Cost and MGMT Acct I Chapter 3 Process Costing

Chapter 3
Process Costing
The process cost system accumulates costs with out attempting to allocate them during the accounting
period to specific units of goods being manufactured. At the end of the fiscal period, the average cost per
unit is determined by dividing the total cost accumulated to the total number of units produced.
Because of these techniques, process costing is often referred to as average costing. If the process costing
system is used, the goods manufactured must be similar in nature so that an average cost will be
meaningful. The process cost system is commonly used in such manufacturing operations as cement plants
and flour mills, in which the production process is standardized and continuous and the product remains
essentially the same from day to day.
In many types of business use process costing, manufacturing consists of a progressive series of distinct
operations or processes. Usually each process is carried out in different department. A unit cost may be
computed for each process or department. This departmental unit cost may be a useful to in measuring and
controlling efficiency. The total cost of production determined by adding up the departmental costs.
 A process costing is most commonly used in industries that produce essentially homogeneous (i.e.
uniform) products on a continuous basis.
 Firms producing distinct and unique products use job order costing where as firms producing similar
or identical units use process-costing system.
 Process costing system accumulate costs by department for a period of time, just as a job order
costing system accumulate costs by job, and the total cost then will be assigned to the units produced
during that period.
Similarities between job-Order and Process Costing
1. The same basic purposes exist in both systems, which are to assign material, labor, and overhead
cost to products and to provide a mechanism for computing unit costs.
2. Both systems maintain and use the same basic manufacturing accounts, including MO, Raw
Materials, Work in Process, and Finished Goods.
3. The flow of costs through the manufacturing accounts is basically the same in both systems.
Differences between Job-Order and Process Costing
Job-Order Costing Process Costing
1. Many different jobs are worked on during 1. A single product is produced either on a
each period, with each job having different continuous basis for long periods of time. All units
production requirements. of product are identical.
2. Costs are accumulated by identical job. 2. Costs are accumulated by department.
3. The job cost sheet is the key document 3. The department production report is the key
controlling the accumulation of costs by a job. document showing the accumulation and
4. Unit costs are computed by job on the job disposition of costs by a department.
cost sheet. 4. Unit costs are computed by department on the
department production report.
Cost & Management Accounting I/ Lecture note on Process Costing 1

 In manufacturing process costing setting, each unit is assumed to receive the same amount of direct
materials cost, direct manufacturing labor costs, and indirect manufacturing costs. Units are
computed by dividing total costs by the number of units.
 The principal difference between process costing and job costing is the extent of averaging used to
compute unit costs of products or services. In job-costing system, individual jobs use different
quantities of production resources. Thus, it would be incorrect to cost each job at the same average
production cost.
 In contrast, when identical or similar units of products or services are mass produced, and not
processed as individual jobs, process costing averages production costs over all units produced.
 The difference between job order and process costing system is, thus, the extent of the averaging
used to compute unit cost. In job order costing each job differs in terms of material used, labor
incurred, and manufacturing overhead. Hence, it is impossible to assign the same cost for different
jobs. On the contrary, identical units produced in mass took equal amount of direct material,
direct labor, and manufacturing overhead. Thus, the unit cost can be found by dividing total cost
by the number of units produced.
The Flow of Costs in Process-Costing System with Sequential Production Departments

1. As direct materials and direct labor are used in production department A, these costs are added to the
Work-in Process inventory account for Department A. Overhead is applied using predetermined
overhead rate. The POR is determined in the same way in job order and process costing.
Work-in Process: Production Department A xxx
Raw Materials xxx
Wage Payable xxx
Manufacturing overhead applied xxx
2. When production department A completes its work on some units of product, these units of product
are transferred to production department B. The costs assigned to these goods are transferred from
the Work-in Process Inventory account for department A to work-in Process inventory account in
department B, the costs assigned to those partially completed products are called transferred-in
costs1.
Work-in Process: Production Department B xxx
Work-in Process: Production Department A xxx
3. Direct material and direct labor are used in production department B, and manufacturing overhead is
applied using POR.
Raw Materials xxx
Wages Payable xxx
Manufacturing overhead applied xxx
4. Goods are completed in production department B and transferred to the finished goods warehouse.
Finished-Goods xxx
5. Goods are sold
Cost of Goods Sold xxx
Finished-Goods xxxx
1
Transferred-in costs are assigned to partially completed products that are transferred into one production
department from a prior department.
Cost Accumulation Methods in Process Costing System
o When a firm produces identical lots of goods repetitively, maintaining a separate job cost sheet would
be unnecessarily expensive. The aggregate cost and the unit cost can be computed without a job cost
sheet, thus saving the costs associated with producing such records.
o Costs accumulate by department over a certain period and the unit cost can be found by dividing the
total cost to the units produced during that period. Process costing system fit among others to, paint
manufacturers, oil refineries, sugar refineries, and salt producers.
o In process costing system, manufacturing costs, direct material, direct labor, and manufacturing
overhead costs are accumulated in the same way as job order costing system. However, the costs are
accumulated by department over some period of time than by individual jobs.
o The time period over which the cost is to be accumulated depends on the information needs of the
company. It can be a week, two weeks, but no longer than a month most often. Cost accumulation is
much simpler for a process costing system than for a job order cost system.
Illustrating Process Costing

Assumptions: ABC Manufacturing Company manufactures thousands of Products A. These components
are assembled in the Assembly Department, upon completion the units are completely transferred to the
Testing Department. The process-costing system for Product A has a single direct cost category (direct
materials) and a single indirect-cost category (conversion costs). Direct materials are added at the
beginning of the process in Assembly. Conversion costs are added evenly during Assembly.
Case 1: Process costing with zero beginning and zero ending work in process inventory that is all
units are started and fully completed by the end of the accounting period.
Data for the Assembly Department for January 2001

Physical Units for January 2001
Work in Process, beginning inventory (January 1) 0 units
Started during January 400 units
Completed and transferred out during January 400 units
Work in Process, ending inventory (January 31) 0 units
Total Costs for January 2001
Direct materials costs added during January Br.32,000
Conversion costs added during January 24,000
Total Assembly Department costs added during January 56,000
Solution:
Direct Material costs per unit (32,000/400) Br. 80
Conversion costs per unit (24000/400) 60
Assembly Department costs per unit 140
Case 2: Process Costing with zero beginning but some ending work in process inventory
Data for the Assembly Department for February 2001

Physical Units for February 2001
Work in Process, beginning inventory (February 1) 0 units
Started during February 400 units
Completed and transferred out during February 175 units
Work in Process, ending inventory (February 28) 225 units
Total Costs for February 2001
Direct materials costs added during February Br.32,000
Conversion costs added during February 18,600
Total Assembly Department costs added during February 50,600
In addition, the Assembly Department estimates that the partially assembled units are on averages 60%
complete as to conversion costs.
How should the co. calculate the cost of fully assembled units in February 2001 and the cost of
partially assembled units still in process at the end of February 2001?
Steps:
 Summarize the flow of physical units of output.
 Compute output in terms of equivalent units.
 Compute equivalent unit costs.
 Summarize total costs to account for.
 Assign total costs to unit’s completed and to units in ending work in process.
Equivalent Units: A key Concept

 Material, labor and overhead costs are incurred at different rates in production process. Direct
material usually placed in production at one or more discreet points in the process. In contrast, direct
labor and manufacturing overhead, called conversion costs, and usually are incurred continuously
throughout the process.
 When an accounting period ends, the partially completed goods that remain in process generally are
at different stages of completion with respect to material and conversion activity.
Example: Suppose there are 1000 physical units in process at the end of an accounting period. Each of the
physical units is 75% complete with respect to conversion. How much conversion activity has been
applied to these partially completed units?
Conversion activity occurs uniformly throughout the production process. Therefore, the amount of
conversion activity required to do 75% of the conversion on 1000 units is equivalent to the amount of the
conversion on 750 units. The number is computed as follows:
1000 partially completed * 75% complete with = 750
Physical units in process respect to Conversion
The term equivalent units is used in process costing to refer to the amount of manufacturing activity that
has been applied to a batch of physical units. The 1000 physical units in process represent 750 equivalent
units of conversion activity.
The term equivalent unit is also used to measure the amount of direct materials represented by the partially
completed goods. Since direct materials are incorporated at the beginning of the production process, the

1000 physical units represent 1000 equivalent units of direct material ( 1000 physical units * 100%
complete with respect to direct materials).
Physical units and Equivalent units (Step 1&2)

Equivalent units is a derived amount of output units that takes the quantity of each input (factor of
production) in units completed or in work in process, and converts it into the amount of completed output
units that could be made with that quantity of input.
Equivalent Units
Flow of Production Physical Direct Conversion
Units Materials costs
Work in process, beginning 0
Started during current period 400
To account for 400
Completed and transferred out during current
period 175 175 175
Work in process, ending 225
225*100%; 225*60% 225 135
Accounted for 400
Work done in current period 400 310
Calculation of Product Costs (Steps 3, 4, and 5)

Total Direct Conversion
Productio Materials Costs
n Costs
(Step 3) Costs added during February divided by 50,600 Br.32,000/ Br.18,000/
equivalent units of work done incurrent period 400 310
Cost per equivalent unit Br. 80 Br. 60
(Step 4) Total costs to account for Br. 50,600
(Step 5) Assignment of costs:
Completed & transferred out (175 units) Br. 24,500 (175*80) (175*60)
Work in process, ending (225 units)
Direct Materials 18,000 225*80
Conversion costs 8,100 135*60
Total work in process 26,100
Total costs accounted for Br.50,600
Journal Entries
Work in Process- Assembly 32,000
Account Payable Control 32,000
(To record direct materials purchased and used in production)
Various accounts 18,600

(To record Assembly department conversion costs)
Work in Process- Testing 24,500
(To record cost of goods completed and transferred from Assembly to
Testing Department)
Case 3: Process costing with some beginning and some ending work in process inventory.
Data for the Assembly Department for March 2001

Physical Units for March 2001
Work in Process, beginning inventory (March 1) 225 units
Direct Materials (100% complete)
Conversion costs (60% complete)
Started during March 275 units
Completed and transferred out during March 400 units
Work in Process, ending inventory (March 31) 100 units
Total Costs for March 2001
Work in process, beginning inventory
Direct materials (225 equivalent units * Br. 80/unit) Br. 18,000
Conversion costs (135 equivalent units * Br.60/unit) 8,100 Br. 26,100
Direct materials costs added during March 19,800
Conversion costs added during March 16,380
Total costs to account for Br.62, 280
 Weighted-Average process costing method

 This method calculates the equivalent unit cost of the work done to date (regardless of the 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 in the work in process account (regardless
of whether it is from the beginning work in process or from work started during the period) divided
by total equivalent units of work done to date.
Equivalent Units
To account for 500
Completed and transferred out during current
period 400 400 400

100*100%; 100*50% 100 50
Accounted for 500

Production Materials costs
Costs
(Step 3) Work in process, beginning Br.26,100 Br.18,000 Br.8,100
Costs added during the current period 36,180 19,800 16,380
Costs incurred to date divided by Br. 37,800/ Br. 24,480/
Equivalent units of work done to date 500 450
Cost per equivalent unit of work done Br.75.60 Br.54.40
(Step 4) Total costs to account for Br.62,280
(Step 5) Assignment of Costs
Completed and transferred out (400 units) 52,000 (400*75.60) (400*54.40)
Direct Materials 7,560 100*75.60
Conversion costs 2,720 50*54.40
Total costs accounted for Br. 62,280
Journal Entries
Account Payable Control 19,800
(To record direct materials purchased and used in production)
Various accounts 16,380
(To record Assembly department conversion costs)
Testing Department)
 First-in, First-out Method

 The FIFO process costing method assigns the cost of the previous period’s equivalent units in
beginning work-in process inventory to the first units completed and transferred out of the process,
and assigns the cost of equivalent units worked on during the current period first to complete
beginning inventory, then to start and complete new units in ending work in process inventory.
 This method assigns that the earliest equivalent units in the work in process-Assembly account are
completed first.

 A distinct 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 in the current period and units produced in the current period are used to calculate
costs per equivalent unit of work done in the current period.
 In contrast equivalent unit and cost per equivalent unit calculations in the weighted average method
merge the units and costs in beginning inventory with units and costs of work done in the current
period.

Equivalent Units
To account for
Completed and transferred out during current 500
period
From beginning work in process
225*(100%-100%); 225*(100%-60%) 225 0 90
Started and Completed
175*100%, 175*100% 175 175 175
Work in process, ending
100*100%; 100*50% 100 100 50
Accounted for 500

Production Materials costs
Costs
(Step 3) Work in process, beginning Br.26,100
Costs added current period 36,180 19,800/ 16,380/
Divided by equivalent units of work 275 315
done in current period
Costs per equivalent unit of work done in the Br. 72 Br. 52
current period
(Step 5) Assignment of Costs (400*75.60) (400*54.40)
Completed and transferred out (400 units)
Work in process, beginning (225 units) Br. 26,100
Direct Materials added in current period 0 0*72
Conversion costs added in current period 4,680 90*52
Total from beginning inventory 30,780
Started and completed (175 units) 21,700 175*72 175*52

Total costs of units completed & transferred 52,480
Direct Materials 7,200 100*72
Total work in process, ending 9,800

Testing Department)
Important points to note:

 The first physical units assumed to be completed and transferred out during the period are the 225
units from the beginning work-in process inventory.
 Of the 275 physical units started, 175 are assumed to be completed. 400 physical units were
completed during March, the FIFO method assumes that the first 225 of these units must have been
started and completed during March.
 Ending work-in process inventory consists of 100 physical units-the 275 physical units started minus
the 175 of these physical units completed.
 Note that the physical units “to account for” equal the physical units “accounted for” (500 units)
 The equivalent unit calculated for each cost category focus on the equivalent units of work done in
the current period only. Under the FIFO method, the work done in the current period is assumed to
first complete the 225 units in beginning work in process. The equivalent unit’s works done in
March on the bigining wirk-in process inventory are computed by multiplying the 225 physical units
by the percentage of work remaining to be done to complete these units: 0% for direct materials, and
40% for conversion costs.
Transferred-in Costs in Process Costing

 Transferred-in costs also called previous department costs are the costs incurred in a previous
department that are carried forward as the product’s cost when it moves to a subsequent process in
the production cycle. That is as the units move from one department to the next, their costs are
transferred with them.
 Transferred in costs are treated as if they are a separate type of direct material added at the beginning
of the process. In other words, 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.
Example: In our example as the assemble process is completed the department transfers the units to
its Testing Department. Here the units receive additional direct materials, such as packing materials
for shipment, at the end of the process. Conversion costs are added evenly during the Testing
Department’s process. As units are completed in Testing, they are immediately transferred to
Finished Goods.

Data for the Testing Department for the month of March 2001 are:
Physical Units for March 2001
Work in Process, beginning inventory (March 1) 240 units
Transferred-in costs (100% complete)
Conversion costs (62.5% complete)
Transferred in during March 400 units
Completed during March 440 units
Work in Process, ending inventory (March 31) 200 units
Transferred-in costs (100% complete)
Costs of Testing Department for March 2001
Work in process, beginning inventory
Transferred-in costs (240 equivalent units*140/ equ. Un) Br. 33,600
Direct materials 0
Conversion costs (150 equivalent units * Br.120/unit) 18,000 Br. 51,600
Transferred-in costs during March
Weighted-average 52,000
FIFO 52,480
Direct materials costs added during March 13,200
Conversion costs added during March 48,600
A. Transferred-in costs and the Weighted-Average Method

Equivalent Units
Flow of Production Physical Transferr DM CC
Units ed in costs
Transferred in during current period 400
To account for 640
Completed and transferred out during
current period 440 440 440 440
200*100%; 200*0%; 200*80% 200 0 160
Accounted for 500
Work done to date 640 440 600
Total Transferr DMs CCs

Production ed in costs
Costs
(Step 3) Work in process, beginning Br.51,600 Br.33,600 Br.0 Br.18,000
Costs added in the current period 113,800 52,000 13,200 48,600
Costs incurred to date divided by Br.85,600/ Br.13,20/ Br 66,600/

Equivalent units of work done to date 640 440 600
Cost per equivalent unit of work done Br.133.75 Br.30 Br.111
Completed and transferred out (440 120,890 (440*133. (440*30) (440*111)
units) 75)
Transferred-in costs 26,750 200*133.7
Direct Materials 0 5 0*30
To record cost of goods completed and transferred from Testing to finished goods.
Finished Goods Control 120,890

Work-in Process: Testing 120,890
B. Transferred-in costs and the FIFO Method
Equivalent Units
Flow of Production Physical Transferred- Direct Conversion
Units in costs Materials costs
Transferred-in current period 400
To account for 640
Completed and transferred out
during current period
From beginning work in 240
process
240*0%; 240*(100%-0%); 0 240 90
200* (100%-62.5%)
Started and Completed 200
200*100%; for the three 200 200 200
200*100%; 200*0%;200*80% 200 0 160
Accounted for 640
Work done in current period 400 440 450
Total Transferred DMs CCs

Production -in cost
Costs

(Step 3)Work in process, beginning Br.51,600
Costs added current period 114,280 52,480/ 13,200/ 48,600/
Divided by equivalent units of 400 440 450
work done in current period
Costs per equivalent unit of work Br.131.20 Br. 30 Br. 108
done in the current period
Completed and transferred out (440
units Work in process, beginning Br.51,600
(240 units)
Transferred-in costs added in current 0 0*131.20
Direct Materials added in current 7,200 240*30
Conversion costs added in current 9,720 90*108
Total from beginning inventory 68,520
Started and completed (200 units) 53,840 200*131.20 200*30 200*108
Total costs of units completed &
transferred 122,360
Transferred-in costs 26,240 200*131.20
Direct Materials 0 0*30
Total work in process, ending 43,520
To record cost of goods completed and transferred from Testing to finished goods.
Finished Goods Control 122,360
Work-in Process: Testing 122,360

Cost and MGMT Acct I Chapter 3 Process Costing

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Chapter 3

Cost & Management Accounting I/ Lecture note on Process Costing 1

The Flow of Costs in Process-Costing System with Sequential Production Departments

Illustrating Process Costing

Data for the Assembly Department for January 2001

Data for the Assembly Department for February 2001

Equivalent Units: A key Concept

Cost & Management Accounting I/ Lecture note on Process Costing 4

Physical units and Equivalent units (Step 1&2)

Calculation of Product Costs (Steps 3, 4, and 5)

Cost & Management Accounting I/ Lecture note on Process Costing 5

Data for the Assembly Department for March 2001

 Weighted-Average process costing method

Cost & Management Accounting I/ Lecture note on Process Costing 6

Calculation of Product Costs (Steps 3, 4, and 5)

 First-in, First-out Method

Cost & Management Accounting I/ Lecture note on Process Costing 7

Physical units and Equivalent units (Step 1&2)

Calculation of Product Costs (Steps 3, 4, and 5)

Cost & Management Accounting I/ Lecture note on Process Costing 8

Work in Process- Testing 52,480

Important points to note:

Transferred-in Costs in Process Costing

Cost & Management Accounting I/ Lecture note on Process Costing 9

A. Transferred-in costs and the Weighted-Average Method

Total Transferr DMs CCs

Cost & Management Accounting I/ Lecture note on Process Costing 10

Finished Goods Control 120,890

B. Transferred-in costs and the FIFO Method

Total Transferred DMs CCs

Cost & Management Accounting I/ Lecture note on Process Costing 11

Cost & Management Accounting I/ Lecture note on Process Costing 12

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