COST TERMINOLOGIES AND COST BEHAVIORS -related to the particular cost object and can

be traced to it in an economically feasible

PART I: THEORIES  (cost-effective) way. 
• Indirect costs
Cost -related to the particular cost object
but cannot be traced to it in an
 resource sacrificed or foregone to achieve a economically feasible (cost-effective)
specific objective. way. 
 usually  measured as the monetary amount
that must be paid to acquire goods and II. REACTION TO CHANGES IN ACTIVITY 
services. Relevant Range – is the assumed range of activity
 It is also defined as the monetary measure that reflects the company’s normal operating range. 
of resources to attain an objective such as Within the relevant range, the two primary cost
making a  good or performing a service.  behaviors are: variable and fixed. 

Cost management system Variable Cost – the cost that varies in total
 set of formal methods developed for proportionate with activity.
planning and controlling an  This is constant amount per unit.  Example: cost of
organization’s cost generating material, hourly wages and sales commissions.  
activities relative to its strategies,
goals and objectives. Fixed Cost – a cost that remains constant in total
 How an entity manages/controls its within the relevant range of activity. On a per unit
costs  basis,  a fixed cost varies inversely with changes in the
level of activity. 
COST CLASSIFICATION Example: salaries (as opposed to hourly range),
CATEGORIES  depreciation, rent 

Mixed Cost – has both a variable and fixed

component. On a per unit basis, a mixed cost does
not fluctuate proportionately with changes in activity
nor does not remain constant with changes in
activity.  Example: electric bill computed as a flat
charge for basic services plus a stated rate per
kilowatt hour of  usage.  

Step Cost – shifts upward or downward when activity

changes by interval or step.  

III. CLASSIFICATION ON THE FINANCIAL

STATEMENTS 
Two basic financial statements: balance sheet and
I. ASSOCIATION WITH COST OBJECTS  income statement 
COST OBJECT – is anything to which management Balance sheet: assets, liabilities and owner’s equity 
wants to collect or accumulate costs. Income statement: revenues and expired cost
(expenses) 
Example are  production operations and services
lines. For example, a car manufacturing plant
Matching concept – provides a basis for deciding
produces the following  cars: Highlander, Sequioa
when an unexpired cost becomes expire cost and
SUVs and Sienna Minivans.  
is  moved from an asset category to an expense or
loss category.  
What are the cost objects? 
• Either the plant; or 
• One of the  

DIRECT AND INDIRECT COST: 

• Direct costs • Product costs are related to making or acquiring
the products or providing the services that 
 directly generate the revenues of an entity. These service.  This should include basic compensation,
are also called INVENTORIABLE COST. This  production efficiency bonuses, employees share
include the following:  of  social security and health taxes. As with
o Direct Materials – any material that materials, some labor cost are treated as indirect
can be easily and economically traced cost  since specifically tracing certain labor costs
to a product to production is inefficient.  
o Direct Labors – refers to the time • Overtime premiums should not be treated as
spent by individuals who work direct labor cost and should be allocated among all
especially on  manufacturing a product units.  
or performing a service.   • There are also occasion when labor costs are
o Indirect Cost (Factory Overhead) – being incurred but no work is being  performed.
any production cost that is indirect to The cost of idle time should be assigned to
the product or  service.  overhead.  

▪ Conversion Cost – is the sum of 3. Overhead – any factory or production that is

direct labor and overhead cost  indirect to manufacturing a product or providing a 
(DL + OH) service.  
• Indirect materials 
▪ Prime Cost – is the sum of direct • Indirect labor 
material and direct labor. (DM+DL) • Depreciation
• Factory license fees 
• Period costs are related to the • Factory insurance and property taxes 
business functions, other than
• Quality costs (prevention cost and appraisal
production.These are associated 
cost)  
with a particular time period rather
than making or acquiring a product or
performing a service.  ACCUMULATION AND ALLOCATION OF
o Example: prepaid insurance for the OVERHEAD 
administrative building, salaries paid • Actual Cost System - actual direct material and
to salesforce and  depreciation on actual direct labor are accumulated in work in 
computers on headquarters.   process inventory.
Actual production overhead are accumulated
EXERCISE: Identify whether the costs incurred by a car separately in an Overhead  Control account and
manufacturer below are product or period costs. are assigned to WIP inventory at either the end
of a period or completion of  production. 
1. Tires and wheels of the SUV PRODUCT
2.Depreciation on the plant where the car is • Normal Cost System – combines actual direct
produced PERIOD material and direct labor costs with overhead
3. Salaries of the sales agent PERIOD that  is assigned using a predetermined rate or
4. Salaries of the accounting department PERIOD rates.  
5. Wages of line personnel working in the plant  o Predetermined overhead rate is a charge
6. Depreciation of the manufacturing machine used per unit of activity that is used to allocate
to produce the car  (or  apply) overhead cost from the
7. Insurance of the plant where the car is overhead control account to WIP
produced  inventory for the period’s  production or
services.  
Distribution Cost – is any cost incurred to
warehouse, transport or delivery of a product or COST OF GOODS MANUFACTURED
service.  

COMPONENTS OF PRODUCT COST: 

1. Direct Material – any readily available part of a
product. Theoretically, direct material cost
should  include all the cost of materials used to
manufacture a product or perform a service.
However some material costs are not
conveniently or economically traceable to the
product. Such costs  are treated as indirect
costs.  
2. Direct Labor – refers to the effort of individuals
who manufactures a product or perform a

Normal Costing and Predetermined Overhead
Normal costing,
 alternative to actual costing
 which assigns actual direct materials and direct
labor to products but allocates manufacturing
overhead to products using a PRE-DETERMINED
RATE.
Four reasons for using pre-determined overhead rates
in product costing:
Pre-determined overhead rates
 facilitate overhead assignment during a period
as goods are produced and sold and services are
rendered.
 improve the timeliness of information.
 adjust for variations in actual overhead costs
that are related to fluctuations in activity.
Overhead cost may vary monthly because of
seasonal or calendar factors.
Example: utility costs could be higher during summer.
 overcome the problem of fluctuations in
activity level that do not impact fixed overhead
costs.
For example, monthly production in September is 3,000
while production in August is 3,750 units. Per unit fixed
OH will change but total fixed manufacturing OH will
remain the same.
Such scenarios can create variances in unit costs.
 Using pre-determined OH rates - especially
when the bases for those rates truly reflect the
cost drivers - often allows managers to be more
aware of individual product or product line
profitability as well as the profitability of
business with a particular customer or vendor.
Formula for Pre-Determined Overhead
With one exception, normal cost system journal entries
are identical to those made in an actual cost system.
In both systems, overhead is debited during the period
to a manufacturing overhead account and credited to
the various accounts that "created" the overhead.
In an actual cost system. the total amount of actual
overhead cost is then transferred from the overhead
account to WIP inventory.
In contrast, a normal cost system assigns overhead cost
to WIP inventory using a pre determined overhead rate.
Predetermined Overhead Rate = Total Budgeted OH
cost at a specified activity level/Volume of Specified
Activity Level.
Rationale:
Overhead cost and its related activity measure are
typically budgeted for one year, although a longer or
shorter period could be more appropriate in some
organizations.
How can this be an effective measure?
Companies should use an activity base that is logically
related to actual overhead incurrence.
Although production volume might be the first activity
base considered, the base is reasonable only if the
company manufactures one type of product or renders
just one type of service. If company makes multiple
products or performs multiple services, products or
services volume cannot be assumed to determine the
"activity volume" because the products and services are
dissimilar.
To effectively allocate overhead to heterogenous
products or services, a measure of activity that is most
common to all output must be selected.
 The activity should be a cost driver that directly
causes the incurrence of overhead costs.
 Direct labor hours and direct labor dollars are
common activity measures.
Other possible measures:
 Number of purchase orders
 Product related physical characteristics such as tons
or gallons
 Number of or amount of time used performing
machine set-ups
 Number of parts
 Material handling time
 Product complexity
 Number of product defects
Applying Overhead to Production
Once calculated, the pre-determined OH rate is used
throughout the period to apply overhead to WIP.
Applied overhead is calculated as the predetermined
OH rate multiplied by the actual activity volume.
(PHOR x ACTUAL ACT VOLUME)
Applied overhead is the amount of overhead assigned
to WIP inventory using the activity measure that was
selected to develop the OH rate.
Overhead can be applied when goods or services are
transferred out of WIP inventory or at the end of each
month if the financial statements are to be prepared.
For convenience, both actual and applied overhead are
recorded in one general ledger account. Debits to the
account is the actual overhead incurred and credits to
the account represent applied overhead.
At year-end, total actual overhead will differ from
applied overhead. The difference is called underapplied
or over applied.
Underapplied overhead occurs when the OH applied to
WIP inventory is less than the actual overhead.
Overapplied overhead occurs when the OH applied to
WIP inventory is more than the actual overhead.
NOTE:
Underapplied and overapplied overhead must be closed
at year-end because the overhead account is
temporary.
Under or overapplication is caused by two factors that
can work independently or jointly. These two factors
are cost differences and capacity utilization differences.
For example, if actual fixed OH cost different from the
expected FOH rate, spending variance is created.
If actual capacity utilization differs from expected
utilization, a volume variance arises.
Actual FOH Cost > Expected FOH Cost = Underapplied
FOH
Actual FOH Cost < Expected FOH Cost = Overapplied
FOH
Actual utilization > Expected utilization = Overapplied
FOH
Actual utilization < Expected utilization = Underapplied
FOH
Disposition of Underapplied and Overapplied OH
Overhead accounts are temporary accounts and are
closed at period-end. Closing the accounts require the
disposition of the underapplied or over applied OH.
Disposition depends on the materiality of the amount
involved. If the amount is immaterial, it is closed in
COST OF GOODS SOLD.
If the amout differs materially from actual overhead
costs, it should be prorated on the accounts in which
FOH is applied: WIP Inventory, Finished Goods
Inventory and Cost of Goods Sold.
Disposition of Underapplied and Overapplied OH
AMOUNT IS IMMATERIAL
Underapplied amount of OH applied to production and
the closing process causes the cost of sales to increase.
If the amount of applied OH differs materially
(significantly) from actual overhead costs, it should be
prorated among the amounts in which applied OH
resides.
 Work in process inventory
 Finished Goods Inventory
 Cost of Goods Sold
Pro-ration of the underapplied or overapplied overhead
makes the account balances confirm more closely to
actual historical cost as required by Generally Accepted
Accounting Principles (GAAP) for external reporting.
Sample Problem
Assume the following for Tri-State Industrial:

Alternatively, overapplied OH reflects the fact that too

much OH was applied to production, so closing of
overapplied OH will cause the cost of sales to decrease.

Continuation of Sample Problem

Assuming that Tri-State Industrial, a manufacturer of

children car seats, budgeted then experienced the
following amounts for the month of January and moving
forward. At year-end, a total of 51,500 hours was Sample Problem
incurred by the company, actual variable OH amounted
to 383,000 while actual fixed OH amounted to 657,000. STEP 1: Determine proportional relationship on the
accounts by adding the account balances.

The over(under) applied overhead is immaterial, STEP 2: Multiply percentages by the overapplied
hence, journal entry to close these amounts would be: overhead to determine the adjustment amount.

STEP 3: Prepare the journal entry to close

manufacturing overhead account and assign adjustment
Disposition of Underapplied and Overapplied OH amount to appropriate accounts.

AMOUNT IS MATERIAL

Alternative Capacity Measures
Theoretical Capacity is defined as the estimated
maximum potential activity for a specified time. This
measure assumes that all production factors are
operating perfectly. Theoretical capacity disregards
realities such as machineries breakdown and reduced or
stop operations during holidays. Using this as setting the
predetermined overhead nearly guarantees significant
amount of over(under) applied OH.
Reducing theoretical capacity by regular on going
interruptions (such as holidays, down time and start up
time) provides for the practical capacity that could be
achieved during regular working hours.
Consideration of historical and future prediction levels
and the cyclical
fluctuations provides a normal capacity that
encompasses the firm's long run (5- 10 years) average
activity and represents an attainable level of activity.
Expected Capacity is a short-run concept that
represents the firm's anticipated activity level for the
coming period based on projected product demand.
Regardless of the capacity level chosen for the
denominator in calculating for predetermined OH, any
mixed overhead cost must be separated into variable
and fixed OH.
Separating Mixed Costs
To simplify estimation of costs, accounts sumple assume
tha costs are linear rather than curvilinear. Because of
this assumption, the general formula for a straight line
can be used to describe any type of cost within a
relevant range of activity.
y = a + bX
y = total cost (dependent variable)
a = fixed portion of the total cost
b = unit change of variable cost related to unit changes
in activity X = activity base to which y is being related
(independent variable)
Two methods in separating mixed costs:
High-Low Method
Least Squares Regression Analysis
Separating Mixed Costs: High Low Method
The high-low method analyzes a mixed cost by first
selecting the highest and lowest levels of activity in a
data set if two points are within the relevant range.
Occasionally, operations occur at a level outside the
relevant range or cost distortions occur within the
relevant range such as leak in water pipe that could go
unnoticed for a period of time or rush orders that could
require excess labor. Such non-representative or
abnormal observations are called outliers and should be
disregarded when analyzing a mixed cost.
Absorption vs. Variable Costing
Absorption Costing
 treats the costs of all manufacturing
components (direct materials, direct labor,
variable and fixed overhead) as inventoriable or
product costs in accordance with GAAP.
 Absorption costing is also known as full costing.
 costs incurred in the non manufacturing areas
of the organization are treated as period costs
and expensed in a manner that properly
matches them with revenues.
Variable Costing
 cost accumulation method that includes only
direct material, direct labor and variable
overhead as product costs. This method treats
fixed manufacturing overhead as period cost.
 Like absorption costing, variable costing treats
incurred in the organization's selling and
administrative areas as period costs.
Absorption Costing vs. Variable Costing
Absorption costing advocates contend that products
cannot be made without the production capacity
provided by fixed manufacturing overhead costs, and
therefore, these costs belong to the product.
Variable costing advocates contend that FOH costs
would be incurred whether any products are
manufactured, thus, such costs are not caused by
production and cannot be product costs.
Introduction to Activity-Based Management
Activity-based management is a business process
model focusing on the control of production or
performance activities so that they improve customer
value and enhance profitability.
Activity is any repetitive action that is performed in
fulfillment of a business function.
A primary component of activity-based management is
activity analysis, which is the process of studying
activities to 1) classify them into one value-added versus
non value added activities and 2) devise ways of
minimizing or eliminating activities that increase
costsbut provide little or no customer value.
Value-Added versus Non-value Added Activities
In black or white perspective, activities are either value
added or non-value added activities.
Value added activity (VA) increases the worth of the
product or service to customer and is one for which the
customer is willing to pay.
Non-value added activity (NVA) increases the time
spent on a product or service but does not increase its
worth and thus, is viewed as unnecessary from the
customer perspective.
NVA activities can be reduced, redesigned or eliminated
without affecting the product's or service's market value
or quality.
Often, an easy way to determine the value provided by
an activity is to ask "why" five times. If the answer
represent valid business reason, the activity generally
adds value.
Businesses can also engage in some activities that are
essential (or appear to be essential) to business
operations for which customers would not willingly
choose to pay. These activities are also known as
business-value added (BVA) activities.
Example of a BVA activity is invoiceing to document
sales and collections. The process must be done and this
entails cost but the customer would prefer not to pay
for this activity at a higher selling price.
Why do we need to analyze business activities?
Many products or service prices are set by the
marketplace rather than by an individual organization
attempting to cover its incurred costs.
However, if the selling price of a product or service is
insufficient to cover the cost of production or
performance and produce a reasonable profit margin,
management generally needs to find a way to reduce
cost.
The easiest way to reduce cost is to minimize or
eliminate NVA activities that are incurred during the
production or performance process.
To begin activity analysis, managers should first identify
the organization's production or performance process.
Manufacturing Cycle Efficiency
Dividing total value-added processing time by total cycle
time results in a measurement referred to as the
manufacturing cycle efficiency.
Manufacturing Cycle Efficiency = Total Value Added
Time / Total Cycle Time
In a retail environment, cycle time relates to the time
between ordering and selling an item. NVA activities in
retail include shipping time from the supplier, delays
spent counting merchandise in the receiving
department, and any storage time between receipt and
sale.
Service Cycle Efficiency
In a service company, cycle time refers to the time
between service order and service completion. All the
time spent on activities that are not actual service
performance are non-value service activities.
Service Cycle Efficiency = Total Actual Service Time /
Total Cycle Time
Cost Driver Analysis
Cost Driver are the factors that have direct cause and
effect relationship to a cost.
Cost drivers are classified as either volume related (such
as labor or machine hours) or non-volume related (such
as setups, work orders or distance traveled), which
generally reflect the incurrence of specific transactions.
Activity-based Costing
Is a cost accounting system that focuses on an
organization's activities, collects costs on the basis of
the underlying nature and extent of those activities, and
uses the gathered information to determine
product/service cost accumulation and asses the
appropriateness of activity elimination.
For these purposes, a cost driver should be easy to
understand, directly related to the activity being
performed and appropriate for performance
measurement.
Levels at which costs are incurred
Traditionally, cost drivers were viewed as existing only
at unit level: for example, the quantity of labor or
machine time expended to make a product or render a
service. Such unit level cost are caused by the
production or acqusition of a single unit of service.
However, most overhead is not incurred on a per unit
basis. Thus, overhead costs typically are incurred for a
broader based categories of activity. These categories
are:
 Batch-level
 Product or process
 Organizational or facility
Batch-level cost are costs that are caused by a group
of things being made, handled or processed at a single
time.
One example of a batch-level cost is machine set-up.
Product-level (process level) cost
A cost caused by the development, production or
acquisition of different items is called a product-level
(process level) cost.
Organizational level costs
These costs are incurred for the sole purpose of
supporting facility operations. Such costs are common
to many products and services and should theoretically
not be assigned to products and services at all.
Job Order Costing
Cost accumulation systems are used to assign
production or performance to products or services for
internal and external financial purposes.
Two principal product costings are as follows:
• Job order costing
• Process costing
• Firms that produce heterogenous and custom outputs
must track product costs to the product or customer
level with job order costing.
• Firms that produce homogenous output in batch or
continuous production process use process costing to
compute an “average” product cost.
Methods of Product Costing
Before product cost can be computed, a determination
of the following must be made:
a. Cost accumulation system – which defines the cost
object and method of
assigning costs
b. Valuation method – specifies how product costs are
measured
Regardless of the type of business, product costing is
concerned with three things:
1. Cost identification
2. Cost measurement
3. Product cost assignment
Job Order Costing vs. Process Costing
 A job order costing system is used by
companies that make relatively small quantities
of distinct products or perform unique services
that conform specifications designated by the
purchase.
Thus, the word job order costing is appropriate for a
cobble making custom shoes and boots, an accountant
preparing tax returns, an architectural firm designing
commercial buildings, and a research firm performing
product development studies. The word job is
synonymous with client, customer, engagement,
project, product or contract.
 A product costing systems are used by
companies that make large quantities of
homogenous goods such as breakfast cereals,
candy bars, detergent, gasoline and bricks.
Given the mass manufacturing process, one unit of
output cannot be readily identified with specific input
costs within a given period – making the use of a cost
averaging approach necessary.
Valuation Methods
Companies using either job order or process costing
may employ standards or predetermined OH for costs
to be incurred and/or quantities to be used.
In standard cost system, unit norms or standards are
developed for direct material and direct labor
quantities and/or costs. Overhead is applied to
production using a predetermined rate that is
considered the standard.
A standard cost system allows companies to quickly
recognize deviations or variances from completed
production costs and to correct problems resulting from
excess usage and/or costs.
Job Order Costing System
costs are accumulated by job, which is a single unit or
multiple similar or dissimilar units that has or have been
processed to distinct customer specifications.
Each job is treated as a unique cost entity or cost object.
Because of the uniqueness of the jobs, costs of
different jobs are maintained in separate subsidiary
ledger accounts and are not added together in the
ledger.
Importance of Job Order Costing
provides information important to managing
profitability and setting prices for output.
Custom manufacturers typically price their goods and
using two methods:
• Cost plus contract – allows producers to cover all
direct costs and some indirect costs and to generate
acceptable profit margin.
• Competitive bidding technique – in such cases, the
company must accurately estimate the costs of making
unique products associated with each contract.
Job Order Costing: Details and Documents
• Job Order Cost Sheet – the source document that
provides virtually all financial information about a
particular job. A job order cost sheet includes a job
number, job description, customer identification,
scheduling information, delivery
instructions and contract price.
• Materials requisition form – to begin a job, this is
prepared so materials can be released from inventory
and be sent to production.
• Employee time sheet – indicates the jobs on which
employee worked and the direct labor time consumed.
Upon completion of the production
• When a job is completed, its total cost is removed
from work in process inventory and transferred to
finished goods inventory account.
• Job order cost sheets for completed jobs are removed
from the WIP subsidiary ledger and is transferred to the
finished goods inventory control account.
• When a job is sold, its cost is transferred from
Finished Goods Inventory to Cost of Goods Sold.
• Job order cost sheets for completed jobs are kept n a
company’s permanent files. A completed job order cost
sheet provides management with a historical summary
about total costs and if appropriate, the cost per
finished unit for a given job.
Process Costing
Companies that manufacture products in a continuous
flow process or in batches of output that are identical
uses process costing.

Examples are those that manufacture food products

(like cereals), bricks, gasoline, candles and paper.

• Both job order costing and process costing accumulate

cost by components (direct materials, direct labor and
overhead). However, the two systems assigns costs to
departmental outputs differently.

• In job order costing system, costs are assigned to

specific jobs and if possible, to units contained with
each job.
• While process costing uses an averaging technique to
assign costs to all units produced during a period.
Assigning costs to product unit requires the use of
averaging process. In the easiest situation, a product’s
actual unit cost is found by dividing a period’s
departmental production costs by that period
departmental production quantity.
Production Quantity: The Denominator
The denominator in the cost formula represents total
production of a given product for the period.
• If all units started during a period were 100%
complete at the end of the period, units could simply
be counted to obtain denominator. However, in most
production process, partially completed units comprise
WIP inventory at the end of one period and WIP
inventory beginning of the next period.
Units in the beginning WIP inventory were started last
period but will be completed in the current period.

• This means that some costs for the units in the

beginning inventory were incurred last period and
additional costs for those units will be incurred in the
Production Cost: The Numerator current period.

The formula numerator is obtained by accumulating
departmental costs incurred in a single period. Because
companies make more than one type of product, costs
must be accumulated by product within each
department.
Cost accumulation in a process costing differs from that
in job order costing in two ways:
• The quantity of products to which costs are
accumulated
• The cost object to which the costs are assigned
• Additionally, partially completed units in ending WIP
inventory were started in the current period but will
not be completed until the next period.
Ending work in process inventory must be physically
inspected to determine the percentage of completion
of each cost component.
• One hundred percent minus each of these
percentages represents the proportion of work to be
completed on the different cost components in future
period.

Thus, if last month it was determined that direct

material was 75% complete, 25% more direct material
would have been needed to complete the product.

If the same item were only 90% complete as to direct

materials at the end of this month, 15% would have
been added in the current month and 10% would be
needed in the next month.
Equivalent Units of Production
Units typically flow through a production department in
first in, first out method. Goods that were incomplete
at the end of the previous period are the first
completed in the current period; and some units are
started in the current period but will not be completed
in the current period.
Since manufacturing efforts relate to different units
(beginning inventory completed, current period started
and completed, and current period started but not
completed), production cannot be measured only by
counting the whole units.
Equivalent Units of Production (EUP) are the
approximations of the number of units of output that
could have been produced during a period from the
actual resources expended during that period.
Assume that a candle shop had no WIP inventory on
November 1. During November, the Company worked
on 220,000 units: 200,000 were fully completed and
20,000 were 40% complete at the end of the period.
The EUP in the period are as follows:
EUP: BI units completed + Units started and Completed
+ EI units partially complete EUP = 0 + 200,000 +(20,000
x 40%)
EUP = 208,000
Equivalent Units of Production
Some quantity of direct material must be introduced at
the start of production to begin the conversion process.
For example, to make its various products, The Candle
Shop production process begins with candle wax. Any
material added at the start of production is 100%
complete at the outset of the process, regardless of
completion of labor and overhead.
On the other hand, most production process requires
multiple direct materials. Additional materials may be
added at any point or even continuously during
processing. A direct material such as box may be even
added at the end of processing.
Equivalent Units of Production
The Candle Shop’s production process occurs as follows:
• Wicks and wax are added at the beginning of the
process. Thus, these materials are 100% complete at
any point in the process after the start if production. No
additional quantities of these materials are added later
to production.
• When enough labor and overhead have been added
to reach 20% completion point, additional materials
(color and scent) are added. Prior to 20% completion,
these materials are 0% complete and after the 20%
completion point, these materials are 100% complete.
• Almost at the end of the process, the candles are
boxed and after this step, the process is 100%
complete. Thus, boxes are 0% complete until the
candles are packaged.
Equivalent Units of Production
Assume that enough wicks and wax are started to make
8,000 candles. At the end of the period, the process is
75% complete as to labor and overhead.
• The candles are 100% complete as to what direct
materials?
• What is the EUP calculation for wicks and wax, scent
and color and boxes?
The labor and overhead components have an
equivalency of 6,000 candles because the candles are
75% complete and labor and overhead are continuously
added during the production process.
When overhead is applied on a direct labor hours, or
when direct labor and overhead are added to the
production at the same rate, a single percentage of
completion can be used. However, because cost drivers
other than direct labor are increasingly be used to
apply overhead costs, single computation for conversion
EUP are being made less often.
Process Costing Methods
The two methods of accounting for cost flows are:
• Weighted average (WA)
• First in, First Out (FIFO)
These methods reflect the way in which cost flows are
assumed in the production process.
Weighted Average

This is used by dividing the total cost of goods available

for sale by the total units available for sale.

These methods reflect the way in which cost flows are

assumed in the production process.