CHAPTER FOUR: PROCESS COSTING SYSTEM

INTRODUCTION
As discussed in the previous unit, the production process influences the choices of cost
accounting system. Firms producing distinct and unique products use job order costing system
where as firms producing similar or identical units use process-costing system. Process costing
system accumulate costs by departments for a period of time, just as a job order costing system
accumulate costs by jobs, and the total cost will be assigned to the units produced in that period.
Process costing system is product costing system which is applied when identical units are
produced in mass. Identical units are assumed to take the same amount of direct material, direct
labor & manufacturing overhead. These costs are accumulated over a period of time and the total
cost is assigned to units produced in the period the cost is accumulated.
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 take 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.
4.1. Process Costing System – Different Cases
Dear learner, how do we prepare cost of production report in process costing system?
A processing department is any location in organizations where work is performed on a product
and where materials, labor or overhead costs are added to the product. For example, a potato chip
factory might have three processing department-one for preparing potatoes, one for cooking, and
one for inspecting and packaging. A company can have as many or as few processing
departments as are needed to complete a product or service. Some products and service may go
through several processing departments, while others may go through only one or two.
Regardless of the number of departments involved, all processing departments have essential
features. First, the activity performed in the processing department must be performed uniformly
on all of the units passing through it, second; the output of the processing department must be
homogenous. The discussion on process costing will be clear when we use examples. Hence, we
use the case of SNAP computers to illustrate three cases under process costing.
Illustration 1: SNAP computers imports component parts of a computer and its accessories from
abroad and assemble computers here in Ethiopia. The components parts are first assembled in the
assembly department. Up on completion, units are transferred to finishing department for testing,
loading the different office software and packaging. Since all computers assembled are the same,
the company uses process costing system for cost accumulation. The process costing system for
the computer has two cost categories (Direct material and Conversion cost). Each unit of
computers passes through two departments, the assembly department and Finishing department.
Every effort is made to ensure that all computers are identical and meet assets of demanding
performance specification. Direct material is added at the beginning of the process in assembly
department. Additional direct material is added at the end of the process in finishing department
when each computer is completed. Conversion cost is added evenly during both processes. When
the finishing department finishes work on each computer, it is immediately transferred to
finished goods and taken to warehouse until it is sold. The following diagram presents these
facts.

Conversion cost added

evenly during the process
Assembly Finishing
Transfer
Department Department

Direct material
added at the beginning

Process costing system separates costs in two categories according to when costs are
introduced in to the process. Often, as in our SNAP computer example, only two cost
classifications, direct material and conversion costs are necessary to assign costs to products.
Because all direct materials are added to the process at one time and all conversion costs are
generally added to the process evenly through time. If, however two different direct materials
were added to the process at different times, two different direct material cost categories
would be needed to assign these costs to products. Similarly, if manufacturing labor costs
 were added to the process at a different time than when the other conversion costs were
added, an additional cost category-direct manufacturing cost - would be needed to separately
assign these costs to products. We will use the assembling of each computer in the assembly
department to illustrate three cases, starting with the simplest case and introducing additional
complexities in subsequent cases.
Case 1: Process Costing with No Beginning or Ending Work in Process Inventory. That
is, all units are started and fully completed by the end of the accounting period. This case
illustrates the basic averaging of cost data, which is a key feature of process costing. On
January 1, 2008, there were no beginnings WIP of computers in the assembly department.
During January 2008, SNAP computers started and completed assembly of computers and
transferred out to finishing department 400 units. Additional information for assembly
department is given below:
Physical unit for January, 2008:
 WIP beginning------------- 0 unit
 Started during January ------- 400 unit
 Completed and transferred --- 400 unit
 WIP ending ------------------ 0 unit
Total cost for January, 2008:
 DM cost added during January --Br. 640,000
 Conversion cost added -------------- 480,000
 Total assembly department cost - Br.1,120,000
SNAP computer should record direct materials and conversions used in the assembly department
as these costs are incurred as follows:
Work In process – Assembly 640,000
Raw material control 640,000
(To record the use of direct materials in the production process)
Work In process – Assembly 480,000
Various accounts 480,000
(To record the use of conversion costs in the production process)
In the above journal entry, various accounts consists of many accounts that can be credited when
conversion cost is incurred such as cash, accounts payable, accumulated depreciation, prepaid
insurance etc. In this case, average cost can be calculated easily by dividing the total cost
incurred to units assembled and completed in the assembly department as follows
Average cost = Total cost = Br.640, 000 + Br.480, 000 = Br 2,800
Total units completed 400 units
When the 400 units completed in assembly department are transferred to the finishing
department, the following journal entries will be recorded:
Work In process – Finishing 1,120,000
Work In process- Assembly 1,120,000
In the real manufacturing process, the above case is a very simplified case, because, usually all
units started in a given period will not be completed and transferred to the next department.
There might be some units which are started but not completed. That is, there might be some
ending work in process. This leads us to the 2nd case of process costing.
Case 2: Process costing with Zero Beginning but Some Ending WIP inventory
Assume that in February, 2008, SNAP computer places another 400 unit in to the assembly
process. Because, all units placed in production in January were completely assembled, there is
no beginning WIP on February 1. Because of different reasons, not all units started in February
were completed by the end of the month. Only 175 units are completed and transferred to the
finishing department. Data for the assembly department for the month of February 2008 are:
 Physical unit for february2008:
 WIP beginning(February 1) ------------------ 0 unit
 Units Started during February --------------- 400 unit
 Completed and transferred out ------------- 175 unit

 WIP ending ( February 29) ---------------- 225 unit

 Direct material (100% complete)
 Conversion cost (60% complete)
 Total cost for February:
 DM cost added during February ------------Br.640,000
 CC cost added during February -------------- 372,000
 Total assembly department cost------------Br.1,012,000
The 225 partially assembled units as of February 29, 2008, are fully processed with respect to
direct materials. This is because; all direct materials in the assembly department are added at the
beginning of the assembly process. Conversion costs however; are added evenly during assembly
process. Based on work completed relative to the total work required to complete each computer
units still in process at the end of February, an assembly department supervisor estimates that the
partially assembled units are on average 60% complete with respect to conversion costs.
The accuracy of the completion estimates of conversion costs depends on the care, skill and
experience of the estimator and the nature of conversion process. Estimating degree of
completion is usually easier for direct material cost than for conversion costs. That is because,
the quantity of direct material needed for completed units and the quantity of direct materials in
partially completed units can be measured more accurately. In contrast, the conversion cost
sequence usually consists of a number of basic operations specified for a specified number of
hours, days, or weeks for various steps in the production process. The point to understand here is
that, a partially assembled unit is not the same as fully assembled unit, faced with some fully
assembled units and some partially assembled units, SNAP Computers calculates in five steps:
1. the cost of fully assembled units and
2. the cost of partially assembled units still in process at the end of that month
Step 1: Summarize the Flow of Physical Units
Physical unit’s express the physical flow of production. It is a measure of the units of production
that have been started and that may or may not be completed. The physical units’ summary,
tracks where the physical units came from and where they went. It does not consider the degree
of completion. The physical flow can be summarized as shown in the schedule below:
Beginning WIP -------------------------XX
Add: Units started ----------------------------- XX
Units to be account for------------------ XX
Units completed ------------------------ XX
Add: Ending WIP-------------------------------XX
Units accounted for ------------------ -- XX
Step 2: Compute Output in Terms of Equivalent Units (EU)
Equivalent units measure output in terms of the physical quantity of each of the input (factor
of production) that has been consumed when producing the units. Equivalent units are
computed using physical units. It disregard birr amount. Equivalent unit of each major
category of production inputs is calculated using the following formula:
Equivalent unit = Physical unit x Percentage of completion

For instance, the 225 partially assembled units in the above case are 100% complete with respect
to direct material. This means that the equivalent units in terms of direct material are 225 units.
but with respect to conversion cost, they are 60% complete, which means, the 225 partially
completed units are equivalent to 135 fully completed units (225x60%= 135 units)
Step 3: Summarize Total Cost to Account For (cost summary)
In this step, we add up all costs incurred in the period. For SNAP computer, the cost to
account for the month of February, 2008 is Br. 1,012,000 (Br.640, 000 + Br. 372,000 = Br.
1,012,000)
Step 4: Compute Equivalent Unit Cost
After computing equivalent units of partially completed units in terms of each cost category,
cost per equivalent unit can be computed using the following formula. This cost per
equivalent unit can be used to assign total cost incurred in the period to units completed and
units in work in process ending.
Cost per EU = Production cost
Equivalent units
Step 5: Assign Total Cost to Units Completed and Units in Ending WIP
In this step, we assign the total cost to account for; to units completed and transferred out and
to units in ending working process at the end of the month. The idea is to attach the Birr
amounts to the equivalent output units for direct material and conversion costs of units
completed and ending working process. Equivalent output units for each input are multiplied
by cost per equivalent unit both for units completed and ending work in process. After costs
have been assigned to units completed and units in work in process ending, the total cost
assigned should agree with the amount we have to account for. The following cost of
production report for SNAP computer summarizes the five steps discussed above for the
month of February, 2008.

(Step 1)
Flow of production Physical flow
Work in process beginning 0 (Step 2)
Units started in current period 400 Equivalent Units
Direct
Units to account for 400 Materials Conversion Costs
Units completed and transferred out 175 175 175
Work in process ending 225 225 135
Units accounted for 400
Work done in current period only
(Equivalent units) 400 310
(Step 3): Cost Summary
Br
Costs added during February Br. 1,012,000 640,000 Br 372,000
Divide by equivalent units ÷ 400 ÷ 310
Cost per equivalent units Br. 1,600 Br. 1,200
(Step 4):
Total cost to account for Br. 1,012,000
(Step 5) Assignment of cost:
 To completed and transferred units
(175 units) Br. 490,000 Br. 1,600×175 + Br. 1,200×175
To work in process ending (225
units) 522,000 Br. 1,600×225 + Br. 1,200×135
Total cost accounted for Br. 1,012,000

The cost of production per unit for the month of February is the sum of the cost per equivalent
unit for both direct material and conversion cost which is Br. 2,800 (Br. 1600 + Br. 1200). The
journal entries for SNAP computer for the month of February, 2008 are given below:
Work In process –
Assembly 640,000
Raw material control 640,000
(To record the use of direct materials in the production process)
Work In process –
Assembly 372,000
Various accounts 372,000
(To record the use of conversion costs in the production process)
Work In process – Finishing 490,000
Work in process - Assembly 490,000
(To record the transfer of completed products from assembly department to finishing)

Case 3: Process costing with some beginning and some ending work in process inventory.
In a production process, in addition to work in process ending, there might be some work in
process available at the beginning of the period. When this is the case, the five steps in the
preparation of cost of production report involve two additional inventory costing systems
(Weighted Average and FIFO methods).
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 they are from beginning work in process
or from work started during the current period) divided by the total equivalent units of work done
to date.
Illustration 3: At the beginning of March, 2008, SNAP computers had 225 units of partially
assembled computers in the assembly department. It started production of another 275 units in
March, 2008; data for assembly department for the month of March are:
 Physical units for March 2008
 WIP beginning------------------------------------ 225 unit
Direct material (100% complete)
Conversion cost (60% complete)
 Started during March ---------------------------- 275 unit
 Completed and transferred out -------------------- 400 unit
 WIP ending ----------------------------------------- 100 units
Direct material (100% complete)
Conversion cost (50% complete)
Total cost for March:
WIP beginning:
DM ------------------------Br.360, 000
CC-------------------------- 162,000 Br.522, 000
DM added during March ---------------------------- 396,000
CC added during March ------------------------------ 327,600
Total cost to account for --------------------------Br.1, 245,600

The cost of production report for Assembly department for the month of March using the five
steps is presented below under weighted Average method.

(Step 1)
Flow of production Physical flow
Work in process beginning 225 (Step 2)
Units started in current period 275 Equivalent Units
Direct
Units to account for 500 materials Conversion costs
Units completed and transferred out 400 400 400
Work in process ending 100 100 50
Units accounted for 500
Work done to date (Equivalent
units) 500 450
(Step 3) ; Cost summary
Work in process beginning Br. 522, 000 Br. 360, 000 Br. 162,000
Costs added during February 723,600 396,000 327,600
Total cost incurred to date Br. 756,000 Br. 489,600
Divide by equivalent units ÷ 500 ÷ 450
Cost per equivalent units Br 1,512 Br 1,088
(Step 4)
Total cost to account for Br. 1,245,600
(Step 5) Assignment of cost:
To completed and transferred units
(400 units) Br. 1,040,000 Br. 1,512×400 + Br. 1,088×400
To work in process ending
(100units) 205,600 Br. 1,512×100 + Br. 1,088×50
Total cost accounted for Br. 1,245,600

In the equivalent unit column of work done to date, there are 500 equivalent units of direct
materials and 450 units of conversion costs. All completed and transferred out units are 100%
complete as to both direct material and conversion cost because direct material is added at the
beginning of the assembly process and they are 100% complete with respect to conversion cost.
But units in WIP ending are 50% complete as to conversion cost, hence the equivalent unit of
WIP ending are 50 units (100x50%) with respect to conversion cost. In step 3, the cost per
equivalent unit is calculated by merging together the cost of beginning inventory and the
manufacturing cost of the period and dividing by equivalent units of work done to date. The
journal entry to recognize the consumption of raw material, conversion cost and transfer of
assembled computers from assembling to finishing department using weighted average costing
method is given below:
Work In process –
Assembly 396,000
Raw material control 396,000
(To record the use of direct materials in the production process)
Work In process –
Assembly 327,600
Various accounts 327,600
(To record the use of conversion cost in the production process)
Work In process – Finishing 1,040,000
Work in process -
Assembly 1,040,000
(To record the transfer of completed products from assembly department to finishing
department)

2. First In First Out (FIFO) Method: the first in first out process costing method 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 assigns the cost of equivalent
units worked on during the current period first to completed beginning inventory, next to started
and completed 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 the 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 units of work
done in the current period. In contrast, equivalent unit and cost per equivalent unit calculation
under the weighted average method merges units and costs in beginning inventory with units and
costs of work done in the current period. For SNAP computers, Under the FIFO method,
equivalent units of work done in March on the beginning work in process inventory equals 225
physical units times the percentage of work remaining to be done in march to complete these
units: 0% for direct materials, because beginning work in process is 100% complete with respect
to directs material last month and 40% (100%- 60%) for conversion costs, because beginning
work in process is 60% complete with respect to conversion costs last month. The results are
0(0%×225) equivalent units of work for direct materials and 90(40%×225) equivalent units of
work for conversion cost. The following is the cost of production report under FIFO method.

(Step 1)
Flow of production Physical flow
Work in process beginning 225 (Step 2)
Units started in current period 275 Equivalent Units
Direct Conversion
Units to account for 500 Materials Costs
Units completed and transferred out:
From beginning work in process 225 0 90
Started and completed 175 175 175
Work in process ending 100 100 50
Units accounted for 500
Work done in current period only 275 315
(Step 3): Cost summary
Work in process beginning Br. 522, 000 Incurred Last Month
Costs added during March 723,600 Br. 396,000 Br. 327,600
Divide by equivalent units ÷ 275 ÷ 315
Cost per equivalent units Br. 1,440 Br. 1,040
(Step 4)
Total cost to account for Br. 1,245,600
(Step 5) Assignment of cost:
To completed units (400 units)
Work In process beginning (225
units) Br. 522, 000 -------------------------------------
Cost added to beginning WIP in the
current month 93600 0×Br. 1,440 + 90×Br. 1,040
Total from beginning Inventory Br. 615,600
Started and completed 434000 175×Br. 1,440 + 175×Br. 1,040
Total cost of units completed Br. 1,049,600
To work in process ending
(100units) 196,000 Br. 1,440×100 + Br. 1,040×50
Total cost accounted for Br. 1,245,600

The equivalent unit of work done on the 175 physical unit started and completed equals 175 units
times 100% for both direct material and conversion cost, because all works on these units is done
in the current period. The equivalent units of work done on the 100 units of ending work in
process equals 100 physical units times 100% for direct materials(because all direct materials for
these units are added in the current period) and 50% for conversion costs because only 50% of
conversion cost work on these units is done in the current period.
Computation of cost per equivalent units for work done in the current period is only based on
direct material and conversion costs of the current period. Under FIFO method, cost of work
done in the current period is assigned, First to the additional work done to complete the
beginning work in process, then to work done on units started and completed during the current
period, and finally to ending work in process. The journal entry to recognize the consumption of
raw material, conversion cost and transfer of assembled computers from assembling to finishing
department using FIFO costing method is given below;
Work In process –
Assembly 396,000
Raw material control 396,000
(To record the use of direct materials in the production process)
Work In process –
Assembly 327,600
Various accounts 327,600
To record the use of conversion cost in the production process)
Work In process – Finishing 1,049,000
Work in process -
Assembly 1,049,000
(To record the transfer of completed products from assembly department to finishing
department)
Managers use information from process costing system to aid them in pricing and product mix
decision and to provide them with feedback about their performance. The weighted average
method merges units’ costs from different accounting periods obscuring period to period
comparison. Advantages of the weighted method however, are its relative computational
simplicity and its reporting of a more-representative average unit cost when inputs prices
fluctuate markedly from month to month. FIFO provides managers with information about
changes in cost per unit from one period to the next. Managers can use this information to adjust
selling price and evaluate performance in the current period. By focusing on work done and cost
of work done during the current period, the FIFO method provides useful information for
planning and control purpose.
4.2. Transferred in Cost
Up to now, we have seen how to prepare cost of production report for the first department in
SNAP computer, how do we accumulate cost in the second department?
Many process-costing systems have two or more departments or processes in the production
cycle. As units move from department to department, the related cost is also transferred by
monthly journal entries. If standard costs are used, accounting for such transfers is simple.
However, if the weighted-average or FIFO method is used, the accounting can become more
complex. We now extend our SNAP computer example to the finishing department. As the
assembly process is completed, the assembly department of SNAP computer immediately
transfers each unit to its finishing department. Here, each unit will be loaded with appropriate
office and application soft wares and the units receive additional direct material such as crating
and other packing materials at the end of the process, to prepare the units for shipment.
Conversion cost is added evenly during period to the finishing department’s process. As units are
completed in finishing department, they are immediately transferred to finished goods and taken
to warehouse. The following diagram shows this fact diagrammatically.
Conversion cost added
evenly during the process

WIP
Assembly Finishing
Transfer
Department Department

Direct material
added at the end
Transferred-in costs (also called previous departments’ cost) are the cost incurred in the previous
process in the production cycle. That is, as the units move from one department to the next, their
costs are transferred with them. Computations of finishing department costs consist of
transferred-in costs as well as the direct materials and conversion costs added in finishing
department. Transferred-in cost is treated as if it is a separate type of direct material added at the
beginning of the process. When successive departments are involved, transferred units from one
 department become all or part of the direct materials of the next department; however, they are
called transferred-in costs not direct materials costs.
Transferred-In costs and the Weighted-Average Method
To examine the weighted-average process-costing method with transferred-in costs, we use the
five-step procedure described earlier to assign costs of the finishing department to units
completed and transferred out and to units in ending work in process. Let us assume the
following data for SNAP computer for the month of April, 2008.
Illustration 4: The assembly department of SNAP computer transfers assembled units to its
finishing department. Here, the units receive additional direct material such as crating and other
packing material to prepare the units for sell at the end of the process. Conversion costs are
added evenly during the process. As units are completed in finishing department, they are
immediately transferred to finished goods.
Physical units
WIP beginning ----------------------------- 240 units
Transferred in Cost (100% complete)
Direct material (0% complete)
Conversion cost (62.5% complete)
Transferred in during April -------------- 400 unit
Completed during April ------------------------- 440 unit
WIP ending ---------------------------------------200 units
Transferred in Cost (100% complete)
Direct material (0% complete)
Conversion cost (80% complete
Cost for finishing department in April:
WIP beginning
Transferred In cost --------------------------Br.672, 000
Direct materials ---------------------------------- 0
Conversion cost ---------------------------- 360,000
Transferred in during April:
Under WA method -------------------------------Br.1, 040,000
Under FIFO method ----------------------------- 1, 049,600
Direct material cost added during April --------- -- -- 13,200
Conversion cost during April ----------------------- --- 48,600
The production report for the month of April for finishing department can be prepared under
weighted average method as follow:

(Step 1)
Flow of production Physical flow
Work in process beginning 240
Units started in current period 400 (Step 2)
 Equivalent Units
Transferred in Direct Conversio
Units to account for 640 cost material n costs
Units completed and transferred
out: 440 440 440 440
Work in process ending 200 200 0 160
Units accounted for 640 - - -
Work done in current period 640
only 440 600
(Step 3): Cost summary
Br. 672,000 Br.
Work in process beginning Br. 1,032,000 0 360,000
Costs added during March 1,101,800 1, 040,000 13,200 48,600
Total cost Br. 1,712,000 Br. 13,200 408,600
Divide by equivalent units ÷ 640 ÷ 440 ÷ 600
Cost per equivalent units Br. 2,675 Br. 30 Br. 681
(Step 4)
Total cost to account for Br.2,133,800
(Step 5) Assignment of cost:
To completed units (440 units) Br.1,489,840 (440×2,675) + (440×30) + (440×681)
To work in process ending (200
units) 643,960 (200×2675) + (0×30) + (160×681)
Total cost accounted for Br. 2,133,800

The computations are the same as the calculations of equivalent units under the weighted-
average method for the assembly department, but here we also have transferred-in costs as
another input. The units, of course are fully completed as to transferred-in costs carried forward
from the previous process. Direct material costs have a zero degree of completion in both the
beginning and ending work-in process inventories because, in finishing department direct
materials are introduced at the end of the process. Beginning work in process and work done in
the current period are combined for purposes of computing equivalent-unit costs for transferred-
in costs, direct material costs and conversion costs. The necessary journal entries for the month
of April in the finishing department are given as follows:
Work In process – Finishing 13,200
Raw material control 13,200
(To record the use of direct materials in the production process)
Work In process – Finishing 48,600
Various accounts 48,600
To record the use of conversion cost in the production process)
Finished Goods 1,489,840
 Work in process – Finishing 1,489,840
(To record the transfer of completed products from finishing department to warehouse)

2. Transferred-In Costs and the FIFO Method:

The cost of production report for finishing department for the month of April can be prepared
using FIFO method as follows:

(Step 1)
Flow of production Physical flow
Work in process beginning 240
(Step 2)
Units started in current period 400 Equivalent Units
Transferred Direct
in cost materia Conversi
Units to account for 640 l on costs
Units completed
From WIP Beginning 240 0 240 90
Started and completed 200 200 200 200
WIP Ending 200 200 0 160
Units accounted for 640 - - -
Work done in current period only 400 440 450
(Step 3): Cost summary
Work in process beginning Br. 1,032,000 Incurred last month
Br. 1, 049,600 Br.
Costs added during April 1,111,400 13,200 48,600
Divide by equivalent units ÷ 400 ÷ 440 ÷ 450
Cost per equivalent units Br. 2,624 Br. 30 Br. 108
(Step 4)
Total cost to account for 2,143,400
(Step 5) Assignment of cost:
To completed units (440 units)
From WIP Beginning (240 units) Br.1,032,000
Cost added to WIP Beginning 16,920 (0×2,624) + (240×30) + (90×108)
Total from beginning Inventory Br. 1,048,920
Started and completed 552,400 (200×2,624)+(200×30)+ (200×108)
Total cost of units completed Br. 1,601,320
To WIP ending (200 units) 542,080 (200×2,624) + (0×30) + (160×108)
Total cost accounted for Br.2,143,400

To examine the FIFO process-costing method with transferred-in costs, we again use the five
step procedure. Other than considering transferred-in costs in the computations of equivalent
units, the remaining are the same as under the weighted average method for the assembly
department. The necessary journal entries for the month of April in the finishing department are
given as follows:
Work In process – Finishing 13,200
Raw material control 13,200
(To record the use of direct materials in the production process)
Work In process – Finishing 48,600
Various accounts 48,600
To record the use of conversion cost in the production process)
Finished Goods 1,601,320
Work in process - Assembly 1,601,320
(To record the transfer of completed products from finishing department to warehouse)

4.3. Process Costing System and Spoilage

Up to now we have assumed as if there are no spoiled units in the production process, what if
there are spoiled products in the production process?
Spoilage is units of production – whether fully or partially completed – that do not meet the
specifications required by customers for good units and that are discarded or sold at reduced
price. Some examples of spoilage are defective shirts, jeans, shoes, and carpeting sold as
“second hand,” or defective aluminum cans sold to aluminum manufacturers for remolding to
produce other aluminum products. Accounting for spoilage aims to determine the magnitude of
spoilage costs and to distinguish between costs of normal and abnormal spoilage
Normal spoilage is spoilage inherent in a particular production process that arises even under
efficient operating conditions. Management decides the spoilage rate it considers normal
depending on the production process. Costs of normal spoilage are typically included as a
component of the costs of good units manufactured because good units cannot be made without
also making some units that are spoiled.
Abnormal spoilage is spoilage that is not inherent in a particular production process and would
not arise under efficient operating conditions. Abnormal spoilage is usually regarded as
avoidable and controllable. Line operators and other plant personnel generally can decrease or
eliminate abnormal spoilage by identifying the reasons for machine breakdowns, operator errors,
and the like, and by taking steps to prevent their recurrence. To highlight the effect of abnormal
spoilage costs, companies calculate the units of abnormal spoilage and record the cost in the loss
from abnormal spoilage account, which appears as a separate line time in the income statement.
Issues about accounting for spoilage arise in both process – costing and job – costing systems.
We first present the accounting for spoilage in process – costing systems using illustrative
example
Illustration 5: ABC Company manufactures a recycling container in its forming department.
Direct materials are added at the beginning of the production process. Some units of this product
are spoiled as a result of defects, which are detectable only upon inspection of finished units.
Normally, spoiled units are 10% of the finished output of good units. That is, for every 10 good
units produced, there is 1 unit of normal spoilage. Summary data for July 2009 are:
Physical Direct Conversion Total Costs
Units (1) Materials Costs (3)
Work in process, beginning inventory (July 1) 1,500 Br.12,000 Br.9,000 Br.21,000
Degree of completion of beginning work in 100% 60%
process
Started during July 8,500
Good units completed and transferred out in July 7,000
Work in process, ending inventory (July 31) 2,000
Degree of completion of ending work in process 100% 50%
Total costs added during July Br.76,500 Br.89,100 Br.165,600
Normal spoilage as a percentage of good units 10%
Degree of completion of normal spoilage 100% 100%
Degree of completion of abnormal spoilage 100% 100%
The five – step procedure for process costing used in the pervious sub section need only slight
modification to accommodate spoilage.
Step 1: Summarize the flow of Physical units of Output. Identify units of both normal and
abnormal spoilage.
Total spoilage = (WIP Beginning + Units started) _ (Good units completed + WIP End)
= (1,500 + 8,500) – (7, 000 + 2,000)
= 10,000 – 9,000 = 1,000 units
Recall that normal spoilage is 10% of good output at ABC Corporation. Therefore, normal
spoilage = 10% of the 7,000 units of good output = 700 units.
Abnormal Spoilage = Total spoilage – Normal spoilage
 = 1,000 units – 700 units = 300 units
Step 2: Compute output in terms of equivalent units. Compute equivalent unit for spoilage in
the same way we compute equivalent units for good units. All spoiled units are included in the
computation of output units. Because ABC’s inspection point is at the completion of production,
the same amount of work will have been done on each spoiled and each completed good unit.
Step 3: Compute cost per Equivalent unit.
Step 4: Summarize Total costs to Account for. The total costs to account for are all the costs
debited to work in process.
Step 5: Assign total Costs to units Completed, to Spoiled Units, and to units in ending work in
process. This step now includes computation of the cost of spoiled units and the cost of good
units. We will illustrate these five steps of process costing for the weighted – average and FIFO
methods using the example of ABC corporation.
1. Weighted – Average Method and Spoilage

(Step 1)
Physical
Flow of production flow
Work in process beginning 1,500 (Step 2)
Units started in current period 8,500 Equivalent Units
Direct
Units to account for 10,000 materials Conversion costs
Good units completed 7,000 7000 7000
Normal spoilage 700 700 700
Abnormal spoilage 300 300 300
Work in process ending 2,000 2,000 1,000
Units accounted for 10,000
Work done to date (Equivalent units) 10,000 9,000
(Step 3) ; Cost summary
Work in process beginning Br.21,000 Br.12,000 Br. 9,000
Costs added during February 165,600 76,500 89,100
Total cost incurred to date Br.88,500 Br.98,100
Divide by equivalent units ÷ 10,000 ÷ 9,000
Cost per equivalent units Br. 8.85 Br. 10.90
(Step 4)
Total cost to account for Br. 186,600
(Step 5) Assignment of cost:
To Good units completed (7000 units) Br. 138,250 Br 8.85×7000 + Br 10.90×7000
Normal spoilage 13,825 Br 8.85×700 + Br 10.90×700
Total cost of good units Br. 152,075
Abnormal spoilage 5,925 Br 8.85×300 + Br 10.90×300
To work in process ending (2000 units) 28,600 Br 8.85×2000 + Br 10.90×1000
Total cost accounted for Br. 186,600
The journal entry to be recorded are given below:
Work In process – Forming 76,500
Raw material control 76,500
(To record the use of direct materials in the production process)
Work In process – Forming 89,100
Various accounts 89,100
To record the use of conversion cost in the production process)
Finished Goods 152,075
Work in process - forming 152,075
(To record the transfer of completed products from forming
department to warehouse)
Loss from abnormal spoilage 5,925
Work in process - forming 5,925
(To record the loss from abnormal spoilage)
2. FIFO Method & Spoilage

(Step 1)
Flow of production Physical flow
Work in process beginning 1,500 (Step 2)
Units started in current period 8,500 Equivalent Units
Direct Conversion
Units to account for 10,000 materials costs
Good units completed :
From WIP Beg. 1,500 0 600
Started and completed 5,500 5,500 5,500
Normal spoilage 700 700 700
Abnormal spoilage 300 300 300
Work in process ending 2,000 2,000 1,000
Units accounted for 10,000
Work done in the current period 8,500 8,100
(Step 3) ; Cost summary
Work in process beginning Br.21,000 ----------------- --------------------
Costs added during February 165,600 76,500 89,100
Divide by equivalent units ÷ 8,500 ÷ 8,100
Cost per equivalent units Br. 9 Br. 11
(Step 4)
Total cost to account for Br.186,600
(Step 5) Assignment of cost:
Good units completed (7000 units)
WIP Beginning (1,500 units) 21,000
Cost added during the period 6,600 Br. 9×0+ Br. 11×600
Total from beginning inventory 27,600
 Started and completed (5,500 units) 110,000 Br. 9×5,500+ Br. 11×5,500
Normal spoilage (700 units) 14,000 Br. 9×700+ Br. 11×700
Total cost of good units completed Br.151,600
Abnormal spoilage 6,000 Br. 9×300 + Br. 11×300
To work in process ending (2000 units) 29,000 Br. 9×2000 + Br. 11×1000
Total cost accounted for Br.186,600
The journal entry for recording consumption of raw material and conversion cost is the same as
in the weighted average method but the remaining journal entries are slightly different & are
given as follows:
Finished Goods 151,160
Work in process - forming 151,160
(To record the transfer of completed products from finishing
department to warehouse)
Loss from abnormal spoilage 6,000
Work in process - forming 6,000
(To record the loss from abnormal spoilage)
Note that Costs of abnormal spoilage are separately accounted for as losses of the accounting
period in which they are detected. However, the cost of normal spoilage is added to the costs of
good units completed in the period.
4.4. Job Costing System and Spoilage, Rework & Scrap
Dear learner, how do we treat spoilage, rework and scraps in job order costing system?
The concepts of normal and abnormal spoilage can also apply to job order costing systems.
Abnormal spoilage is separately identified so companies can work to eliminate it altogether.
Costs of abnormal spoilage are not considered to be inventorable cost and are written off as costs
of the accounting period in which the abnormal spoilage is detected. Normal spoilage costs in
job – costing systems – as in process – costing systems – are inventorable costs, although
increasingly companies are tolerating only small amounts of spoilage as normal. When
assigning costs, job costing systems generally distinguish normal spoilage attributable to a
specific job from normal spoilage common to all jobs. We describe accounting for spoilage in
job costing using the following example.
Illustration 5.5: In the BOING Machine Shop, 5 aircraft parts out of a job lot of 50 aircraft
parts are spoiled. Costs assigned prior to the inspection point are Br. 2, 000 per part. Our
presentation here and in subsequent sections focuses on how the Br. 2, 000 cost per part is
accounted for. When the spoilage is detected, the spoiled goods are inventoried at Br. 600 per
part which is the net disposal value.
Normal Spoilage attributable to a specific job: when normal spoilage occurs because of the
specifications of a particular job, that job bears the cost of the spoilage minus the disposal value
of the spoilage. The journal entry to recognize disposal value is:
Materials Control - spoiled goods (5  Br. 600) 3,000
Work-in-Process Control (specific job) 3,000
Note, the Work – in – process Control (specific job) has already been debited (charged) Br.10,
000 for the spoiled parts (5 spoiled parts  Br.2, 000 per part). The net cost of normal spoilage =
Br. 7, 000 (Br.10, 000 - Br.3, 000), which is an additional cost of the 45(50 – 5) good units
produced. Therefore, total cost of the 45 good units is Br.97, 000: Br.90, 000 (45 units  Br.2,
000 per unit) incurred to produce the good units plus the Br.7, 000 net cost of normal spoilage.
Cost per good unit is Br.2, 155.56 (97,000  45 good units).
Normal spoilage common to all jobs: In some cases, spoilage may be considered a normal
characteristic of the production process. The spoilage inherent in production will of course,
occur when a specific job is being worked on. But the spoilage is not attributable to, and hence
is not charged directly to, the specific job. Instead, the spoilage is allocated indirectly to the job
as manufacturing overhead because the spoilage is common to all jobs. The journal entry is:
Materials Control -spoiled goods (5 Br. 600) 3,000
MOH control - normal spoilage (Br.10, 000 - Br. 3, 000) 7,000
Work-in-Process control (specific job): 5 unit  Br.2, 000 10,000
When normal spoilage is common to all jobs, the budgeted manufacturing overhead rate includes
a provision for normal spoilage cost. Normal spoilage cost is spread, through overhead
allocation, over all jobs rather than allocated to a specific job.
Abnormal Spoilage: If the spoilage is abnormal, the net loss is charged to the loss from
abnormal spoilage account. Unlike normal spoilage costs, abnormal spoilage costs are not
included as a part of the cost of good units produced. Total cost of the 45 good units is
Br.90,000 (45 units  Br.2,000 per unit). Cost per good unit is Br.2,000 (Br.90,000  45 good
units).
Materials Control - spoiled goods (5  Br.600) 3,000
Loss from Abnormal Spoilage: (Br.10,000 - Br.3,000) 7,000
Work – in- process control (specific job): 5 units  Br.2,000 10,000
Job costing and Rework: Rework is units of production that are inspected, determined to be
unacceptable, repaired, and sold as acceptable finished goods. We again distinguish (1) normal
rework attributable to a specific job, (2) normal rework common to all jobs, and (3) abnormal
rework.
1. Normal Rework attributable to specific job: Consider the BOING Machine shop data in
illustration above; assume the five spoiled parts are reworked. The journal entry for the
Br.10,000 of total costs (the details of these costs are assumed) assigned to the five spoiled units
before considering rework costs is:
Work-in-Process Control (specific job) 10,000
Materials Control 4,000
Wages payable control 4,000
Manufacturing Overhead Allocated 2,000
2. Normal rework common to all jobs: When rework is normal and not attributable to a
specific job, the costs of rework are charged to manufacturing overhead and are spread, through
overhead allocation, over all jobs.
Manufacturing overhead control (rework costs) 10,000
Materials Control 4,000
Wage Payable Control 4,000
Manufacturing overhead allocated 2,000
3. Abnormal rework: If the rework is abnormal, it is recorded by charging abnormal rework to a
loss account.
Loss from Abnormal Rework 10,000
Materials Control 4,000
Wages Payable Control 4,000
Manufacturing Overhead Allocated 2,000
Accounting for rework in a process – costing system also requires abnormal rework to be
distinguished from normal rework. Process costing system accounts for abnormal rework in the
same way as job order costing. Accounting for normal rework follows the accounting described
for normal rework common to all jobs (units) because masses of identical or similar units are
being manufactured.
Accounting for Scrap: Scrap is residual material that results from manufacturing a product; it
has low total sales value compared with the total sales value of the product. No distinction is
made between normal and abnormal scrap because no cost is assigned to scrap. The only
distinction made is between scrap attributable to a specific job and scrap common to all jobs.
When should the value of scrap be recognized in the accounting records – at the time scrap is
produced or at the time scrap is sold? How should revenues from scrap be accounted for? To
illustrate this, we extend the case of BOING machine shop. Assume the manufacture of aircraft
parts generates scrap and that the scrap from a job has a net sales value of Br.900.
1. Recognizing Scrap at the Time of Its Sale
When the Birr amount of the scrap is immaterial, the simplest accounting is to record the
physical quantity of scrap returned to the storeroom and to regard scrap sales as a separate line
item in the income statement. In this case, the only journal entry is:
Sales of Scrap: Cash or Accounts Receivable 900
Scrap Revenues 900
When the Birr amount of scrap is material and the scrap is sold quickly after it is produced, the
accounting depends on whether the scrap is attributable to a specific job or is common to all jobs.
Scrap Attributable to a Specific Job: Job-costing systems sometimes trace scrap revenues to
the jobs that yielded the scrap. This method is used only when the tracing can be done in an
economically feasible way. For example, BOING Machine Shop and its customers may reach an
agreement that provides for charging specific jobs with all rework or spoilage costs and then
crediting these jobs with all scrap revenues that arise from the jobs. The journal entry is:
Scrap returned to storeroom: No journal entry.
Sale of scrap: Cash or Accounts Receivable 900
Work-in-Process Control 900
Unlike spoilage and rework, there is not cost assigned to the scrap, so no distinction is made
between normal and abnormal scrap. All scrap revenues, whatever the amount, are credited to
the specific job. Scrap revenues reduce the costs of the job. The journal entry for Scrap common
to all jobs is given as follows
Scrap returned to storeroom: No journal entry.
Sale of Scrap: Cash or accounts receivable 900
MOH control 900
2. Recognizing Scrap at the Time of its Production
Our Preceding illustrations assume that scrap returned to the storeroom is sold quickly, is not
assigned an inventory cost figure. Sometimes, as in the case with edges of molded plastic parts,
the value of scrap is not immaterial, and the time between storing it and selling reusing it can be
long. In these situations, the company assigns an inventory cost to scrap at a conservative
estimate of its net realizable value so that production costs and related scrap revenues are
recognized in the same accounting period. Some companies tend to delay sales scrap until its
market price is considered attractive. Volatile price fluctuations are typical for scrap metal. In
these cases, it’s not easy to determine some “reasonable inventory value.”
Scrap attributable to a specific job: The journal entry in the BOING example is:
Scrap retuned to storeroom: Materials Control 900
Work-in-process control 900
Scrap common to all jobs: The journal entry in this case is:
Scrap returned to storeroom: Materials Control 900
Manufacturing Overhead Control 900
Observe that the materials control account is debited in place of cash or account receivable.
When the scrap is sold, the journal entry is:
Sale of Scrap: Cash or Accounts Receivable 900
Materials Control 900
Scrap is sometimes reused as direct material rather than sold as scrap. In this case, materials
control is debited at its estimated net realizable value when the scrap is reused. For example, the
entries when the scrap is common to all jobs are:
Scrap returned to storeroom: Materials Control 900
Manufacturing overhead control 900
Reuse of scrap: Work-in-process control 900
Materials Control 900
Accounting for scrap under process costing is like the accounting under job costing when scrap
is common to all jobs. That is because; the scrap in process costing is common to the
manufacture of mass of identical or similar units.