Chapter 6 Process Costing

Cost Accounting Foundations and Evolutions Kinney, Prather, Raiborn

Chapter 6 Process Costing

Learning Objectives (1 of 2) • Contrast process costing and job order costing • Explain why equivalent units of production are used in process costing • Calculate equivalent units of production, unit costs, and inventory values using weighted average method of process costing

Learning Objectives (2 of 2) • Compute equivalent units of production, unit costs, and inventory values using FIFO method of process costing • Explain how standard costs are used in a process costing system • Explain why a company would use a hybrid costing system

Job Order vs. Process Costing Job Order • Assign costs to job and then to units within the job

Process Costing • Using an averaging technique, assign costs directly to units produced during the period

Process Costing Averaging technique to assign costs to units produced

Unit Cost =

Production Costs Production Quantity

Process Costing • The Numerator - Production Costs – – – – –

Accumulate costs by department Accumulate costs by product Direct material from material requisitions Direct labor from time sheets and wage rates Overhead • Actual • Predetermined application rates Unit Cost =

Production Costs Production Quantity

Process Costing • Production Costs – Direct material from material requisitions – Direct labor from time sheets and wage rates – Overhead • Actual • Predetermined application rates

Process Costing • The Denominator - Units Produced • Complicated by work in process – Units started last period and completed this period – Units started this period and not completed

• Convert partially completed units to equivalent whole units Unit Cost =

Production Costs Production Quantity

Equivalent Units of Production (EUP) • Approximation of the number of whole units of output that could have been produced from the actual effort expended • Includes units – started last period and finished this period – started and finished this period – started this period and not finished

• Assumes FIFO physical flow through the production department

Two Process Costing Methods • Weighted Average Method – combines • beginning work in process • current period production

• FIFO Method – separates • beginning work in process • current period production

Process Costing • Direct material – added at the beginning, during, and/or at the end of process

• Direct labor – added throughout the process

• Overhead – added throughout the process • based on direct labor • based on other, multiple cost drivers

Process Costing Steps 1 2 3 4 5 6

Units to account for Units accounted for Determine equivalent units Costs to account for Compute cost per equivalent unit Assign costs to inventories

Units

Costs

Step 1 - Units to Account For Beginning WIP Started Units to account for

5,000 200,700 205,700

Step 2 - Units Accounted For Beginning WIP Started Units to account for Finished and transferred Ending WIP Units accounted for

5,000 200,700 205,700

must 203,000 be 2,700 equal 205,700

Step 3 - Compute Equivalent Units DM Conversion Beginning WIP inventory 5,000 5,000 Started and completed 198,000 198,000 Ending WIP inventory 2,700 2,160* Equivalent units 205,700 205,160 * ending units * % complete 2,700 * 80% = 2,160

Weighted Average Method

Step 4 - Costs to Account For Beginning WIP Current costs To account for

DM Conversion Total $ 5,943 $ 16,758 $ 22,701 321,120 660,270 981,390 $327,063 $677,028 $1,004,091

Weighted Average Method

Step 5 - Cost per Equivalent Unit Beginning WIP Current costs To account for Divide by EUP

Cost per EUP

DM Conversion Total $ 5,943 $ 16,758 $ 22,701 321,120 660,270 981,390 $327,063 $677,028 $1,004,091 205,700

$1.59 +

205,160

$3.30 = $4.89

Weighted Average Method

Step 6 - Assign Costs to Inventories Transferred (203,000 * $4.89) $992,670 Transferred Ending WIP Inventory Out Ending Direct Materials WIP (2,700 * $1.59) $ 4,293 Conversion Costs (2,700 * 80% * $3.30) 7,128 11,421 Cost accounted for $1,004,091* *must agree with costs to account for Weighted Average Method

Process Costing - FIFO • Emphasizes current period costs and production • Steps 1 and 2 are the same

Process Costing - FIFO • Step 3

DM Conversion Beginning WIP/completed 0 3,000* Started and completed 198,000 198,000 Ending WIP Inventory 2,700 2,160 Equivalent units 200,700 203,160

* beginning units * % complete in current period 5,000 * 60% = 3,000

Process Costing - FIFO • Step 4 is the same • Step 5 Current costs Divide by EUP Cost per EUP

DM Conversion Total $321,120 $660,270 $981,390 200,700 $1.60 +

203,160 $3.25 = $4.85

Step 6 Assign Costs to Inventories - FIFO

Transferred Beginning WIP Inventory $22,701 Cost to complete Conversion (3,000 * $3.25) 9,750 Started and completed (198,000 * $4.85) Total cost transferred Transferred Ending inventory Out Direct Materials (2,700 * $1.60) $4,320 Conversion Costs (2,7000 * 80% * $3.25) 7,020 Cost accounted for *must agree with costs to account for

$ 32,451 960,300 $992,751

Ending WIP 11,340 $1,004,091*

Process Costing Comparison Weighted Average • EUP DM 205,700 • EUP Conversion 205,160 • Cost per unit DM $ 1.59 • Cost per unit Conv. 3.30 • Total $4.89 • Transferred Out $992,670 • Ending WIP 11,421 • Total $1,004,091

FIFO • EUP DM 200,700 • EUP Conversion 203,160 • Cost per unit DM $ 1.60 • Cost per unit Conv. 3.25 • Total $ 4.85 • Transferred Out $ 992,751 • Ending WIP 11,340 • Total $1,004,091

Process Costing • The purpose of the six steps – Assign a value to ending work in process – Assign a value to items transferred out – Prepare this journal entry Finished Goods Work in Process or Transferred In Cost (successor department) Work in Process (current department)

Process Costing with Standard Costs • Simplify costing process • Eliminate periodic cost recomputations • Same as FIFO computations – emphasize current period costs and production

• Inventories are stated at standard cost • Variances are calculated for material, labor, and overhead

Process Costing with Standard Costs • Assigns a “normal” production cost to the equivalent units of output each period • Allows managers to quickly recognize and investigate significant deviations from expected production costs • Allows benchmarking with other firms

Hybrid Costing Systems • Characteristics of job order and process costing systems • Various product lines – different direct material - job order costing – different direct labor – job order costing – same process - process costing

• Hybrid costing used for furniture, clothing, jam

Questions • What is an equivalent unit of production? • What is the difference between the weighted average and FIFO methods of calculating equivalent units? • Why would a company use a hybrid costing system?