Chapter 5

Normal Historical Full Absorption Process Costing

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CONTENTS
Learning objectives Introduction
Exhibit 5-1
Concepts and Terminology Process Cost Techniques Excluding Spoilage &
Six Categories of Units in Work in Process Lost Units
Exhibit 5-2, Exhibit 5-3 Exhibit 5-4,
Methods of Accounting for BWIP
Example 5-1 Comparing FIFO and Weighted Average
Exhibit 5-5, Exhibit 5-6, Exhibit 5-7, Exhibit 5-10, Exhibit 5-11
Exhibit 5-8, Exhibit 5-9
Accounting For Spoilage Example 5-2
Exhibit 5-12, Exhibit 5-13, Exhibit 5-14
System Related to System Functions Questions
Problems Problem Solutions
Extra MC Questions
Other Useful Links
MAAW's Book Main Page Process Costing Main Page

LEARNING OBJECTIVES

After you have read and studied this chapter, you should be able to:

1. Explain the difference between process cost accumulation and job order cost
accumulation.
2. Describe the various categories of units in a process cost system and how they are
related.
3. Define and use the concept of an equivalent unit.
4. Solve process cost problems when there is no beginning inventory of work in process.
5. Explain the conceptual difference between the weighted average and first-in, first out
cost flow assumptions.
6. Solve process cost problems when the weighted average cost flow assumption is
chosen.
7. Solve process cost problems when the first-in, first out cost flow assumption is
chosen.
8. Solve process cost problems that include normal spoilage, or lost units.
9. Solve process cost problems that include abnormal spoilage, or lost units.
10. Discuss normal historical, full absorption, process costing in terms of the four
functions of an information system outlined in Chapter 2.

INTRODUCTION
1
This chapter is similar to Chapter 4 in that it moves from the abstract concepts described
in Chapter 2 towards an operational cost accounting system. The main focus of this
chapter is the manner in which costs flow through the perpetual inventory accounts in
normal historical, full absorption, process costing. These sub-components and the two
cost flow assumptions that are applicable to process costing are highlighted in Exhibit 5-
1. More specifically, the chapter combines normal historical, full absorption costing with
process cost accumulation and the weighted average and first-in, first-out (FIFO) cost
flow assumptions.

The chapter includes six sections. The first section introduces the concepts and
terminology associated with the process cost accumulation method. This section
illustrates the general cost flow in a process cost system, the various categories of units
involved and the concept of an equivalent unit. The second section introduces the
techniques associated with process costing when there are no spoiled or lost units
involved. This section includes: 1) a solution algorithm for situations when there is no
beginning inventory, 2) a solution algorithm for situations when there is a beginning
inventory and the weighted average cost flow assumption is used and 3) a solution
algorithm for situations when there is a beginning inventory and the FIFO cost flow
assumption is used. This section also includes a discussion of the conceptual differences
between the accounting treatments under the two cost flow assumptions and a decision
flow chart to help you visualize these differences. The third section provides an example
where both the weighted average and FIFO cost

flow assumptions are used. Section four extends the solution algorithms to include
spoiled and lost units and section five provides an example to illustrate the techniques.
The last section provides a short discussion of normal historical, full absorption, process
costing in relation to the four functions of an information system outlined in Chapter 2.

2
 CONCEPTS AND TERMINOLOGY IN PROCESS COSTING

As described in Chapter 2, process costing means that costs are accumulated by

departments, operations, or processes. The method is applicable where a continuous
mass production or assembly operation is involved and the work performed on each unit
is standardized or uniform. This type of system is different from job order cost
accumulation in terms of: 1) the manner in which the cost flow through the accounts, 2)
the terminology and concepts involved, and 3) how costs are assigned to the units
produced. Each of these aspects of process costing is discussed below.

3
GENERAL COST FLOW IN PROCESS COSTING

The work in process accounts associated with a simplified process cost system are
illustrated in Exhibit 5-2. Although a process cost system can include any number of
processes, this illustration assumes that there are five departments or operations. In this
type of system, direct materials, direct labor, and factory overhead are charged to work
in process in the same manner illustrated in the previous chapter. For this reason, the
accounts for materials, payroll and factory overhead are omitted from the exhibit to
simplify the illustration and avoid unnecessary redundancy. However, notice that there
are several work in process accounts involved rather than a single account. The general
idea is that the costs of the completed units in Process #1 are transferred to Process #2
along with the completed units. Each subsequent process performs an additional
operation on the products before transferring the units and costs to the next department.
Note also that this transfer of units and costs from process to process creates a new cost
category in the WIP accounts. This new category is referred to as transferred-in costs (TI
in Exhibit 5-2).

PROCESS COSTING TERMINOLOGY AND CONCEPTS

All of the costs that are charged to the WIP accounts must be assigned or allocated to the
units produced in the various departments or processes. The techniques designed to
accomplish this cost assignment depend on six categories of units.

4
Six Categories of Units in Work in Process

The various categories of units applicable in a process cost accumulation system are
defined below.

1) Units in the Beginning Inventory. These are units that were started during the
previous month and finished during the current month. These units are designated as
BWIP, i.e., beginning work in process.

2) Units started, or transferred-in, during the month. The sum of categories 1 and 2
provides the total number of units to be accounted for at the end of the month.

3) Units started during the current month and finished during the current month.
Some of the units started during the month will be completed at the end of the month and
some will be partially complete.

4) Units completed. This group normally includes the units in categories 1 and 3. The
units that are in the beginning work in process are normally finished during the month,
as well as some of the units that are started during the month. Usually units completed
and units transferred are the same, but there are exceptions, e.g., where the next process
has limited space. Any completed units that are spoiled are not included in this category.

5) Units in the ending inventory. These are units started during the current month, but
not finished. This group of units is referred to as EWIP, i.e., ending work in process.

6) Spoiled or lost units. These units do not meet product specifications, or in the case of
lost units, simply cannot be found. Lost units are fairly common for companies that
produce liquid products such as beverages, cleansers, lubricants and a host of other
products.

The connections between the various categories of units are illustrated in Exhibit 5-
3.The following equation summarizes the key relationships.

1 2 4 5 6
BWIP + UNITS STARTED = UNITS COMPLETED + EWIP + SPOILED & LOST UNITS

This equation is important because it is frequently needed to find an unknown such as

the number of units spoiled or lost. The left hand side of the equation represents the
number of units to be accounted for, while the right hand side shows the three categories
of units that usually exist at the end of a period. Category 4 includes categories 1 and 3.
You can see this in Exhibit 5-3. Also notice from the exhibit that any spoiled and lost
units are assumed to come from the units started. 1 The task to be performed in every
process cost system, is to allocate the costs accumulated in the work in process account
to the groups of units on the right-hand side of this equation. To keep the initial
illustrations relatively simple, we will ignore the possibility of spoiled or lost units until
later in the chapter.
5
Equivalent Units

Each problem involves calculating a unit cost, i.e., average cost per unit, and then using
this unit cost to assign the cost to be accounted for to the units completed and the units in
the ending inventory of work in process, i.e., categories 4 and 5. Normally there are
some fully completed units and some partially completed units, i.e., those in the ending
inventory. To calculate a cost per unit we must state all units in terms of a common
denominator. This common denominator is referred to as an equivalent whole unit, or
equivalent unit for short. For example, 100 units ½ complete represents 50 equivalent
units. The stage of completion for the beginning and ending inventories is used to
calculate the equivalent units for those categories. The stage of completion for a group of
units is based on an estimate of the average level of completion for all the units in the
group.

PROCESS COST TECHNIQUES EXCLUDING SPOILAGE AND LOST UNITS

Three types of situations are discussed in this section. These include: 1) cases where a
beginning inventory is not involved, 2) cases that include a beginning inventory and the
weighted average cost flow assumption is chosen and 3) cases that include a beginning
inventory and the FIFO cost flow assumption is chosen. These three cases are discussed
individually below. A summary of the entire section appears in Exhibit 5-4.

6
ALGORITHM USED WHEN THERE IS NO BEGINNING INVENTORY

The following two step approach is applicable when there is no beginning inventory of
work in process. The numbered equations are referred to in the examples illustrated in
subsequent sections of this chapter. NB indicates that (N)o (B)eginning inventory is
involved.

Step I. Calculate The Unit Cost NB

[1 NB] Unit Cost = Costs Added during the month

Units Completed + Equivalent units in EWIP

Usually, at least two unit cost calculations are required, one for direct materials and one
for conversion, i.e., labor and overhead. This is because the stage of completion of the
units in the ending inventory is usually different for materials and conversion. The idea
is that conversion work is preformed more or less continuously, while materials are
added at a specific point in the process, e.g., at the beginning of the process or at the end
of the process.

Step II. Account For The Cost NB

[2 NB] Cost of Units Completed

(Unit Cost)(Units Completed)
and Transferred =

[3 NB] Cost of EWIP = (Unit cost)(Equivalent units in EWIP)

As indicated by these equations, the second step involves determining how much cost to
assign to the two categories of units, i.e., the completed units that are transferred to the
next department, or to finished goods, and the units that remain in the ending inventory.
A cost flow assumption is not needed when there is no beginning inventory. A
conceptual view of this algorithm is presented on the left-hand side of Exhibit 5-4.

7
METHODS OF ACCOUNTING FOR BWIP

When there is a beginning inventory of work in process, a cost flow assumption is

required. The two assumptions commonly used are weighted average (WA) and first-in,
first-out (FIFO).

Algorithm for the Weighted Average Cost Flow Assumption

This algorithm does not keep the units in the beginning inventory separate from the units
started during the period. They are lumped together in a single cost pool as indicated in
step I below.

Step I. Calculate The Unit Cost WA

[1 WA] Unit Cost Cost of BWIP + Cost added during the month
Weighted average = Units Completed + Equivalent units in EWIP

Step II. Account For The Cost WA

8
 [2 WA] Cost of Units Completed
(Unit Cost)(Units Completed)
and Transferred =

[3 WA] Cost of EWIP = (Unit Cost)(Equivalent Units in EWIP)

A conceptual view of this algorithm appears on the right-hand side of the flow chart in
Exhibit 5-4. The completed units include the units that were in the beginning inventory,
as well as the units started and finished during the month.

Algorithm for the First-in, First-out Cost Flow Assumption

The previous month’s ending inventory becomes the current month’s beginning
inventory. When FIFO is used, the costs that were charged to the current month’s
beginning inventory at the end of the previous month are kept separate from the costs
added during the current month. This means that there are two cost pools when FIFO is
used. One cost pool is for the cost that were assigned to the ending inventory from the
previous period. As noted above, the previous period’s ending inventory becomes the
current period’s beginning inventory. These costs are not lumped together with the
current period costs as in the weighted average method. The unit cost calculation is
based on the second cost pool that represents only cost added during the current month.
The denominator in the calculation represents the work performed during the current
month.

Step I. Calculate The Unit Cost FIFO

[1 FIFO] Unit Cost Added during the month

Cost FIFO = Work performed during the month stated in Equivalent Units

= Cost Added during the month

Equivalent work on Completed Units during month + Equivalent work on EWIP units

= Cost Added during the month

Units Completed - Equivalent Units in BWIP + Equivalent Units in EWIP

The first form of Equation [1 FIFO] provides a conceptual definition for unit cost when
the FIFO cost flow assumption is chosen. The last form of the equation provides an
operational definition that is used to calculate the unit cost. The equation is developed in
stages to connect the conceptual and the operational definitions. In this calculation, the
cost of the work performed during the current month is divided by the equivalent work
performed during the current month stated in terms of equivalent units. The units
completed includes the equivalent units in beginning work in process. Since this
represents work performed during the previous month, it must be subtracted from the
units completed to obtain the equivalent work performed on the completed units during

9
 the current month. In this way, the work performed during the previous month is taken
out of the denominator while keeping the cost of that work out of the numerator.

An alternative calculation for the denominator in Equation [1 FIFO] is:

Units Started and Equivalent work performed on

Equivalent Work performed on the
Finished during the + + the units in EWIP during the
units in BWIP during the month
month month

Comparing the two denominators reveals alternative ways of excluding the equivalent
work performed during the previous month.

Units Started and Equivalent Work performed

Units Equivalent Units in
- = Finished during + on the units in BWIP during
Completed BWIP
the month the month

The expression on the left-hand side of the equation above, starts with all the work
performed and then removes the work performed during the previous month. The
expression on the right-hand side, only includes the work performed during the month.
The expression on the left-hand side tends to be more confusing, but is included in
Equation [1 FIFO] because it requires less work to obtain a solution. However, study
both alternatives to help strengthen your understanding of the concepts involved.

Step II. Account For The Cost FIFO

When the cost are assigned, the units in beginning work in process keep the costs that
were charged to them at the end of the previous month, and are charged with additional
cost for the additional work required during the current month. Then the cost assigned to
the units started and finished is based on the current month’s unit cost. This approach is
more accurate, although it is more involved.

[2 FIFO] Cost of Cost of units in BWIP at beginning of month

Units Completed and = + (Unit cost)(1- Stage of BWIP)(Number of BWIP Units)
Transferred + (Unit cost)(Units started and finished)

[3 FIFO] Cost of EWIP = (Unit Cost)(Equivalent units in EWIP)

Observe that the two groups of completed units are kept separate in Equation [2 FIFO].
The units that were in the beginning inventory keep the costs that were charged to them
at the end of the previous month and are charged with additional costs based on the
amount of current period work required for completion. For example, if the units were
seventy percent complete at the end of the previous month, (i.e., beginning of the current
month) then they would need 1 - .7 = .3 or thirty percent more work to convert them into

10
completed units. The other completed units, i.e., the units that were started and finished
during the current month are charged with a full dose of unit cost. A conceptual view of
the FIFO algorithm appears in the middle of the flow chart in Exhibit 5-4. The chart
provides a summary of the decisions and steps required for the three types of process
cost problems.

EXAMPLE 5-1

The Windsole Shoe Company produces running shoes in two processes. Canvas is
placed in production at the beginning of the process in the first department where it is
cut to product specifications. These materials are transferred to the second department
where they are sewn and then assembled with the shoe soles at the end of the process. In
the first department a unit refers to the amount of canvas required for one pair of shoes.
In the second department, a unit of finished product refers to one pair of Windsole
running shoes. Relevant information for a recent month is provided in Exhibit 5-5. The
requirements in each department are to: 1) calculate the unit cost, and 2) assign the total
costs to the two categories of units remaining at the end of the process, i.e., the units
transferred out and the units in the ending inventory.

STAGE OF COMPLETION

11
The stage of completion that appears in Exhibit 5-5 for the beginning and ending
inventories refers to the average stage applicable to the conversion work performed. As
far as material is concerned, the units are either 100% complete, or 0% complete
depending on where the material is placed in production. In the cutting department, the
units in BWIP and EWIP are 100% complete in terms of material because the material
(canvas) is added at the beginning of the process. In the assembly department, the units
in BWIP and EWIP are 0% complete in terms of materials because the materials (soles)
are added at the end of the process.

WEIGHTED AVERAGE SOLUTION

The requirements for the weighted average cost flow assumption are provided in Exhibit
5-6 for both departments. The calculations applicable to the Cutting Department appear
on the left-hand side and those applicable to the Assembly Department appear on the
right-hand side of the exhibit.

Cutting Department.

Step I WA. Observe from Exhibit 5-6 that two unit cost calculations are required in the
Cutting Department. This is because the stage of completion for the units in ending work
in process is different for material and conversion. Since all material is added at the
beginning of the process, the stage of completion for EWIP is 100 percent for material,
although the stage for conversion is only 45%. A single unit cost calculation can be made
for labor and overhead as long as overhead is applied on the basis of direct labor. Then
the same stage of completion is applicable to both labor and overhead. Refer back to
Equation [1 WA] to verify how the unit costs are calculated. They are carried out to four
decimal places to avoid large rounding errors.

Step II WA. Accounting for the cost involves assigning an appropriate amount of cost to
the two categories of units that are present at the end of the month, i.e., the completed
units and units in EWIP. This is accomplished with the equations designated as [2 WA]
and [3 WA] in the previous section. The order of these two calculations is not
particularly important, but the total must be equal to the total cost to be accounted for,
i.e., $887,920. The calculation based on Equation [2 WA] provides the amount of cost
allocated to the units completed. Note from the calculations based on Equation [3 WA]
that EWIP is 100 percent complete as far as material is concerned, but only 45 percent
complete in terms of labor and overhead. Adding the cost of EWIP to the cost of the
units completed equals $887,927. This amount exceeds the total cost to be accounted for
by $7 due to rounding. When a rounding error occurs, it is convenient to adjust the
largest amount so that the total will be equal to the total cost to be accounted for.
Observe that the cost transferred out is reduced by $7 to adjust for the error. Therefore,
$804,314 is transferred from Cutting to Assembly rather than $804,321.

12
Assembly Department

Step I WA. The unit cost calculations for the Assembly Department are also based on
Equation [1 WA], but there are two important differences in this department. First, there
is an additional category of cost referred to as transferred-in cost. These costs represent
Cutting Department costs in the Assembly Department's inventory. This is logical since
all the completed units (cut canvas) in Cutting are transferred to Assembly along with
the cost allocated to those units. The $80,000 in the Assembly Department's beginning
inventory represents Cutting Department costs that remained in the Assembly
Department's inventory at the end of the previous month. The units in the ending
inventory (12,000) are 100 percent complete as far as Cutting Department costs are
concerned.

The second difference involves the unit material cost calculation. Since the materials
(shoe soles) are added, or attached at the end of the process in Assembly, there is no
Assembly Department material cost in the beginning inventory. This is because these
10,000 units (see Exhibit 5-5) did not reach the end of the process during the previous
month. Therefore, the soles were attached to these units during the current month as they
were completed. The same logic is used to explain why the denominator in the unit
material cost calculation does not include EWIP. These 12,000 units are only 46 percent
complete and will not receive the Assembly material (soles) until they reach the end of
the production process next month.
13
Step II WA. The cost are accounted for in the usual way by determining how much cost
to allocate to the two categories of units at the end of the month, i.e., units completed
and units in the ending inventory. Equations [2 WA] and [3 WA] are used for this
purpose just as they were in the Cutting Department calculations. However, there are
some notable differences between the two departments. First, the ending inventory
includes transferred-in cost. The EWIP is 100 percent complete as far as transferred-in
cost is concerned because this category represents work performed in the first
department. No material costs are assigned to EWIP because these 12,000 units have not
reached the point where the materials (soles) are attached. Since EWIP is 46 percent
complete as far as labor and overhead is concerned, .46 multiplied by the unit conversion
cost of 5.222 is assigned to each of the 12,000 units. The cost of the units completed and
transferred to finished goods is calculated in the usual way using Equation [2 WA]. The
amount is rounded up by approximately $3 to adjust for the rounding error.

Journal Entries WA

The journal entries to record the transfers are provided in Exhibit 5-7. Remember that all
the other entries to record and distribute material and labor, record other overhead costs,
and apply overhead costs are essentially the same as in Chapter 4. Direct labor and
factory overhead are combined in this example to simplify the illustration. The overhead
variance analysis illustrated in Chapter 4 is also applicable to normal historical process
costing. However, different overhead rates are frequently used in each process or
department. We will consider when plant wide, departmental and activity based overhead
rates are appropriate in the next two chapters.

14
FIRST-IN FIRST-OUT SOLUTION

The solution to Example 5-1 based on the FIFO cost flow assumption appears in Exhibit
5-8. To make it easier to trace the calculations back to the original data, Exhibit 5-1 is
restated below.

15
Cutting Department

Step I FIFO. The unit cost calculations in Exhibit 5-8 are based on Equation [1 FIFO].
The cost of the beginning inventory is excluded from the numerator in each calculation,
and the equivalent work performed on the beginning units during the previous month is
subtracted from the denominator. In the Cutting department, the 6,000 units in BWIP
received material when started last month. Since the FIFO unit cost is only based on the
work performed during the current month, these 6,000 units must be subtracted from the
90,000 completed units. These 6,000 units are included in the 90,000 completed units,
but only the equivalent work performed during the current month belongs in the
denominator. This includes the 84,000 units started and finished this month (i.e., 90,000
- 6,000) and the 16,000 units in the ending inventory. The entire 16,000 units are
included in the denominator because these units received 100 percent of the required
material during the current month. In fact, in the Cutting Department, the unit is the
material.

The same logic is used to calculate the unit conversion cost. Since the beginning units
were 40 percent complete at the end of the previous month, 2,400 equivalent units (.4
multiplied by 6,000) are subtracted to determine the amount of conversion work
performed on the completed units during the current month. Although there are 90,000
completed units, only 87,600 equivalent units represent work performed during the
current month (i.e., 90,000 - 2,400). The addition of 7,200 units (.45 multiplied by
16
16,000) to the denominator includes the equivalent conversion work that has been
performed on the units that remain in the ending inventory.

Step II FIFO. Assigning cost to the completed units is more involved when FIFO is
used. We can't just multiply the completed units by the total unit cost as in the weighted
average method. Remember, when FIFO is used, the two categories of completed units
are kept separate. The cost of the units in the beginning inventory is calculated first in
Equation [2 FIFO]. These units keep the $26,400 assigned to them at the end of the
previous month and are charged with 60 percent more conversion costs to determine
their completed cost. Observe that 60 percent is added, not 40 percent. Since these units
received 40 percent of the required conversion work (and conversion costs) last month,
an additional 60 percent was needed during the current month. The costs allocated to the
rest of the completed units, i.e., the 84,000 units that were started and finished during the
current month, is also calculated in Equation [2 FIFO]. Then the sum of these two
calculations (i.e., 50,762 + 753,236) provides the amount to transfer to the Assembly
Department before the rounding error adjustment. The cost of the ending inventory is
calculated using equation [3 FIFO]. Mechanically, the EWIP calculation is just like the
one used in the weighted average solution, although the unit costs are different.

Assembly Department

17
Step I FIFO. There are three unit cost calculations in the Assembly Department. The
unit transferred-in cost represents the unit cost of the 90,000 units transferred in from the
Cutting Department during the current month, i.e., $803,997 divided by 90,000 units
equals 8.9333.

The denominator in the unit material cost calculation deserves a little extra attention.
Remember that Assembly Department material is added at the end of the process. The
10,000 units in the beginning inventory received material (soles) during the current
month as they reached the end of the process. Therefore these units are included in the
denominator as part of the 88,000 completed units. The 12,000 units in the ending
inventory have not reached the end of the process, therefore no Assembly Department
material (soles) has been added to these units and they are logically excluded from the
denominator in the unit material cost calculation.

Unit conversion costs are also calculated using Equation [1 FIFO]. The mechanics and
logic of this equation are the same as those used in the Cutting Department calculation.
However, trace each amount back to the original data to insure that you understand the
calculation.

Step II FIFO. There are a few important differences in the way the cost are accounted
for in the Assembly Department. The total cost of the 88,000 units transferred to
Finished Goods is based on Equation [2 FIFO]. Observe, from Exhibit 5-8 that the costs
are assigned to the two categories of completed units separately. The beginning
inventory units keep the $104,000 assigned to them at the end of the previous month.
Then, a full dose of assembly material costs ($3 each) is added since these units received
this material (soles) at the end of the process as they were finished. Since 48 percent of
the conversion work on these 10,000 units was performed during the previous month,
these units are charged with an extra 52 percent based on the current month's unit cost.
The other 78,000 completed units that were started and finished during the month
(88,000 - 10,000) are each charged with $17.167, i.e., the total unit cost for the current
month. The sum of these separate calculations, (i.e., 161,217 + 1,339,049) provides the
amount of costs charged to finished goods before the rounding error adjustment. The
cost of the ending inventory is determined using Equation [3 FIFO]. Material costs do
not appear in the calculation because these 12,000 units will not receive assembly
material (soles) until next month when they reach the finish line. The journal entries to
record the transfers are provided in Exhibit 5-9.

18
THE STAGE FOR MATERIAL

The stage of completion for material is seldom mentioned in a process cost problem.
However, it is normally based on the point in the production process where material is
added. Obviously, some material must be placed in production at the beginning of the
process in the first department, but material can be added anywhere in subsequent
departments. In some departments, material is added continuously during the process.
For this reason, when calculating unit material cost and assigning material costs to
ending work in process, we must always think about where the material is added. If more
than one type of material is added in a department, additional calculations are obviously
required. Although solving problems with multiple materials placed in production at
different points in the process does not involve any new concepts or techniques,
generating correct solutions requires careful thinking.

COMPARING FIFO AND WEIGHTED AVERAGE

The FIFO and weighted average solutions are compared in Exhibits 5-10 and 5-11.
Exhibit 5-10 provides a flow chart view of the FIFO and weighted average solutions for
the Cutting Department. Exhibit 5-11 provides a similar view for the Assembly
Department. These exhibits emphasize that two cost pools are maintained in the FIFO
approach, while only one cost pool is used in the weighted average method.

19
Cutting Department Comparison

Exhibit 5-10 shows that the two cost pools for FIFO are the cost of BWIP ($26,400) and
the cost added ($861,520). The single cost pool for weighted average includes both of
these amounts ($887,920). The amounts that appear in the cost pools are from Exhibit 5-
5. The FIFO unit costs are based on the $861,520 cost added (The calculations are the
same as those in Exhibit 5-8). When assigning the Cutting Department costs to units
based on FIFO, the $26,400 stays with the BWIP and the costs added ($861,520) are
spread across all units based on the current month work performed, i.e., $24,362 to the
BWIP and $753,236 to the units started and finished during the month.

The weighted average unit costs are based on the $887,920 single cost pool that includes
the $26,400 assigned to the BWIP at the end of the previous period (These calculations
are the same as those in Exhibit 5-6). Therefore, when assigning the Cutting Department
costs to units based on weighted average, the entire $887,920 is spread across the units
based on the work performed on the units during both periods.

Assembly Department Comparison

Exhibit 5-11 presents a similar view of the Assembly Department. Two cost pools are
maintained in the FIFO method. One cost pool represents the $104,000 assigned to
BWIP at the end of the previous period and the other cost pool is for the $1,532,357

20
added during the current period. These amounts are from Exhibit 5-5. When assigning
the cost to units, the $104,000 stays with the BWIP. The FIFO unit costs are based on the
second cost pool and then assigned to the units based on the work performed during the
current month, i.e., $30,000 + $27,217 to BWIP and $1,339,049 to the units started and
finished during the month (The calculations are from Exhibit 5-8).

The weighted average unit costs in the Assembly Department are based on the
$1,636,674 single cost pool that includes the $104,000 assigned to BWIP at the end of
the previous month. Therefore, when assigning the costs to the units based on weighted
average, the entire $1,636,674 is spread across the units based on the work performed on
the units during both periods (The calculations for weighted average are the same as
those in Exhibit 5-6).

ACCOUNTING FOR SPOILAGE IN HISTORICAL PROCESS COSTING

Spoilage, rework, defective units and scrap are defined in Chapter 4. Refer back to those
definitions if you need to refresh your memory. This section illustrates how spoilage is
accounted for in process costing. Rework and scrap are handled in essentially the same
way they are in job order costing. The sections in Chapter 4 that describe the accounting
for rework and scrap common to all jobs are also applicable to this chapter.

TREATMENT OF SPOILED OR LOST UNITS

21
 The previous sections of this chapter are definitely prerequisites for this section.
However, once you understand the basic accounting techniques for process cost
accumulation, then you will be ready for the more realistic problems that include
spoilage. You might find it helpful to work one or two problems that do not include
spoilage (e.g., Problems 5-1 and 5-2) before you tackle this section. Adding spoilage is a
fairly easy step in the learning process, once you have the necessary foundation, but
before you reach that point, it tends to be confusing.

WEIGHTED AVERAGE COST FLOW ASSUMPTION

Step I WA. When the weighted average cost flow assumption is used, the equivalent
units spoiled (or lost) are added to the denominator in the unit cost calculations.
Therefore, Step I includes revising Equation [1 WA] as follows:

Cost of BWIP + Cost Added during the month

[1 WA] Unit
Units Completed + Equivalent units in EWIP + Equivalent Units
Cost WA =
Spoiled or Lost

The stage of completion of the units spoiled or lost is indicated by the inspection point.
For example, if the inspection point is at the end of the process, then the spoiled or lost
units are assumed to be 100% complete. If the inspection point is midway through the
process, then the spoiled or lost units are considered ½ complete as far as conversion is
concerned. If material enters production before the inspection point then the spoiled or
lost units are considered 100% complete for material. If material is placed in production
after the inspection point, then the spoiled or lost units are 0% complete as far as
material is concerned. Both normal and abnormal spoilage are treated in the same way in
the unit cost calculations.

Step II WA. When spoiled, or lost units are involved, accounting for the costs includes
determining the cost of the normal spoilage and assigning these costs to the units that
have been inspected. In addition, the cost of the abnormal spoilage must be determined
so that it can be charged to a loss account. The calculations for [2 WA] and [3 WA] are
revised as follows:

[2 WA] Cost of Units completed Cost transferred to next department

and transferred = = (Good Units Completed)(Unit Cost)

+ (Cost of Normal Spoilage*)(Proportion

Applicable to Units Transferred**)

+ Cost transferred to Loss Account

= (Equivalent Units of Abnormal
Spoilage)(Unit Cost) - Disposal Value

[3 WA] Cost of EWIP = = (Unit Cost)(Equivalent Units in EWIP)

22
 + (Cost of Normal Spoilage*)(Proportion
Applicable To EWIP**)

* (Equivalent Units of Normal Spoilage)(Unit Cost)

- Disposal Value

** All units that have passed the point of inspection

share the cost of normal spoilage.

If the inspection point is at the end of the process, then only the units that have been
completed share the normal spoilage costs. The proportion applicable to the units
transferred will be 1, i.e., 100 percent. However, if the units in ending work in process
have been inspected, then these units share the cost of normal spoilage with the other
units that have been inspected. This situation can occur when the inspection point is
before the end of the process and the EWIP units have passed that point. Then, the
applicable proportions in the calculations above are based on the ratio of the number of
good units in each category (i.e., transferred and EWIP), to the total good units in both
categories.

If reasonably accurate estimates of the disposal values of the spoilage can be made, these
amounts are subtracted in determining the spoilage costs as indicated in Equations [2
WA] and [3 WA]. Then the disposal value is charged to a spoilage inventory account
until sold. The offsetting credit is to the work in process account.

FIRST-IN FIRST-OUT COST FLOW ASSUMPTION

When the FIFO cost flow assumption is used, a complicating problem arises. This
involves determining which category of completed units the spoilage came from. If the
spoiled or lost units are assumed to have come from the units started during the period,
then the equivalent units spoiled or lost are added to the denominator in the unit cost
calculation [1 FIFO]. Note, that this is the same way spoilage is handled in the weighted
average method. It is the usual treatment because it is not practical to identify the source
of each spoiled or lost unit. However, if the spoiled or lost units are assumed to have
come from the beginning work in process, then only the equivalent work performed on
them during the period is included in the denominator. To simplify, we will assume that
any spoiled or lost units come from the units started during the period. With this
assumption, the treatment of spoiled and lost units is essentially the same in both FIFO
and weighted average. These techniques are illustrated in Example 5-2 presented below.

EXAMPLE 5-2

The Texas Tanning Company produces leather from animal hides. Relevant information
for the Tanning Department is provided in Exhibit 5-12. The materials, (raw hides) are
added at the beginning of the process where they are hung on racks and dipped in a
tanning solution. The inspection point is at the end of the process when the hides are
23
removed from the solution. Spoilage up to five percent of the good completed units
(leather hides) is considered normal. Any spoilage above this level is considered
abnormal. For convenience, all spoilage is assumed to come from the units started during
the period and have a disposal value of $2 per unit.

StepI Both Methods. The solutions to Example 5-2 for both the weighted average and
FIFO cost flow assumptions appear in Exhibit 5-13. The unit cost calculations are
developed in the same way as those presented in the previous example except that the
1,300 units of spoilage are added to the denominator. The number of spoiled units is
determined by entering the known values in the equation that defines the relationships
between the various categories of units. A note at the bottom of Exhibit 5-13 shows this
calculation. The entire 1,300 units of spoilage are 100% complete because the inspection
point is at the end of the process. Thus, 1,300 units are added to the denominator in the
unit cost calculations for both material and conversion.

24
 Notes apply to both sides of the Exhibit:
* Spoiled Units = 1,000+9,000-6,200-2,500 = 1,300.
** Normal Spoilage = (.05)(6,200) = 310. Abnormal Spoilage = 1,300-310 = 990.
*** Total unit cost less disposal value. Answers rounded in WA solution.

Step II Both Methods. The procedure to determine the costs of units transferred
includes three new calculations in both cost flow assumptions. These include calculating
the cost of the normal spoilage, the abnormal spoilage and the disposal value of the
spoiled units. Since any spoiled units up to five percent of the good completed units are
considered normal, 310 units (.05 multiplied by 6,200), are treated as normal spoilage
and the other 990, (1,300 - 310) are treated as abnormal spoilage. The $2 per unit
disposal value is subtracted from the unit cost in determining the (unrecoverable) cost of
normal and abnormal spoilage. The disposal value is charged to a spoilage inventory
account until these units are sold.

Step III Both Methods. In accounting for the costs, no spoilage costs are charged to the
units in ending work in process (in either weighted average or FIFO) because the units in
the ending inventory have not passed the inspection point. Therefore, the cost assigned
to EWIP is calculated in the manner illustrated in the previous example. The entries to
record the cost flows are illustrated in Exhibit 5-14.

25
Alternative Methods of Accounting For Spoilage

There are some alternative methods of accounting for spoilage in process costing. For
example, some companies do not include the number of units spoiled in the unit cost
calculations. Conceptually, this is a less accurate method because the spoilage costs are
spread over all units whether or not they have passed the inspection point. However,
when the spoilage costs are not significant, this is an acceptable method. Another
approach that could be used involves including spoilage in the departmental overhead
rate calculations. Then spoilage costs are applied along with all other overhead costs.
Actual normal spoilage costs, less any disposal value, is charged back to factory
overhead. It is not practical to illustrate all possible methods in a textbook, but you
should be aware that many alternatives exist.

SYSTEM RELATED TO SYSTEM FUNCTIONS

Most of the discussion that appears under the heading of "Normal Historical Costing
Related To System Functions" in Chapter 4, is also applicable to the cost system
described in this chapter. The normal historical, full absorption, process cost system
described in this chapter is adequate for satisfying GAAP external reporting
requirements (Function 1 in Exhibit 2-4). However, it is inadequate for planning and
controlling activities and processes (Function 2) because of the timing lags in reporting
and the cost aggregations involved. Since the overhead variance analysis presented in

26
Chapter 4 is also applicable to this chapter, the cost system described in this chapter also
provides some general information for monitoring overhead costs. But it does not
provide similar information concerning direct material and direct labor. This deficiency
relates to the basic system, i.e., normal historical costing, not to the cost accumulation
method involved.

From the product costing perspective, process cost accumulation tends to provide more
accurate product cost than job order costing because there is much less product and
volume diversity in process costing. In a job order cost environment, there are many
different product variations and volume levels prescribed by customer specifications. In
a process cost environment, there is considerably less product diversity and the
production volume is controlled by overall demand, not specific customer demands.
Therefore, process cost accumulation tends to satisfy the requirements of function 3
(e.g., short term decisions such as pricing products) better than job order costing because
there is less diversity in the manufacturing environment. Long term strategic decisions
(Function 4 in Exhibit 2-4) require special study and analysis in either of the two
systems described in Chapters 4 and 5. The next five chapters discuss improvements in
the cost system that enhance the value of the information provided to satisfy the
requirements of system functions 2 and 3.

FOOTNOTE

1
The reason for this is explained later in this chapter. See the section on spoilage.

QUESTIONS

1. What is the main difference between process costing and job order costing? (See
Chapter 2)

2. What is transferred-in cost? (See Terminology & Concepts)

3. How is unit cost calculated in a job order cost system?

4. Generally, how is unit cost calculated in a process cost system?

5. Which cost accumulation method, job order or process costing, is more involved as far
as the bookkeeping aspect is concerned? Why?

6. What is an equivalent unit?

7. When do we need a cost flow assumption to calculate unit cost in process costing?
(See Exhibit 5-4)

8. What is the conceptual difference between the weighted average and FIFO unit cost
calculations? (See Exhibit 5-4)

27
9. Conceptually, what is the numerator in the weighted average unit cost calculation?
(See Exhibit 5-4)

10. Conceptually, what is the denominator in the weighted average unit cost calculation?
(See Exhibit 5-4)

11. Conceptually, what is the numerator in the FIFO unit cost calculation? (See Exhibit
5-4)

12. Conceptually, what is the denominator in the FIFO unit cost calculation? (See
Exhibit 5-4)

13. Why do two separate unit cost calculations need to be made for direct materials and
conversion costs? (See

14. What makes combining direct labor and overhead for unit cost calculations an
acceptable
procedure?

15. In process costing, which cost flow assumption provides the most accurate product
cost?
Why?

16. Do we need a predetermined overhead rate in process costing? In developing your

answer,
consider the reasons for using a predetermined overhead rate discussed in Chapter 4.

17. Is overhead more accurately traced to products in process costing or job order
costing?
Why?

18. Which cost flow assumption requires a two part calculation for the cost transferred
out?

19. Why is this two part calculation needed?

20. Is process costing only used by manufacturers? (See Chapter 2)

21. Can you think of any service organizations that use process costing? (See Chapter 2)

22. Do you think control charts are more useful in a process cost environment or a job
order
cost environment? Why?

23. How would the overhead variance analysis differ in normal historical process costing
compared to normal historical job order costing?

28
24. How well does the cost system described in this chapter satisfy the four functions of
a
system discussed in Chapter 2? (See Exhibit 2-4)

PROBLEMS

PROBLEM 5-1

THIS PROBLEM DOES NOT INCLUDE SPOILAGE.

WEIGHTED AVERAGE AND FIFO COST FLOW ASSUMPTIONS.

The Bilco Co. produces a product in two processing departments, Forming and
Assembly. Direct material is placed in production at the beginning of the process in
Forming and at the end of the process in Assembly. Relevant information for a month is
provided below. The stage of completion refers to the average stage as far as conversion
is concerned.

1.) Assume Bilco uses the weighted average cost flow assumption. Determine the unit
costs as indicated on the following page. Then determine the costs of the units in the
ending inventory and the cost of the units completed and transferred. When working
with the Assembly Department assume the cost transferred-in was $122,000 regardless
of your calculations in the Forming Department.
29
2.) Solve the problem assuming Bilco uses the FIFO cost flow assumption. Assume, as
in question 1 that $122,000 is transferred to Assembly. Round unit cost to four decimal
places. Round all other answers to dollars.

PROBLEM 5-2

THIS PROBLEM DOES NOT INCLUDE SPOILAGE. SECOND DEPARTMENT,

WEIGHTED AVERAGE AND FIFO COST FLOW ASSUMPTIONS.

The Rival Company produces a single product in two processes. The following
information is provided for the second department.

Units Stage
Beginning work in process 100 .90
Transferred in 400
Completed and transferred out 450
Ending work in process 50 .80

Work in Process #2
Beg. Transferred in $2,000
Beg. Conversion $4,000
Transferred in $12,000
Material added $10,000
Conversion added $20,000

Material is added at the end of the process and spoilage does not occur.

REQUIRED:

Part I. Assume the weighted average cost flow assumption is used and determine the
following amounts.

1. Unit transferred in cost.

2. Unit material cost.
3. Unit conversion cost.
4. The cost transferred to finished goods.
5. The cost of the ending inventory of work in process.

Part II. Assume the FIFO cost flow assumption is used and calculate the five
requirements listed in Part I.

PROBLEM 5-3
30
THIS PROBLEM DOES NOT INCLUDE SPOILAGE. SECOND DEPARTMENT,
WEIGHTED AVERAGE AND FIFO COST FLOW ASSUMPTIONS. (ALTERNATIVE
FOR 5-2)

The Ajax Company produces a single product in two processes. The following
information is provided for the second department.

Units Stage
Beginning work in process 1,000 .75
Transferred in 9,000
Completed and transferred out 9,500
Ending work in process 500 .80

Work in Process #2
Beg. Transferred in $ 24,000
Beg. Conversion $ 20,000
Transferred in $ 90,000
Material added $ 60,000
Conversion added $ 200,000

Material is added at the end of the process and spoilage does not occur.

REQUIRED:

Part I. Assume the weighted average cost flow assumption is used and determine the
following amounts.

1. Unit transferred in cost.

2. Unit material cost.
3. Unit conversion cost.
4. The cost transferred to finished goods.
5. The cost of the ending inventory of work in process.

Part II. Assume the FIFO cost flow assumption is used and calculate the five
requirements listed in Part I.

PROBLEM 5-4

THIS PROBLEM INCLUDES SPOILAGE WITHOUT A DISPOSAL VALUE. FIFO

COST FLOW.

The Blending Department of the Mattall Company uses the FIFO cost flow assumption.
Material is added at the beginning of the production process. The inspection point is at
the end of the process and spoilage (or lost units) up to 20% of good output is considered
31
normal. Spoilage (or lost units) in excess of 20% is treated as abnormal. All spoilage (or
lost units) is assumed to come from the units started during the period. The relevant data
are given below:

Units Stage
Beginning work in process 1,000 60%
Started 9,000
Completed 6,200
Ending work in process 2,400 40%
Spoilage ?

Work In Progress
Beginning Material $8,000
Beginning Conversion $16,000
Material Added $22,800
Conversion Added $52,000

REQUIRED

1. Determine the unit material cost.

2. Determine the unit conversion cost.
3. Calculate the cost transferred out to the next department.
4. Calculate the cost transferred to a loss account if any.
5. Calculate the cost of the ending inventory of work in process.

PROBLEM 5-5

THIS PROBLEM INCLUDES SPOILAGE WITHOUT A DISPOSAL VALUE.

WEIGHTED AVERAGE COST FLOW.

The Bow Co. produces a product in two processing departments, Forming and Assembly.
Direct material is placed into production at the beginning of the process in Forming and
at the

end of the process in Assembly. Assume Bow Co. uses the weighted average cost flow
assumption. When working with the Assembly Department assume the cost transferred-
in was $109,500 regardless of your calculations in the Forming Department. The
inspection point is at the end of the process in both departments and that any spoilage is
considered normal. Bow Company does not ignore spoilage.

FORMING ASSEMBLY
Units Stage Units Stage

32
BWIP 1,000 60% BWIP 2,000 40%
Started 10,000 Started 8,000
Completed 8,000 Completed 9,000
EWIP 2,000 75% EWIP 1,000 60%
WIP Forming WIP Assembly
Beg. Mat $2,000 Beg Tran-in $26,500
Beg Conv. $12,000 Beg Conv. $9,600
Mat added $31,000 Transferred in $109,500*
Conv added $85,280 Mat added $45,000
Total $130,280 Conv added $109,440
Total $300,040

* Assume for convenience.

REQUIRED FOR FORMING

1. Unit Material Cost.
2. Unit Conversion Cost.
3. Cost of Ending WIP.
4. Cost of Units Completed

REQUIRED FOR ASSEMBLY

5. Unit Transferred in Cost.
6. Unit Material Cost.
7. Unit Conversion Cost.
8. Cost of Ending WIP and Transferred to Assembly.
9. Cost of Units Completed and transferred to Finished Goods.

PROBLEM 5-6

THIS PROBLEM INCLUDES SPOILAGE AND A DISPOSAL VALUE. WEIGHTED

AVERAGE AND FIFO COST FLOW ASSUMPTIONS.

The Berry Company produces a product in a process cost environment. The following
information is provided for the first department in the process.

Units Stage
Beginning work in process 2,000 .75
Started 8,000
Completed (Good) 7,500
Ending work in process 1,700 .60

33
Work in Process #1
Beg. Material $14,000
Beg. Conversion $20,000
Material added $58,000
Conversion added $104,500

Material is added at the beginning of the process and the inspection point is at the end of
the process. All spoilage is assumed to come from the units started during the period.
Any spoilage up to ten percent of the good completed units is considered normal.
Spoilage above ten percent is considered abnormal. Spoiled units have a disposal value
of $4 each. Berry Company charges this amount to a spoilage inventory account until the
spoilage is sold.

REQUIRED: Determine the following amounts.

1. Total spoilage (in units).

2. Normal spoilage (in units).
3. Abnormal spoilage (in units).

Assume a weighted average cost flow, calculate the following and round your answers to
four decimal places.
4. The unit material cost.
5. The unit conversion cost.
6. The cost transferred to the next department.
7. The cost transferred to a loss account if any.
8. The cost transferred to the spoilage inventory account.
9. The cost allocated to the ending inventory of work in process.
10. Make the appropriate journal entry to record the cost flow.

Now assume a FIFO cost flow, calculate the following and round your answers to four
decimal places.
11. The unit material cost.
12. The unit conversion cost.
13. The cost transferred to the next department.
14. The cost transferred to a loss account if any.
15. The cost transferred to the spoilage inventory account.
16. The cost allocated to the ending inventory of work in process.
17. Make the appropriate journal entry to record the cost flow.

PROBLEM 5-7

THIS PROBLEM INCLUDES SPOILAGE. WEIGHTED AVERAGE AND FIFO COST

FLOW ASSUMPTIONS. EMPHASIS ON WEIGHTED AVERAGE.

34
Wheel Company I. The following information is given for the second department in a
process cost environment.

Units Stage
Beginning work in process 1,000 .60
Started 9,000
Completed (Good) 9,200
Ending work in process 600 .80
Spoilage ?

Work in Process #2
Beg transferred in $12,000
Beg Conv $20,000
Transferred in $102,600
Conv added $210,000
Mat added $61,000

Material is added at the end of the process. Inspection is also at the end of the process
after the material is added. Spoilage up to five percent of good completed units is
considered normal. Any spoilage is assumed to come from the units started during the
period. Note: Unit cost calculations are rounded to four decimal places.

REQUIRED:

1. The unit transferred-in cost based on a weighted average cost flow is:
a. $11.1696 b. $11.6939 c. $11.4000 d. 11.4600 e. None of these.

2. The unit material cost based on a weighted average cost flow is:
a. 6.5733 b. 6.4894 c. 6.6304 d. 6.7778 e. None of these.

3. The unit conversion cost based on a weighted average cost flow is:
a. 22.6293 b. 23.0263 c. 23.2794 d. 22.0126 e. None of these.

4. Now, ignore your previous calculations and assume that the unit costs using weighted
average are: transferred-in = $11, material = $6, and conversion = $23. The cost
transferred to the next department using the weighted average method would be: (Note:
Answers will not agree with the total cost to be accounted for.)
a. $376,000 b. $368,000 c. $360,000 d. $383,200 e. None of these.

5. Now, ignore your previous unit cost calculations and assume the unit costs using FIFO
are: transferred-in $11, material = $6, conversion = $23. The costs charged to the next
department using FIFO would be: (Note: Answers will not agree with the total cost to be

35
accounted for.)
a. $376,000 b. $368,000 c. $383,200 d. $336,000 e. None of these.

PROBLEM 5-8

THIS PROBLEM INCLUDES SPOILAGE.

WEIGHTED AVERAGE AND FIFO COST FLOW ASSUMPTIONS. EMPHASIS ON
FIFO.

Wheel Company II. The following information is given for the second department in a
process cost environment.

Units Stage
Beginning work in process 1,000 .60
Started 9,000
Completed (Good) 9,200
Ending work in process 600 .80
Spoilage ?

Work in Process #2
Beg transferred in $12,000
Beg Conv 20,000
Transferred in 102,600
Conv added 210,000
Mat added 61,000

Material is added at the end of the process. Inspection is also at the end of the process
after the material is added. Spoilage up to five percent of good completed units is
considered normal. Any spoilage is assumed to come from the units started during the
period. Note: Unit cost calculations are rounded to four decimal places.

REQUIRED:
1. The unit transferred-in cost using FIFO is:
a. $10.3846 b. $11.0799 c. $11.4000 d. 11.4600 e. None of these.

2. The unit material cost using FIFO is:

a. 6.5733 b. 6.4894 c. 6.6304 d. 6.7778 e. None of these.

3. The unit conversion cost using FIFO is:

a. 22.6293 b. 23.0263 c. 23.2794 d. 22.0126 e. None of these.

36
4. Now, ignore your previous unit cost calculations and assume the unit costs using FIFO
are: transferred-in $10, material = $6, conversion = $20. The costs charged to the next
department using FIFO would be:
a. $331,200 b. $342,400 c. $348,400 d. $338,400 e. None of these.

5. Now, ignore your previous calculations and assume that the unit costs using weighted
average are: transferred-in = $10, material = $6, and conversion = $20. The cost
transferred to the next department using the weighted average method would be:
a. $331,200 b. $342,400 c. $348,400 d. $338,400 e. None of these.

Problem Solutions Extra MC Questions

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