1Copyright © 2008 Cengage Learning South-Western.

Heitger/Mowen/Hansen

Process CostingChapter Five

Fundamental Cornerstones of Managerial Accounting

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Characteristics of Process Manufacturing

Process costing works well whenever relatively homogeneous products pass through a series of processes and they

receive similar amounts of manufacturing costs.

Example industries:

Large manufacturing

plants

Tire manufacturers

Chemicals Food

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Types of Processes

Sequential processing

Requires that units pass through one process before they can be worked on in later

processes.

In each department materials, labor, and overhead may be added. After

completing one process, the partially completed goods are transferred to the

next department.

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Types of Processes

Parallel processing

Partially completed units can be worked on simultaneously in different processes and then

brought together in a final process for completion.

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Raw Materials Cost Flow

The manufacturing cost flows are generally the same as those for a job-

order system.

Raw Materials

Materials purchases

As raw materials are purchased, the

cost of these materials flow into

a raw materials account.

+

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Cost Flows into Work in Process

Work in Process+ Materials

+ Direct Labor

+ Overhead

Materials, labor and overhead flow

into the Work in Process account

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Cost Flows into Finished Goods

Work in Process+ Materials

+ Direct Labor

+ Overhead

Finished Goods

+ Completed Goods

CompletedGoods

Completed goods are transferred out of Work in Process and into Finished

Goods

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Cost Flows into Cost of Goods Sold

Finished Goods Cost of Goods Sold

+ Sold GoodsSold Goods

Goods that are sold are transferred out of Finished

Goods and into Cost of Goods Sold

+ Completed Goods

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Transferred-In Costs

Transferred-In Costs are costs transferred from a prior process to a

subsequent process.

From the viewpoint of the subsequent process, transferred-in costs are a type of

raw material cost.

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Production Report

Summarizes the manufacturing activity of a process department for a given period of time.

Two sections:

Unit Information section

Cost Information section

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Production Report

Two sections:

Unit Information section

Cost Information section

Units to Account For

Units Accounted For

Unit Information Section has two major subdivisions

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Production Report

Two sections:

Costs to Account For

Costs Accounted For

Cost Information Section also has two major

subdivisions

Unit Information section

Cost Information section

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Computing unit cost is a key part of the production report.

Unit Cost is needed to:

This is not easy. It is difficult to define the

number of units produced.

Production Report

• Compute the cost of goods transferred out of a department

• Value ending work-in-process inventory

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Equivalent Units Example

Assume that Department A had the following data for October:

Units in beginning work in process ---Units completed 1,000Units in ending work in process (25% complete) 600Total manufacturing costs $11,500

What is the output for this department? 1000 units?

1600 units?

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Assume that Department A had the following data for October:

Units in beginning work in process ---Units completed 1,000Units in ending work in process (25% complete) 600Total manufacturing costs $11,500

If we say 1000, we ignore the ending work in

process.

Equivalent Units Example

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Assume that Department A had the following data for October:

Units in beginning work in process ---

Units completed 1,000

Units in ending work in process (25% complete) 600

Total manufacturing costs $11,500

1600? Then we ignore the fact that the units in ending work in process are only

partially completed

Equivalent Units Example

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Equivalent Units of Output

• What are equivalent units?◦ The total number of complete units that could

have been produced given the total manufacturing effort used during the period

• Dilemma◦ Some units are physically complete

∙ Called Units Completed

∙ When complete, units are transferred out

◦ Some units are not complete ∙ Remain in Work in Process

∙ Degree of completion must be determined

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Beginning Work-In-Process Inventory

• Work done on these beginning inventory units◦ Represents prior period costs

◦ How should these costs figure into the computation of current period unit costs?

• Two methods:◦ Weighted Average Method

◦ FIFO Method

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Weighted Average Method

• Combines◦ Beginning inventory costs

◦ Current-period costs

• Calculates Unit Cost for the period ◦ By averaging

• Unit cost is used to compute costs for:◦ Goods transferred-out

◦ Goods remaining in work-in-process

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FIFO Method

Separates work and costs for the equivalent units in beginning inventory from work and costs of the equivalent

units produced during the current period.

Only current work and costs are used to calculate this

period’s unit cost.

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Preparing a Weighted Average Production Report

• Trace the physical units of production◦ Two amounts are computed

∙ Units Started and Completed

∙ Units Started

Step #1 Physical Flow Analysis

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• Adding together◦ Units Completed

◦ Units in Ending Work in Process x Fraction Complete

• Beginning inventory ◦ Included in the units completed

◦ Treats beginning inventory as if it was started and completed the current period

Step #2 Calculation of Equivalent Units

Preparing a Weighted Average Production Report

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• Manufacturing Costs ÷ Equivalent Units◦ Costs include:

∙ Prior period costs associated with beginning work in process

∙ Current period manufacturing costs

Step #3 Computation of Unit Cost

Preparing a Weighted Average Production Report

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• Computing cost of goods transferred out◦ Multiplying

∙ Unit cost (computed in step #3)

∙ Units completed (computed in step #1)

• Computing cost of ending work in process

◦ Multiplying∙ Unit cost (computed in step #3)

∙ Equivalent units (computed in step #2)

Step #4 Valuation of Inventories

Preparing a Weighted Average Production Report

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• Checks to see if ◦ Costs to account for

∙ Beginning Work in Process + Costs incurred during the period

◦ Equal◦ Costs assigned to inventory

∙ Transferred Out + Ending Work In Process

Step #5 Cost Reconciliation

Preparing a Weighted Average Production Report

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Evaluation of the Weighted Average Method

Major benefit of this method is the simplicity.

Main disadvantage is reduced accuracy in computing unit costs.

If greater accuracy is desired, a company should

use the FIFO method to determine unit costs.

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Nonuniform Application of Manufacturing Inputs

This leads to separate completion percentages for materials and conversion

costs.

• In the prior example◦ Materials, labor and overhead were applied

uniformly throughout the process

• But often material is not added uniformly◦ Instead it is added at the beginning and end

of the process

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Nonuniform Application of Manufacturing Inputs

Separate equivalent units, unit costs and category costs are computed for materials and

conversion costs.

Cornerstone 6-7 will walk us through this.

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Multiple Departments

Some departments receive partially completed goods from prior departments.

Usual approach is to treat transferred-in goods as a separate material category.

Cost of this material is the cost of the goods

transferred out as computed in the prior department.