1. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Chapter Four Systems Design: Process Costing

2. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-2 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 cost. 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. Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product cost. 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. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-3 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 are worked on each period. 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 are worked on each period. Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. 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. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet. 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 are worked on each period. 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 are worked on each period. Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. 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. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet.

4. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-4 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. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-5 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. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-6 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.

7. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-7 T-Account and Journal Entry Views of 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.

8. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-8 Raw Materials Process Cost Flows (in T-account form) Work in Process Department B Work in Process Department A Direct Materials

9. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-9 Process Cost Flows (in journal entry form)

10. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-10 Process Cost Flows (in T-account form) Work in Process Department B Work in Process Department A Wages Payable Direct Materials Direct Labor

11. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-11 Process Costing (in journal entry form)

12. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-12 Process Cost Flows (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

13. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-13 Process Costing (In journal entry form)

14. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-14 Process Cost Flows (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

15. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-15 Process Costing (in journal entry form)

16. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-16 Finished Goods Process Cost Flows (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

17. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-17 Process Costing (in journal entry form)

18. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-18 Finished Goods Cost of Goods Sold Process Cost Flows (in journal entry 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

19. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-19 Process Costing (in journal entry form)

20. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-20 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.

21. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-21 Equivalent Units – The Basic Idea Two half completed products are equivalent to one completed product. So, 10,000 units 70% complete are equivalent to 7,000 complete units. + = 1

22. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-22 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

23. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-23 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

24. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-24 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.

25. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-25 Equivalent Units of Production Weighted-Average Method The weighted-average method... Makes no distinction between work done in prior or current periods. Blends together units and costs from prior and current periods. 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.

26. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-26 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 Conversion

27. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-27 Treatment of Direct Labor Type of Product Cost Dollar Amount Conversion Direct labor and manufacturing overhead may be combined into one product cost called conversion. Direct Materials 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.

28. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-28 Weighted-Average Example Double Diamond Skis reported the following activity in Shaping and Milling Department for the month of May:

29. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-29 The first step in calculating the equivalent units is to identify the units completed and transferred out of the Department in May (4,800 units) Weighted-Average Example

30. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-30 The second step is to identify the equivalent units of production in ending work in process with respect to materials for the month (160 units) and add this to the 4,800 units from step one. Weighted-Average Example

31. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-31 Weighted-Average Example The third step is to identify the equivalent units of production in ending work in process with respect to conversion for the month (100 units) and add this to the 4,800 units from step one.

32. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-32 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 Example

33. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-33 Beginning work in process: 200 units Materials: 55% complete $9,600 Conversion: 30% complete5,575 Production started during May5,000 units Production completed during May4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost 350,900 Ending work in process 400 units Materials: 40% complete Conversion: 25% complete Beginning work in process: 200 units Materials: 55% complete $9,600 Conversion: 30% complete5,575 Production started during May5,000 units Production completed during May4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost 350,900 Ending work in process 400 units Materials: 40% complete Conversion: 25% complete Compute and Apply Costs

34. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-34 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 +

35. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-35 Here is a schedule with the cost and equivalent unit information. Compute and Apply Costs

36. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-36 Compute and Apply Costs $356,475 ÷ 4,900 units = $72.75 $378,200 ÷ 4,960 units = $76.25 Here is a schedule with the cost and equivalent unit information.

37. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-37 Applying Costs

38. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-38 Applying Costs

39. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-39 Applying Costs

40. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-40 Computing the Cost of Units Transferred Out

41. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-41 Computing the Cost of Units Transferred Out

42. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-42 Computing the Cost of Units Transferred Out

43. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-43 Reconciling Costs

44. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-44 Reconciling Costs

45. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-45 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.

46. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Appendix 4A FIFO Method

47. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-47 FIFO vs. Weighted-Average Method The FIFO method (generally considered more accurate that 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 in the cost reconciliation report. 1.The computation of equivalent units. 2.The way in which the costs of beginning inventory are treated in the cost reconciliation report.

48. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-48 Equivalent Units – FIFO Method Let’s revisit the Double Diamond Skis example. Assume the following activity is reported in Shaping and Milling Department for May:

49. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-49 Equivalent Units – FIFO Method Step 1 Step 1: Determine equivalent units needed to complete beginning inventory.

50. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-50 Equivalent Units – FIFO Method Step 2 Step 2: Determine units started and completed during the period.

51. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-51 Equivalent Units – FIFO Method Step 3 Step 3: Add the equivalent units in ending working in process inventory.

52. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-52 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.

53. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-53 Cost per Equivalent Unit - FIFO Let’s revisit the Double Diamond Skis Shaping and Milling Department for the Month of May to prepare our production report. Beginning work in process: 200 units Materials: 55% complete $9,600 Conversion: 30% complete5,575 $15, 175 Production started during May5,000 units Production completed during May4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost 350,900 Ending work in process: 400 units Materials: 40% complete Conversion: 25% complete Beginning work in process: 200 units Materials: 55% complete $9,600 Conversion: 30% complete5,575 $15, 175 Production started during May5,000 units Production completed during May4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost 350,900 Ending work in process: 400 units Materials: 40% complete Conversion: 25% complete

54. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-54 Cost per Equivalent Unit - FIFO The formula for computing the cost per equivalent unit under FIFO method is : Cost per equivalent unit = Cost added during the period Equivalent units of production

55. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-55 Cost per Equivalent Unit - FIFO

56. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-56 Applying Costs - FIFO Step 1 Step 1: Record the equivalent units of production in ending work in process inventory.

57. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-57 Applying Costs - FIFO Step 2 Step 2: Record the cost per equivalent unit.

58. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-58 Applying Costs - FIFO Step 3 Step 3: Compute the cost of ending work in process inventory.

59. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-59 Cost of Units Transferred Out Step 1 Step 1: Record the cost in beginning work in process inventory.

60. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-60 Cost of Units Transferred Out Step 2 Step 2: Compute the cost to complete the units in beginning work in process inventory.

61. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-61 Cost of Units Transferred Out Step 3 Step 3: Compute the cost of units started and completed this period.

62. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-62 Cost of Units Transferred Out Step 4 Step 4: Compute the total cost of units transferred out.

63. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-63 Reconciling Costs

64. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-64 Reconciling Costs

65. Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-65 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.