Process Cost Systems: Principles of Managerial Accounting

Process Cost Systems
11e
Principles of Managerial Accounting
Chapter 3
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
Reeve Warren Duchac
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objectives
1. Describe process cost systems.
2. Prepare a cost of production report.
3. Journalize entries for transactions using a process
cost system.
4. Describe and illustrate the use of cost of
production reports for decision making.
5. Compare just-in-time processing with traditional
manufacturing processing.
Learning Objective 1
Describe process
cost systems.
LO 1
Comparing Job Order and Process Cost
 Uses perpetual inventory system for materials,

work in process, and finished goods.
 Provides useful product cost information for
decision making.
LO 1
Process Cost System

 A process manufacturer produces products that
are indistinguishable from each other using a
continuous production process.
 The cost accounting system used by process
manufacturers is called the process cost system.
LO 1
Company
LO 1
 Process and job order cost systems are similar in

that each system:
 Records and summarizes product costs.
 Classifies product costs as direct materials, direct
labor, and factory overhead.
 Allocates factory overhead costs to products.
(continued)
LO 1
 Uses perpetual inventory system for materials, work

in process, and finished goods.
 Provides useful product cost information for decision
making.
LO 1
(continued)
LO 1
LO 1
 Process cost systems are used to manufacture

homogeneous products. Examples are:
 Tennis balls
 Motor oil
 Candy bars
 Soft drinks
LO 1
 In contrast, job cost systems are used to

manufacture unique products or provide unique
services. Examples are:
 Custom-built homes
 Landscape design services
 Custom cabinets
 Airplanes
EE 3-1
LO 1
Cost Flows for a Process Manufacturer
LO 1
Cost Flows for a Process Manufacturer FD
Materials
a. Purchased
a.a. The
Thecost
costof
ofmaterials
materialspurchased
purchased
isisrecorded
recordedin
inthe
theMaterials
Materials
account.
account.
(continued)
LO 1
Work in Process–
Materials Mixing Department
a. Purchased Direct b. Direct
materials materials
b.
b.The
Thecost
costof
ofdirect
directmaterials
materials Work in Process–
used
usedby
bythe
theMixing
Mixingand
and Packaging Department
Packaging
Packagingdepartments
departmentsisis
recorded b. Direct
recordedin
inthe
theWork
Workinin
Process
Processaccounts
accountsforforeach
each materials
department.
department.
(continued)
LO 1
Work in Process–
Mixing Department
c. Direct
labor
c.c.The
Work in Process–
Thecost
costof
ofdirect
directlabor
laborused
used Packaging Department
by
bythe
theMixing
Mixingand
andPackaging
Packaging
departments
departmentsisisrecorded
recordedininthe
the c. Direct
Work
WorkininProcess
Processaccounts
accountsfor
for labor
each department.
each department.
(continued)
LO 1
Factory Overhead–
Materials Mixing Department
Indirect d. Indirect
materials materials
Factory Overhead–
d.
d. The
Thecost
costof
ofindirect
indirectmaterials
materials
Packaging Department
is
isrecorded
recordedininthe
theFactory
Factory d. Indirect
Overhead
Overheadaccounts
accountsforforeach
each materials
department.
department.
(continued)
LO 1
Factory Overhead–
Mixing Department
d. Depreciation
of factory
machinery
Factory Overhead–
d.
d. Depreciation
Depreciationfor
foreach
each Packaging Department
department
departmentisisrecorded,
recorded,and
and
its
itsrelated
relatedAccumulated
Accumulated d. Depreciation
Depreciation
Depreciationaccount
accountisis of factory
credited.
credited. machinery
(continued)
LO 1
Factory Overhead–
Mixing Department
d. Utilities
Factory Overhead–
d.
d. Other
Otherfactory
factoryoverhead
overheadcosts,
costs,
such
suchasasutilities
utilitiesand
andindirect
indirect d. Utilities
labor,
labor,are
arerecorded.
recorded.
(continued)
LO 1
Factory Overhead–
Mixing Department
d. Factory
overhead
incurred
Factory Overhead–
d.
d. In
InExhibit
Exhibit3,3,these
theseitems
itemsare
are
combined
combinedas asfactory
factoryoverhead
overhead d. Factory
incurred.
incurred. overhead
incurred
(continued)
LO 1
Work in Process– Factory Overhead–

Mixing Department Mixing Department
b. Direct d. Factory e. Factory
materials overhead overhead
incurred applied
c. Direct
labor
e. Factory
overhead
applied
e.e. The
Thefactory
factoryoverhead
overheadincurred
incurredin
inthe
the
Mixing
MixingDepartment
Departmentis
isapplied
appliedto
tothe
the
Work
WorkininProcess—Mixing
Process—MixingDept.
Dept.account.
account.
(continued)
LO 1
Work in Process– Factory Overhead–

Packaging Department Packaging Department
b. Direct d. Factory e. Factory
materials overhead overhead
incurred applied
c. Direct
labor
e. Factory
overhead
applied
e.e. The
Thefactory
factoryoverhead
overheadincurred
incurredininthe
the
Packaging
PackagingDepartment
Departmentisisapplied
appliedtotothe
the
Work
WorkininProcess—Packaging
Process—PackagingDept.Dept.account.
account.
(continued)
LO 1
Work in Process– Work in Process–

Mixing Department Packaging Department
b. Direct f. Costs of b. Direct
materials units materials
transferred
c. Direct c. Direct labor
out
labor e. Factory
e. Factory overhead
overhead applied
applied f. Costs of
f.f. The cost of units completed in the units trans-
The cost of units completed in the
Mixing ferred in
MixingDepartment
Departmentis istransferred
transferredtotothe
the
Packaging
PackagingDepartment.
Department. (continued)
LO 1
Work in Process–
Packaging Department Finished Goods
b. Direct g. Costs of g. Costs of
materials units units
transferred transferred
c. Direct labor
out in
e. Factory
overhead
applied g.
g. The
Thecost
costof
ofunits
unitscompleted
completedin
inthe
the
Packaging
PackagingDepartment
Departmentis
istransferred
transferredto
to
f. Costs of Finished
units trans- FinishedGoods.
Goods.
ferred in
(continued)
LO 1
Finished Goods Cost of Goods Sold

g. Costs of h. Cost of h. Cost of
units goods sold goods sold
transferred
in
h.
h. The
Thecost
costofofunits
unitssold
soldis
is
transferred
transferredto
toCost
CostofofGoods
Goods
Sold.
Sold.
(continued)
LO 1
(concluded)
Prepare a cost of
production report.
LO 2
Cost of Production Report

 The cost of production report summarizes the
production and cost data for a department as
follows:
 The units the department is accountable for and the
disposition of those units
 The product costs incurred by the department and the
allocation of those costs between completed
(transferred out) and partially completed units
LO 2
Cost of Production Report

 Preparing a cost of production report requires
making a cost flow assumption.
 Like merchandise inventory, costs can be
assumed to flow through the manufacturing
process using one of several methods.
 In the following example, the first-in, first-out
(FIFO) method is used because it is often the
same as the physical flow of units.
LO 2
Cost of Production Report FD
Mixing Department of Frozen Delight
Preparing a cost of
production report will
provide these missing
amounts.
LO 2
Determine the Units to be Assigned Costs
 To determine the units to be assigned costs, first

know that a unit can be any measure of
completed production, such as tons, gallons,
pounds, barrels, or cases.
LO 2

FD
Step
Step 1:
1:
LO 2

FD
EE 3-2
LO 2
Compute Equivalent Units of Production
 Whole units are the number of units in

production during a period, whether completed
or not.
 Equivalent units of production are the portion of
whole units that are complete with respect to
either materials or conversion (direct labor and
factory overhead) costs.
LO 2
Compute Equivalent Units of Production FD
Step
Step 2:
2:
Conversion
Conversion Costs
Costs
A 1,000-gallon batch (vat) of ice cream is only 40%
complete in the mixing process on May 31. Thus,
the batch is only 40% complete as to conversion
costs.
LO 2
Direct
Direct Materials
Materials
Frozen Delight adds all the materials at the
beginning of the mixing process.
EE 3-3
LO 2
LO 2
Conversion Equivalent Units

 To compute equivalent units for conversion costs,
it is necessary to know how direct labor and
factory overhead enter the manufacturing
process.
 It is assumed that Frozen Delight incurs
conversion costs evenly throughout its
manufacturing process.
LO 2
Conversion Equivalent Units FD
LO 2
Conversion Equivalent Units FD
EE 3-4
LO 2
Determine the Cost per Equivalent Unit
Step
Step 3:
3:
Direct Materials Cost Total Direct Materials Cost for the Period
per Equivalent Unit =
Total Equivalent Units of Direct Materials
Conversion Cost Total Conversion Costs for the Period

per Equivalent Unit = Total Equivalent Units of Conversion
Costs
LO 2
Determine the Cost per Equivalent Unit FD
LO 2
Direct
Direct Materials
Materials
per Equivalent Unit = Total Equivalent Units of Direct Materials
Direct Materials Cost $66,000

60,000 gallons
Direct Materials Cost

per Equivalent Unit = $1.10 per gallon
LO 2
Conversion
Conversion Cost
Cost
per Equivalent =
Total Equivalent Units of Conversion
Unit
Costs
Conversion Cost
$17,775
per Equivalent =
Unit 59,250 gallons
Conversion Cost
per Equivalent = $0.30 per gallon
Unit
EE 3-5
LO 2
Allocating Costs to Units
Step
Step 4:
4:
 Product costs must be allocated to the units
transferred out and the partially completed units
on hand at the end of the period.
LO 2
Allocating Costs to Units FD
The total production costs to be assigned for Frozen

Delight in July are $90,000.
LO 2
The units to be assigned these costs are shown

below. The costs to be assigned these units are
indicated by question marks.
LO 2
Group 1: Inventory in Process on July 1

The 5,000 gallons of inventory in Group 1 were
completed and transferred out to the Packaging
Department in July. The cost is determined as
follows:
LO 2
Group 2: Started and Completed

The 57,000 units started and completed in July
(Group 2) incurred all of their direct materials and
conversion costs in July. The cost assigned to
these 57,000 units is shown below.
LO 2
Group 2: Started and Completed

The total cost transferred to the Packaging
Department in July of $86,475 is the sum of the
beginning inventory cost and the costs of the units
started and completed in July.
Group 1 Cost of July 1 in-process inventory $ 6,675
Group 2 Cost of the units started and
completed in July 79,800
Total costs transferred to
Packaging Department in July $86,475
LO 2

The 3,000 gallons in process on July 31 (Group 3)
incurred all of their direct materials costs and 25%
of their conversion costs in July for a total cost of
$3,525.
LO 2

The total manufacturing costs for Frozen Delight in
July were assigned as shown below. Note that
amounts now appear where question marks
appeared earlier.
EE 3-6
EE 3-6
LO 2
Preparing the Cost of Production Report

 A cost of production report is prepared for each
processing department at periodic intervals. The
report summarizes the following production
quantity and cost data:
1. The units for which the department is accountable and
the disposition of those units
2. The production costs incurred by the department and
the allocation of those costs between completed and
partially completed units
LO 2
FD
(continued)
LO 2
FD
Journalize entries
for transactions
using a process
cost system.
LO 3
Journal Entries for Frozen Delight FD
a. Purchased materials, including milk, cream, sugar,

packaging, and indirect materials on account,
$88,000.
LO 3
b. The Mixing Department requisitioned milk, cream,

and sugar, $66,000. Packaging materials of $8,000
were requisitioned by the Packaging Department.
Indirect materials for the Mixing and Packaging
departments were $4,125 and $3,000, respectively.
direct materials
direct materials
indirect materials
indirect materials
LO 3
c. Incurred direct labor in the Mixing and Packaging

departments of $10,500 and $12,000, respectively.
LO 3
d. Recognized equipment depreciation for the Mixing

and Packaging departments of $3,350 and $1,000,
respectively.
LO 3
e. Applied factory overhead to Mixing and Packaging

departments of $7,275 and $3,500, respectively.
LO 3
f. Transferred costs of $86,475 from the Mixing

Department to the Packaging Department per the
cost of production report.
LO 3
g. Transferred goods of $106,000 out of the Packaging

Department to Finished Goods according to the
Packaging Department cost of production report (not
illustrated).
LO 3
h. Recorded cost of goods sold out of the finished

goods inventory of $107,000.
LO 3
Frozen Delight’s Cost Flows FD
LO 3
Frozen Delight’s Cost Flows FD
The ending inventories for Frozen Delight are reported

on the July 31 balance sheet as follows:
EE 3-7
Describe and
illustrate the use
of cost of
production reports
for decision
making.
LO 4
Using the Cost of Production Report FD
The cost of production report for the Mixing

Department (Exhibit 7) shows that the 5,000
units in the beginning inventory cost $6,225.
This inventory cost of $6,225 consists of the

following costs:
LO 4
June costs per equivalent unit of materials and

conversion costs can be determined as follows:
Total Equivalent Units of Direct Materials
Direct Materials Cost $5,000

5,000 gallons
Direct Materials Cost

per Equivalent Unit = $1.00 per gallon
(continued)
LO 4

per Equivalent Unit = Total Equivalent Units of Conversion Costs
Conversion Cost $1,225

per Equivalent Unit = (5,000 x 70%) gallons
Conversion Cost = $0.35 per gallon

per Equivalent Unit
LO 4
Holland Beverage Company
LO 4
Holland Beverage Company
LO 4
Yield
 In addition to unit costs, managers of process
manufacturers are also concerned about yield
trends. The yield is computed as follows:
Quantity of Material Output

Yield =
Quantity of Material Input
LO 4
Yield
Assume that 1,000 pounds of sugar enter the
Packaging Department, and 980 pounds of sugar
were packed. The yield is 98% as computed below.
Quantity of Material Output

Yield =
Quantity of Material Input
980 pounds
Yield = = 98%
1,000 pounds
EE 3-8
Compare just-in-
time processing
with traditional
manufacturing
processing.
LO 5
Just-In-Time (JIT) Processing

 Just-in-time (JIT) processing is a management
approach that focuses on reducing time and cost
and eliminating poor quality.
LO 5
LO 5

 In a just-in-time system, processing functions are
combined into manufacturing cells that perform
several manufacturing steps.
 Workers are cross-trained to perform more than
one function. This provides flexibility and
increases worker pride and involvement in the
final product.
LO 5
LO 5

 The activities supporting the manufacturing
process are called service activities.
 Repair and maintenance of manufacturing
equipment are service activities.
LO 5

 The primary objective of JIT systems is to
increase the efficiency of operations by:
 Eliminating waste
 Simplifying the production process
 Continually improving the manufacturing process and
product quality
Appendix
Average Cost
Method
Appendix
S&W Ice Cream Company

S&W Ice Cream Company mixes direct materials
in refrigerated vats and has two manufacturing
departments, Mixing and Packaging.
Appendix
The manufacturing data for the Mixing Department

for July 2012 are as follows:
Appendix
Step
Step 1:
1: Determine
Determine the
the Units
Units to
to be
be Assigned
Assigned
Costs
Costs
Appendix
Step
Step 2:
2: Compute
Compute Equivalent
Equivalent Units
Units of
of
Production
Production
Appendix
Step
Step 3:
3: Determine
Determine the
the Cost
Cost per
per Equivalent
Equivalent Unit
Unit
Appendix
Step
Step 4:
4: Allocate
Allocate Costs
Costs to
to Transferred
Transferred Out
Out and
and
Partially
Partially Completed
Completed Units
Units
Appendix
(continued)
Appendix
The
The End
End
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
© 2012 Cengage
permitted Learning. All distributed
in a license Rights Reserved.
with aMay notproduct
certain be copied,
or scanned,
service ororotherwise
duplicated,
on ainpassword-protected
whole or in part, except for for
website useclassroom
as use.

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Process Cost Systems

Principles of Managerial Accounting

Comparing Job Order and Process Cost

 Uses perpetual inventory system for materials,