Prepared by Debby Bloom-Hill CMA, CFM

CHAPTER 3CHAPTER 3

Process CostingProcess Costing

Difference Between Job-Order and Process Costing Systems

Difference Between Job-Order and Process Costing Systems

Job-Order Costing Each unique product or batch is

considered a job for which cost information is needed

Necessary to trace manufacturing costs to specific jobs

When completed, cost of job is removed from Work in Process and included in Finished Goods

Slide 3-3 Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Difference Between Job-Order and Process Costing Systems

Difference Between Job-Order and Process Costing Systems

Process Costing Large quantities produced of

homogeneous products Average cost = total costs divided by

total number of items produced When completed, number of units

completed times average cost determines cost to be moved from WIP to Finished Goods

Slide 3-4 Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Which of the following characteristics are associated with a process costing system?

a. Heterogeneous productsb. Homogeneous products

Answer: b Heterogeneous products are unique Homogeneous products are

identical Process costing is associated with

identical productsSlide 3-5 Learning objective 1: Describe how products flow through departments

and how costs flow through accounts

Which of the following characteristics are associated with a process costing system?

a. Continuous productionb. Discontinuous production

Answer: a Job order costing is associated with

discontinuous production Process costing is associated with

continuous productionSlide 3-6 Learning objective 1: Describe how products flow through departments

and how costs flow through accounts

Which of the following characteristics are associated with a process costing system?

a. Costs are traced to jobsb. Costs are traced to processing

departments

Answer: b Job order costing requires tracing costs

to jobs Process costing is associated with

tracing costs to departmentsSlide 3-7 Learning objective 1: Describe how products flow through departments

and how costs flow through accounts

An example of a business requiring a process costing system would be a(n):

a. Custom cabinet shopb. Antique furniture restorerc. Soap manufacturerd. Automobile repair shop

Answer: c A soap manufacturer produces many identical units

Slide 3-8 Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Job-Order Costing SystemJob-Order Costing System

Slide 3-9 Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Process Costing SystemProcess Costing System

Slide 3-10 Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Cost Flows through Departments

Cost Flows through Departments

Manufacturing operations typically pass through two or more departments Costs are accumulated in each

department Easy to identify when materials are

added Harder to identify when labor and

overhead are added Often grouped together as conversion

costs Assumed to be added evenly throughout

the processSlide 3-11 Learning objective 1: Describe how products flow through departments

and how costs flow through accounts

The costs in a process costing system are traced to:

a. Specific jobsb. Specific customersc. Specific company administratorsd. Specific production departments

Answer: dSpecific production departments

Slide 3-12 Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Cost Flows through Accounts

Cost Flows through Accounts

The product costs accumulated in process are the same as in job-order costing Direct materials Direct labor Manufacturing overhead

A processing department might have transferred in costs from another department

Each processing department accumulates product cost in a separate Work in Process accountSlide 3-13 Learning objective 1: Describe how products flow through departments

and how costs flow through accounts

Cost Flows through Accounts

Cost Flows through Accounts

Direct Material Suppose that $142,000 of direct

materials are used Journal entry:

Slide 3-14

(date) Work in Process, Mixing 142,000 Raw Materials 142,000

To record use of raw material

Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Cost Flows through Accounts

Cost Flows through Accounts

Direct Labor Suppose that $62,200 of direct labor

costs are incurred Journal entry:

Slide 3-15

(date) Work in Process, Mixing 62,200 Wages Payable 62,200

To record direct labor cost

Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Cost Flows through Accounts

Cost Flows through Accounts

Manufacturing Overhead A company may use either actual

overhead costs or a predetermined overhead rate to assign overhead to products Unless production and overhead costs are

constant from month to month, use of actual overhead may result in substantial fluctuations in the unit cost

For that reason most companies use a predetermined overhead rate

Slide 3-16 Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Cost Flows through Accounts

Cost Flows through Accounts

Manufacturing Overhead Suppose manufacturing overhead is

applied at a rate of $3 per direct labor dollar

Journal entry:

Slide 3-17

(date) Work in Process, Mixing 186,600 Manufacturing Overhead 186,600

To record manufacturing overhead applied to Work in Process

Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Cost Flows through Accounts

Cost Flows through Accounts

Transferred-in Cost When a department completes its work,

the items are transferred to the next department

Related costs are transferred as well Suppose the Mixing Department

completed units with a cost of $360,000

Slide 3-18

(date) Work in Process, Packaging 360,000 Work in Process, Mixing 360,000

To record transfer of units

Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Flow of Costs Between Processing DepartmentsFlow of Costs Between

Processing Departments

Slide 3-19 Learning objective 1: Describe how products flow through departments and how costs flow through accounts

Calculating Unit CostCalculating Unit Cost

Equivalent Units Partially completed units are converted to

a comparable number of completed units, called equivalent units Multiply the number of units by the percent

complete to calculate the equivalent units 100 units that are 50% complete are

equivalent to 50 complete units (100 x 50%) Equivalent units may be different for

material and conversion costs if materials and conversion costs enter production at different times.

Slide 3-20 Learning objective 2: Discuss the concept of an equivalent unit

Equivalent Units – Material and Conversion Costs

Equivalent Units – Material and Conversion Costs

Slide 3-21 Learning objective 2: Discuss the concept of an equivalent unit

Calculating Equivalent Units

Calculating Equivalent Units

Equivalent units are normally calculated for materials and conversion costs The equivalent units produced is the

sum of the units finished and the units in ending work in process Units finished are always 100%

complete in terms of materials and conversion costs

Multiply the number of units in ending work in process by the corresponding percent complete to calculate the equivalent unitsSlide 3-22 Learning objective 3: Calculate the cost per equivalent unit

At Rainier Chemical, conversion costs (labor and overhead) enter evenly throughout the production process. At the end of the year, 200 units in work in process are 80 percent complete. With respect to conversion costs, how many equivalent units are in work in process?

a. 200b. 160c. 360d. 280

Answer: b200 units * 80% complete = 160 equivalent units

Slide 3-23 Learning objective 3: Calculate the cost per equivalent unit

Beginning Work in Process 500 units% complete = 65% materials, 45%

conversion Units started: 2,300 Units finished: 2,500 Ending Work in Process 300 units

% complete = 85% materials, 50% conversion

1. Calculate equivalent units for materials

Slide 3-24

Units finished 2,500 X 100% 2,500 Ending Work in Process 300 X 85% 255 Equivalent Units - Materials 2,755

Learning objective 2: Discuss the concept of an equivalent unit

Beginning Work in Process 500 units % complete: 65% materials, 45%

conversion Units started: 2,300 Units finished: 2,500 Ending Work in Process 300 units

% complete: 85% materials, 50% conversion

2. Calculate equivalent units conversion

Slide 3-25

Units finished 2,500 X 100% 2,500 Ending Work in Process 300 X 50% 150

2,650 Equivalent Units - Conversion Costs

Learning objective 2: Discuss the concept of an equivalent unit

Calculating Unit CostCalculating Unit Cost Cost Per Equivalent Unit

The average unit cost in a process costing system is referred to as cost per equivalent unit

The numerator represents the total cost for which a processing department must account in each period

Divide by the units completed plus the equivalent units in ending Work in Process

Slide 3-26 Learning objective 3: Calculate the cost per equivalent unit

Calculating Cost per Equivalent Unit

Calculating Cost per Equivalent Unit

Consider cost per equivalent unit calculations for the mixing department Beginning Work in Process inventory:

10,000 gallons that are 80% complete Direct material costs = $18,000 Direct labor =$7,80 Overhead = $23,400

70,000 gallons started, 60,000 gallons completed Direct material costs = $142,000 Direct labor cost = $62,200 Overhead cost = $186,600

Slide 3-27 Learning objective 3: Calculate the cost per equivalent unit

Cost per EU – Mixing Department

Cost per EU – Mixing Department

Slide 3-28 Learning objective 3: Calculate the cost per equivalent unit

At Rainier Chemical, labor cost in Work in Process at the start of April was $50,000 and $450,000 of labor was incurred during the month. 200 units are in WIP at the end of April and they are 80% complete with respect to labor. 840 units were completed during the month. What is the cost per equivalent unit for labor?

a. $225b. $481c. $536d. $500

Answer: dTotal labor cost = $50,000 + $450,000 = $500,000Equivalent units = 840 units + 200 units * 80% = 1,000 unitsCost per equivalent unit = $500,000 / 1,000 = $500

Slide 3-29 Learning objective 3: Calculate the cost per equivalent unit

Costs Transferred OutCosts Transferred Out 60,000 gallons completed by the Mixing

Department Unit cost is $6 per gallon $360,000 (60,000 X $6) of cost transferred

to the Packaging Department

Slide 3-30 Learning objective 4: Calculate the cost of goods completed and the ending Work in Process balance in a processing department

Ending Work in ProcessEnding Work in Process

Slide 3-31 Learning objective 4: Calculate the cost of goods completed and the ending Work in Process balance in a processing department

Summary of Cost Activity –Mixing Department

Summary of Cost Activity –Mixing Department

Slide 3-32 Learning objective 4: Calculate the cost of goods completed and the ending Work in Process balance in a processing department

Production Cost ReportProduction Cost Report

Slide 3-33 Learning objective 5: Describe a production cost report

An end of the month report for a process costing system Provides a reconciliation of units Provides a reconciliation of costs Provides the details of the cost per

equivalent unit calculations The reconciliations help ensure

that mistakes are not made in calculations

Production Cost ReportProduction Cost Report

Slide 3-34

Reconciliation of Units

Learning objective 5: Describe a production cost report

Production Cost ReportProduction Cost Report

Slide 3-35

Reconciliation of Costs

Learning objective 5: Describe a production cost report

Basic Steps in Process Costing

Basic Steps in Process Costing

Step 1: Reconcile the physical number of units. The number of units at the start of the period plus the number of units started during the period should equal the number of units completed plus the number of units in ending Work in Process

Slide 3-36 Learning objective 5: Describe a production cost report

Basic Steps in Process Costing

Basic Steps in Process Costing

Step 2: Calculate the cost per equivalent unit for material, labor, and overhead. Remember that cost (numerator in the calculation) includes both beginning cost and cost incurred during the period. The number of equivalent units (denominator) includes the number of units completed and the number of equivalent units in ending Work in Process

Cost per equivalent unit =(cost in beginning WIP + costs added)(units completed + EU of ending WIP)

Slide 3-37 Learning objective 5: Describe a production cost report

Basic Steps in Process Costing

Basic Steps in Process Costing

Step 3: Assign cost to items completed and items in ending Work in Process. The cost of items completed is simply the product of the total cost per equivalent unit and the number of units completed. The cost of items in Work in Process is the sum of the products of equivalent units in process and cost per equivalent unit for material, labor, and overhead

Slide 3-38 Learning objective 5: Describe a production cost report

Basic Steps in Process Costing

Basic Steps in Process Costing

Step 4: Account for the amount of product cost. The cost of beginning inventory plus the cost incurred during the period should equal the amount of cost assigned to completed items plus the amount of cost assigned to items in ending Work in Process

Slide 3-39 Learning objective 5: Describe a production cost report

Dealing with Transferred-In Cost

Dealing with Transferred-In Cost

Packaging Department summary Beginning Work in Process 15,000

gallons 50% through packaging operation Costs in WIP: materials $10,500, labor

$4,500, $9,000 overhead, $92,250 transferred in

Units transferred in 60,000 gallons with $360,000 transferred in cost Costs added: Materials $49,500, labor

$27,900, $55,800 overhead Ending Work in Process 5,000 gallons

40% through packaging operation

Slide 3-40 Learning objective 5: Describe a production cost report

Production Cost Report –Packaging Department

Production Cost Report –Packaging Department

Slide 3-41 Learning objective 5: Describe a production cost report

Production Cost Report –Packaging Department

Production Cost Report –Packaging Department

Slide 3-42 Learning objective 5: Describe a production cost report

Production Cost Report –Packaging Department

Production Cost Report –Packaging Department

Slide 3-43 Learning objective 5: Describe a production cost report

The packaging department at Rainier Chemical had no beginning Work in Process at the start of April. During April, the department received $300,000 of transferred-in cost. During April, the department completed 600 units and 200 were in Work in Process.

With respect to transferred-in cost, the 200 units in Work in Process are:

a. Equivalent to 200 completed unitsb. Equivalent to 0 completed unitsc. Equivalent to 100 completed unitsd. Identical to the equivalent units for conversion

costs

Answer: aSince processing was completed in another department, units transferred in are 100% complete for all categories

Slide 3-44 Learning objective 3: Calculate the cost per equivalent unit

Process Costing and Incremental AnalysisProcess Costing and Incremental Analysis

Slide 3-45

Whenever we make a decision, we need to perform incremental analysis We need to determine the change in

revenue and the change is cost, assuming a particular alternative is selected If the net change is positive, the

decision alternative is “good” since it will have a positive impact on firm profit

If the net change is negative, the decision alternative is “bad” in that it will have a negative impact on firm profit

Learning objective 5: Describe a production cost report

Process Costing and Incremental AnalysisProcess Costing and Incremental Analysis

Slide 3-46

When using process costing information to make a decision, we have to be careful to recognize that the cost per unit is the average of fixed and variable costs It does not measure the change in cost

associated from producing an additional unit

Generally, total fixed costs do not change when one additional unit is produced

Learning objective 5: Describe a production cost report

Process Costing and Incremental AnalysisProcess Costing and Incremental Analysis

Slide 3-47

A company has no beginning or ending Work in Process

Variable costs are materials and labor Fixed cost is manufacturing overhead Cost summary:

Learning objective 5: Describe a production cost report

Process Costing and Incremental AnalysisProcess Costing and Incremental Analysis

Slide 3-48

Decreasing price to $2.90 will increase demand to 275,000 units

$2.90 is less than equivalent cost per unit

Incremental analysis: profit will increase

Learning objective 5: Describe a production cost report

You Get What You MeasureYou Get What You Measure

Slide 3-49

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