1. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 Process Costing Chapter Eleven

2. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 2 Identify the types of firms or operations for which a process costing system is most suitable Explain and calculate equivalent units produced Describe the five steps in process costing Demonstrate the weighted-average method of process costing Demonstrate the FIFO method of process costing Learning Objectives

3. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 3 Apply process costing to a firm with multiple departments Prepare journal entries to record the flow of costs in a process cost system Explain how process cost systems are implemented and enhanced in practice Account for spoilage in process costing Learning Objectives (continued)

4. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 4 Process costing: a product costing system that accumulates costs according to processes or departments Accumulated costs are spread over output of the period Used when outputs are standardized/ homogeneous Examples: chemicals, oil refining, textiles, paints, flour, canneries, rubber, steel, glass, cement, and sporting goods Process Costing

5. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 5 Prepared each period (e.g., each month) for each department Each department has its own WIP Inventory account The production cost report summarizes: –The number of physical and equivalent units –Costs incurred during the period –Cost per equivalent unit for each cost element (e.g., DL, DM, factory overhead) –Costs assigned to units completed and to units in ending WIP inventory Production Cost Report

6. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 6 Equivalent units: –A measure of output for the period Example: 2 units 50% complete = 1 unit fully complete –An expression of partially completed units in terms of fully completed units Cost/equivalent unit = costs in each department for the period by the “number of equivalent units” produced during the period –Definition of numerator and denominator depends on whether FIFO or weighted-average method is used Production Cost Report (continued)

7. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 7 Some Cost Issues Because of the relatively small DL content in many process industries, factory overhead and DL costs are often combined into a separate cost element and called conversion costs Many firms incur conversion costs uniformly throughout the production process DM costs can be added at discrete points of manufacturing or continuously over production (in the latter case, DM for equivalent-unit purposes will be calculated using the same proportion as conversion costs)

8. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 8 Flow of Costs in Process Costing

9. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 9 Completing the Production Cost Report: 5 Steps  Account for the physical units  Calculate equivalent units for each manufacturing cost element (FIFO or weighted-average method)  Determine total costs for each manufacturing cost element (FIFO or weighted-average method)  Compute cost per equivalent unit for each manufacturing cost element  Assign total manufacturing costs to units completed and ending WIP Inventory

10. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 10 Weighted-Average vs. FIFO? The weighted average method includes all costs (i.e., beginning WIP inventory + current period manufacturing costs) in calculating cost per equivalent unit for each cost element the unit cost –Thus, prior period and current period costs are averaged The FIFO method includes in calculating the unit cost only costs incurred and work effort performed during the current period –Thus, FIFO costs represent the current period’s cost per equivalent unit for each manufacturing cost element

11. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 11 Process Costing Example HSU Toy Company has two production departments, molding and finishing. Molding places direct materials into production at the beginning of the process. Direct labor and factory overhead costs are incurred gradually throughout the process with different proportions. The molding department’s units of production and costs for the month of June are provided.

12. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 12 Process Costing Example (continued)

13. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 13 Step 1: Account for Physical Product Flow

14. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 14 Step 2: Calculate Equivalent Units for Each Cost Element

15. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 15 Step 3: Determine Total Cost for Each Cost Element “Total Costs for Each Manufacturing Cost Element” = Numerator in cost per equivalent unit calculation (and is different for FIFO vs. Weighted-Average method)

16. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 16 Step 4: Calculate Cost per Equivalent Unit for Each Cost Element

17. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 17 Step 5: Cost Assignment

18. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 18 FIFO Example: Step 1

19. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 19 Step 2, Alternative 1: Calculate FIFO Equivalent Units

20. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 20 Step 2, Alternative 2: Calculate FIFO Equivalent Units

21. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 21 Step 3: Calculate FIFO (i.e., Current Period) Costs

22. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 22 Step 4: Calculate FIFO Costs per Equivalent Unit

23. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 23 Step 5, Part 1: Assign Costs to Units Completed from Beginning WIP Inventory

24. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 24 Step 5, Part 2: Assign Costs to Units Started & Completed and Account for Total Costs

25. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 25 Weighted-Average vs. FIFO Weighted- Average FIFO Handling of partially completed beginning WIP No separate treatment Separates the units in the beginning WIP (and their costs) from the units started and completed during the period Ease of calculation and appropriateness Easier; best in situations where WIP is small and prices/costs are stable More difficult; best in situations where prices/costs fluctuate; better for “control” purposes

26. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 26 Process Costing with Multiple Departments As a product passes from one department to another, the accumulated cost passes from department to department Transferred-in costs, or prior department costs, are costs of work performed in earlier departments that are transferred into the present department These costs are treated like an additional cost element

27. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 27 Implementation and Enhancement of Process Costing Sometimes process-based manufacturers have very different products going through different processes, making process costing by itself inadequate Activity-based costing (ABC) is an important enhancement to process costing when product and process variety arises Process costing also lacks the ability to identify the most profitable product mix--to remedy this shortcoming we might use: –The contribution methods (Chapter 9) –The theory of constraints (Chapter 10)

28. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 28 Spoilage in Process Costing There are two options to account for normal spoilage: –Count the number of spoiled units, prepare a separate equivalent unit computation with the cost per unit of the spoiled goods, and then allocate the cost of spoilage to the good units produced –Omit the spoiled units in computing the equivalent units of production; the spoilage cost is thus included as part of total manufacturing costs

29. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 29 Process costing is a product costing system that accumulates costs according to processes or departments and assigns them to a large number of nearly identical products The typical firm that uses process costing employs a standardized production process (often mass production) to manufacture homogeneous products Process costing is used in industries such as chemicals, oil refining, textiles, paints, flour, canneries, rubber, steel, glass, cement, and sporting goods Chapter Summary

30. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 30 Chapter Summary (continued) Each period, each department prepares a production cost report Five steps in preparing a production cost report: –Analyze the physical flow of units –Calculate equivalent units for each manufacturing cost element (FIFO or Weighted-average method) –Determine total costs for each manufacturing cost element (FIFO or Weighted-average method) –Compute cost per equivalent unit for each manufacturing cost element –Allocate total manufacturing costs for the period to units completed and to ending WIP

31. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 31 Chapter Summary (continued) The weighted average method includes all costs in calculating unit costs, including both costs incurred during the period and those in the beginning WIP inventory (i.e., those costs brought forward from last period into the current period) –Thus, prior period and current period costs are averaged

32. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 32 Chapter Summary (continued) The FIFO method includes in calculating equivalent unit cost only costs incurred and work effort performed during the current period; thus, the FIFO costs can be considered “current period manufacturing costs per equivalent unit” for each cost element –For cost assignment purposes, the cost of units from the beginning WIP inventory will include a combination of last period’s costs + the current period’s (FIFO) cost to complete the units –Units that are both started and completed during the period are assigned the current period costs per equivalent unit –Ending inventory is assigned the current (FIFO) period’s costs

33. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008 33 Chapter Summary (continued) Transferred-in costs, or prior department costs, are costs of work performed in an earlier department that are transferred into the present department –These costs are treated like an additional cost element Activity-based costing (ABC), the contribution methods, and the theory of constraints are important enhancements to a process costing system There are two options when accounting for spoilage: –Calculate the cost per spoiled unit and allocate it to the good units –Omit the spoiled units from the computation