Week 6 - Process Costing

PROCESS COSTING
Arika Artiningsih
Learning Objectives
1. Describe the basic characteristics and cost flows
associated with process manufacturing.
2. Define equivalent units and explain their role in
process costing. Explain the differences between the
weighted average method and the FIFO method of
accounting for process costs.
3. Prepare a departmental production report using the
weighted average method.
4. Explain how nonuniform inputs and multiple
processing departments affect process costing.
Characteristics of Process
Manufacturing
• Each product within a line passing through the
processes would receive similar ‘‘doses’’ of
materials, labor, and overhead costs.
• Process costing works well whenever
homogeneous products pass through a series
of processes and receive similar amounts of
manufacturing costs.
LO-1
How Costs Flow through the
Accounts in Process Costing
• Although job-order and process cost flows are
generally similar, some differences exist.
• In process costing, each producing department
has its own WIP account.
• As goods are completed in one department,
they are transferred to the next department.
• The costs attached to the goods transferred out
are also transferred to the next department.
LO-1
How Costs Flow through the
Accounts in Process Costing (cont.)
LO-1
Cornerstone 6.1
Calculating Cost Flows
without Work in Process
LO-1
Cornerstone 6.1
Calculating Cost Flows
without Work in Process
LO-1
Accumulating Costs in
the Production Report
• A production report traces the flow of units through a
department, identifies the costs charged to the department,
shows the computation of unit costs, and reveals the
disposition of the department’s costs for the reporting
period.
Unit information section: The unit information Unit
section has two major subdivisions: ^^^^^^^^
• units to account for Cost
• units accounted for ^^^^^^^^
Cost information section: The cost information
section has two major subdivisions:
• costs to account for
• costs accounted for
LO-1
Traditional Manufacturing Firms
• Traditional manufacturing firms may have
significant beginning and ending WIP
inventories.
• This causes complications in process costing
due to several factors such as the presence of
beginning and ending WIP inventories
• Also, different approaches to the treatment of
beginning inventory cost.
LO-1
The Impact of Work-In-Process Inventories
on Process Costing
• The computation of unit cost for the work
performed during a period is a key part of the
production report.
• This unit cost is needed both to compute the
cost of goods transferred out of a department
and to value ending work-in-process (EWIP)
inventory.
LO-2
The Impact of Work-In-Process Inventories
on Process Costing (cont.)
• How should the costs and work of beginning
work-in-process (BWIP) be treated?
• Should they be counted with the current
period work and costs or treated separately?
• Two methods have been developed to solve
this problem: the weighted average method
and the FIFO method.
LO-2
Equivalent Units of Production
• By definition, EWIP is not complete.
• The solution is to calculate equivalent units of
output.
• Equivalent units of output are the complete units
that could have been produced given the total
amount of manufacturing effort expended for the
period under consideration.
• Determining equivalent units of output for
transferred-out units is easy; a unit would not be
transferred out unless it was complete.
LO-2
Cornerstone 6.2
Equivalent Units of Production:
No Beginning Work in Process
LO-2
Cornerstone 6.2
Calculating Equivalent Units of
Production: No Beginning Work in Process
LO-2
Ethical Decisions and
Estimating Completeness
• Estimating the degree of completion is an act that requires
judgment and ethical behavior.
• Overestimating the degree of completion will increase the
equivalent units of output and decrease per-unit costs.
• This outcome would cause an increase in both income (cost
of goods sold will be less due to decrease per-unit cost) and
in assets (WIP cost will increase due to overestimating the
decree of completion).
• Deliberately overestimating the degree of completion would
clearly be in violation of ethical professional practice.
LO-2
Cornerstone 6.3
Measuring Output and Assigning Costs:
LO-2
Cornerstone 6.3
LO-2
Two Methods of Treating Beginning Work-
in-Process Inventory
• In computing a current-period unit cost for a
department, two approaches have evolved for
dealing with the prior-period output and prior-
period costs found in BWIP:
– The weighted average costing method
– The FIFO costing method.
LO-2
The Weighted Average
Costing Method
• The weighted average costing method combines
beginning inventory costs and work done with
current-period costs and work to calculate this
period’s unit cost.
• The costs and work carried over from the prior period
are counted as if they belong to the current period.
• Beginning inventory work and costs are pooled with
current work and costs, and an average unit cost is
computed and applied to both units transferred out
and units remaining in ending inventory.
LO-2
The FIFO Costing Method
• The FIFO costing method separates work and costs of
the equivalent units in beginning inventory from work
and costs of the equivalent units produced during the
current period.
– Only current work and costs are used to calculate this
period’s unit cost.
– It is assumed that units from beginning inventory are
completed first and transferred out.
– The costs of these units include the costs of the work done
in the prior period as well as the current period costs
necessary to complete the units.
LO-2
The FIFO Costing Method (cont.)
• Units started in the current period are divided
into two categories:
– units started and completed and
– units started but not finished (EWIP).
• Units in both of these categories are valued
using the current period’s cost per equivalent
unit.
LO-2
NOTE
• If product costs do not change from period to
period, or if there is no BWIP inventory, the
FIFO and weighted average methods yield the
same results.
LO-2
Weighted Average Costing
• The weighted average costing method treats
beginning inventory costs and the
accompanying equivalent output as if they
belong to the current period.
– This is done for costs by adding the manufacturing
costs in BWIP to the manufacturing costs incurred
during the current period.
LO-3
Weighted Average Costing (cont.)
• The total cost is treated as if it were the
current period’s total manufacturing cost.
– Similarly, beginning inventory output and current
period output are merged in the calculation of
equivalent units.
– Under the weighted average method, equivalent
units of output are computed by adding units
completed to equivalent units in EWIP.
LO-3
Cornerstone 6.4
Weighted Average Method
LO-3
Cornerstone 6.4
LO-3
Cornerstone 6.4
LO-3
Five Steps in Preparing
a Production Report
• The production report is subsidiary to the WIP
account for a department.
• The following five steps describe the general
pattern of a process-costing production report:
1. physical flow analysis
2. calculation of equivalent units
3. computation of unit cost
4. valuation of inventories (goods transferred out and
EWIP)
5. cost reconciliation
LO-3
Step 1: Physical Flow Analysis
• The purpose of the physical flow analysis is to trace the
physical units of production.
• Physical units are not equivalent units.
– They are units that may be in any stage of completion.
• Two calculations are needed to construct a physical flow
schedule:
• ‘‘Total units to account for’’ must equal the ‘‘Total units

accounted for.’’
LO-3
Cornerstone 6.5
Preparing a Physical Flow Schedule
LO-3
Cornerstone 6.5
Preparing a Physical Flow Schedule
LO-3
Step 2: Calculation of
Equivalent Units
• The weighted average method treats beginning
inventory units as if they were started and
completed during the current period.
• Because of this, the equivalent unit schedule
shown in Step 2 shows only the total units
completed.
• There is no need to show whether the units
completed are from the month in question (July)
or from BWIP as was done by Cornerstone 6-4.
LO-3
Step 3: Computation of Unit Cost
• The weighted average method rolls back and includes the
manufacturing costs associated with the units in BWIP and
counts these costs as if they belong to month in question
(July).
• Manufacturing costs are carried over from the prior period

and treated as if they were current period costs.
LO-3
Step 4: Valuation of Inventories
• Cornerstone 6-4 also showed how to value
goods transferred out and EWIP.
• Units completed (from Step 1), equivalent
units in EWIP (from Step 2), and the unit cost
(from Step 3) are all needed to value both
goods transferred out and EWIP.
LO-3
Step 5: Cost Reconciliation
• Finally, the cost reconciliation checks to see if
the costs to account for are exactly assigned to
inventories.
• Remember, the total costs assigned to goods
transferred out and to EWIP must agree with
the total costs in BWIP and the manufacturing
costs incurred during the current period.
LO-3
Cornerstone 6.6
Preparing a Production Report:
LO-3
Cornerstone 6.6
Preparing a Production Report:
LO-3
Evaluation of the
Advantages Disadvantages
• Unit cost computations are • Inaccuracies in computing unit
simplified costs for current period output
• Units in BWIP are treated as and for units in BWIP
those of the current period and • If the unit cost in a process is
all equivalent units belong to the stable from one period to the
same category to calculate unit next, the weighted average
costs. method is accurate.
• If the price of manufacturing
inputs increases from one period
to the next, the unit cost of
current output is understated,
and the unit cost of BWIP units is
overstated.
LO-3
Multiple Inputs and
Multiple Departments
• Accounting for production under process
costing gets complicated because of
– nonuniform application of manufacturing inputs
and
– presence of multiple processing departments.
LO-4
Nonuniform Application of
Manufacturing Inputs
• Assuming uniform application of conversion
costs (direct labor and overhead) is not
unreasonable.
– Direct labor input is usually needed throughout the
process, and overhead is normally assigned on the
basis of direct labor hours.
– Direct materials are not as likely to be applied
uniformly.
– In many instances, materials are added either at the
beginning or the end of the process.
LO-4
Manufacturing Inputs (cont.)
• Different percentage completion figures for
manufacturing inputs pose a problem for the
calculation of equivalent units, unit cost, and
valuation of EWIP (steps 2-4).
• In such cases, equivalent unit calculations are
done for each category of manufacturing
input.
• Equivalent units are calculated for each
category of materials and for conversion cost.
LO-4
Manufacturing Inputs (cont.)
• The individual category costs are then used in
Step 4 to cost out EWIP.
• The total unit cost is used to calculate the cost
of goods transferred out in the same way as
when there was only one input category.
LO-4
Cornerstone 6.7
Equivalent Units, Costs, and Valuing Inventories
with Nonuniform Inputs
LO-4
Cornerstone 6.7
Equivalent Units, Costs, and Valuing Inventories
with Nonuniform Inputs
LO-4
Production Report:
Applying
manufacturing
inputs at different
stages of a
process poses no
serious problems,
though it requires
more effort.
LO-4
Multiple Departments
• In process manufacturing, some departments receive
partially completed goods from prior departments.
• The usual approach is to treat transferred-in goods
as a separate material category when calculating
equivalent units.
• Thus, the department receiving transferred-in goods
would have three input categories:
– one for the transferred-in materials
– one for materials added
– one for conversion costs
LO-4
Transferred-In Goods
• In dealing with transferred-in goods, two
important points should be remembered.
– The cost of this material is the cost of the goods
transferred out as computed in the prior
department.
– The units started in the subsequent department
correspond to the units transferred out from the
prior department (assuming that there is a one-to-
one relationship between the output measures of
both departments).
LO-4
Cornerstone 6.8
Physical Flow Schedule, Equivalent
Units, Unit Costs: Transferred-In Goods
LO-4
Cornerstone 6.8
LO-4
Cornerstone 6.8
LO-4
Appendix 6A: Production Report- First-In, First-Out Costing
• Under the FIFO costing method, the equivalent units and manufacturing costs in B WIP are
excluded from the current period unit cost calculation
• This method recognizes that the work and costs carried over from the prior period
legitimately belong to that period
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 7th Edition. © 2018 Cengage. All
Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part
Evaluation of the Weighted Average
Method
FIFO
• More Accurate: If changes occur in the prices of the manufacturing inputs
from one period to the next
• Better cost control
• Better pricing decisions
Weighted Average
• Most firms use this method due to simplicity
• FIFO has little advantage over weighted average, if unit costs are
calculated for short periods
First-In, First-Out Method (1 of 2)
• Since FIFO excludes prior-period work and costs, it is necessary to create two
categories of completed units:
o BWIP units (FIFO assumes that units in B WIP are completed first, before any new units
are started)
o Units started and completed during the current period
• These two categories of completed units are needed in the F IFO method so that
each category can be costed correctly
First-In, First-Out Method (2 of 2)
• For the units started and completed, the unit cost is obtained by dividing total
current manufacturing costs by the current period equivalent output
• For the BWIP units, the total associated manufacturing costs are the sum of the
prior period costs plus the costs incurred in the current period to finish the units
Example 6.9: How to Calculate Output and Cost
Assignments: First-In, First-Out Method (1 of 5)
In July, Healthblend had the following results:
Production:
Units in process, July 1, 75% complete 20,000 gallons
Units completed and transferred out 50,000 gallons
Units in process, July 31, 25% complete 10,000 gallons
Costs:
Work in process, July 1 $ 3,525
Costs added during July $ 10,125
Required:
1. Calculate the output measure for July.
2. Assign costs to units transferred out and E WIP using the FIFO method.
Example 6.9: How to Calculate Output and Cost Assignments: First-
In, First-Out Method (3 of 5)
2. Costs for July:
$10,125
Cost per unit  units  $ 0.27
37,500
Transferred out:
Cost from BWIP (prior period carryover) $3.525
To complete BWIP ($0.27 × 5.000) 1350
Started and completed ($0.27 × 30.000) 8.100
Total $12,975
EWIP ($0.27 × 2.500) 6-5
Total cost assigned $13,650
Step 1: Physical Flow Schedule
• The purpose of Step 1 is to trace the physical units of production. As with the weighted average
method, in the FIFO method, a physical flow schedule is prepared. This schedule is identical
for both methods
Units to account for:

Units in beginning work in process (75% complete) 20,000
Units started during the period 40,000
Total units to account for 60,000
Units accounted for:
Units completed:
Started and completed 30,000
From beginning work in process 20,000 50,000
Units in ending work in process (25% complete) 10,000
Total units accounted for 60,000
Step 2: Calculation of Equivalent
Units (2 of 3)
• From the equivalent unit computation, one difference between weighted average
and FIFO becomes immediately apparent
• Under FIFO, the equivalent units in BWIP (work done in the prior period) are not
counted as part of the total equivalent work
• Only the equivalent work to be completed this period is counted
Step 2: Calculation of Equivalent Units
(3 of 3)
• In this example the percentage of work done in the prior period is 75%, the
percentage left to be completed this period is 25%, or an equivalent of 5,000
additional units of work
• The effect of excluding prior period effort is to produce the current period
equivalent output
• Under FIFO, equivalent units are 37,500 units – all current period output
Step 3: Computation of Unit Cost
(2 of 2)
• The additional manufacturing costs incurred in the current period are $10,125
$10,125
• Thus, the current period unit manufacturing cost is , or $0.27
37,500
• Notice that the costs of beginning inventory are excluded from this calculation
• Only current period manufacturing costs are used
(1 of 2)
• Example 6.9 shows FIFO values for EWIP and goods transferred out
• Since all equivalent units in ending work in process are current period units, the
cost of EWIP is simply $0.27 × 2,500, or $675, the same value that the weighted
average method would produce
• When it comes to valuing goods transferred out, a significant difference emerges
between the weighted average method and F IFO
(2 of 2)
• Under weighted average, the cost of goods transferred out is simply the unit cost
times the units completed
• Under FIFO there are two categories of completed units:
o Units started and completed
o Units from beginning inventory
• The cost of each category must be calculated separately and then summed to obtain
the total cost of goods transferred out
Step 5: Cost Reconciliation (2 of 2)
• In Step 5, the costs assigned to production are reconciled to the total
manufacturing costs to account for
• With the completion of Step 5, the production report can be prepared
The Production Report
• A production report has two sections:
o a unit information section
o a cost information section
• The unit information section presents the physical flow schedule and the equivalent
units schedule.
• The cost information section has two major subdivisions:
o costs to account for
o costs accounted for
• The first cost subdivision includes the calculation of the unit cost, and the second subdivision
includes the valuation of goods transferred out and EWIP
Example 6.10: How to Prepare a Production Report:
First-In, First-Out Method
(1 of 2)
• Refer to the five steps for the Healthblend Company.
• Required:
• Prepare a production report for July 2017 (F IFO method).
• Solution:
Example 6.10: How to Prepare a Production Report: First-In, First-
Out Method (2 of 2)
Chapter 18 (Horngren)
Spoilage, Rework, and Scrap

Basic Definitions (1 of 2)
• Spoilage—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 for
reduced prices.
• Rework—units of production that do not meet the
specifications required by customers but that are
subsequently repaired and sold as good finished goods.
Basic Definitions (2 of 2)
• Scrap—residual material that results from manufacturing a
product. Scrap has low total sales value compared with the
total sales value of the product.
• Scrap is similar to byproducts but scrap arises as a residual
from the manufacturing process and is not a product targeted
for manufacture or sale by the firm.
Accounting for Spoilage
• A certain amount of spoilage, rework, or scrap is inherent in
many production processes.
• Accounting for spoilage aims to determine the magnitude of
spoilage costs and to distinguish between costs of normal and
abnormal spoilage.
• To manage, control, and reduce spoilage costs, they should be
highlighted, not simply folded into production costs.
Two Types of Spoilage: Normal and
Abnormal Normal (1 of 2)
• Normal spoilage is spoilage inherent in a particular production
process that arises even under efficient operating conditions.
– Normal spoilage rates are computed by dividing the units
of normal spoilage by total good units completed, not total
actual units started in production.
– Management makes a conscious decision about the
production rate per hour which generates a certain level of
normal spoilage.
Two Types of Spoilage: Normal and
Abnormal Abnormal (2 of 2)
• 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.
– 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 on the income
statement.
Spoilage in Process-Costing Using Weighted
Average and FIFO
• Units of normal spoilage can be counted or not counted when
computing output units (physical or equivalent) in a process-
costing system.
• Counting all spoilage is considered preferable and will be used
in our examples here.
Inspection Points and Spoilage
• Inspection point—the stage of the production process at which
products are examined to determine whether they are
acceptable or unacceptable units.
• Spoilage is typically assumed to occur at the stage of
completion where inspection takes place.
• As a result, the spoiled units in our example are assumed to be
100% complete for direct materials.
The Five-step Procedure for Process
Costing with Spoilage (Slight
Modifications to Accommodate Spoilage)
(1 of 2)
• Step 1: Summarize the flow of physical units of output—

identify both normal and abnormal spoilage.
• Step 2: Compute output in terms of equivalent units. Spoiled
units are included in the computation of output units.
The Five-step Procedure for Process
Costing with Spoilage (Slight
Modifications to Accommodate Spoilage)
(2 of 2)
• Step 3: Summarize total costs to account for.

• Step 4: Compute cost per equivalent unit.
• Step 5: Assign total costs to:
1. Units completed
2. Spoiled units
3. Units in ending work-in-process
Steps 1 And 2, Example (with Spoilage
Using Weighted Average)
Exhibit 18.2 Weighted-Average Method of Process Costing with Spoilage for the Forming Department for
July 2017
Steps 3, 4, and 5, Example (with Spoilage
Using Weighted Average)
Steps 1 and 2, Example (with Spoilage
Using FIFO)
Exhibit 18.3 First-In, First-Out (FIFO) Method of Process Costing with Spoilage for the Forming
Department for July 2017
Steps 3, 4, and 5, Example (with Spoilage
Using FIFO)
Inspection Points and Allocating Costs of
Normal Spoilage
• Spoilage might occur at various stages of a production process
but it is typically detected only at one or more inspection
points.
• The unit costs of normal and abnormal spoilage are the same
when the two are detected at the same inspection point.
• Early inspections can help prevent any further costs being
wasted on units that are already spoiled.
• Firms often conduct multiple inspections and also empower
workers to identify and resolve defects on a timely basis.
Job Costing and Spoilage
Job-costing systems generally distinguish between normal
spoilage attributable to a specific job from normal spoilage
common to all jobs.
Job Costing and Accounting for 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 would be:
Materials Control xx
WIP Control (job abc) xx
Job Costing and Accounting for Normal
Spoilage Common to All Jobs
• In some cases, spoilage may be considered a normal
characteristic of the production process.
– The spoilage is costed as manufacturing overhead because
it is common to all jobs.
– The budgeted manufacturing overhead rate includes a
provision for normal spoilage.
– For spoilage common to all jobs, Manufacturing Overhead
Control will be debited instead of Materials Control.
Job Costing and Accounting for 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 part of the cost of good units products.
• Instead, the costs are written off to an account called “Loss
from Abnormal Spoilage.”.
Job Costing and Rework
Rework refers to units of production that are inspected,
determined to be unacceptable, repaired, and sold as
acceptable.
• Three types of rework:
1. Normal rework attributable to a specific job—the rework
costs are charged to that job.
2. Normal rework common to all jobs—the costs are
charged to manufacturing overhead and are spread,
through overhead allocation, over all jobs.
3. Abnormal rework is charged to Loss from Abnormal
Rework account that appears on the income statement.
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.
Two Aspects of Accounting for Scrap
1. Planning and control, including physical tracking.
2. Inventory costing, including when and how it affects
operating income.
• Scrap records not only help measure efficiency, but also help
keep track of scrap and so reduce the chances of theft.
• NOTE: Many firms maintain a distinct account for scrap costs.
• When the dollar amount of the scrap is immaterial, it is
simplest to record the physical quantities of scrap returned to
the storeroom and to regard the revenues from the sale of
scrap as a separate line item in the income statement.
Accounting for Scrap Attributable to a
Specific Job
• Job-costing systems sometimes trace the scrap revenues to
the jobs that yielded the scrap.
– Done only when the tracing can be done in an
economically feasible way.
– No cost assigned to scrap so no distinction is made
between normal and abnormal scrap.
– All scrap revenues, whatever the amount, are credited to
the specific job thereby reducing the costs of the job.
Accounting for Scrap Attributable to All Jobs
• Because the scrap is not linked with any particular job or

product, all products bear its costs without any credit for
scrap revenues except in an indirect manner.
• The expected scrap revenues are considered when setting the
budgeted overhead manufacturing overhead rate.
• This method of accounting for scrap is also used in process
costing when the dollar amount of scrap is immaterial
because the scrap in process costing is common to the
manufacture of all the identical or similar units produced.
Accounting for Scrap at the Time of
Production
• We’ve been assuming that scrap returned to the storeroom is
sold quickly so it is not assigned an inventory cost figure,
however, sometimes the value of the scrap is not immaterial,
and the time between storing and selling it can be long and
unpredictable.
• In that case, 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.
Accounting for Scrap Under Process-Costing
• Accounting for scrap under process costing is similar to

accounting under job costing when scrap is common to all
jobs.
• This works because the scrap in process costing is common to
the manufacture of masses of identical or similar units.
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Week 6 - Process Costing

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Week 6 - Process Costing

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PROCESS COSTING

• ‘‘Total units to account for’’ must equal the ‘‘Total units

• Manufacturing costs are carried over from the prior period

Units to account for:

Spoilage, Rework, and Scrap

• Step 1: Summarize the flow of physical units of output—

• Step 3: Summarize total costs to account for.

• Because the scrap is not linked with any particular job or

• Accounting for scrap under process costing is similar to

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