1. © 2010 The McGraw-Hill Companies, Inc. Systems Design: Process Costing Chapter 4

2. McGraw-Hill/Irwin Slide 2 Similarities Between Job-Order and Process Costing  Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product costs.  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.

3. McGraw-Hill/Irwin Slide 3 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 having different production requirements are worked on each period.  Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs.  Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet.

4. McGraw-Hill/Irwin Slide 4 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. 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. Quick Check

5. McGraw-Hill/Irwin Slide 5 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. 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. Quick Check

6. McGraw-Hill/Irwin Slide 6 Processing Departments Any unit in an organization where materials, labor 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. Products in a process costing environment typically flow in a sequence from one department to another.

7. McGraw-Hill/Irwin Slide 7 Learning Objective 1 Record the flow of materials, labor, and overhead through a process costing system.

8. McGraw-Hill/Irwin Slide 8 Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Work in Process Direct Materials Direct Labor Manufacturing Overhead

9. McGraw-Hill/Irwin Slide 9 Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead JobsJobs Costs are traced and applied to individual jobs in a job-order cost system. Direct Materials

10. McGraw-Hill/Irwin Slide 10 Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead Processing Department Processing Department Costs are traced and applied to departments in a process cost system. Direct Materials

11. McGraw-Hill/Irwin Slide 11 T-Account and Journal Entry Views of Process 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.

12. McGraw-Hill/Irwin Slide 12 Raw Materials Process Cost Flows: The Flow of Raw Materials (in T-account form) Work in Process Department B Work in Process Department A Direct Materials

13. McGraw-Hill/Irwin Slide 13 Process Cost Flows: The Flow of Raw Materials (in journal entry form)

14. McGraw-Hill/Irwin Slide 14 Process Cost Flows: The Flow of Labor Costs (in T-account form) Work in Process Department B Work in Process Department A Salaries and Wages Payable Direct Materials Direct Labor

15. McGraw-Hill/Irwin Slide 15 Process Costing: The Flow of Labor Costs (in journal entry form)

16. McGraw-Hill/Irwin Slide 16 Process Cost Flows: The Flow of Manufacturing Overhead Costs (in T-account form) Work in Process Department B Work in Process Department A Manufacturing Overhead Overhead Applied to Work in Process Applied Overhead Direct Labor Direct Materials Direct Labor Direct Materials Actual Overhead

17. McGraw-Hill/Irwin Slide 17 Process Cost Flows: The Flow of Manufacturing Overhead Costs (in journal entry form)

18. McGraw-Hill/Irwin Slide 18 Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept. B (in T-account form) Work in Process Department B Work in Process Department A Direct Materials Direct Labor Applied Overhead Direct Materials Direct Labor Applied Overhead Transferred to Dept. B Transferred from Dept. A Department A Department B

19. McGraw-Hill/Irwin Slide 19 Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept. B (in journal entry form)

20. McGraw-Hill/Irwin Slide 20 Finished Goods Process Cost Flows: Transfers from WIP-Dept. B to Finished Goods (in T-account form) Work in Process Department B Cost of Goods Manufactured Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Cost of Goods Manufactured

21. McGraw-Hill/Irwin Slide 21 Process Cost Flows: Transfers from WIP-Dept. B to Finished Goods (in journal entry form)

22. McGraw-Hill/Irwin Slide 22 Finished Goods Cost of Goods Sold Process Cost Flows: Transfers from Finished Goods to COGS (in T-account form) Work in Process Department B Cost of Goods Manufactured Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Cost of Goods Sold Cost of Goods Manufactured

23. McGraw-Hill/Irwin Slide 23 Process Cost Flows: Transfers from Finished Goods to COGS (in journal entry form)

24. McGraw-Hill/Irwin Slide 24 Equivalent Units of Production Equivalent units are the product of the number of partially completed units and the percentage completion of those units. We need to calculate equivalent units 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.

25. McGraw-Hill/Irwin Slide 25 Equivalent Units – The Basic Idea Two half completed products are equivalent to one complete product. So, 10,000 units 70% complete are equivalent to 7,000 complete units. + = 1

26. McGraw-Hill/Irwin Slide 26 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 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 Quick Check

27. McGraw-Hill/Irwin Slide 27 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 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 10,000 units + (5,000 units × 0.30) = 11,500 equivalent units Quick Check

28. McGraw-Hill/Irwin Slide 28 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 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.

29. McGraw-Hill/Irwin Slide 29 Learning Objective 2 Compute the equivalent units of production using the weighted-average method.

30. McGraw-Hill/Irwin Slide 30 Equivalent Units of Production Weighted-Average Method The weighted-average method... 1.Makes no distinction between work done in prior or current periods. 2.Blends together units and costs from prior and current periods. 3.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. The weighted-average method... 1.Makes no distinction between work done in prior or current periods. 2.Blends together units and costs from prior and current periods. 3.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.

31. McGraw-Hill/Irwin Slide 31 Treatment of Direct Labor Direct labor costs may be small in comparison to other product costs in process cost systems. Direct labor costs may be small in comparison to other product costs in process cost systems. Direct Materials Type of Product Cost Dollar Amount Direct Labor Manufacturing Overhead

32. McGraw-Hill/Irwin Slide 32 Treatment of Direct Labor Type of Product Cost Dollar Amount Conversion Direct labor and manufacturing overhead may be combined into one classification of product cost called conversion costs. Direct Materials Direct Labor Manufacturing Overhead

33. McGraw-Hill/Irwin Slide 33 Weighted-Average – An Example Smith Company reported the following activity in the Assembly Department for the month of June:

34. McGraw-Hill/Irwin Slide 34 The first step in calculating the equivalent units is to identify the units completed and transferred out of Assembly Department in June (5,400 units) Weighted-Average – An Example

35. McGraw-Hill/Irwin Slide 35 The second step is to identify the equivalent units of production in ending work in process with respect to materials for the month (540 units) and adding this to the 5,400 units from step one. Weighted-Average – An Example

36. McGraw-Hill/Irwin Slide 36 Weighted-Average – An Example The third step is to identify the equivalent units of production in ending work in process with respect to conversion for the month (270 units) and adding this to the 5,400 units from step one.

37. McGraw-Hill/Irwin Slide 37 Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in work in process Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in work in process Weighted-Average – An Example

38. McGraw-Hill/Irwin Slide 38 Beginning Work in Process 300 Units 40% Complete Ending Work in Process 900 Units 60% Complete 6,000 Units Started 5,400 Units Completed 5,100 Units Started and Completed Weighted-Average – An Example Materials 5,400 Units Completed 540 Equivalent Units 900 × 60% 5,940 Equivalent units of production

39. McGraw-Hill/Irwin Slide 39 6,000 Units Started 5,400 Units Completed 5,100 Units Started and Completed 270 Equivalent Units 900 × 30% 5,670 Equivalent units of production Beginning Work in Process 300 Units 20% Complete Ending Work in Process 900 Units 30% Complete Weighted-Average – An Example Conversion

40. McGraw-Hill/Irwin Slide 40 Learning Objective 3 Compute the cost per equivalent unit using the weighted-average method.

41. McGraw-Hill/Irwin Slide 41 Beginning Work in Process Inventory: 400 units Materials: 40% complete $6,119 Conversion: 20% complete $3,920 Production started during June 6,000 units Production completed during June 5,400 units Costs added to production in June Materials cost $ 118,621 Conversion cost $ 81,130 Ending Work in Process Inventory: 900 units Materials: 60% complete Conversion: 30% complete Compute and Apply Costs

42. McGraw-Hill/Irwin Slide 42 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 +

43. McGraw-Hill/Irwin Slide 43 Here is a schedule with the cost and equivalent unit information. Compute and Apply Costs

44. McGraw-Hill/Irwin Slide 44 Compute and Apply Costs Here is a schedule with the cost and equivalent unit information. $124,740 ÷ 5,940 units = $21.00 $85,050 ÷ 5,670 units = $15.00 Cost per equivalent unit = $21.00 + $15.00 = $36.00

45. McGraw-Hill/Irwin Slide 45 Learning Objective 4 Assign costs to units using the weighted-average method.

46. McGraw-Hill/Irwin Slide 46 Applying Costs

47. McGraw-Hill/Irwin Slide 47 Applying Costs

48. McGraw-Hill/Irwin Slide 48 Applying Costs

49. McGraw-Hill/Irwin Slide 49 Computing the Cost of Units Transferred Out

50. McGraw-Hill/Irwin Slide 50 Computing the Cost of Units Transferred Out

51. McGraw-Hill/Irwin Slide 51 Computing the Cost of Units Transferred Out

52. McGraw-Hill/Irwin Slide 52 Learning Objective 5 Prepare a cost reconciliation report.

53. McGraw-Hill/Irwin Slide 53 Reconciling Costs

54. McGraw-Hill/Irwin Slide 54 Reconciling Costs

55. McGraw-Hill/Irwin Slide 55 Operation Costing Operation cost is a hybrid of job-order and process costing because it possesses attributes of both approaches Operation costing is commonly used when batches of many different products pass through the same processing department.

56. © 2010 The McGraw-Hill Companies, Inc. FIFO Method Appendix 4A

57. McGraw-Hill/Irwin Slide 57 FIFO vs. Weighted-Average Method The FIFO method (generally considered more accurate than the weighted-average method) differs from the weighted-average method in two ways: 1.The computation of equivalent units. 2.The way in which the costs of beginning inventory are treated. 1.The computation of equivalent units. 2.The way in which the costs of beginning inventory are treated.

58. McGraw-Hill/Irwin Slide 58 Learning Objective 6 Compute the equivalent units of production using the FIFO method.

59. McGraw-Hill/Irwin Slide 59 Equivalent Units – FIFO Method Let’s revisit the Smith Company example. Here is information concerning the Assembly Department for the month of June.

60. McGraw-Hill/Irwin Slide 60 Equivalent Units – FIFO Method Step 1 Step 1: Determine equivalent units needed to complete beginning Work in Process Inventory.

61. McGraw-Hill/Irwin Slide 61 Equivalent Units – FIFO Method Step 2 Step 2: Determine units started and completed during the period.

62. McGraw-Hill/Irwin Slide 62 Equivalent Units – FIFO Method Step 3 Step 3: Add the equivalent units in ending Work in Process Inventory.

63. McGraw-Hill/Irwin Slide 63 Beginning Work in Process 300 Units 40% Complete Ending Work in Process 900 Units 60% Complete 6,000 Units Started 5,100 Units Started and Completed FIFO Example MaterialsMaterials 5,100 Units Completed 540 Equivalent Units 900 × 60% 5,820 Equivalent units of production 180 Equivalent Units 300 × 60%

64. McGraw-Hill/Irwin Slide 64 Beginning Work in Process 300 Units 20% Complete Ending Work in Process 900 Units 30% Complete 6,000 Units Started 5,100 Units Started and Completed FIFO Example ConversionConversion 5,100 Units Completed 270 Equivalent Units 900 × 30% 5,610 Equivalent units of production 240 Equivalent Units 300 × 80%

65. McGraw-Hill/Irwin Slide 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.

66. McGraw-Hill/Irwin Slide 66 Learning Objective 7 Compute the cost per equivalent unit using the FIFO method.

67. McGraw-Hill/Irwin Slide 67 Beginning work in process: 400 units Materials: 40% complete $6,119 Conversion: 20% complete $3,920 Production started during June6,000 units Production completed during June5,400 units Costs added to production in June Materials cost $ 118,621 Conversion cost $ 81,130 Ending work in process 900 units Materials: 60% complete Conversion: 30% complete Cost per Equivalent Unit - FIFO Let’s revisit the Smith Company Assembly Department for the month of June to prepare our production report.

68. McGraw-Hill/Irwin Slide 68 Cost per Equivalent Unit - FIFO The formula for computing the cost per equivalent unit under FIFO method is:

69. McGraw-Hill/Irwin Slide 69 Cost per Equivalent Unit - FIFO Total cost per equivalent unit = $20.3816 + $14.4617 = $34.8433 $118,600 ÷ 5,820 $81,130 ÷ 5,610

70. McGraw-Hill/Irwin Slide 70 Learning Objective 8 Assign costs to units using the FIFO method.

71. McGraw-Hill/Irwin Slide 71 Applying Costs - FIFO Step 1 Step 1: Record the equivalent units of production in ending Work in Process Inventory. 900 units × 60% 900 units × 30%

72. McGraw-Hill/Irwin Slide 72 Applying Costs - FIFO Step 2 Step 2: Record the cost per equivalent unit.

73. McGraw-Hill/Irwin Slide 73 Applying Costs - FIFO Step 3 Step 3: Compute the cost of ending Work in Process Inventory. 540 × $20.3816 270 × 14.4617

74. McGraw-Hill/Irwin Slide 74 Cost of Units Transferred Out Step 1 Step 1: Record the cost in beginning Work in Process Inventory.

75. McGraw-Hill/Irwin Slide 75 Cost of Units Transferred Out Step 2 Step 2: Compute the cost to complete the units in beginning Work in Process Inventory.

76. McGraw-Hill/Irwin Slide 76 Cost of Units Transferred Out Step 3 Step 3: Compute the cost of units started and completed this period.

77. McGraw-Hill/Irwin Slide 77 Cost of Units Transferred Out Step 4 Step 4: Compute the total cost of units transferred out.

78. McGraw-Hill/Irwin Slide 78 Learning Objective 9. Prepare a cost reconciliation report using the FIFO method.

79. McGraw-Hill/Irwin Slide 79 Reconciling Costs

80. McGraw-Hill/Irwin Slide 80 Reconciling Costs

81. McGraw-Hill/Irwin Slide 81 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.

82. © 2010 The McGraw-Hill Companies, Inc. Service Department Allocations Appendix 4B

83. McGraw-Hill/Irwin Slide 83 Operating Departments An operating department carries out the central purpose of the organization The Surgery Department at Mount Sinai Hospital. A Production Department at Mitsubishi. The Geography Department at the University of Washington.

84. McGraw-Hill/Irwin Slide 84 Service Departments Service departments do not directly engage in operating activities. The Accounting Department at Macy’s. The Human Resources Department at Walgreens.

85. McGraw-Hill/Irwin Slide 85 Interdepartmental Services Service Department Operating Department Costs of the service department become overhead costs to the operating department

86. McGraw-Hill/Irwin Slide 86 Allocation Approaches

87. McGraw-Hill/Irwin Slide 87 Reciprocal Services Service Department 1 Service Department 2 When service departments provide services to each other we call them reciprocal services.

88. McGraw-Hill/Irwin Slide 88 Learning Objective 10 Allocate service department costs to operating departments using the direct method.

89. McGraw-Hill/Irwin Slide 89 Direct Method Service Department (Cafeteria) Service Department (Custodial) Operating Department (Machining) Operating Department (Assembly) Interactions between service departments are ignored and all costs are allocated directly to operating departments. Interactions between service departments are ignored and all costs are allocated directly to operating departments.

90. McGraw-Hill/Irwin Slide 90 Direct Method – An Example

91. McGraw-Hill/Irwin Slide 91 Direct Method – An Example How much of the Cafeteria and Custodial costs should be allocated to each operating department using the direct method of cost allocation?

92. McGraw-Hill/Irwin Slide 92 Direct Method – An Example Allocation base: Number of employees

93. McGraw-Hill/Irwin Slide 93 Direct Method – An Example Allocation base: Number of employees $360,000 × 30 20 + 30 = $216,000

94. McGraw-Hill/Irwin Slide 94 Direct Method – An Example Allocation base: Square feet occupied $90,000 × 25,000 25,000 + 50,000 = $30,000

95. McGraw-Hill/Irwin Slide 95 Direct Method – An Example Allocation base: Square feet occupied 50,000 25,000 + 50,000 $90,000 × = $60,000

96. McGraw-Hill/Irwin Slide 96 Learning Objective 11 To allocate service department costs to operating departments using the step-down method.

97. McGraw-Hill/Irwin Slide 97 Operating Department (Machining) Operating Department (Assembly) Step-Down Method Once a service department’s costs are allocated, other service department costs are not allocated back to it. Service Department (Cafeteria) Service Department (Custodial)

98. McGraw-Hill/Irwin Slide 98 There are three key points to understand regarding the step-down method:   In both the direct and step-down 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. Step-Down Method

99. McGraw-Hill/Irwin Slide 99 We will use the same data used in the direct method example. Step-Down Method – An Example

100. McGraw-Hill/Irwin Slide 100 Allocate Cafeteria costs first since it provides more service than Custodial. Step-Down Method – An Example

101. McGraw-Hill/Irwin Slide 101 $360,000 × 10 10 + 20 + 30 = $60,000 Allocation base: Number of employees Step-Down Method – An Example

102. McGraw-Hill/Irwin Slide 102 $360,000 × 20 10 + 20 + 30 = $120,000 Allocation base: Number of employees Step-Down Method – An Example

103. McGraw-Hill/Irwin Slide 103 $360,000 × 30 10 + 20 + 30 = $180,000 Allocation base: Number of employees Step-Down Method – An Example

104. McGraw-Hill/Irwin Slide 104 New total = $90,000 original Custodial cost plus $60,000 allocated from the Cafeteria. Step-Down Method – An Example

105. McGraw-Hill/Irwin Slide 105 $150,000 × 25,000 25,000 + 50,000 = $50,000 Allocation base: Square feet occupied Step-Down Method – An Example

106. McGraw-Hill/Irwin Slide 106 $150,000 × 50,000 25,000 + 50,000 = $100,000 Allocation base: Square feet occupied Step-Down Method – An Example

107. McGraw-Hill/Irwin Slide 107 Reciprocal Method Interdepartmental services are given full recognition rather than partial recognition as with the step method. Service Department (Cafeteria) Service Department (Custodial) Operating Department (Machining) Operating Department (Assembly) Because of its mathematical complexity, the reciprocal method is rarely used.

108. McGraw-Hill/Irwin Slide 108 Quick Check Data for Direct and Step-Down Methods Allocation bases: Business school administration costs (ADMIN): Number of employees Business Administration computer services (BACS): Number of personal computers The direct method of allocation is used.

109. McGraw-Hill/Irwin Slide 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

110. McGraw-Hill/Irwin Slide 110 How much cost will be allocated from Administration to Accounting? a. $ 36,000 b. $144,000 c. $180,000 d. $ 27,000 Quick Check $180,000 × 20 20 + 80 = $36,000

111. McGraw-Hill/Irwin Slide 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

112. McGraw-Hill/Irwin Slide 112 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 Quick Check

113. McGraw-Hill/Irwin Slide 113 Quick Check Data Allocation bases: Business school administration costs (ADMIN): Number of employees Business administration computer services (BACS): Number of personal computers Allocation bases: Business school administration costs (ADMIN): Number of employees Business administration computer services (BACS): Number of personal computers The step method of allocation is used.

114. McGraw-Hill/Irwin Slide 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

115. McGraw-Hill/Irwin Slide 115 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 Quick Check