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Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An

Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
Chapter 5
Process costing and
operation costing



Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
2
Product costing systems
 Job costing and process costing are two
extremes of the continuum of conventional
product costing systems
 Job costing systems accumulate the costs
of each job
 Process costing systems accumulate the
cost of each process, then average these
costs across all units produced
 Many businesses use a combination of job
and process costing—hybrid costing
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
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Process costing
 Used by businesses that mass-produce one
product or a small range of almost identical
products
Involves a number of processes that are
performed repetitively
Used by oil refineries, food processors,
manufactures of tobacco, chemicals and paper
Also used by producers of repetitive services—
routine processing of cheques in banks and
delivery of standard letters in Australia Post
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
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Process costing
 Two main steps
Estimate the cost of the production process
Calculate the average cost per unit by dividing
the cost of the process by the number of units
produced
 Process costing can be used in situations
where there is no opening or closing WIP
inventory (see Chapter 4)
 More complex process costing takes place
where there is WIP inventory
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
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Process costing with WIP
 WIP inventory
Product is not complete at the beginning or end
of the month
 Production costs will relate to
Units started in the previous period and
completed in current period (beginning WIP)
Units started and completed in the period
Units that are incomplete at the end of the
period (ending WIP)
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
6
Process costing with WIP
 Partially-completed goods at the beginning
or end of the period change the way we
allocate production costs
 Equivalent units
The amount of production inputs that have been
applied to the physical units in production
Physical units are all units currently in
production whether complete or incomplete
WIP inventory needs to be converted to
equivalent units

continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
7
Process costing with WIP
 Labour and overhead are incurred at
different stages of the production process
 Units in ending WIP are generally at
different stages of completion in respect to
material and labour
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
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Calculation of equivalent
units for ending WIP
 If WIP is 50% complete for 10,000 litres on
hand at the end of the month:
100% complete for direct materials, which are
added at the start of the process  10,000
equivalent units of material
50% complete for conversion costs, assuming
that conversion costs occur uniformly across the
production process  5,000 equivalent units of
conversion cost
Equivalent units are used to calculated unit
costs when there is WIP

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
9
The effect of beginning
and ending WIP
 Four steps in process costing
1. Analyse the physical flow of units
2. Calculate the equivalent units
3. Calculate the unit costs
4. Analyse the total costs
 Product are costed using either
 Weighted average method
 First in first out (FIFO) method

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
10
Process costing using the
weighted average method
 Step one: analyse the physical flow of units

Physical units
in beginning
WIP
Physical
units
started
Physical units
completed and
transferred out
Physical units
in ending WIP
=
-
+
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
11
Process costing using the
weighted average method
 Step two: calculate the equivalent units
The equivalent units in beginning WIP are not
identified separately, a key feature of weighted
average cost method

Equivalent units
completed and
transferred out
Equivalent units
in ending WIP
Total equivalent
units
+
=
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
12
Process costing using the
weighted average method
 Step three: calculate the unit costs
The cost per equivalent unit for direct material
is the total direct material (conversion costs)
costs divided by the total equivalent units
Under the weighted average method the cost
per equivalent unit is based on the total costs
incurred, including the cost of beginning WIP
 Step four: analyse the costs

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
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Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
14
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
15
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
16
Process costing using the
FIFO method
 It is assumed that the oldest inventory is
completed before new production
commences
 Step one: analyse the physical flow of units
Identical to the weighted average method
 Step two: calculate the equivalent units
Under FIFO, equivalent units in opening WIP
are subtracted from total equivalent units to
give new units of production
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
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Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
18
Process costing using the
FIFO method
 Step three: calculate the unit costs
Cost per equivalent unit is calculated for direct
material (or conversion cost) by dividing the
direct material cost incurred during the current
month only by the new equivalent units added
during the current month only.
 Step four: analyse total costs
Assumes that the units in beginning inventory
are completed and transferred out first
Cost of the beginning WIP are not mixed with
those incurred during current month
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
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Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
20
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
21
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
22
Comparison of weighted
average vs. FIFO
 Key difference is the treatment of the
beginning WIP
Under weighted average costs, cost of
beginning WIP and equivalent units of work
done on it are included in the calculation of the
cost per equivalent unit
Under FIFO, cost per equivalent unit is based
only on costs incurred in the current month
Weighted average is more commonly used
Simpler and WIP inventory may be negligible
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
23
Process costing and spoilage
 Spoilage cost: the cost of defective product
and wasted resources that cannot be
recovered by rework or recycling
 When spoilage occurred there are three forms
of output
Units completed and transferred out
Spoiled units, and
Unfinished units remaining in WIP
 Spoiled units are costed using cost per
equivalent unit along with other two outputs
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
24
Process costing and spoilage
 Spoilage is accounted for depending on
whether it is normal or abnormal
 Normal spoilage: inherent in the production
process and occurs even under efficient
operating conditions
Included as part of the cost of good units
completed
 Abnormal spoilage: should not occur under
efficient operating conditions
Cost of abnormal spoilage are expensed
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
25
Operation costing
 Some businesses have repetitive production
processes, but produce a narrow range of
products that differ in some significant
aspects
 In batch manufacturing processes,
individual product lines are produced in
large batches and require specific
combinations of direct materials and a
specific sequence of production processes
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
26
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
27
Operation costing
 Hybrid costing has features of both job
costing and process costing
 Operation costing is used to estimate
product costs in a batch manufacturing
environment
Direct costs are assigned to individual batches
—a job costing approach
Conversion costs are accumulated by
department—a process costing approach
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
28
Other issues in process
costing
 Standard costs are more likely to be used
that actual costs
 Process costing and operation costs are
consistent with concepts of responsibility
accounting
Processes or operations are usually performance
in different departments, and
Departmental managers may be held
responsible for the department’s costs and
output produced
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
29
Other issues in process
costing
 A pre-determined overhead rate may be
used in process costing and a pre-
determined conversion cost rate in
operation costing
 Production units are usually used as the
cost driver in process costing and operation
costing
Inputs may be used as cost drivers in operation
costing
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
30
Other issues in process
costing
 The percentage of completion is difficult to
determine and is often only a rough
estimate
 In service firms, some routine repetitive or
similar services can be costing using
process or operation costing