Process Costing System:

Cost accumulation procedures used by manufacturing concerns are classified as either job order costing or process costing. The Job Order Costing System deals with the procedures applicable to job order costing. It is important to understand that, except for some modifications, the accumulation of materials costs, labor costs, and factory overhead also applies to process costing system. Process costing a system applicable to a continuous process of production of the same or similar goods. It is used for industries producing chemicals, petroleum, textiles, steel, rubber, cement, flour, pharmaceuticals, shoes, plastics, sugar, and coal. Process costing system is also used by firms manufacturing items such as rivets, screws, bolts, and small electrical parts. A third type of industry using process costing system is the assembly type industry which manufactures such things as typewriters, automobiles, airplanes, and household electric appliances (washing machines, refrigerators, toasters, irons, radios, television sets, etc.). Finally certain service industries, such as gas, water, and heat, cost their products by using process costing system. Thus, process costing is used when products are manufactured under conditions of continuous processing or under mass production methods. In fact, process costing procedures are often termed "continuous or mass production cost accounting procedures". The type of manufacturing operations performed determines the cost procedures that must be used. For example, company manufactures custom machinery will use job order costing, whereas a chemical company will use process costing. In the case of machinery manufacturer, a job order cost sheet is prepared for each order, accumulating the costs of materials, labor, and factory overhead. In contrast the chemical company cannot identify materials, labor, and factory overhead with each order, since each order is part of a batch or a continuous process. The individual order identity is lost, and the cost of a completed unit must be computed by dividing total cost incurred during a period by total units completed. The summarization of the costs takes place via the cost of production report, which is an extremely efficient, economical, and timesaving device for the collection of large amounts of data. This matter considers the (1) cost of production report, (2) calculation of departmental unit costs, (3) costing of work in process, (4) computations of costs transferred to other departments or to the finished goods storeroom, and (5) effect of lost units on unit costs. Process Costing System - Addition of Materials, Average and FIFO Costing deals with (1) special problems involved in adding materials in departments other than the first, (2) problems connected with the beginning work in process, and (3) the possibility of using costing methods.

Characteristics and Procedure of Process Costing System:

The characteristics of process costing system: A cost of production report is used to collect, summarize and compute total and unit costs. 2. Production is accumulated and reported by departments. 3. Costs are posted to departmental work in process accounts.

1. 4. 5. 6.

Production in process at the end of a period is restated in terms of completed units. Total cost charged to a department is divided by total computed production of the department in order to determine a unit cost for a specific period. Costs of completed units of a department are transferred to the next processing department in order to arrive at the total costs of the finished products during a period. At the same time, costs are assigned to units still in process.

The procedures of process costing are designed to:

1. 2. 3. 4.

Accumulate materials, labor, and factory overhead costs by departments. Determine a unit cost for each department. Transfer costs from one department to the next and to finished goods. Assign costs to the inventory of work in process (WIP)

If accurate units and inventory costs are to be established by process costing procedures, costs of a period must be identified with units produced in the same period.

Costing By Departments:
The nature of manufacturing operations in firms using process or job order cost procedures is usually such that work on product takes place in several departments. With either procedure, departmentalization of materials, labor, and factory overhead costs facilitates application of responsibility accounting. Each department performs a specific operation or process towards the completion of the product. For example, after the blending department has completed the starting phase of the work on product, units are transferred to the testing department, after which they may go to the terminal department for completion and transferred to the finished goods storeroom. Both units and costs are transferred from one manufacturing department to another manufacturing department. Separate departmental work in process (WIP) accounts are used to charge each department for the materials, labor, and factory overhead used to complete its share of manufacturing process. Process costing involves averaging costs for a particular period in order to obtain departmental and cumulative unit costs. The cost of a completed unit is determined by dividing the total cost of a period by the total units produced during the period. Determining departmental production for a period includes evaluating units still in process. The breakdown of costs for the computation of total unit costs and for costing units transferred and departmental work in process (WIP) inventories is also desirable for cost control purposes. Departmental total and unit costs are determined by the use of the cost of production report, which is described and illustrated in detail on the Cost Of Production Report page. Most of the activity in process costing system involves the accumulation of data needed for the preparation of these reports. Product Flow in Process Costing System: A product can flow through a factory in numerous ways. Three product flow formats associated with process costing - sequential, parallel, and selective - are illustrated here to indicate that basically the same costing procedures can be applied to all types of product flow situations. Sequential Product Flow: In a sequential product flow, each item manufactured goes through the same set of operation, as illustrated below.

Work in Process Blending Department Materials Labor FOH*

Work in Process Testing Department Labor FOH*

Work in Process Terminal Department Labor FOH*

Finished Goods

*Factory Overhead

Materials are placed into production in the Blending Department, and labor and factory overhead are added. When the work is finished in the Blending Department, it moves to the Testing Department. The second process, and any succeeding processes, may add more materials or simply work on the partially completed input from the preceding departments, adding only labor and factory overhead, as in this example. After the product has been processed by the Terminal Department, it is a completed product and becomes a part of finished goods inventory.

Parallel Flow:
In a parallel product flow, certain portion of the work are done simultaneously and then brought together in a final process or processes for completion and transfer to finished goods inventory. As in the previous illustration, materials may be added in subsequent processes.

Selective Product Flow:

In a selective product flow, the product moves to different departments within the plant, depending upon the desired final product. For example, in meet processing, after the initial butchering process, some of the product goes directly to the Packaging Department and then to finished goods inventory; some goes to the Smoking Department and then to the Packaging Department and finally to finished goods inventory; Some goes to the grinding department, then to the packaging department and lastly to finished goods inventory. Transfer of costs from the Butchering Department involves joint cost allocation, discussed on By-Products and Joint Products Costing page. Procedures for Materials, Labor, and Factory Overhead Costs Accumulations: In process costing, materials, labor, and factory overhead costs are accumulated in the usual accounts, using normal cost accounting procedures. Costs are then analyzed by departments or processes and charged to departments by appropriate journal entries. The details involved in process costing are usually fewer than those in the job order costing, where accumulation of costs for many orders can become unwieldy. Materials Costs: In job order costing system, materials requisitions are used to charge jobs for direct materials used. If requisitions are used in process costing, details are considerably reduced because materials are charged to departments rather than to jobs, and the number of departments using materials is usually less than the number of jobs a firm might handle at a given time. Frequently materials are issued only to the process-originating department; subsequent department other than the first, they are charged to that department performing the specific operation. For materials control purposes, materials need not always be priced individually on requisition forms. The cost of materials used can be determined at the end of the production period through inventory difference procedures, i.e., adding purchases to beginning inventory and then deducting ending inventory. Or consumption reports which state the cost of materials or quantity of materials put into process by various departments can be used. Costs or quantities charged to departments by consumption reports may be based on formulas or proration. Formulas specify the type and quantity of materials required in the various products and are applied to finished production in order to calculate the materials consumed. Chemical and pharmaceutical industries use such procedures, particularly when more than one product is manufactured by a department. Frequently the cost of materials used by a department must by prorated to different products on various estimated bases. This topic will be discussed By-Products and Joint Products Costing. For any of the materials cost computation methods discussed, a typical journal entry charging direct manufacturing materials used during a period is: Work in Process - Blending department Materials 24,500 24,500

The source of the cost figures for the above entry as well as the entries for labor and factory overhead is the cost of production report which is discussed on cost of production report page. Direct Labor: Labor costs are identified by and charged to departments in process costing, thus eliminating the detailed clerical work of accumulating labor costs by jobs. Daily time tickets or weekly time clock cards are used instead of job time tickets. Summary labor charges are made to departments through an entry which distributes the direct manufacturing payroll: Work in Process - Blending department Work in Process - Testing Departments Work in Process - Terminal Department Payroll 29,140 37,310 32,400 98,850

Factory Overhead Costs: Factory overhead incurred in process costing as well as in job order costing should be accumulated in the factory overhead subsidiary ledger for producing and service departments. This procedure is consistent with requirements for responsibility accounting and responsibility reporting. Normally it is emphasized to use the predetermined overhead rates for charging overhead to jobs and products. However, in various process and job order costing procedures, actual rather than applied overhead is sometimes used for product costing. This practice is feasible when production remains comparatively stable from period to period, since factory overhead will then remain about the same from one month to the next. The use of actual overhead can also be justified when factory overhead is not an important part of total cost. However, predetermined overhead rates for producing departments should be used if: 1. 2. Production is not stable. Factory overhead, especially fixed overhead, is a significant cost.

Fluctuations in production can lead to the unequal incurrence of actual factory overhead from month to month. In such cases, factory overhead should be applied to production using predetermined rates, so that units produced receive proper charges for factory overhead. Similarly, if factory overhead especially fixed factory overhead - is significant, it is desirable to allocate factory overhead on the basis of normal or uniform production using predetermined overhead rates. Indeed, the use of predetermined rates is highly recommended for improving cost control and facilitating cost analysis. Prior to charging factory overhead to departments via their respective work in process accounts, expenses must be accumulated in a factory overhead control account. As expenses are incurred the entry is:

Factory overhead control Accounts Payable Accumulated Depreciation - Machinery Prepaid Insurance Materials Payroll

xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx

The use of factory overhead control account requires a subsidiary ledger for factory overhead, with departmental expense analysis sheet to which all expenses are posted. Service department expenses are kept in like manner and distributed later to producing departments. At the end of each period, departmental expense analysis sheets are totaled. These totals, which also include distributed service department costs, represent factory overhead for each department. By debiting the actual cost incurred or by using the predetermined overhead rates multiplied by the respective actual activity base (e.g., direct labor hours) for each producing department, the entry charging these expenses to work in process is as follows:

Work in Process - Blending department Work in Process - Testing Departments Work in Process - Terminal Department Factory Overhead Control

28,200 32,800 19,800 80,800

Cost of Production Report (CPR):

Definition and Explanation of Cost of Production Report (CPR): A departmental cost of production report (CPR) shows all costs chargeable to a department. It is not only the source for summary journal entries at the end of the month but also a most convenient vehicle for presenting and disposing of costs accumulated during the month. A cost of production report shows: 1. 2. 3. 4. 5. 6. Total unit costs transferred to it from a preceding department. Materials, labor, and factory overhead added by the department. Unit cost added by the department. Total and unit costs accumulated to the end of operations in the department. The cost of the beginning and ending work in process inventories. Cost transferred to a succeeding department or to a finished goods storeroom.

It is customary to divide the cost section of the report into two parts: one was showing costs for which the department is accountable, including departmental and cumulative total and unit costs, the other showing the disposition of these costs. A quantity schedule showing the total number of units for which a department is accountable and the disposition made of these units is also part of each department's cost of production report. Information in this schedule, adjusted for equivalent production is used to determine the unit costs added by a department, the costing of the ending work in process inventory, and the cost to be transferred out of the department. A cost of production report determines periodic total and unit costs. However, a report that would merely summarize the total costs of materials, labor, and factory overhead and shows only the unit cost for the period would not be satisfactory for controlling costs. Total figures mean very little; cost control requires detailed data. Therefore, in most instances, the total cost is broken down by cost elements for each department head responsible for the costs incurred. Furthermore, detailed departmental figures are needed because of the various completion stages of the work in process inventories. Either in the cost of production report itself or in the supporting schedules, each item of material used by a department is listed; every labor operation is shown separately; factory overhead components are noted individually; and a unit cost is derived for each item. To condense the illustrated cost of production reports, only total materials, labor, and factory overhead charged to departments are considered; and unit costs are computed only for each cost element rather than for each item. Example: The reports of The Starex Corporation, which manufactures one product in three producing departments (Blending, Testing, and Terminal), are used to illustrate the details involved in the preparation of cost of production reports. Cost of Production Report - Blending Department (1st Department): Learning Objective: 1. 2. 3. Prepare a cost of production report of first department in a process costing system. How equivalent units are calculated in a process costing system? How the lost units are treated in the cost of production report of first department?

The cost of production report of the Blending Department, the originating department of The Starex Corporation, is shown on the following page. It illustrates the detailed computations needed to complete a cost of production report.

The Starex Corporation Blending Department (1st Dept.) Cost of Production Report For the Month of January, 2011 Quantity Schedule: Units started in process Units transferred to next department Units still in process (all materials - 1/2 labor and FOH) Units lost in process Cost Charged To the Department: Cost added by the department: Materials Labor Factory Overhead (FOH) Total cost to be accounted for 45,000 4,000 1,000 ------Total Cost P24,500 29,140 28,200 ------P81,840 ====== Cost Accounted for as Follows: Transferred to next department (45,000 P1.72) Work in process - ending inventory: Materials (4,000 P0.50) Labor (4,000 1/2 P0.60) Factory Overhead (4,000 1/2 P0.60) Total cost accounted for P2,000 1,240 1,200 -----4,440 -----P81,840 ===== Additional Computations Equivalent Production: Materials = 45,000 + 4,000 = 49,000 units Labor and factory overhead = 45,000 + 4,000 / 2 = 47,000 units Unit Costs: Materials = P24,500 / 49,000 = P0.50 per unit Labor = P29,140 / 47,000 = P0.62 per unit Factory overhead = P28,200 / 47,000 = 0.60 per unit P77,400 50,000 ====== unit Cost P0.50 0.62 0.60 ----P1.72 ==== 50,000 ======

Explanation: The quantity schedule of the cost report shows that Blending Department put 50,000 units in process, with units reported in terms of finished product. Finished units could be stated in pounds, feet, gallons, barrels, etc. If materials issued to a department are stated in pounds and finished product is reported in gallons, units in the quantity schedule will be in terms of the finished product, gallons. A product conversion table would be used to determine the number of units for which the department is accountable. The quantity schedule of the Blending Department's report shows that of the 50,000 units for which the department was responsible, 45,000 units were transferred to the next department (Testing Department - second department), 4,000 units are still in process, and 1,000 units were lost in processing. Equivalent Production: Costs charged to a department come from an analysis of materials used, payroll distribution sheets, and department expense analysis sheets. The Blending Department's unit cost amounts to P1.72 (P0.50 for materials, P0.62 for labor, and P0.60 for factory overhead). Calculations of individual unit costs require an analysis of the ending work in process to determine its stage of completion. This analysis is usually made by a supervisor or is the result of using predetermined formula. Materials, labor, and factory overhead have been used on the 4,000 units in the process but not in an amount sufficient for completion. To assign costs equitably to in process inventory and transferred units, units still in process must be restated in terms of completed units, which is 4,000 units for materials cost but less than 4,000 for labor and overhead costs. The figure for partially completed units in process is added to units actually completed in order to arrive at the equivalent production figure for the period. This equivalent production figure represents the number of units for which sufficient materials, labor, and overhead were issued or used during a period. Materials, labor and overhead costs are divided by the appropriate equivalent production figure to compute unit costs by elements. Should a cost element be at a different stage of completion with respect to units in process, then a separate equivalent production figure must be computed. In many manufacturing processes, all materials are issued at the start of production. Unless stated otherwise, the illustrations in this discussion assume such a procedure. Therefore, the 4,000 units still in process have all the materials needed for their completion but not all labor and factory overhead (FOH). Only 50% of the labor and factory overhead needed to complete the units has been used. In terms of equivalent production, labor and factory overhead in process are sufficient to complete 2,000 units. Units Costs: Departmental cost of production reports indicates the cost of units as they leave department. These individual departmental units costs are accumulated into a completed unit cost for the period. The report for the Blending Department shows a materials cost of P24,500, labor cost of P29,140, and factory overhead of P28,200. The materials cost of P24,500 is sufficient to complete 49,000 units (the 45,000 units transferred out of the department as well as the work in process for which enough materials are in process to complete 4,000 units). The unit materials cost is, therefore, P0.50 (P24,500 / 49,000). A similar computation determines the number of units actually and potentially completed with the labor cost of P29,140 and the factory overhead of P28,200. The 2,000 equivalent units in process are added to the 45,000 units completed and transferred to obtain a total equivalent production figure of 47,000 units for both labor and factory overhead (FOH). When the equivalent production figure of 47,000 units is divided into the monthly labor cost of P29,140, a unit cost for labor of P0.62 (P29,140 / 47,000) is computed. The unit cost for factory overhead is P0.60 (P28,200 / 47,000). The unit cost added by the department is P1.72, which is the sum of the materials, labor, and overhead unit costs - P0.50, P0.62, and P0.60. This departmental unit cost figure cannot be determined by dividing the total departmental cost of P81,840 by a single equivalent production figure, because no such figure exists; units in process are at different stages of completion as to materials, labor and factory overhead. Disposition of Departmental Costs: In the departmental cost report, the section titled "Cost Charged to the Department" shows a total departmental cost of P81,840. The section titled "Cost Accounted for as Follows" show the disposition of this cost. The 45,000 units transferred to the next department have a cost of P77,000 (45,000 P1.72). The balance of the cost to be accounted for, P4,440 (P81,840 - P77,400), is the cost of work in process.

The inventory figure must be broken down into its component parts: materials, labor, and factory overhead. These individual costs are easily determined. The cost of materials in process is obtained by multiplying total units in process by the materials unit cost (4,000 P0.50 = P2,000). The costs of labor and overhead in process is sufficient to complete only 50 percent or 2,000 of the units in process. Therefore, the cost of labor in process is P1,240 (2,000 P0.62) and factory overhead in process is P1,200 (2,000 P0.60). Lost Units: Continuous processing leads to the possibility of waste, seepage, shrinkage, and other factors which cause loss or spoilage of production units. Management is interested not only in the quantities reported as completed production, units in process, and lost units but also in a comparison of planned and actual results. In verifying reported figures, the accountant must reconcile quantities put into process with quantities reported as completed and lost. One method of making such reconciliation is to establish the process yield, i.e., the finished production that should result from processing various materials. This yield is computed as follows: Percent Yield = (Weight of finished product / weight of materials charged) 100 The yield figure is useful to management for controlling materials consumption and ties in closely with a firm's quality control procedures. Various yields are established as normal. Yields below normal are measures of inefficiencies and are some times used to compute lost units. Frequently quality control data are used to compute production costs, since the use of incorrect quantities would result in incorrect unit costs. Units Lost in the First Department: Lost units reduce the number of units over which total cost can be spread, causing an increase in unit costs. The 1,000 units lost in the Blending Department increase the units costs of materials, labor, and factory overhead. Had these units not been lost, the equivalent production figure would be 50,000 units for materials and 48,000 for labor and factory overhead. The unit cost for materials would be P0.49 instead of P0.50; labor, P0.607 instead of 0.62; and factory overhead, P0.588 instead of P0.60. In the first department, the only effect of losing units is an increase in the unit cost of the remaining good units. In this situation, the loss is assumed to apply to all good units and to be within normal tolerance limits.

Cost of Production Report - Testing Department (2nd Department):

Learning Objective: 1. 2. Prepare a cost of production report of second department in a process costing system. How lost units are treated in process costing system when a cost of production report of subsequent to the first department is prepared? The Starex Corporation Testing Department (2nd Dept.) Cost of Production Report For the Month of January, 2011

Quantity Schedule: Units received from the preceding department Units transferred to next department Units still in process (1/2 labor and FOH) Units lost in process 40,000 3,000 2,000 45,000 ====== 45,000 ======

Cost Charged To the Department:

Total Cost

unit Cost

Cost from preceding department: Transferred in during the month Cost added by the department: Labor Factory Overhead (FOH) Total cost added Adjusted for lost units ------Total cost to be accounted for P147,510 ====== Cost Accounted for as Follows: Transferred to next department (40,000 P3.51) Work in process - ending inventory: Adjusted cost from preceding department [3,000 (P1.72 + P0.08)] Labor (4,000 1/2 P0.60) Factory Overhead (4,000 1/2 P0.60) Total cost accounted for P5,400 910 800 -----7,110 -----P147,510 ====== Additional Computations Equivalent Production: Labor and factory overhead = 40,000 + 3,000 / 3 = 41,000 units Unit Costs: Labor = P37,310 / 41,000 = P0.91 per unit Factory overhead = P32,800 / 41,000 = 0.80 per unit *Adjustment for lost units: Method No.1: P77,400 / 43,000 = P1.80; P1.80 - P1.72 = P0.08 per unit Method No.2: 2,000 units P1.72 = P3,440; P3,440 / 43,000 = P0.08 per unit Explanation: The Blending Department (first department) transferred 45,000 units to the Testing Department, where labor and factory overhead were added before the units were transferred to the Terminal Department P140,400 29,140 28,200 ------P81,840 0.91 0.80 ----P1.71 0.08* -----P3.51 ====== P77,400 P1.72

(third or final department). Costs incurred in the the additional departmental as well as cumulative unit costs.

testing

department

resulted

in

The cost of production report of the testing department differ from that of the Blending Department (first department) in several respects. Several additional calculations are made, for which space has been provided on the report. The additional information deals with: 1. 2. 3. Cost received from the preceding department. An adjustment of the preceding department's unit cost because of lost units. Cost received from the preceding department to be included in the cost of ending work in process inventory.

The quantity schedule of the Testing Department shows that the 45,000 units received from the Blending Department (first department) were accounted for as follows: 1. 2. 3. 40,000 units sent to terminal department. 3,000 units still in process. 2,000 units lost.

An analysis of the work in process (WIP) indicates that units in process are but one third complete as to labor and factory overhead. Unit costs, P0.91 for labor and P0.80 for factory overhead, were calculated as follows: Equivalent production of the testing department is 41,000 units [40,000 + P1/3 (3,000)], the labor unit cost is P0.91 (P37,310 / 41,000), and the factory overhead unit cost P0.80 (P32,800 / 41,000). There is no materials unit cost, since no materials were added by the department. The department unit cost is P1.71, the sum of the labor unit cost of P0.91 and the factory overhead unit cost of P0.80. The testing department is responsible for the labor and factory overhead used as well as for the cost of units received from the Blending Department (first department). This latter cost is inserted as a cost charged to the department under the title "cost from preceding department" which is immediately above the section of the report dealing with cost added bythe department. The cost transferred in was P77,400, previously shown in the cost report of the Blending Department (first department) as cost transferred out of that department by this journal entry: Work in process - Testing department Work in process - Blending department 77,400 77,400

The work in process account of the testing department is charged with cost received from the preceding department and with P70,110 of departmental labor and factory overhead (FOH), a total cost of P147,510 to be accounted for by the department. Units Lost in the Department Subsequent to the First: The Blending Department (first department) unit cost was P1.72 when 45,000 units were transferred to the Testing Department. However, because 2,000 of these 45,000 units were lost during processing in the Testing Department, the P1.72 unit cost figure no longer applies and must be adjusted. The total cost of the units transferred remains at P77,400, but 43,000 units must now absorb this total cost, causing an increase of P0.08 in the cost per unit due to the loss of 2,000 units in the testing department. The lost units cost can be computed by one of two methods. Method No.1: Determines a new unit cost work done in the preceding department and subtracts the preceding departments old unit costs figure from the adjusted unit cost figure. The difference between the two figures is the additional cost due to the lost units. P1.80 new adjusted unit cost for work done in the preceding department is obtained by dividing the remaining good units, 43,000 (45,000 - 2,000), into the cost transferred in, P77,400. The old unit cost figure of P1.72 is subtracted from the revised unit cost to arrive at the adjustment of P0.08.

Method No. 2: Determines the lost units share of total cost and allocates this cost to the remaining good units. total cost previously absorbed by the units lost is P3,440, which is the result of multiplying the 2,000 lost units by their unit cost of P1.72. The P3,440 cost must now be absorbed by the remaining good units. The additional cost to be picked up by each remaining good unit is P0.08 (3,440 / 43,000 units). The lost unit cost adjustment must be entered in the cost of production report. TheP0.08 is entered on the "Adjustment for lost units" line. The departmental unit cost of P1.71 does not have to be adjusted for units lost. In the testing department, the cost of any work done on lost units has automatically been absorbed in the departmental unit cost by using the equivalent production figure of 41,000 instead of 43,000. The P1.72 unadjusted units cost for work done in the preceding department, the P1.71 departmental unit cost, and the P0.08 adjustment for lost units are totaled in order to obtain the P3.51 cumulative unit cost for work done up to the end of operations in the testing department. Timing of Lost Units: Lost units may occur at the beginning, during, or at the end of a manufacturing process. For purposes of practicality and simplicity, it is ordinarily assumed that units lost at the beginning or during the process were never put in process. The cost of units lost is spread over the units completed and units still in process. When units are lost or are identified as lost at the end of a process, the cost of the lost units is charged to completed units only. No part of the loss is charged to units still in process. Assume that the 2,000 units lost by the testing department were the result of spoilage found at final inspection by the quality control department; their cost would be charged only the 40,000 finished units, as illustrated below: The Starex Corporation Testing Department (2nd Dept.) Cost of Production Report For the Month of January, 2011 Quantity Schedule: Units received from the preceding department Units transferred to next department Units still in process (1/2 labor and FOH) Units lost in process Cost Charged To the Department: 40,000 3,000 2,000 Total Cost 45,000 ====== unit Cost 45,000 ======

Cost from preceding department: Transferred in during the month Cost added by the department: Labor Factory Overhead (FOH) Total cost added 37,310 32,800 ------P70,110 ------Total cost to be accounted for P147,510 ====== 0.87 0.76 ----P1.63 -----P3.35 ====== P77,400 -------P1.72 -------

Cost Accounted for as Follows: Transferred to next department [(40,000 P3.51+P0.167)]* Work in process - ending inventory: From preceding department (3,000 P1.72) Labor (3,000 1/3 P0.87) Factory Overhead (3,000 1/2 P0.76) Total cost accounted for P5,160 870 760 -----6,790 -----P147,510 ====== Additional Computations: Equivalent Production: Labor and factory overhead = 40,000 + 3,000 / 3 + 2,000 lost units = 41,000 units Unit Costs: Labor = P37,310 / 43,000 = P0.87 per unit Factory overhead = P32,800 / 43,000 = P0.76 per unit Lost unit cost = P3.35 2,000 units = P6,700 + 40,000 units P0.1675 per unit to be added to P3.35 to make the transfer cost P3.5175. *40,000 units P3.5175 = P140,700. To avoid a decimal discrepancy, the cost transferred is computed: P147,510 - P6,790 = P140,720. A comparison of the differences between the two cost of production reports for the testing departments as to amounts for costs of units transferred and work in process inventory is shown below the production report. Not the offsetting increases and decreases. In this illustration, the assumption has been made that the lost units, identified at the end of the process, were complete as to all costs. In sum companies, members of the quality control or inspection departments make production checks prior to the end of the process. Such a procedure uncovers lost units that are not complete when the loss is incurred or the spoilage discovered and yet the loss may pertain only to units completed and not to units still in process. In such a case the lost units should be adjusted for their equivalent stage of completion. For example, 2,000 units lost at the 90% stage of conversion would appear as 1,800 equivalent units with regard to labor and factory overhead costs. Normal Vs Abnormal Loss of units: Units are lost through evaporation, shrinkage, substandard yields, spoiled work, poor work man ship, or inefficient equipment. In many instances the nature of operations makes certain losses normal or unavoidable, because they are considered with in normal tolerance limits for human and machine errors. The cost of these normally lost units does not appear as a separate item of cost but is spread over the remaining good units. A different situation is created by abnormal or avoidable spoilage or losses that are not expected to arise under normal, efficient operating conditions. The cost of such abnormal spoilage or losses is charged either to factory overhead as shown below, thereby appearing as an additional unfavorable able factory overhead variance, or directly to a current period expense account and reported as a separate item in the cost of goods sold statement. Factory Overhead Control Work in process - Testing Department (lost units) 6,700 6,700 P140,720

The cost of production report would show the abnormal spoilage or loss as follows: Transferred to next department (40,000 units P3.35) ..............P134,020* Transferred to factory overhead [40,000 units P0.1675) or (2,000 lost units P3.35)].......................................................6,700 *40,000 units P3.35 = P134,000. To avoid decimal discrepancy, the cost transferred is computed: P147,510 - P6,790 ending inventory - P6,700 = P134,020 If the lost units were only partially complete, equivalent production calculations should consider their stage of completion when lost or spoiled, and the costing of the abnormal loss should be weighted accordingly. If one part of the loss is normal and another abnormal, each portion must be treated in accordance with the above discussion. The critical factor in distinguishing between normal and abnormal spoilage or loss is the degree of controllability. Normal or unavoidable spoilage or loss is produced by the process under efficient operating conditions, referred to as uncontrollable. Abnormal or avoidable spoilage or loss is considered unnecessary, because the conditions resulting in the loss are controllable. For this reason, within the limits set by the state of the art of production, the difference is a short-run condition; in the long run, management should adjust and control all factors of production and eliminate all abnormal conditions. The cost of production report at the beginning of this page shows a total cost of P147,510 to be accounted for by the Testing department. The department completed and transferred 40,000 units to the Terminal Department (third or final department) at a cost of P140,000 (40,000 P3.51). The remaining cost is assigned to the work in process inventory. This balance is broken down by the various costs in process. When computing the cost of the ending work in process inventory of any department subsequent to the first, costs received from the preceding departments must be included. The 3,000 units still in process, completed by the Blending Department (first department) at a unit cost of P1.72, were later adjusted by P0.08 (to P1.80) because of the loss of some of the units transferred. Therefore, the Blending Department's (first department) cost of the 3,000 units still in process is P5,400 figure is not broken down further , since such information is not pertinent to the Testing Department's operations. However, the amount is listed separately in the cost of production report, because it is part of the Testing Department's ending work in process inventory. Materials (if any), labor, and factory overhead (FOH) added by a department are costed separately in order to arrive at total work in process (WIP). In the testing department, no materials were added to the units received; thus, the ending inventory shows no materials in the process. However, labor and factory overhead costs were incurred. The work in process analysis stated that labor and factory overhead used on the units in process were sufficient to complete 1,000 units. The cost of labor in process is P910 (1,000 P0.91) and factory overhead is process is P800 (1,000 P0.80). The total cost of the 3,000 units in process is P7,110 (P5,400 + P910 + P800). This cost, added to that transferred to the Terminal Department (third or final department), P140,400, accounts for the total cost of P147,510 charged to the Testing Department. Cost of Production Report - Terminal Department (3rd - Final Department): The cost of production report of 3rd and final department is illustrated below: The Starex Corporation Terminal Department (3rd Dept.) Cost of Production Report For the Month of January, 2011 Quantity Schedule: Units received from the preceding department Units transferred to finished goods storeroom Units still in process (1/4 labor and FOH) Units lost in process Cost Charged To the Department: Cost from preceding department: Transferred in during the month 35,000 4,000 1,000 Total Cost P140,400

40,000 ======

40,000 ====== unit Cost P3.51

Cost added by the department: Labor Factory Overhead (FOH) Total cost added Adjusted for lost units Total cost to be accounted for Cost Accounted for as Follows: Transferred to finished goods storeroom (35,000 P5.05) Work in process - ending inventory: Adjusted cost from preceding department [4,000 (P3.51 + P0.09)] Labor (4,000 1/4 P0.90) Factory Overhead (4,000 1/4 P0.55) Total cost accounted for

32,400 19,800 ------P52,500 ------P192,600 ======

0.90 0.55 ----P1.45 0.09* -----P5.05 ====== P176,750

P14,400 900 550 ------

15,850 -----P192,600 ======

Additional Computations: Equivalent Production: Labor and factory overhead = 35,000 + 4,000 / 4 = 36,000 units Unit Costs: Labor = P32,400 / 36,000 = P0.90 per unit Factory overhead = P19,800 / 36,000 = 0.55 per unit *Adjustment for lost units: Method No.1: P140,400 / 39,000 = P3.60; P3.60 - P3.51 = P0.09 per unit Method No.2: 1,000 units P3.51 = P3,510; P3,510 / 39,000 = P0.09 per unit Explanation: Total and unit cost figures were derived by using procedures discussed for the cost of production report of the Testing Department. The work completed is transferred to thefinished goods storeroom; thus, the title "Transferred to finished goods storeroom" is used in place of the title "Transferred to next department." Cost charged to the Terminal Departmentcome from the payroll distribution and the department's expense analysis sheet. The journal entry transferring costs from the Testing Department follows: Work in process - Terminal Department Work in process - Testing Department 140,000 140,000

The entry to transfer finished units to the finished goods storeroom is presented below: Finished Goods Work in process - Terminal Department 176,750 176,750

Combined Cost of Production Report (CPR) - Process Costing: The three cost of production reports for the Starex Corpora have been discussed and computed separately.

These reports would most likely be consolidated in a single report summarizing manufacturing operations of the firm for a specific period. Such a report, as illustrated below, should be reviewed in order to observe the interrelationship of the various department reports. The Starex Corporation Cost of Production Report All Producing Departments For the Month of January, 2011 Quantity Schedule: Units started in process Units received from the preceding department Units transferred to next department Units transferred to finished goods storeroom Units still in process Units lost in process Blending Testing Terminal 1stDepartment 2ndDepartment 3rdDepartment 50,000 ====== 45,000 40,000 ====== ====== 45,000 40,000 35,000 4,000 1,000 ------50,000 ====== Total unit Cost cost 3,000 4,000 2,000 1,000 ------------45,000 40,000 ====== ====== Total unit Total cost unit cost Cost Cost P77,400 P1.72 P140,400 P3.51 -------- ----- -------- ----P24,500 P.50 29,140 .62 P37,310 P.91 P32,400 P.90 28,200 .60 32,800 .80 19,800 .55 -------------------------P81,840 P1.72 P70,110 P1.71 P52,200 P1.45 P.08 P.09 ---------------- ----- ----------P81,840 P1.72 P147,510 P3.51 P192,600 P5.05 ====== === ====== === ====== === P77,400 P140,400 P176,750

Cost Charged To the Department: Cost from preceding department: Transferred in during the month Cost added by the department: Materials Labor Factory Overhead (FOH) Total cost added Adjusted for lost units Total cost to be accounted for Cost Accounted for as Follows: Transferred to next department Transferred to finished goods storeroom (35,000 P5.05) Work in process - ending inventory: Adjusted cost from preceding department [4,000 (P3.51 + P0.09)] Materials Labor (4,000 1/4 P0.90) Factory Overhead (4,000 1/4 P0.55) Total cost accounted for

P5,400 P2,000 1,240 1,200 -----4,440 -------P81,840 ======

P14,400

910 800 -----7,110 -----P147,510 ======

900 550 -----15,850 -------P192,600 ======