Lesson 7: Operation Costing

Isn’t Managerial Accounting fun?!?

- Accounting professor
 Learning Objectives
• Define Operation Costing
Operation Costing is a cost system that is a hybrid of Job-order Costing and
Process Costing

• Learn how and why a firm would use Operation Costing

Operation Costing is useful when a firm manufactures multiple products
using different direct materials but similar conversion processes
• Calculate the per-unit product cost using Operation Costing
- Direct materials costs are assigned by batch
- Conversion costs are assigned by department
• Understand the flow of costs by journalizing transactions
 Today’s Topics
- Definition of Operation Costing
Operation Costing - When to use Operation Costing
- How to use Operation Costing
 Today’s Topics
- Definition of Operation Costing
Operation Costing - When to use Operation Costing
- How to use Operation Costing
 What is Operation Costing?
• Firms can use a hybrid costing system that includes
features of both Job-order Costing and Process Costing
• One hybrid system is known as Operation Costing
– Operation Costing is helpful when a company manufactures
products with similar conversion processes but different materials
 Hybrid Approach
• Consider a company that manufactures suits using an Let’s refer to each type
identical process, except that some suits are made with of suit as a “batch”
wool and some are made with a wool/silk blend instead of a “job”
• Direct materials (wool and/or silk) can be tracked by batch so we don’t confuse
• Conversion costs can be tracked by department Operation Costing with
Job-order Costing
 Example
• Let’s say Clif Bar manufacturers 3 types of
energy bars: chocolate, mint, and apricot
 Clif Bar
Here are budgeted data for each batch

Chocolate Mint Apricot Total

Units produced 200,000 225,000 150,000 575,000
Direct material costs $17,000 $42,000 $37,000 $96,000

Here are budgeted data for each department

Baking Packaging Total

Conversion costs $75,000 $40,000 $115,000

All direct materials are added in the Baking Department.

Each flavor is processed through both departments

If the beginning WIP inventory and ending WIP inventory are both zero,
what is the per-unit product cost of each flavor of Clif Bar?
 The Per-unit Product Cost
Chocolate Mint Apricot Total
Units produced 200,000 225,000 150,000 575,000
Direct material costs $17,000 $42,000 $37,000 $96,000

Baking Packaging Total

Conversion costs $75,000 $40,000 $115,000

$17,000 / 200,000 $42,000 / 225,000

Chocolate
Chocolate
Chocolate Mint
Mint
Mint Apricot
Apricot
Apricot
Per-unit direct material cost $0.09
$0.09 $0.19
$0.19
$0.19 $0.25
$0.25
$0.25
$75,000 / 575,000
Per-unit conversion cost: Baking $0.13 $0.13
$0.13 $0.13
$0.13
Per-unit conversion cost: Packaging $0.07 $0.07 $0.07 $40,000 / 575,000
Per-unit product cost $0.29 $0.39 $0.45
 Journal Entries
Chocolate Mint Apricot Total
Units produced 200,000 225,000 150,000 575,000
Direct material costs $17,000 $42,000 $37,000 $96,000

Baking Packaging Total

Conversion costs $75,000 $40,000 $115,000

Journal Entries
Work-in-Process Inventory: Baking $96,000 Direct materials are
Raw Materials Inventory $96,000 used in baking
Work-in-Process Inventory: Baking $75,000 Conversion costs are applied
Conversion Costs $75,000 in baking
Work-in-Process Inventory: Packaging $171,000 Units are transferred from
Work-in-Process Inventory: Baking $171,000 baking to packaging
Work-in-Process Inventory: Packaging $40,000 Conversion costs are applied
Conversion Costs $40,000 in packaging
Finished Goods Inventory $211,000
Work-in-Process Inventory: Packaging $211,000
Units are completed
 Quiz A
• Tight Fit makes 2 types of men’s underwear: cotton and wool.
While the materials are different for each type, the conversion
process is identical. Budgeted data are below. Assume the
beginning and ending WIP inventory will both be zero and the
company uses Operation Costing.
1. What is the per-unit product cost for each underwear type?
Wool Cotton Total
Units produced 50,000 80,000 130,000
Direct material costs $21,000 $8,000 $29,000

Cutting Sewing Total

Conversion costs $30,000 $45,000 $75,000