Job-Process Costing Systems

Chapter Three
Job, Process and Operation Costing

Building-Block Concepts of Costing Systems
Before we begin our discussion of costing systems, let’s review cost-related terms and introduce
the new terms that we will need for our primary discussion.
1. Cost object—anything for which a measurement of costs is desired—for example, a
product, such as a DELL computer, or a service, such as the cost of repairing a DELL
computer.
2. Direct costs of a cost object—costs related to a particular cost object that can be traced to
that cost object in an economically feasible (cost-effective) way—for example the cost of
purchasing the main computer board or the cost of parts used to make a DELL computer.
3. Indirect costs of a cost object—costs related to a particular cost object that cannot be
traced to that cost object in an economically feasible (cost-effective) way—for example,
the costs of supervisors who oversee multiple products, or the rent paid for the repair
facility that repairs many different DELL computer products. Indirect costs are allocated
to the cost object using a cost allocation method.
Recall that cost assignment is a general term for assigning costs, whether direct or indirect, to a
cost object. Cost tracing is a specific term for assigning direct costs; cost allocation refers to
assigning indirect costs.
4. Cost pool. A cost pool is a grouping of individual indirect cost items. Cost pools can
range from broad, such as all manufacturing-plant costs, to narrow, such as the costs of
operating metal-cutting machines. Cost pools are often organized in conjunction with
cost-allocation bases.
5. Cost-allocation base. How should a company allocate costs to operate metal-cutting
machines among different products? One way to allocate costs is based on the number of
machine-hours used to produce different products. The cost-allocation base (number of
machine-hours) is a systematic way to link an indirect cost or group of indirect costs
(operating costs of all metal-cutting machines) to cost objects (different products). For
example, if indirect costs of operating metal-cutting machines is $500,000 based on
running these machines for 10,000 hours, the cost allocation rate is $500,000 ÷ 10,000
hours = $50 per machine-hour, where machine-hours is the cost allocation base. If a
product uses 800 machine-hours, it will be allocated $40,000; $50 per machine-hour and
800 machine-hours. The ideal cost-allocation base is the cost driver of the indirect costs,
because there is a cause-and-effect relationship between the cost allocation base and the
indirect costs. A cost-allocation base can be either financial (such as direct labor costs) or
nonfinancial (such as the number of machine-hours). When the cost object is a job,
product, or customer, the cost-allocation base is also called a cost-application base.
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Job-Costing and Process-Costing Systems
Companies frequently adopt one of two basic types of product costing system to assign costs to
products or services: A product costing system is a set of procedures used to account for an
organization’s product costs and to provide timely and accurate unit cost information for pricing,
cost planning and control, inventory valuation, and financial statement preparation.
 The product costing system enables managers to track costs throughout the management
process.
 It provides a structure for recording the revenue earned from sales and the costs incurred
for direct materials, direct labor, and overhead.
1. Job-costing system. In this system, the cost object is a unit or multiple units of a distinct
product or service called a job. Each job generally uses different amounts of resources. The
product or service is often a single unit, such as a specialized car made at Ford, a construction
project managed by Afro Tsion, a repair job done at Local mobile maintenance, or an
advertising campaign produced by Serawit Fikrie Promotion. Each special car made by Ford
is unique and distinct. An advertising campaign for one client at Serawit Fikrie Promotion is
unique and distinct from advertising campaigns for other clients. Job costing is also used by
companies such as Furniture producers to cost multiple identical units of distinct furniture
products. Because the products and services are distinct, job-costing systems accumulate costs
separately for each product or service.
2. Process-costing system. In this system, the cost object is masses of identical or similar units
of a product or service. For example, Dashen bank provides the same service to all its
customers when processing customer deposits. Dashen Beer and MOHA soft drinks produce
identical beer and soft drinks, respectively. In each period, process-costing systems divide the
total costs of producing an identical or similar product or service by the total number of units
produced to obtain a per-unit cost. This per-unit cost is the average unit cost that applies to
each of the identical or similar units produced in that period.
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Comparison between Job costing and Process costing
Job costing Process Costing
Wide Variety of Distinct Products Homogeneous products
Costs accumulated by jobs Costs accumulated by processes or departments
Unit cost is computed by dividing total job costs by Unit cost is computed by dividing total process costs of
units produced in that job the period by the number of units produced in the period
Examples of job costing and process costing in the service, merchandising and manufacturing
sectors
Service Sector Merchandising Manufacturing
Sector Sector
Job Costing System  Accounting Firm  Sending a catalogue  Aircraft assembly
audits to a mailing list  House Construction
 Advertising agency  Special promotion
campaign of a new store
product
Process Costing  Deposit processing  Grain dealing  Oil refining
System  Postal delivery  Processing new  Beverages
magazine production
subscriptions
Features of Job Costing System
 Each job has its own characteristics and need a separate treatment.
 Each job is taken as a job unit.
 For each job, a distinct number is assigned and a separate job cost sheet if used.
 The costing department keeps a separate work in process account for each job.
 Profit or loss is determined for each job.
 The cost of production of every job is ascertained or known after the completion of each
job.
Steps to be involved in Job costing System
Step 1: Identify the Job That Is the Chosen Cost Object:
Step 2: Identify the Direct Costs of the Job.
Step 3: Select the Cost-Allocation Bases to Use for Allocating Indirect Costs to the Job.
Step 4: Identify the Indirect Costs Associated with Each Cost-Allocation Base.
Step 5: Compute the Rate per Unit of Each Cost-Allocation Base Used to Allocate Indirect Costs
to the Job.
Step 6: Compute the Indirect Costs Allocated to the Job.
Step 7: Compute the Total Cost of the Job by Adding All Direct and Indirect Costs Assigned to
the Job.
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Actual Costing Vs Normal costing
Actual costing is a costing system that:
1)Traces direct costs to a cost object by using the actual direct cost rates times the
actual quantities of the direct-cost inputs.
2) It allocates indirect costs based on the actual indirect-cost rates times the actual
quantities of the cost-allocation bases. The actual indirect-cost rate is calculated by
dividing actual total indirect costs by the actual total quantity of the cost-allocation base.
As its name suggests, actual costing systems calculate the actual costs of jobs.
Yet, actual costing systems are not commonly found in practice because actual
costs cannot be computed in a timely manner. The problem is not with
computing direct-cost rates for direct materials and direct manufacturing
labor.
Normal costing is a costing system that
1) Traces direct costs to a cost object by using the actual direct-cost rates times the actual
quantities of the direct-cost inputs and;
2) Allocates indirect costs based on the budgeted indirect-cost rates times the actual
quantities of the cost-allocation bases.
The budgeted indirect-cost rate for each cost pool is computed as follows:
Budgetd Annual Indirect Costs

Budgeted Indirect Cost Rate=
Budgetd annual quantity of cost allocation base
Note:- Manufacturing Overhead application
MOH must be included with direct materials and direct labor on the job cost sheet since it is a product cost. However,
assigning MOH to units of product can be a difficult task. There are three reasons for this:-
 MOH is an indirect cost. This is to mean that it is either impossible of difficult to trace these costs to a
particular job or product.
 MOH consists of many different items.
 Although output may fluctuate due to seasonal or other factors, most MOH costs tend to remain relatively
constant due to the presence of fixed costs.
Source Documents
These are the original records that support journal entries in accounting system. The key source
document in job costing system is job cost sheet or job cost record. It is a form prepared for each
separate job that records the direct materials, direct labor, and manufacturing overheads. This
document assigned to a specific job.
Illustration on job order costing system in manufacturing company
Assume that XYZ Company is a manufacturing firm that uses job costing system. Consider the
company has two direct cost categories; that is direct materials and direct labor, and one indirect
cost pool; that is manufacturing overhead. The company applies overhead cost to jobs on the
basis of machine-hours worked. For the current year, the company estimated that it would work
for 75,000 hours and incur Br. 450,000 in manufacturing overhead costs.
The following transactions were completed during the year:
a. Raw materials were purchased on account 410,000.
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b. Raw materials were requisitioned for use in production 380, 000 (360, 000 direct materials
and 20,000 indirect materials).
c. The following costs were incurred for employee services; direct labor, 75,000; indirect labor,
110,000; sales commission, 90,000; and administrative salaries, 200,000.
d. Utility costs were incurred in the factory, 43,000.
e. Advertising costs were incurred, 180,000.
f. Depreciation expenses were recorded for the year, 350,000 (80% to factory equipment, and
20 % selling and administrative activities).
g. Insurance expired during the year, 10,000 (70% relates to factory operations, and 30% for
selling and administrative activities).
h. Manufacturing overhead was applied to production. Due to greater demand than expected
for its products, the company worked 80,000 machine hours during the year.
i. Goods costing 900,000 to manufacture according to their job cost sheet were completed
during the year.
j. Goods were sold on account to customers during the year at a total selling price of
1,500,000. The goods cost 870,000 to manufacture according to their job cost sheets.
Required :- Prepare journal entries to record the preceding transactions.
Solution
a Raw Materials 410,000
Accounts payable 410,000
b Work in process 360,000
Manufacturing Overhead 20,000
Raw Materials 380,000
c Work in Process 75,000
Manufacturing Overhead 110,000
Sales commission expense 90,000
Admin. Salary Expense 200,000
Wages payable 475,000
d Manufacturing Overhead 43,000
e Advertising expense 180,000
f Manufacturing Overhead 280,000
Depreciation expense 70,000
Accumulated depreciation 350,000
g Manufacturing Overhead 7,000
Insurance Expense 3,000
Prepaid insurance 10,000
h Budgetd Annual Indirect Costs
Budgeted Indirect Cost Rate=
Budgetd annual quantity of cost allocation base
450,000
¿
75,000
= Br. 6 per machine hour
Manufacturing Overhead Applied = 6 x 80,000 = Br. 480,000
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Work in process 480,000
MOH Allocated 480,000
i Finished Goods 900,000
j Accounts Receivable 1,500,000
Sales 1,500,000
Cost of goods Sold 870,000
Finished goods 870,000
Problem of Overhead Application and the concept of Under/Over Applied Overhead

Since the predetermined overhead rate is established based on entirely estimated data, generally,
there will be a difference between the amount of overhead cost which is applied to work in
process and the actual overhead costs. Budgeted/estimated indirect manufacturing costs rate have
the advantage of being timeliness than actual indirect manufacturing cost rate.
Indirect costs can be assigned to individual jobs on ongoing basis rather than waiting until the
end of the accounting period when actual costs will be known. But, the disadvantage of
budgeted/predetermined rate is that they likely will be inaccurate. Hence, we should consider
adjustments when the indirect costs allocated differ from actual indirect cost incurred. The
difference between the overhead cost applied to work in process and actual overhead costs
incurred are termed as either under applied or over applied overhead cost. Under allocated
indirect costs occur when the allocated amount of indirect costs in an accounting period is less than
the actual (incurred) amount. Over allocated indirect costs occur when the allocated amount of
indirect costs in an accounting period is greater than the actual (incurred) amount .
Under allocated (over allocated) indirect costs = Actual indirect costs incurred - Indirect costs allocated
There are two indirect-cost accounts in the general ledger that have to do with manufacturing
overhead:
 Manufacturing Overhead account: - the record of the actual costs in all the individual
overhead categories (such as indirect materials, indirect manufacturing labor, supervision,
engineering, utilities, and plant depreciation).
 Manufacturing Overhead Allocated: - the record of the manufacturing overhead
allocated to individual jobs on the basis of the budgeted rate multiplied by actual quantity
of cost allocation base.
Generally, the difference, actual with allocated, is resulted from the computation of the
predetermined rate; i.e.
 Budgeted allocation base vary from actual allocation base.
 Budgeted indirect cost rate vary from actual indirect cost rate.
There are three approaches to dispose/clear any balance in the manufacturing overhead account
at the end of an accounting period.
I. Proration Approach
Proration spreads under allocated/over allocated overhead costs among ending work in process,
finished goods and cost of goods sold balances.
II. Adjusted allocation rate approach
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The adjusted allocation-rate approach restates all overhead entries in the general ledger and
subsidiary ledgers using actual cost rates rather than budgeted cost rates. First, the actual
manufacturing overhead rate is computed at the end of the fiscal year. Then, the manufacturing
overhead costs allocated to every job during the year are recomputed using the actual
manufacturing overhead rate (rather than the budgeted manufacturing overhead rate). Finally,
end-of-year closing entries are made. The result is that at year-end, every job-cost record and
finished goods record—as well asthe ending Work-in-Process Control, Finished Goods Control,
and Cost of Goods Sold accounts—represent actual manufacturing overhead costs incurred.
The adjusted allocation-rate approach yields the benefits of both the timeliness and convenience
of normal costing during the year and the allocation of actual manufacturing overhead costs at
year-end.
III.Write-off to cost of goods sold approach
In this case, the total under/over applied/allocated overhead cost is included in the current year’s
cost of goods sold amount.
Illustration
ABC company uses a normal costing with a single manufacturing overhead cost pool and
machine hours as cost allocation base. The following data were for 2013:
Budgeted MOH Br. 4,800,000
Overhead allocation base Machine hours
Budgeted machine hours 80,000
MOH Incurred Br. 4,900,000
Actual machine hours 75,000
Machine hours data and the ending balances (before proration of under/over allocated overhead)
are as follows:
Actual Machine hours 2013, end of year balances
Cost of goods sold 60,000 Br. 8,000,000
Finished goods 11,000 Br. 1,250,000
Work in process 4,000 Br. 750,000
Required:-
1. Compute the predetermined allocation rate for 2013.
2. Compute the under/over allocated MOH for 2013 and dispose the amount using:
a. Proration approach
1. If allocated MOH cost of Finished goods, cost of goods sold, and work in
process is the base for proration.
2. If ending balance of Finished goods, cost of goods sold, and work in process
is the base for proration.
b. Write –off to cost of goods sold approach
Solutions
Budgetd Annual Indirect Costs
1. Predetermined Indirect Cost Rate=
Budgetd annual quantity of cost allocationbase
4,800,000
¿ = Br. 60/machine hour
80,000
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2. MOH allocated = Predetermined allocation rate x actual allocation base
= 60 x 75,000 = Br. 4,500,000
Under/ over applied MOH = Actual MOH incurred – MOH allocated
= 4,900,000 – 4,500,000
= Br. 400,000 (MOH under applied)
MOH applied for the three items will be:-
Cost of goods sold = 60,000 x 60 = Br. 3,600,000
Finished goods = 11,000 x 60 = Br. 660,000
Work in process = 4,000 x 60 = Br. 240,000
Total MOH applied = Br. 4,500,000
a. Proration approach
Item Account balance Proration Base Proration Proration Account balance
before Proration amount after proration
CGS 8,000,000 3,600,000 3.6 320,000 8,320,000
x 400,000
4.5
Finished goods 1,250,000 660,000 0.66 58,667 1,308,667
x
4.5
400,000
WIP 750,000 240,000 0.24 21,333 771,333
x
4.5
400,000
Total 10,000,000 4,500,000 100% 400,000 10,400,000
MOH allocated 4,500,000

CGS 320,000
WIP 21,333
MOH, Control 4,900,000
(To record allocation and proration of MOH)
NB: - Some Companies base the ending balance of finished goods, CGS, and WIP to prorate
the under/over applied MOH.
Item Account balance Proration Base Proration Proration Account balance

before Proration amount after proration
CGS 8,000,000 8,000,000 8 320,000 8,320,000
x 400,000
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Finished goods 1,250,000 1,250,000 1.25 50,000 1,300,000
x
10
400,000
WIP 750,000 750,000 0.75 30,000 780,000
x
10
400,000
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Total 10,000,000 10,000,000 100% 400,000 10,400,000
CGS 320,000
WIP 30,000
b. Write off to cost of goods sold approach

Cost of goods sold = 8,000,000 + 400,000 = 8,400,000

CGS 400,000
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2) process costing
In process costing, the cost object is masses of identical or similar units of product or service.
Process costing is used in those industries which provide basically homogeneous products such
as bricks, flour, cement, screw, and pharmaceutical items. The basic idea of process costing is to
divide the total manufacturing costs of a period by the period’s output inorder to determine the
average unit cost. In the industries, relatively homogeneous products are processed in a very
similar manner and are hence assumed to receive the same amount of direct materials, direct
labor, and manufacturing overhead costs.
The principal difference between process costing and job costing is the extent of averaging used
to compute unit cost of products or services. The cost object in a job cost system is a job that
constitutes a distinctly identifiable product or service. In contrast, when similar units are mass-
produced and not processed as individual jobs, process costing averages manufacturing costs for
overall units produced.
Because quantities typically are small and unit costs relatively high in situations utilizing job
order costing, the focal point for cost accumulation is the job or contract. The emphasis is
different in process costing, however, large quantities of homogeneous products with relatively
low unit costs render it not only difficult but also unnecessary to cost by small lots. Instead, the
focal point for process cost accumulation is usually the department or process center. The
fundamental problem is to match the total department costs with the total number of units
processed in any given period. Since it is basic assumption of process costing that we are dealing
with identical units, a simple averaging is sufficient. The task of accumulating the major
manufacturing cost elements is not different under process costing with that of job costing.
Essentially, the same source documents recording techniques will develop for the input of direct
materials, direct labor, and factory overhead. The chief difference lie in the method measuring
units produced, reporting the product costs and valuing work in process inventories.
Knowing what product costs is helpful information for inventory valuation, pricing decisions,
and product profitability analysis.
Similarities between job and process costing
 Both systems have the same basic purposes- to assign material, labor, and overhead cost
to products and to provide a mechanism for computing unit product costs.
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 Both systems use the same basic manufacturing accounts, including manufacturing
overhead, raw materials, work in process, and finished goods.
 The flow of costs through the manufacturing accounts is basically the same in both
systems.
Difference between job and process costing
Job costing Process Costing

Wide Variety of Distinct Products Homogeneous products
Costs accumulated by jobs Costs accumulated by processes or
departments
The job cost sheet is the key document The department production report is the
controlling the accumulation of costs by job key document showing the accumulation
and disposition of costs by a department.
Unit cost is computed by dividing total job Unit cost is computed by dividing total
costs by units produced in that job process costs of the period by the number of
units produced in the period
Note:- Production Report is a report that summarize all activity in a department’s work in
process account during a period and that contains three parts; a quantity schedule and a
computation of equivalent units, a computation of total and unit cost, and a cost reconciliation. It
is prepared for each department in which work is done on products.
Basic steps to be involved in Process Costing

The basic steps involved in the structure and operation of a process costing system are:
1. Identify the individual processing centers/departments
A processing center/department is any location in an organization where work is performed on a

product and where materials, labor, or overhead costs are added to the product. For instance, a
brick producer might have two processing center; one for mixing and molding and one for firing
the molded bricks.
2. Accumulate materials, labor, and overhead costs for each separate processing center over
some specified time period.
3. Divide the materials, labor, and overhead costs by the equivalent units to get the unit cost of
production for each separate processing center.
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4. Add the unit costs of each separate processing center to get the total unit cost of fully
completed unit of a product.
Materials, labor, and overhead Costs journal entries

Assume that XYZCompany produces A12 bricks. It has two processing centers; molding
department in which mixing and also molding of the bricks are undertaken, and firing
department which is responsible to fire the molded bricks and assure for the quality of the bricks.
 MaterialsCosts: -As job costing, materials are drawn from the storeroom using materials
requisition form. Materials can be added in any processing department, although it is not
unusual for materials to be added only in the first department with subsequent departments
adding only labor and overhead costs as the partially completed units move along toward
completion.
At XYZ Company, some materials (sand, clay, cement) are added in the molding department, the
journal entry for placing materials into the first department is:
Work in process-Molding xx
Accounts payable xx
 LaborCosts:- In process costing, labor costs are traced to departments; not to specific jobs.
Since XYZ company has two processing department, molding and firing, the following
journal entry will record labor costs for specific period:
Work in process-Firing xx
Salary/wage Payable xx
 OverheadCosts:- the following journal entry is used to apply overhead costs to units of
product for the molding and firing departments.
Conversion costsapplied xx
 Completingthecostflows:- once processing has been completed in a department, the product

units are transferred to the next department for further processing. The following journal entry
is used to transfer the costs of partially completed units from molding to the firing department
Note:- Transferred-in cost:- the cost attached to products that have been received from a prior
department.
After processing has been completed in the final department, the costs of the completed units are
then transferred to finished goods inventory account.
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Finished Goods xx
Work in Process – Firing xx
Finally, when a customer’s order is filled and units are sold, the cost of the units is transferred to
cost of goods sold.
Cost of goods sold xx
Finished Goods xx
Illustrating Process Costing System

Assume
o XYZ Company produces bricks namedA12 brick.

o The product costing system has single direct cost category (direct materials) and a single
indirect cost category (conversion cost).
o Each unit of product passes through two processing centers; molding and firing
departments. Process-costing systems separate costs into cost categories according to
when costs are introduced into the process.
o Direct materials are added at the beginning of the process in molding department.
o Conversion costs are added (incurred) evenly during both processes.
o Conversion costs are all manufacturing costs other than direct materials cost
(manufacturing labor, indirect materials, energy, plant depreciation, plant insurance,
property taxes, and so on).
o When the firing department finishes work on each brick, it is transferred to finished
goods.
o The following graph summarizes theses facts:
CC added evenly during process CC added evenly during process
Molding Firing
Dep’t Dep’t
Direct materials added at the beginning
There are three cases in application of process costing. We will use the production of A12 bricks
to illustrate the cases.
Case 1: Process costing with no beginning or ending work in process inventory of A12; i.e. all
units are started and fully completed by the end of the accounting period. This case illustrates the
basic averaging of cost idea that is a key feature of process costing systems.
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Case 2: process costing with no beginning work in process inventory but an ending work in
process inventoryA12; that is some units of A12bricks started during the accounting period are
incomplete at the end of the period. This case introduces the five steps of process costing and the
concept of equivalent units.
Case 3:Process costing with both beginning and ending work in process inventory of A12. This
case describes the effect of weighted average and first-in, first-out (FIFO) cost flow assumptions
and cost of units completed and cost of work in process inventory.
Note: - Often, as in our XYZ Company example, only two cost classifications—direct materials and conversion costs—are necessary to
assign costs to products. Why only two? Because all direct materials are added to the process at one time and all conversion costs
generally are added to the process evenly through time. If, however, two different direct materials were added to the process at different
times, two different direct-materials categories would be needed to assign these costs to products. Similarly, if manufacturing labor costs
were added to the process at a different time from when the other conversion costs were added, an additional cost category—direct
manufacturing labor costs—would be needed to separately assign these costs to products.
 Case 1: Process costing with no beginning or ending work in process inventory
There was no beginning inventory of A12 during January, the company started, completed, and
transferred out to firing department 85,000 A12 bricks.
Datafor molding department for January:

Physical units for January:
WIP, beginning 0 units
Started during January 85,000 units
Completed & transferred out during January 85,000 units
WIP, ending (January 31) 0 units
Total Cost for January:
Direct materials cost added during January $ 340,000
Conversion costs added during January 250,000
Total costs added in Molding Dep’t 590,000
Based on the above data, the unit cost for molding department in January is
Direct materials cost per unit (340,000/85,000) $ 4 per unit
Conversion costs per unit (250,000/85,000) $ 2.94 per unit
Molding department cost per unit(590,000/85,000) $ 6.94 per unit
Case 1 shows that in a process-costing system, average unit costs are calculated by dividing total
costs in a given accounting period by total units produced in that period. Because each unit is
identical, we assume all units receive the same amount of direct material costs and conversion
costs. Case 1 applies whenever a company produces a homogeneous product or service but has
no incomplete units when each accounting period ends, which is a common situation in service-
sector organizations.
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The Journal entries to record the costs and transfer of units from molding department to firing
department are as follows:
 To record direct materials used in production during February:
Work in process-Molding dep’t 340,000
 To record the molding department conversion costs such as labor, depreciation, energy,
utility, etc.)
Various accounts 250,000
 To record cost of goods completed and transferred out from molding department to firing
department:
Work in process-Firing dep’t 590,000
Case 2:Process costing with no beginning work in process inventory but an ending work in
process inventory
Because all units placed into production in Januarywere completed, there is no beginning
inventory of partially completed units in the molding department on February 1. Some customers
order late, so not all units started in February are completed by the end of the month.
Datafor molding department for February:
Physical units for February:
WIP, beginning 0 units
Started during February 62,000 units
Completed & transferred out during February 35,000 units
WIP, ending (February 28) 27,000 units
The work in process, 27,000 units, are fully processed with respect to direct materials, because
all direct materials in molding department are added at the beginning of the process. However,
conversion costs are added evenly during the process in the molding department. Based on the
work completedrelative to the work required to complete the A12 bricks still in process, the
moldingdepartment supervisor estimates that the partially completed units are, on average, 70%
complete from the perspective of conversion costs.
Total Cost for February:
Direct materials cost added during February $ 310,000
Conversion costs added during February $ 214,000
Total costs added in Molding Dep’t $ 524,000
How accurate the completion is with respect to conversion costs depends on the care, skill, and
experience of the estimator and the nature of the conversion process. The point to understand
here is that a partially completed unit is not the same as a fully completed unit.Estimating the
degree of completion is usually easier for direct material costs than for conversion costs, because
the quantity of direct materials needed for a completed unit and the quantity of direct materials in
a partially completed unit can be measured more accurately. In contrast, the conversion sequence
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usually consists of a number of operations, each for a specified period of time, at various steps in
the production process. The degree of completion for conversion costs depends on the proportion
of the total conversion costs needed to complete one unit (or a batch of production) that has
already been incurred on the units still in process. It is a challenge for management accountants
to make this estimate accurately.
The five steps of process costing are as follows:
Step 1: Summarize the flow of physical units of output.
Step 2: Compute output in terms of equivalent units.
Step 3: Summarize total costs to account for.
Step 4: Compute cost per equivalent unit.
Step 5: Assign total costs to units completed and to units in ending work in process.
Note:- Equivalent units are the number of complete units that could have been obtained from the materials and
effort that went into partially complete units. It is the product of the Number of partially completed units and their
percentage of completion with respect to a particular cost.
Equivalent units = # of partially completed units X %age of completion
Physical flow of products(Step 1 and 2)

Flow of production Physical Units Equivalent Units
Direct Materials Conversion Costs
Work in Process, Beginning 0
Started During February 62,000
To Account for 62,000
Completed &Transferred out during 35,000 35,000 35,000

February
WIP, ending 27,000
(27,000 x 100%, 27,000 x 70%) 27,000 18,900
Accounted for 62,000
Equivalent units of Work done in the 62,000 53,900

current period only
Calculation of Product Cost (Step 3, 4, and 5)

Total Production costs Direct materials Conversion costs
Costs added during $ 524,000 $ 310,000 $ 214,000

February
Equivalent units of work 62,000 53,900

done during February
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Cost per equivalent unit $5 $ 3.97
Total cost to account for $ 524,000
Assignment of costs:
Completed & transferred 313, 961 (35,000 x 5) (35,000x 3.97)
out (35,000 units)
WIP, ending (27,000 units)
Direct Materials 135,000 (27,000 x 5)
Conversion costs 75,039 (18,900 x 3.97)
Total WIP 210,039
Total costs accounted for $ 524,000

utility, etc.)
department:
Case 3: Process costing with both beginning and ending work in process inventory
At the beginning of March 2012, XYZ Company had 27,000 partially completed A12 units in the
molding department. It started production of another 30,000 units in March, 2012. Data for
molding department for March is as follows:
Physical units for March:
WIP, beginning (March 1) 27,000 units
Direct materials (100% complete)
Conversion costs (70% complete)
Started during February 30,000 units
Completed & transferred out during February 40,000 units
WIP, ending (March31) 17,000 units
17
Total costs for March 2012

WIP, beginning
Direct materials (27,000 x 5) 135,000
Conversion costs (18,900 x 3.97) 75,039 210,039
Direct materials cost added during March 290,000
Conversion costs added during March 160,000
Total cost to account for 660,039
In this case, we have both beginning and also ending work in process inventory of A12 bricks.
We use the five steps described earlier to calculate:
The cost of units completed and transferred out, and
The cost of ending work in process
To assign costs to each of these categories, we need to choose an inventory cost flow
assumptions.
A. Weighted Average Method

The weighted-average process-costing method calculates cost per equivalent unit of all work
done to date (regardless of the accounting period in which it was done) and assigns this cost to
equivalent units completed and transferred out of the process and to equivalent units in ending
work-in-process inventory. The weighted-average cost is the total of all costs entering the Work
in Process account (whether the costs are from beginning work in process or from work started
during the current period) divided by total equivalent units of work done to date.
Flow of production Physical units Equivalent units
Direct materials Conversion costs
WIP, Beginning 27,000 units
Started during March 30,000 units
To account for 57,000 units
Completed & transferred out 40,000 units 40,000 units 40,000 units
during March
WIP, ending 17,000 units
(17,000 x 100%, 17,000 x 17,000 units 12,750 units

75%)
Accounted for 57,000 units
Equivalent units of work done 57,000 units 52,750 units

in current period
Here, we have summarized the physical flow of products and computed the work done to date interms of equivalent units.
The next table summarizes the total costs to account for and how they are accounted for.
18
Total production cost Direct materials Conversion costs
WIP, beginning $ 210,039 $ 135,000 $ 75,039
Costs added in March 450,000 290,000 160,000
Costs incurred to date 425,000 235,039
EU of work done to date 57,000 52,750
Cost per EU of work done to $7.456 4.4557

date
Completed and transferred out 476,474.25 (40,000 x 7.456) (40,000 x 4.4557 )
WIP, ending
Direct materials 126,754.38 (17,000 x 7.456)
Conversion costs 56,810.37 (12,750 x 4.4557)
Total WIP, ending 183,564.75
Total cost accounted for 660,039
The following table summarizes total costs to account for ($660,039) and how they are
accounted for. The arrows indicate that the costs of units completed and transferred out and units
in ending work in process are calculated using weighted-average total costs obtained after
merging costs of beginning work in process and costs added in the current period.
Costs to Account For Costs Accounted for Calculated on a Weighted-Average Method
Beginning work in process $210,039 Completed and transferred out $476,474.25
Costs added in current period 450,000 Ending work in process 183,564.75
Total costs to account for $660,039 Total costs accounted for $660,039
utility, etc.)
department:
Work in process-Firing dep’t 476,474.25
Work in process-Molding dep’t 476,474.25
B. First in, first out method
19
The first-in, first-out (FIFO) process-costing method
1. assigns the cost of the previous accounting period’s equivalent units in beginning work-
in-process inventory to the first units completed and transferred out of the process, and
2. assigns the cost of equivalent units worked on during the current period first to complete
beginning inventory, next to start and complete new units, and finally to units in ending
work-in-process inventory. The FIFO method assumes that the earliest equivalent units in
work in process are completed first.
A distinctive feature of the FIFO process-costing method is that work done on beginning
inventory before the current period is kept separate from work done in the current period. Costs
incurred and units produced in the current period are used to calculate cost per equivalent unit of
work done in the current period. In contrast, equivalent-unit and costper-equivalent-unit
calculations under the weighted-average method merge units and costs in beginning inventory
with units and costs of work done in the current period.
Assume XYZ Company use the first in, first out method and assign the total costs to the units
completed and transferred out and in the work in process.
Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units
Using FIFO Method of Process Costing for firing Department of XYZ Company for March 2012
Direct materials Conversion costs
WIP, Beginning 27,000 units (Work done in the previous period)
Started during March 30,000 units
To account for 57,000 units
Completed & transferred out during March:
From WIP, beginning 27,000 - 8,100
(27,000 x 0%), (27,000x30%)
Started & completed 13,000 13,000 13,000
WIP, ending 17,000
(17,000x100%), (17,000x75%) 17,000 12,750
Accounted for 57,000 units
Equivalent units of work done 30,000 units 33,850 units

in current period
Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign
Total Costs to Units Completed and to Units in Ending Work in Process Using Weighted-Average
Method of Process Costing for firing Department of XYZ Company for March 2012
Total production cost Direct materials Conversion costs
WIP, beginning $ 210,039 Costs of work done before the current period
Costs added in March 450,000 290,000 160,000

20
EU of work done to date 30,000 units 33,850 units
Cost per EU of work done to $9.667 $4.7267

date
Completed and transferred out:
 WIP, beginning 210,039
Direct materials 0 (0 x 9.667)
Conversion costs 38,285 (810 x 4.7267)
Total from WIP beginning 248,324
 Started & Completed 187,115 (13,000 x 9.667) (13,000 x 4.7267)
Total cost of units completed 435,439

and transferred out
WIP, ending
Direct materials 164,334 (17,000 x 9.667)
Conversion costs 60,266 (12,750 x 4.7267)
Total WIP, ending 224,600
Total cost accounted for 660,039
The goal is to use the cost of work done in the current period to determine total costs of all units
completed from beginning inventory and from work started and completed in the current period,
and costs of ending work in process.
The following table summarizes total costs to account for and costs accounted for of $660,039.
Notice how under the FIFO method, the layers of beginning work in process and costs added in
the current period are kept separate. The arrows indicate where the costs in each layer go—that
is, to units completed and transferred out or to ending work in process. Be sure to include costs
of beginning work in process ($210,039) when calculating costs of units completed from
beginning inventory.
Costs to Account for Costs Accounted for Calculated on a FIFO
Basis
Completed and transferred out
Beginning work in process $210,039 Beginning work in process $210,039
Costs added in current period 450,000 Used to complete beginning
Started and completed 187,115
Completed and transferred out 225,400
Ending work in process 224,600
Total costs to account for $660,039 Total costs accounted for $660,039
21
utility, etc.)
department:
Comparison of Weighted-Average and FIFO Methods

Consider the summary of the costs assigned to units completed and to units still in process under
the weighted-average and FIFO process-costing methods in our example for March 2012:
Weighted Average FIFO Difference
Cost of units completed 476,474.25 435,439 + 41,035.25
and transferred out
Work in process, ending 183,564.75 224,600 - 41,035.25
Total costs accounted for 660,039 660,039
The weighted-average ending inventory is lower than the FIFO ending inventory by $ 41,035.25,
or 18.27% (41,035.25/224,600 = 0.1827, or 18.27%). When completed units are sold, the
weighted-average method in our example leads to a higher cost of goods sold and, therefore,
lowers operating income and lower income taxes than the FIFO method.
Cost of units completed and, hence, operating income can differ materially between the
weighted-average and FIFO methods when
1. direct material or conversion cost per equivalent unit varies significantly from period to
period and
2. Physical-inventory levels of work in process are large in relation to the total number of
units transferred out of the process.
As companies move toward long-term procurement contracts that reduce differences in unit costs
from period to period and reduce inventory levels, the difference in cost of units completed under
the weighted-average and FIFO methods will decrease.
Managers use information from process-costing systems to aid them in pricing and product-mix
decisions and to provide them with feedback about their performance. FIFO provides managers
with information about changes in costs per unit from one period to the next. Managers can use
this information to adjust selling prices based on current conditions. They can also more easily
evaluate performance in the current period compared with a budget or relative to performance in
the previous period (for example, recognizing the decline in both unit direct material and
conversion costs relative to the prior period). By focusing on work done and costs of work done
22
during the current period, the FIFO method provides useful information for these planning and
control purposes.
The weighted-average method merges unit costs from different accounting periods, obscuring
period-to-period comparisons. Advantages of the weighted-average method, however, are its
relative computational simplicity and its reporting of a more-representative average unit cost
when input prices fluctuate markedly from month to month.
Transferred-In Costs in Process Costing
Many process-costing systems have two or more departments or processes in the production
cycle. As units move from department to department, the related costs are also transferred by
monthly journal entries. Transferred-in costs (also called previous-department costs) are costs
incurred in previous departments that are carried forward as the product’s cost when it moves to
a subsequent process in the production cycle.
We now extend our XYZ company example to the firing department. As the mixing and molding
process is completed, the molding department of XYZ Company immediately transfers A12
units to the firing department. Conversion costs are added evenly during the firing department’s
process. At the end of the process in firing, units receive additional direct materials, to prepare
units for shipment. As units are completed in firing, they are immediately transferred to Finished
Goods. Computation of firing department costs consists of transferred-in costs, as well as direct
materials and conversion costs that are added in firing.
The following diagram represents these facts:
CC added evenly during process
Transfer
Molding Firing
Dep’t Dep’t Finished Goods
DM added at the end of the process
Transferred-in costs are treated as if they are a separate type of direct material added at the
beginning of the process. That is, transferred-in costs are always 100% complete as of the
beginning of the process in the new department. When successive departments are involved,
transferred units from one department become all or a part of the direct materials of the next
department; however, they are called transferred-in costs, not direct material costs.
Transferred-In Costs and the Weighted-Average Method
 Physical units for March:
WIP, beginning (March 1) 24,000 units

Transferred In 40,000 units
Completed & transferred out during March 41,000 units
23
WIP, ending (March 31) 23,000 units
Transferred In (100%complete)
 Total costs
WIP, beginning
Transferred In $ 120,000
Direct materials 0
Conversion costs $ 45,000
Direct materials cost added during March $ 30,000
Conversion costs added during March 160,000
Total cost added in Marchin firing Dep’t 190,000
Transferred In cost $ 476,474.25
Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units Using
Weighted-Average Method of Process Costing for firing Department of XYZ Company for March 2012
Transferred-InCosts Direct materials Conversion costs
WIP, Beginning 24,000
Transferred in during 40,000

current period
To account for 64,000
Completed & transferred 41,000 41,000 41,000 41,000

out during March
WIP, ending 23,000
(23,000 x 100%, 23,000 0 16,100

23,000x0%, 23,000 x 70%)
Accounted for 64,000
Equivalent units of work 64,000 41,000 57,100

done in current period
Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and
Assign Total Costs to Units Completed and to Units in Ending Work in Process Using Weighted-
Average Method of Process Costing for firing Department of XYZ Company for March 2012
Total production cost Transferred-In Costs Direct materials Conversion costs
WIP, beginning 165,000 120,000 0 45,000
Costs added in March 666,474.25 476,474.25 30,000 160,000
24
Costs incurred to date 831,474.25 596,474.25 30,000 205,000
EU of work done to date 64,000 41,000 57,100
Cost per EU of work done 9.31991 0.7317 3.59

to date
Total cost to account for 831,474.25
Completed and 559,314.215 (41,000x9.31) (41,000x0.73) (41,000x3.59)

transferred out
WIP, ending
Transferred-In 214,357.934 (23,000x9.31)
Direct materials 0 (0x0.73)
Conversion costs 57,802.1015 (16,100x3.59)
Total WIP, ending 272,160.0355
Total cost accounted for 831,474.25
 To record cost of goods completed and transferred from testing to Finished Goods.
Finished Goods
Work in Process—Firing dep’t
25

Job-Process Costing Systems

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Job-Process Costing Systems

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Chapter Three

Job, Process and Operation Costing

Budgetd Annual Indirect Costs

Problem of Overhead Application and the concept of Under/Over Applied Overhead

MOH allocated 4,500,000

Item Account balance Proration Base Proration Proration Account balance

b. Write off to cost of goods sold approach

MOH allocated 4,500,000

Difference between job and process costing

Job costing Process Costing

Basic steps to be involved in Process Costing

1. Identify the individual processing centers/departments

A processing center/department is any location in an organization where work is performed on a

Materials, labor, and overhead Costs journal entries

 Completingthecostflows:- once processing has been completed in a department, the product

Illustrating Process Costing System

o XYZ Company produces bricks namedA12 brick.

Direct materials added at the beginning

 Case 1: Process costing with no beginning or ending work in process inventory

Datafor molding department for January:

Physical flow of products(Step 1 and 2)

Direct Materials Conversion Costs

Work in Process, Beginning 0

Started During February 62,000

To Account for 62,000

Completed &Transferred out during 35,000 35,000 35,000

WIP, ending 27,000

(27,000 x 100%, 27,000 x 70%) 27,000 18,900

Accounted for 62,000

Equivalent units of Work done in the 62,000 53,900

Calculation of Product Cost (Step 3, 4, and 5)

Costs added during $ 524,000 $ 310,000 $ 214,000

Equivalent units of work 62,000 53,900

Total cost to account for $ 524,000

WIP, ending (27,000 units)

Direct Materials 135,000 (27,000 x 5)

Conversion costs 75,039 (18,900 x 3.97)

Total WIP 210,039

Total costs accounted for $ 524,000

 To record direct materials used in production during February:

Total costs for March 2012

A. Weighted Average Method

Flow of production Physical units Equivalent units

Direct materials Conversion costs

WIP, Beginning 27,000 units

Started during March 30,000 units

To account for 57,000 units

WIP, ending 17,000 units

(17,000 x 100%, 17,000 x 17,000 units 12,750 units

Accounted for 57,000 units

Equivalent units of work done 57,000 units 52,750 units

WIP, beginning $ 210,039 $ 135,000 $ 75,039

Costs added in March 450,000 290,000 160,000

Costs incurred to date 425,000 235,039

EU of work done to date 57,000 52,750

Cost per EU of work done to $7.456 4.4557

Total cost to account for 660,039

Completed and transferred out 476,474.25 (40,000 x 7.456) (40,000 x 4.4557 )

Direct materials 126,754.38 (17,000 x 7.456)

Conversion costs 56,810.37 (12,750 x 4.4557)

Total WIP, ending 183,564.75

Total cost accounted for 660,039

B. First in, first out method