations.
C2: Define equivalent units and explain their use in process cost accounting.
C3: Explain the four steps in accounting for production activity in a period.
C4: Define a process cost summary and describe its purposes.
C5: Appendix 16A: Explain and illustrate the four steps in accounting for production activity using FIFO.

3. Analytical Learning Objectives
A1: Compare process cost accounting and job order cost accounting.
A2: Explain and illustrate a hybrid costing system.
In this chapter, you will learn the following analytical objectives:
A1: Compare process cost accounting and job order cost accounting.
A2: Explain and illustrate a hybrid costing system.

4. Procedural Learning Objectives
P1: Record the flow of direct materials costs in process cost accounting.
P2: Record the flow of direct labor costs in process cost accounting.
P3: Record the flow of factory overhead costs in process cost accounting.
P4: Compute equivalent units produced in a period.
P5: Prepare a process cost summary.
P6: Record the transfer of completed goods to Finished Goods Inventory and Cost of Goods Sold.
In this chapter, you will learn the following procedural objectives:
P1: Record the flow of direct materials costs in process cost accounting.
P2: Record the flow of direct labor costs in process cost accounting.
P3: Record the flow of factory overhead costs in process cost accounting.
P4: Compute equivalent units produced in a period.
P5: Prepare a process cost summary.
P6: Record the transfer of completed goods to Finished Goods Inventory and Cost of Goods Sold.

5. Process Manufacturing Operations
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.
Examples: Crude Oil; Chemicals
Profen: Pain Reliever by GenX Co
Process costing is used to determine the unit costs of small, low-cost items. We could not justify the use of job order costing for such small items.

6. Process Manufacturing Operations GenX
Direct
Materials
Indirect
Goods in Process
Factory Overhead
Finished Goods
Allocated Overhead
Let’s look at an example illustrating the flow of units and costs in a process system. We will use an example of a company called GenX.
Direct materials and direct labor are traced to the processes. Factory overhead items are indirect and must be allocated to the process using a predetermined overhead rate.
Delivered to Customers
Indirect
Direct
Labor

7. Process Manufacturing Operations
PROCESS OPERATIONS: CHEMICALS
EXHIBIT 16.1: PAGE 675
-PREPARING the chemicals; -MIXING the chemicals; -BOTTLING the chemical mix; -Packaging the bottles.
Process costing is used to determine the unit costs of small, low-cost items. We could not justify the use of job order costing for such small items.

8. Process Manufacturing Operations
PRODUCTION FLOOR : PROFEN
EXHIBIT 16.3: PAGE 676
Profen is produced by: -Mixing its active ingredient, Profelene, with flavorings and preservatives, -Molding it into tablets, and -Packaging the tablets.
Process costing is used to determine the unit costs of small, low-cost items. We could not justify the use of job order costing for such small items.

9. Process Manufacturing Operations
Process Operations & Costs: GenX
EXHIBIT 16.4: PAGE 676: FLOWCHART
How GenX uses Process Cost Accounting to compute product costs: COST FLOWS 1 thru 10
EXHIBIT 16.21: PAGE 688: Cost Flow thru GenX Summary of Cost Flows: COST FLOWS 1 thru 10
Process costing is used to determine the unit costs of small, low-cost items. We could not justify the use of job order costing for such small items.

10. Process Manufacturing Operations GenX
Direct
Materials
Indirect
Goods in Process
Factory Overhead
Finished Goods
Allocated Overhead
Let’s look at an example illustrating the flow of units and costs in a process system. We will use an example of a company called GenX.
Direct materials and direct labor are traced to the processes. Factory overhead items are indirect and must be allocated to the process using a predetermined overhead rate.
Delivered to Customers
Indirect
Direct
Labor

11. Comparing Job Order and Process Production
Job Order Systems
Custom orders
Heterogeneous products
Low production volume
High product flexibility
Low to medium standardization
Example: Aircraft
Process Systems
Repetitive operations
Homogeneous products
High production volume
Low product flexibility
High standardization
Exhibit 16.1 (Page 675): Chemicals Processing
On the left you see characteristics of a job order system that you learned in the previous chapter. Compare the characteristics of a process costing system on the right with those of a job order system. In a job order system, the focus is on the job, while in a process system, the focus is on the process.

12. Job and Process Costing Similarities
Same objective: to determine the cost of products
Same inventory accounts: raw materials, work in process, and finished goods
Same overhead assignment method: predetermined rate times actual activity
There are a great number of similarities between job order and process costing, so we will use many of the same concepts we learned in Chapter 15 as we study process costing.

13. Job and Process Costing Similarities and Differences
Journal entries for both job order and process costing are identical
The difference between job order and process costing lies in how the cost of goods transferred to finished goods is determined.
All of the journal entries – for the acquisition and use of raw materials, the acquisition and use of labor, the incurring and allocation of fixed overhead, and the transfer of completed goods from goods in process to finished goods – are identical.
The difference lies in how to determine the cost of completed goods.

14. Job Order and Process Costing Differences
The cost of goods transferred to finished goods equals the number of completed units times the cost per equivalent unit
Job order costing
The cost of goods transferred to finished goods is equal to the sum of all of the completed jobs for that period

15. Equivalent Units of Production
Equivalent units is a concept expressing a number of partially completed units as a smaller number of fully completed units.
Two one-half full pitchers are equivalent to one full pitcher.
Direct material, direct labor, and factory overhead costs are accumulated for a process for a production period. Once the costs are properly accumulated in the process, we will divide these costs by the equivalent units processed to get the cost per unit for the period.
Equivalent units is a term that refers to the number of units that would have been completed if all of the effort during a period had been applied only to the units started in that period. For example, four thousand units that are sixty percent complete would total two thousand four hundred equivalent units (sixty percent of four thousand is two thousand four hundred).
Take a few minutes to answer the following two questions. They deal with calculating and using equivalent units. Check your progress on these concepts before moving on. + =

16. Cost Per Equivalent Unit=
Product costs for the period Equivalent units for the period
Total production costs for a production period are divided by the equivalent units produced for the period to get the cost per unit.

17. The process is now complete.
Equivalent Units C2
40% of Material
60% of Material
Stage 1
Stage 2
Stage 3
25% of Labor and Overhead
25% of Labor and Overhead
50% of Labor and Overhead
If materials, labor and overhead are added at different rates in the process, the completion percentages will be different. Multiplying different percentages times the unfinished units will result in different equivalent units for materials, labor and overhead.
In this example, we see that material is added before labor and overhead, resulting in a higher completion percentage. This is not unusual as material must be present first before the work can begin. Think about baking cookies. All of the ingredients (materials) are present before the processing begins in the oven.
Once all of the labor and overhead are added to the materials in the process, the units are complete.
The process is now complete.

18. Process Manufacturing Operations GenX
Direct
Materials
Indirect
Goods in Process
Factory Overhead
Finished Goods
Allocated Overhead
Let’s look at an example illustrating the flow of units and costs in a process system. We will use an example of a company called GenX.
Direct materials and direct labor are traced to the processes. Factory overhead items are indirect and must be allocated to the process using a predetermined overhead rate.
Delivered to Customers
Indirect
Direct
Labor

19. Accounting for GenX C3
Let’s look at actual units processed and actual costs incurred for GenX.
Now let’s add numbers of units and dollars of costs to the example. We will examine the two processing departments in order of the production and cost flows, Grinding.first, and then Mixing.
Here we see the units processed and the completion percentages. Take a minute to become familiar with these numbers before moving on to the cost information. Process costing applications include lots of numbers and computations, so you may find yourself referring back to this given information as we work through the example.

20. Accounting for GenX C4
The beginning inventory costs were incurred in March for the partially completed units left in ending inventory in Grinding. March’s ending inventory in Grinding becomes April’s beginning inventory. The current period’s costs were incurred in Grinding to complete the beginning inventory and to start additional units.

21. Accounting for GenX C5
GenX uses a weighted average cost flow system with the following four steps:
Determine physical flow of units.
Compute equivalent units of production.
Compute cost per equivalent unit.
Assign and reconcile costs.
As with all situations involving inventory costs, we must choose a cost flow method. We will use the weighted average method for GenX,. Process cost applications can be overwhelming if we do not use a well-planned approach. The four-step procedure will enable us to solve a process cost application in manageable parts.

22. Determine Physical Flow of Units
The beginning inventory of units plus the units started in April equal the total units to account for in the Grinding process for April. The total number of units is either completed and transferred to Mixing or is left partially completed in Grinding. Notice how the two bottom lines are reconciled.

23. Compute Equivalent Units of Production - Materials
To convert units to equivalent units, we multiply by the appropriate percentage. Since the materials are added at the start of the period, the physical units ending goods in process have 100% of the materials attached to them.

24. Compute Equivalent Units of Production – Direct Labor and Factory Overhead
Now that we have completed the equivalent units computations for material, we can move on to labor and overhead. We can compute equivalent units for labor and overhead at one time since both labor and overhead have the same completion percentages.

25. Compute Equivalent Units of Production
The equivalent units computation for material, labor, and overhead from the preceding computations are summarized in this table. Notice that the equivalent units for material differs from the equivalent units for labor and overhead because the completion percentages differed.

26.  Compute Cost Per Equivalent Unit
Costs for April are divided by the equivalent units for April to get the cost per equivalent unit.

27. Cost Reconciliation C5
In the cost reconciliation, we will account for all costs incurred by assigning unit costs to the:
A. 100,000 units transferred out.
B. 20,000 units remaining in ending inventory.
Now that we have completed the computations for equivalent units and for costs per equivalent unit, we can use those results to compute the cost of the one hundred thousand units completed and transferred out and the cost of the partially completed units remaining in the process at the end of April.

28. C5
First, we show the section called “Costs to Account For.” In this section, we add the beginning inventory costs to the costs incurred for April to get the total costs to be accounted for in Grinding.
The we complete the “Costs Accounted for As” section. The cost of the units completed equal the cost of the 100,000 equivalent units of production for the direct materials, direct labor and factory overhead. Finally we compute the costs of ending goods in process.
The ending inventory cost in Grinding is the sum of direct material, direct labor and factory overhead costs. The number of equivalent units for each product cost is multiplied by the respective unit cost. For example, the direct labor cost in ending inventory, three hundred dollars, is computed by multiplying five thousand equivalent units times 60 cents per unit. The total costs accounted for, twenty seven thousand sixty five dollars, is equal to the total costs to account for, twenty seven thousand sixty dollars. There is a good deal of information provided. Take a moment to insure that you understand each step.

29. Process Cost Summary Process Cost Summary
Helps managers control their departments.
Provides cost information for financial statements.
Shows the flow of units and costs through work in process.
Helps factory managers evaluate department manager performance.
Process Cost Summary
The computations of equivalent units, unit costs, and cost assignments to units completed and transferred, and to units remaining in ending inventory are summarized in a report called the process cost summary. In addition to providing inventory costs for financial statements, this report helps managers evaluate performance and control department operations,.

30. Process Cost Summary C4
The process cost summary has three parts: (1) costs charged to production; (2) computation of equivalent units and cost per equivalent unit; and (3) the cost assignment to unfinished units remaining in process and to units completed and transferred. Costs charged to production for April include the costs in beginning inventory and the costs for direct material, direct labor, and factory overhead that are incurred in April.

31. C4
The first portion of the Process Cost Summary summarizes the flow of units and the computation of equivalent units for each product cost. In the lower portion, you see the computation of cost per equivalent unit for each product cost for April.

32. C4
The ending inventory cost is the sum of direct material, direct labor and factory overhead costs for the unfinished units. The number of equivalent units for each product cost is multiplied by the respective unit cost. For example, the factory overhead cost in ending inventory, three hundred sixty dollars, is computed by multiplying five thousand equivalent units times point zero seven two per unit. The total costs accounted for are twenty seven thousand sixty dollars, which is equal to the twenty seven thousand sixty dollars to account for.

33. C4
Here we see the computation of the cost of the 100,000 units completed and transferred out.

34. Hybrid Costing SystemsA2
Hybrid costing systems contain features of both job order and process operations.
Job Order Costing
Hybrid Costing
Process Costing
Hybrid costing includes features of both job order and process costing. Material costs are traced directly as in job order costing, but conversion costs (labor and overhead) are accounted for in the same manner as used in process costing.
Material costs are accounted for using a job order system.
Conversion costs are accounted for using a process system.

35. Process Costing Typical Accounting Entries
The following journal entries illustrate the recording process for a process cost system.
To record material purchased on account, we increase the raw materials inventory account with a debit entry and we increase accounts payable with a credit entry.

36. Process Costing Typical Accounting Entries
When direct material is used, we increase goods in process with a debit entry and decrease the raw materials inventory account with a credit entry.

37. Process Costing Typical Accounting Entries
When indirect materials are used, we charge the factory overhead account using a debit entry and decrease the raw materials inventory account with a credit entry.

38. Process Costing Typical Accounting Entries
When salaries and wages are paid, we record the amount in the factory payroll account with a debit entry and we reduce cash with a credit entry.

39. Process Costing Typical Accounting Entries
The portion of factory payroll that is classified as direct labor increases the goods in process inventory accounts which is accomplished with a debit entry.

40. Process Costing Typical Accounting Entries
The portion of factory payroll that is classified as indirect direct labor increases the factory overhead account, a debit entry.

41. Process Costing Typical Accounting Entries
Other actual costs for factory overhead items are recorded with a debit entry to the factory overhead account. Prepaid insurance is an asset account that is reduced with a credit as the insurance coverage is used. Accrued liabilities payable is a liability account that is increased with a credit. Cash is an asset account that is reduced with a credit indicating that cash has been paid. Accumulated depreciation is a contra asset account that is increased with a credit to reflect the adjusting entry for depreciation on factory buildings and equipment..

42. Process Costing Typical Accounting Entries
Factory overhead is applied to the process using a predetermined overhead rate, resulting in an increase in the goods in process inventory account.

43. Process Costing Typical Accounting Entries
Completed units are transferred from production to the finished goods inventory account. We record the increase in finished goods with a debit entry and we record the decrease in goods in process with a credit entry.

44. Process Costing Typical Accounting Entries
When the completed units are sold, we reduce the finished goods inventory account with a credit entry. Cost of goods sold is an expense account that is recorded with a debit entry.

45. End of Chapter 16
Now that we have mastered the basic concepts of Process Cost Accounting, we are ready to move on to the next chapter.

46. Process Manufacturing Operations GenX
Direct
Materials
Indirect
Goods in Process
Factory Overhead
Finished Goods
Allocated Overhead
Let’s look at an example illustrating the flow of units and costs in a process system. We will use an example of a company called GenX.
Direct materials and direct labor are traced to the processes. Factory overhead items are indirect and must be allocated to the process using a predetermined overhead rate.
Delivered to Customers
Indirect
Direct
Labor

47. Process Manufacturing Operations GenX
Direct
Materials
Indirect
Goods in Process
Factory Overhead
Finished Goods
Allocated Overhead
Let’s look at an example illustrating the flow of units and costs in a process system. We will use an example of a company called GenX.
Direct materials and direct labor are traced to the processes. Factory overhead items are indirect and must be allocated to the process using a predetermined overhead rate.
Delivered to Customers
Indirect
Direct
Labor