Module No.

1 – Process Costing (Nature and Operations)

Learning Outcome/s:
Familiarize the nature and operations of the process costing

Core Values/Biblical Principles:

The fear of the Lord is the beginning of wisdom, and the knowledge of the Holy One is insight. –
Proverbs 9:10 (ESV)

Introduction:
Process costing is a system of accumulating costs of production by departments or cost center. This
accounting system is commonly used by companies where a large number of similar products pass
through different departments in a continuous process until completed in the last department then
transferred to finished goods inventory.

Body:
Process cost system is used when products are manufactured by mass production while job order cost
system is most suitable when a single product or batch of product is manufactured according to
customer’s specification.

Job Order Cost system Process Cost System

Manufacturing cost elements Both track and record three elements of costs: direct materials,
direct labor, and manufacturing overhead.
Accumulation of costs All raw materials are debited to Materials account; all direct labor
are debited to Factory Payroll account; and all actual
manufacturing overhead costs are debited to Manufacturing
Overhead Control account.
Flow of costs The accumulated manufacturing costs are assigned to the same
accounts in both costing systems: Work in Process, Finished Goods,
and Cost of Goods Sold.
Number of Work in Process Only one Multiple accounts are used for
accounts used each production department
Point at which total costs is When the job is completed At the end of each month while
determined the units are being processed
Unit cost computation Unit cost is determined by Unit cost is computed by
dividing the total cost per job by dividing the total manufacturing
the units produced. costs for the period by the units
produced during the period.

Assignment of Manufacturing Costs

 Normal costing – direct materials and direct labor are applied at actual cost while
manufacturing overhead is applied at a predetermined rate.
 Standard costing – direct materials, direct labor, and manufacturing overhead are applied at
standard cost or estimated cost.

Direct materials:
Work in Process – Department 1 xxx
Work in Process – Department 2 xxx
Work in Process – Department 3 xxx
Materials xxx
Direct labor:
Work in Process – Department 1 xxx
Work in Process – Department 2 xxx
Work in Process – Department 3 xxx
Factory Payroll xxx

Manufacturing overhead:
Work in Process – Department 1 xxx
Work in Process – Department 2 xxx
Work in Process – Department 3 xxx
Applied Manufacturing Overhead xxx

Transfer to next department:

Work in Process – Department 2 xxx
Work in Process – Department 1 xxx

Work in Process – Department 3 xxx

Work in Process – Department 2 xxx

Transfer to finished goods:

Finished Goods xxx
Work in Process – Department 3 xxx

Production report – shows the number of units that were in process in the department at the start of
the month, the number of units started during the month, the number of units transferred out of the
department during the month, the number of units still in process at the end of the month, and the
percentage of completion of the units still in process at the end of the month.

Cost of production report – shows the flow of units as well as the flows of costs related to that
department. This shows the costs incurred in the department, the average cost per unit of product, the
total costs of products completed and transferred out of the department, and the costs related to the
ending inventory of work in process in each department.

Illustration
Star Paper Company manufactures high quality paper boxes in three departments. The Cutting
Department that cuts and trims paper to the required dimensions and sizes; the Assembly Department
that folds the paper and form the boxes; and the Packaging Department that put the boxes in a
container for storage. Starting from the Cutting Department, the product moves into the Assembly
Department and then to the Packaging Department. As the production moves from department to
department, the accumulated costs move with it.

Assumed data relating to Star Paper Company for January 2020, the first month of manufacturing
operations, are as follows:

Cutting Department
The manufacturing costs incurred and charged to the Work in Process – Cutting Department for the
month of January 2020 are presented below:
Materials Php 77,280
Labor 95,616
Overhead 156,632
 Cutting Department
Monthly Production Report
January 2020
Quantity
- Started in Process – Current Month 12,880
- Transferred Out to Next Department 9,120
- Work in Process – Ending 3,760
Stage of Completion of Ending Work in Process
- Materials 100%
- Labor 40%
- Overhead 55%

Equivalent production – is the measure of work done during the month, express in fully completed
units. This is determined by multiplying the number of units in process by the percentage of completion.

Cutting Department
Equivalent Units of Production Computations
January 2020
Materials
- Transferred Out to Next Department 9,120
- Work in Process – Ending (3,760 x 100%) 3,760
Equivalent Units for Materials 12,880
Labor
- Transferred Out to Next Department 9,120
- Work in Process – Ending (3,760 x 40%) 1,504
Equivalent Units for Labor 10,624
Overhead
- Transferred Out to Next Department 9,120
- Work in Process – Ending (3,760 x 55%) 2,068
Equivalent Units for Overhead 11,188

The cost of production report for Star Paper Company’s Cutting Department is shown below. The report
contains two sections namely, the quantity schedule and the cost schedule.
 Cutting Department
Cost of Production Report
January 2020
Quantity Schedule Units
a. Quantity to be accounted for:
Started in process 12,880
Total to be accounted for 12,880
b. Quantity accounted for:
Transferred out to next department 9,120
Work in process – ending 3,760
Total accounted for 12,880

Cost Schedule Total Cost EUP Unit Costs

c. Costs to be accounted for:
Materials Php 77,280 12,880 Php 6
Labor 95,616 10,624 9
Overhead 156,632 11,188 14
Total costs to be accounted for Php 329,528 Php 29
d. Costs accounted for:
Transferred out Php 264,480 9,120 Php 29
Work in process – end
-Materials Php 22,560 3,760 6
-Labor 13,536 1,504 9
-Overhead 28,952 2,068 14
Total work in process Php 65,048
Total costs accounted for Php 329,528

Assembly Department
The units completed in the Cutting Department are transferred to the Assembly Department for further
processing. The costs accumulated in the Work in Process – Assembly Department during the month are
shown below:
Materials Php 21,830
Labor 82,954
Overhead 69,856

Assembly Department
Monthly Production Report
January 2020
Quantity
- Transferred In From Prior Department 9,120
- Transferred Out 8,150
- Work in Process – End 970
Stage of Completion of Ending Work in Process
- Transferred In Cost 100%
- Materials 60%
- Labor 60%
- Overhead 60%
 Assembly Department
Equivalent Units of Production Computations
January 2020
Materials
- Transferred Out to Next Department 8,150
- Work in Process – Ending (970 x 60%) 582
Equivalent Units for Materials 8,732
Labor
- Transferred Out to Next Department 8,150
- Work in Process – Ending (970 x 60%) 582
Equivalent Units for Labor 8,732
Overhead
- Transferred Out to Next Department 8,150
- Work in Process – Ending (970 x 60%) 582
Equivalent Units for Overhead 8,732

Assembly Department
Cost of Production Report
January 2020
Quantity Schedule Units
a. Quantity to be accounted for:
Started in process 9,120
Total to be accounted for 9,120
b. Quantity accounted for:
Transferred out to next department 8,150
Work in process – ending 970
Total accounted for 9,120

Cost Schedule Total Cost EUP Unit Costs

c. Costs to be accounted for:
Costs transferred in Php 264,480 9,120 Php 29
Costs incurred in this department
-Materials 21,830 8,732 2.50
-Labor 82,954 8,732 9.50
-Overhead 69,856 8,732 8.00
Total costs in the Assembly Department Php 174,640 Php 20.00
Total costs to be accounted for Php 439,120 Php 49.00
d. Costs accounted for:
Transferred out Php 399,350 8,150 Php 49
Work in process – end
Costs transferred in 28,130 970 Php 29
Costs incurred in this department
-Materials 1,455 582 2.50
-Labor 5,529 582 9.50
-Overhead 4,656 582 8.00
Total work in process Php 39,770
Total costs accounted for Php 439,120

Packaging Department
This is the last department, so the units completed in this department is transferred to finished goods.
The costs accumulated in the Work in Process – Packaging Department during the month are as follows:
Materials Php 2,172
Labor 24,492
Overhead 14,596
Packaging Department
Monthly Production Report
January 2020
Quantity
- Transferred In From Prior Department 8,150
- Transferred Out 5,430
- Work in Process – End 2,720
Stage of Completion of Ending Work in Process
- Transferred Out 100%
- Materials 0%
- Labor 20%
- Overhead 15%

Packaging Department
Equivalent Units of Production Computations
January 2020
Materials
- Transferred Out to Finished Goods 5,430
- Work in Process – Ending (2,720 x 0%) 0
Equivalent Units for Materials 5,430
Labor
- Transferred Out to Finished Goods 5,430
- Work in Process – Ending (2,720 x 20%) 544
Equivalent Units for Labor 5,974
Overhead
- Transferred Out to Finished Goods 5,430
- Work in Process – Ending (2,720 x 15%) 408
Equivalent Units for Overhead 5,838
 Packaging Department
Cost of Production Report
January 2020
Quantity Schedule Units
a. Quantity to be accounted for:
Transferred in 8,150
Total to be accounted for 8,150
b. Quantity accounted for:
Transferred out to finished goods 5,430
Work in process – ending 2,720
Total accounted for 8,150

Cost Schedule Total Cost EUP Unit Costs

c. Costs to be accounted for:
Costs transferred in Php 399,350 8,150 Php 40.00
Costs incurred in this department
-Materials 2,172 5,430 0.40
-Labor 24,492 5,974 4.10
-Overhead 14,596 5,838 2.50
Total costs in the Assembly Department Php 41,260 Php 7.00
Total costs to be accounted for Php 440,610 Php 56.00
d. Costs accounted for:
Transferred out to finished goods Php 304,080 5,430 Php 56.00
Work in process – end
Costs transferred in Php 133,280 2,720 49.00
Costs incurred in this department
-Materials 0 0 0.40
-Labor 2,230 544 4.10
-Overhead 1,020 408 2.50
Total work in process Php 136,530
Total costs accounted for Php 440,610

Recording Manufacturing Operations

The journal entries for Star Paper Company to record manufacturing operations for the month of
January 2020 are the following:

Cutting Department
Work in Process – Cutting Department 329,528
Materials 77,280
Factory Payroll 95,616
Applied Manufacturing Overhead 156,632

Work in Process – Assembly Department 264,480

Work in Process – Cutting Department 264,480

Assembly Department
Work in Process – Assembly Department 174,640
Materials 21,830
Factory Payroll 82,954
Applied Manufacturing Overhead 69,856

Work in Process – Packaging Department 399,350

Work in Process – Assembly Department 399,350
Packaging Department
Work in Process – Packaging Department 41,260
Materials 2,172
Factory Payroll 24,492
Applied Manufacturing Overhead 14,596

Finished Goods 304,080

Work in Process – Packaging Department 304,080

The balances of the Departmental Work in Processes on January 2020 are computed below:
Cutting Assembly Packaging
Materials Php 77,280 Php 21,830 Php 2,172
Labor 95,616 82,954 24,492
Overhead 156,632 69,856 14,596
Total costs incurred Php 329,528 Php 174,640 Php 41,260
Transferred in - 264,480 399,350
Transferred out (264,480) (399,350) (304,080)
Balance January 31 Php 65,048 Php 39,770 Php 136,530

Recording sales and cost of goods sold

Assume that 5,300 units were sold during January for Php 80 each, for a total selling price of Php
424,000. Since this is the first month of operation of Star Paper Company, all the units sold came from
January production. The 5,300 units sold had a total cost of Php 296,800 (5,300 x Php 56).

Accounts Receivable 424,000

Sales 424,000

Cost of Goods Sold 296,800

Finished Goods 296,800

Summary:
The process cost system is used by companies that manufacture on a continuous basis only one or a few
products that are homogeneous. The system is ideal in the accounting for costs in mass-production.
Under this cost system, the equivalent units of production are first identified before the costs of each
department are determined.

References:
Cost Accounting Principles and Procedural Applications by Pedro P. Guerrero, 2014-2015 edition