11

ManufacturingManufacturingProcess Cost AccountingProcess Cost Accounting

Equivalent UnitsEquivalent Units

Dr. Clive Vlieland-Boddy

22

Understand process costing and Understand process costing and when it is appropriate to be used.when it is appropriate to be used.

Determine unit costs, inventories, Determine unit costs, inventories, and costs transferred.and costs transferred.

Explain the concept of equivalent Explain the concept of equivalent units of production.units of production.

Understand Production ReportsUnderstand Production Reports

ObjectivesObjectivesObjectivesObjectives

After reading this After reading this chapter, you chapter, you

should be able to:should be able to:

After reading this After reading this chapter, you chapter, you

should be able to:should be able to:

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Process Costing Example Process Costing Example Process Costing Example Process Costing Example

44

Process Cost AccountingProcess Cost AccountingProcess Cost AccountingProcess Cost Accounting

Nature of Nature of Process Cost Process Cost

SystemsSystems

Nature of Nature of Process Cost Process Cost

SystemsSystems

Equivalent Equivalent UnitsUnits

Equivalent Equivalent UnitsUnits

Contemporary Contemporary DevelopmentsDevelopments

Contemporary Contemporary DevelopmentsDevelopments

UsesUses

Process Cost Process Cost FlowFlow

Assignment Assignment of of ManufacturiManufacturing Costs ng Costs

Weighted-Weighted-Average Average MethodMethod

RefinementRefinementss

Production Production Cost ReportCost Report

Just-in-Time Just-in-Time ProcessingProcessing

Computer Computer Controlled Controlled ManufacturingManufacturing

TQMTQM

Activity-Based Activity-Based CostingCosting

ComprehensiComprehensive Example ve Example of Process of Process

CostingCosting

ComprehensiComprehensive Example ve Example of Process of Process

CostingCosting

Physical UnitsPhysical Units

Equivalent Equivalent Units of Units of ProductionProduction

Unit Production Unit Production CostsCosts

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Preview of ChapterPreview of ChapterPreview of ChapterPreview of Chapter

Process cost accounting focuses on mass-production of products that are identical or very similar in nature.

Evaluate Equivalent Units of production that are not complete but are equated in complete units.

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Nature of Process Cost Nature of Process Cost SystemsSystemsNature of Process Cost Nature of Process Cost SystemsSystemsUse to apply costs to similar products that are

massed produced in a continuous fashion

Examples include the production ofCereal, Paint, and Soft Drinks

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The essence of process costing is the accumulation of costs by process, or department, for a period of time.

It is applied to mass production of similar products. Materials, labour & direct overheads can be easily established based on the number of units produced per hour.

Process Costing Process Costing Process Costing Process Costing

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Overview of Process Costing Overview of Process Costing SystemsSystems

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Cost Flows Through AccountsCost Flows Through Accounts– Direct MaterialDirect Material– Direct LaborDirect Labor– Manufacturing OverheadManufacturing Overhead

Product and Cost FlowsProduct and Cost FlowsProduct and Cost FlowsProduct and Cost Flows

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Process Costing SystemProcess Costing SystemProcess Costing SystemProcess Costing System

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• Account for the number of physical unitsAccount for the number of physical units

• Calculate the cost per unit or equivalent Calculate the cost per unit or equivalent unit for materials, labor, and overheadunit for materials, labor, and overhead

• Assign cost to items completed and Assign cost to items completed and items in ending Work in Processitems in ending Work in Process

• Account for the amount of product costAccount for the amount of product cost

Basic Steps in Process Basic Steps in Process CostingCostingBasic Steps in Process Basic Steps in Process CostingCosting

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Unit cost =

Basic process costing formula used by a manufacturer of a single,

homogeneous product.

Total Costs of ProductionTotal Units of Production

Process Costing Process Costing Process Costing Process Costing

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Incremental AnalysisIncremental Analysis– Compare change in revenue with Compare change in revenue with

change in costchange in costProcess CostingProcess Costing– Utilizes an average of fixed and Utilizes an average of fixed and

variable costsvariable costs– Could impact decision making when Could impact decision making when

considering additional productionconsidering additional production– We will return to this laterWe will return to this later

Process Costing and Process Costing and Incremental AnalysisIncremental AnalysisProcess Costing and Process Costing and Incremental AnalysisIncremental Analysis

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Product Flows Through DepartmentsProduct Flows Through Departments– A product typically passes through A product typically passes through

multiple departmentsmultiple departments– Conversion Costs (Labor and Overhead)Conversion Costs (Labor and Overhead)

Product and Cost FlowsProduct and Cost FlowsProduct and Cost FlowsProduct and Cost Flows

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Illustrating Process CostingIllustrating Process CostingTwo DepartmentsTwo Departments

Direct Materials, Direct LaborManufacturing Overhead

DepartmentA

DepartmentB

Finished Goods Cost of Goods Sold

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Process Costing System Process Costing System DiagramDiagram

AssemblyDepartment

FinishedGoods

Inventory

MaterialCosts

Conversion

CostsConversion

Costs

MaterialCosts

Transferred

Costs

TestingDepartment

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Flow of Cost Between Flow of Cost Between Processing DepartmentsProcessing DepartmentsProduct and Cost Flows Product and Cost Flows Two DepartmentsTwo DepartmentsProduct and Cost Flows Product and Cost Flows Two DepartmentsTwo Departments

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Five Steps in Process Five Steps in Process CostingCosting

•Summarize the flow of physical units of output.

•Compute output in terms of equivalent units

•Compute equivalent unit costs

•Summarize total costs to account for

•Assign total costs to units completed and to units in ending work in process inventory

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Use Process Cost Information Use Process Cost Information to:to:• Measure costs of products mass-produced Measure costs of products mass-produced

productsproducts• Assign costs to inventory and cost of goods sold Assign costs to inventory and cost of goods sold

for financial statements and income tax returnsfor financial statements and income tax returns• Monitor operations and costsMonitor operations and costs• Develop estimates of future costs for decision Develop estimates of future costs for decision

makingmaking• Analyze the costs and benefits of quality Analyze the costs and benefits of quality

improvementsimprovements• Identify potential areas for process Identify potential areas for process

improvementsimprovements

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Actual cost flows might not be known:Actual cost flows might not be known:

** When are direct materials added?When are direct materials added?

** When are conversion costs incurred?When are conversion costs incurred?

** How complete are the units in ending How complete are the units in ending work in process?work in process?

** What amount of spoilage is normal?What amount of spoilage is normal?

Uncertainties and Measurement Uncertainties and Measurement Errors in Process CostingErrors in Process Costing

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Equivalent UnitsEquivalent Units

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Equivalent Units: A Key Equivalent Units: A Key ConceptConcept

• Costs are accumulated for a period of time for Costs are accumulated for a period of time for products in work-in-process inventory. products in work-in-process inventory.

• Products in work-in-process inventory at the Products in work-in-process inventory at the beginning and end of the period are only beginning and end of the period are only partially complete. partially complete.

• Equivalent units is a concept expressing Equivalent units is a concept expressing these partially completed products as a these partially completed products as a smaller number of fully completed productssmaller number of fully completed products..

• Costs are accumulated for a period of time for Costs are accumulated for a period of time for products in work-in-process inventory. products in work-in-process inventory.

• Products in work-in-process inventory at the Products in work-in-process inventory at the beginning and end of the period are only beginning and end of the period are only partially complete. partially complete.

• Equivalent units is a concept expressing Equivalent units is a concept expressing these partially completed products as a these partially completed products as a smaller number of fully completed productssmaller number of fully completed products..

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What Are Equivalent Units, and What Are Equivalent Units, and How Do They Relate to the How Do They Relate to the Production Process?Production Process?

Equivalent Units:Equivalent Units:• Measure the resources used in partially completed units Measure the resources used in partially completed units

relative to the resources needed to complete the units.relative to the resources needed to complete the units.Equivalent Units Depend on the Pattern of Cost Flow:Equivalent Units Depend on the Pattern of Cost Flow:

Direct Materials:Direct Materials:** Added at the beginning of the processAdded at the beginning of the process** Added during the processAdded during the processConversion Costs:Conversion Costs:** Incurred uniformly throughout the processIncurred uniformly throughout the process** Incurred non-uniformlyIncurred non-uniformly

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Equivalent UnitsEquivalent Units– Partially completed units are converted Partially completed units are converted

to a comparable number of completed to a comparable number of completed unitsunits

Calculating Unit CostCalculating Unit CostCalculating Unit CostCalculating Unit Cost

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Equivalent Units ExampleEquivalent Units Example

Two one-half completed products are equivalent to one completed product.

So, 10,000 units 70 percent completeare equivalent to 7,000 complete units.

+ = l

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Calculating and Using Calculating and Using Equivalent Units of Equivalent Units of ProductionProduction

To calculate the direct materials and conversion To calculate the direct materials and conversion costs per equivalent unit for the period:costs per equivalent unit for the period:

Materials cost per

equivalent

unit

=Materials cost for the periodMaterials equivalent units for

the period

Conversion cost per

equivalent

unit

=Conversion cost for the periodConversion equivalent units for

the period

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Uniformity of Cost Flows!Uniformity of Cost Flows!

• Calculation Equivalent Units is simple Calculation Equivalent Units is simple if the production process is even. if the production process is even.

• That the conversion cost are level That the conversion cost are level through the process. through the process.

• However, this is not unusually the However, this is not unusually the case.case.

• For this reason a weighting process to For this reason a weighting process to correct this distortion is required.correct this distortion is required.

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How Is the Weighted Average How Is the Weighted Average Method Used in Process Costing?Method Used in Process Costing?

Weighted Average Method:Weighted Average Method:

Costs from beginning WIP (performed last Costs from beginning WIP (performed last period) are averaged with costs incurred period) are averaged with costs incurred during the current period and then during the current period and then allocated to all units completed and allocated to all units completed and ending WIP.ending WIP.

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Calculation of Cost Per Equivalent Calculation of Cost Per Equivalent Unit Under the Weighted Average Unit Under the Weighted Average MethodMethod

Beg. WIP Costs + Costs Added This Beg. WIP Costs + Costs Added This PeriodPeriod

Weighted Average Equivalent Weighted Average Equivalent UnitsUnits

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Equivalent Units of Equivalent Units of Production –Production –Weighted-Average MethodWeighted-Average MethodThe weighted-average method . . .The weighted-average method . . .

– Makes no distinction between work done Makes no distinction between work done in the prior period and work done in the in the prior period and work done in the current period.current period.

– Blends together units and costs from the Blends together units and costs from the prior period and the current period.prior period and the current period.

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Production ReportProduction Report

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Departmental Production Departmental Production ReportReport

ProductionReport

Analysis of physical flow

of units.

Calculationof equivalent

units.

Computationof unit costs.

Analysis of total costs.

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Production Report ExampleProduction Report Example

• MVP Sports Equipment Company makes baseball MVP Sports Equipment Company makes baseball gloves in two departments, Cutting and Stitching. gloves in two departments, Cutting and Stitching.

• MVP uses the MVP uses the weighted-average weighted-average cost procedure.cost procedure.

• Material is added at the beginning of the Cutting Material is added at the beginning of the Cutting Department, and conversion is incurred uniformly Department, and conversion is incurred uniformly throughout the process.throughout the process.

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Production Report ExampleProduction Report Example

• Using the following information for the month of Using the following information for the month of March, let’s prepare a production report for the March, let’s prepare a production report for the Cutting Department. Cutting Department.

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Production Report ExampleProduction Report ExampleAnalysis of Physical Flow of Units

PhysicalUnits

Work in process, March 1 20,000 Units started during March 30,000 Total units to account for 50,000

Units completed and transferred out during March 40,000 Work in process, March 31 10,000 Total units accounted for 50,000

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Production Report ExampleProduction Report Example

Conversion Equivalent UnitsPhysical Percentage Direct

Units Complete Material Conversion

Work in process, March 1 20,000 10%Units started during March 30,000 Total units to account for 50,000

Units completed and transferred 40,000 100% 40,000 40,000 Work in process, March 31 10,000 50% 10,000 5,000 Total units accounted for 50,000

Total equivalent units 50,000 45,000

Calculation of Equivalent Units

50% of 10,000 units

Beginning inventory % is not used in weighted-average method.

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Production Report ExampleProduction Report Example

Conversion Equivalent UnitsPhysical Percentage Direct

Units Complete Material Conversion

Work in process, March 1 20,000 10%Units started during March 30,000 Total units to account for 50,000

Units completed and transferred 40,000 100% 40,000 40,000 Work in process, March 31 10,000 50% 10,000 5,000 Total units accounted for 50,000

Total equivalent units 50,000 45,000

Calculation of Equivalent Units

100% of 10,000 units, allmaterial added at beginning

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Production Report ExampleProduction Report Example

1-38

DirectMaterial Conversion Total

Work in Process, March 1 50,000$ 7,200$ 57,200$ Costs incurred during March 90,000 193,500 283,500 Total costs to account for 140,000$ 200,700$ 340,700$

Equivalent units 50,000 45,000 Cost per equivalent unit 2.80$ 4.46$ 7.26$

Computation of unit costs

$140,000 ÷ 50,000 equivalent units

$200,700 ÷ 45,000 equivalent units

$2.80 + $4.46

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Reconciliation of UnitsReconciliation of UnitsReconciliation of UnitsReconciliation of Units

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Example – XYZ CollegeCompute the cost of instruction at XYZ College per full-time equivalent student based on the following information:

Total cost of instruction is $9,000,000.

There are 900 full-time students and 1,000 part-time students.Part-time students take 60% of the classes of a regular student.

Equivalent UnitsEquivalent Units

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Equivalent Units Example Equivalent Units Example ContinuedContinuedEquivalent Units Example Equivalent Units Example ContinuedContinued

Cost of instructionper full-time equivalent student

equals

Total cost of instruction

divided byNumber of full-time equivalent students

$9,000,000 / 1,500 = $6,000

LO 5: Compute equivalent units.LO 5: Compute equivalent units.

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Equivalent units – Equivalent units – Material and Conversion costsMaterial and Conversion costs

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Example Exercise #1Example Exercise #1Example Exercise #1Example Exercise #1

McMillian Tire Company produces tires used on small McMillian Tire Company produces tires used on small trailers. The month of June ended with 300 tires in trailers. The month of June ended with 300 tires in process, 85% complete as to direct materials and process, 85% complete as to direct materials and 50% complete as to conversion costs; 2,500 tires 50% complete as to conversion costs; 2,500 tires were transferred to finished goods during the month were transferred to finished goods during the month and 2,300 were started during the month. The and 2,300 were started during the month. The beginning WIP inventory was 65% complete as the beginning WIP inventory was 65% complete as the direct materials and 45% complete as to conversion direct materials and 45% complete as to conversion costs.costs.

1.1. Determine the denominators to be used in the Determine the denominators to be used in the calculations of cost per equivalent unit for materials calculations of cost per equivalent unit for materials and conversion costs.and conversion costs.

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Example Exercise #1 Example Exercise #1 SolutionSolutionExample Exercise #1 Example Exercise #1 SolutionSolutionMaterialsMaterials– Units completedUnits completed 2,5002,500– Equivalent units (300*85%)Equivalent units (300*85%) 255 255

2,755 units2,755 units

LaborLabor– Units completedUnits completed 2,5002,500– Equivalent units (300*50%)Equivalent units (300*50%) 150 150

2,650 units2,650 units

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Example Exercise #2Example Exercise #2Example Exercise #2Example Exercise #2

The balance in beginning WIP at Bing Rubber The balance in beginning WIP at Bing Rubber Company for direct labor was $135,000. During the Company for direct labor was $135,000. During the month of March, an additional $650,000 of direct month of March, an additional $650,000 of direct labor was incurred, and 25,000 pounds of rubber labor was incurred, and 25,000 pounds of rubber were produced. At the end of March, 8,000 pounds were produced. At the end of March, 8,000 pounds of rubber were in process and the units were 50% of rubber were in process and the units were 50% complete. At the start of March, the company had complete. At the start of March, the company had 5,000 pounds of rubber that were 30% complete.5,000 pounds of rubber that were 30% complete.

1.1. Calculate the cost per equivalent unit for labor Calculate the cost per equivalent unit for labor assuming that labor is added uniformly throughout assuming that labor is added uniformly throughout the production process.the production process.

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Example Exercise #2 Example Exercise #2 SolutionSolutionExample Exercise #2 Example Exercise #2 SolutionSolution

Direct LaborDirect Labor– Beginning WIPBeginning WIP $135,000$135,000– March laborMarch labor $650,000$650,000– Total Labor CostTotal Labor Cost $785,000$785,000

UnitsUnits– Units completedUnits completed 25,00025,000– Equivalent units (8,000*50%) Equivalent units (8,000*50%) 4,000 4,000– Total UnitsTotal Units 29,00029,000

Cost per Equivalent UnitCost per Equivalent Unit– $785,000 / 29,000 pounds = $27.07 per pound$785,000 / 29,000 pounds = $27.07 per pound

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Example – Process CostingExample – Process Costing

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Maker of automatic can openersManufacturing consists of two processes:

Machining – raw materials are shaped, honed, and drilled

Assembly – parts assembled and packagedMaterials, labor, and manufacturing overhead added in both departments

Example – Tyler Company

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Example – Tyler Company

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Accumulation of materials, labor, and overhead costs:

Debit Raw Materials Inventory for purchases of raw materials

Debit Factory Labor for factory labor incurred

Debit Manufacturing Overhead for overhead cost incurred

Assignment of Manufacturing CostsAssignment of Manufacturing Costs

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Material Costs

All materials consumed within

a production department area cost of processing.

Assignment of Manufacturing CostsAssignment of Manufacturing Costs

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Factory Labor Costs

Time tickets are used

All labor costs incurred withina production department area cost of processing.

Assignment of Manufacturing CostsAssignment of Manufacturing Costs

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Manufacturing Overhead Costs

Objective of assigning overhead – allocate overhead to departments on an

objective and equitable basis

Use the activity that “drives” or causes the costs

Machine or Labor time usedprimary driver in continuous manufacturing operations

Assignment of Manufacturing Assignment of Manufacturing CostsCosts

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Production Cost ReportProduction Cost ReportProduction Cost ReportProduction Cost Report

Key document used to understand activities.

Prepared for each department and shows:Production QuantityCost data

Four steps in preparation:

Step 1: Compute physical unit flow

Step 2: Compute equivalent units of production

Step 3: Compute unit production costs

Step 4: Prepare a cost reconciliation schedule

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Flow of Costs in Making Frozen Flow of Costs in Making Frozen

BunsBuns Flow of Costs in Making Frozen Flow of Costs in Making Frozen

BunsBuns

5656

Basic InformationBasic Information

5757

Step 1: Compute Physical Unit Flow.Step 1: Compute Physical Unit Flow.

Physical units actual units to be accounted for during a period, regardless of work performed

Total units to be accounted for units started (or transferred) into production during the period + units in production at beginning of period

Total units accounted forunits transferred out during

period + units in production at end of period

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Step 1: Compute Physical Unit Flow Step 1: Compute Physical Unit Flow

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Step 2: Compute Equivalent Units of ProductionStep 2: Compute Equivalent Units of Production

Measure of a department’s productivity

Two computations required:

one for materials and one for conversion costs

Beginning work in process ignored

6060

Step 3: Compute Unit Production CostsStep 3: Compute Unit Production Costs

Costs expressed in terms of equivalent units of production

When equivalent units of production are different for materials and for conversion costs, three unit costs are computed:

Materials

Conversion

Total Manufacturing

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Step 3: Compute Unit Production Cost - continuedStep 3: Compute Unit Production Cost - continued

Total Materials Cost Computation:

Direct Materials Cost in Beginning Work in Process $ 50,000Conversion Costs Added to Production During Month 400,000

Total Materials Costs $450,000

The Computation of Unit Materials Costs:

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Step 3: Compute Unit Production Cost - continuedStep 3: Compute Unit Production Cost - continued

Conversion Cost Computation:

Conversion Costs in Beginning Work in Process $ 35,000Conversion Costs Added to Production in Month 170,000

Total Conversion Costs $205,000

The Computation of Unit Conversion Costs:

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Step 3: Compute Unit Production Cost – continuedStep 3: Compute Unit Production Cost – continued

Total Manufacturing Cost Per Unit

The computation of unit total manufacturing cost:

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Step 4: Prepare Cost Reconciliation ScheduleStep 4: Prepare Cost Reconciliation ScheduleCosts Charged to Mixing Department:

Cost of Beginning Work in Process $ 85,000Costs Started into Production During Period 570,000

Total Costs to be Accounted For $ 655,000

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Production Cost Report - Mixing Production Cost Report - Mixing DepartmentDepartment Production Cost Report - Mixing Production Cost Report - Mixing DepartmentDepartment

6666

Contemporary DevelopmentsContemporary Developments Contemporary DevelopmentsContemporary Developments

Just-in-Time (JIT) Processing

A processing system that is dedicated to having the right products or parts as they are needed

Objective: To eliminate all manufacturing inventories to make funds and space available for more productive purposes

Elements of JIT: Dependable suppliers; Multi-skilled workforce; Total quality control system

Benefits of JIT: Reduced inventory; Enhanced product quality; Reduced rework and storage costs; Savings from improved flow of goods

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Contemporary DevelopmentsContemporary Developments - - JITJITContemporary DevelopmentsContemporary Developments - - JITJIT

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Contemporary DevelopmentsContemporary Developments Contemporary DevelopmentsContemporary Developments Activity-Based Costing (ABC)

An overhead cost allocation system that focuses on activities performed in producing a product.

Traditional Costing System: allocates overhead to products using predetermined unit-based output rate

ABC System: allocates overhead to multiple activity cost pools and assigns cost pools to products using cost drivers that represent activities used

Assumptions of ABC: All overhead costs for an activity must have the same cost driver and should respond proportionally to changes in the activity of the cost driver.

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Contemporary DevelopmentsContemporary Developments Contemporary DevelopmentsContemporary Developments Activity-Based Costing (ABC) -

continued

May be used with either a job order or a process costing system.

Primary Benefit: More accurate and meaningful product costing

Secondary Benefit: Improved cost data regarding an activity may lead to reduced costs for that activity

ABC makes managers realize that activities not products ultimately determine company profitability

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Question TimeQuestion TimeProduction costs chargeable to the Finishing Production costs chargeable to the Finishing

Department in June in Cliven Company are:Department in June in Cliven Company are:• Materials $15,000, Materials $15,000, • Labor $29,500, Labor $29,500, • Production Overheads $18,000. Production Overheads $18,000. Equivalent units of production are Equivalent units of production are • Materials 20,000 and Materials 20,000 and • Conversion costs 19,000. Conversion costs 19,000. Compute the unit costs for materials and conversion Compute the unit costs for materials and conversion

costs.costs.

7171

Unit costs for Materials:Unit costs for Materials:

$15,000 ÷ 20,000 units = $.75 per unit

7272

Unit costs for Conversion Costs:Unit costs for Conversion Costs:

Conversion Costs

= $29,500 + 18,000 = $47,500

$47,500 ÷ 19,000 = $2.50 per unit

7373

Total Manufacturing Costs per Unit:Total Manufacturing Costs per Unit:

$.75 + $2.50 = $3.25 per unit

7474

Operation CostingOperation CostingOperation costing employs some aspects

of both job-order and process costing.

Job-order Operation CostingOperation Costing Process Costing (Products produced in batches)(Products produced in batches) Costing

7575

Operation CostingOperation CostingOperation costing employs some aspects

of both job-order and process costing.

Job-order Operation CostingOperation Costing Process Costing (Products produced in batches)(Products produced in batches) Costing

Conversion costsassigned to batches

as in process costing.

Material Costs chargedto batches as in

job-order costing.

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Modern Manufacturing Modern Manufacturing PracticesPractices• Just-in-Time Production (JIT)Just-in-Time Production (JIT)

• Computer-Controlled ManufacturingComputer-Controlled Manufacturing

• Total Quality Management (TQM)Total Quality Management (TQM)

• Activity Based Costing (ABC)Activity Based Costing (ABC)

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JIT or Just-in-Case?JIT or Just-in-Case?

7878

Bye for now!Bye for now! I’m ready forsome leisure time.

Please ensure you Prepare for next session