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Topic 5 System Design Process Costing
Topic 5 System Design Process Costing
Topic 5 System Design Process Costing
Lecture Notes
A. Job-Order Costing vs. Process Costing. Process costing is used in industries that produce
homogenous products such as bricks, flour, and cement on a continuous basis.
1. Similarities between job-order and process costing. Job-order and process costing
systems share some characteristics:
a. Both systems have the same basic purpose—to assign material, labor, and overhead
cost to products.
b. Both systems use the same basic manufacturing accounts: Manufacturing Overhead,
Raw Materials, Work In Process, and Finished Goods.
c. The flow of costs through the manufacturing accounts is basically the same.
2. Differences between job-order and process costing. The differences between job-order
and process costing occur because the flow of units in a process costing system is more or
less continuous and the units are essentially indistinguishable from one another. Under
process costing:
b. Costs in process costing are accumulated by department, rather than by individual job.
c. The department production report is the key document in process costing, showing the
accumulation and disposition of cost. In job-order costing, the job-cost sheet is the key
document.
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C. Equivalent Units of Product. In order to calculate the average cost per unit, the total
number of units must be determined. Partially completed units pose a difficulty that is overcome
using the concept of equivalent units. Equivalent units are the equivalent, in terms of completed
units, of partially completed units. The formula for computing equivalent units is:
Number of
Equivalent partially completed Percentage
units units completion
Equivalent units are the number of complete, whole units one could obtain from the materials
and effort contained in partially completed units.
The following example can be used to illustrate the equivalent units’ concept.
Example 1
A company which had no beginning inventory completed 100 units last month. In addition, the
company worked on another 60 units that were 40% complete. Identify the number of units that
were produced during the period.
By simply adding up the total number of units that were worked on (100 + 60 = 160) would
provide a misleading answer since the 60 units in ending inventory are only 40% complete. Ask
the question, “If all work was directed to finishing products before starting any others, how
many units could have been made in this period?” In terms of totally completed units, the
amount of effort expended was equivalent to the production of 124 units (100 + 60 40%).
Example 2
Halsey Company manufactures a product that goes through two departments. During the period,
the following activity took place in the first Department:
Percent Completed
Units Materials Conversion
Work in process, beginning 15,000 100% 80%
Units started into production 180,000
Units completed and transferred 175,000
Work in process, ending 20,000 70% 30%
Materials Conversion
Units completed and transferred out 175,000 175,000
Work in process, ending:
20,000 units x 70% complete 14,000
20,000 units x 30% complete 6,000
Equivalent units of production 189,000 181,000
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Under the weighted-average method, the equivalent units for a particular cost category (e.g.,
materials or conversion cost) is computed by adding together the number of units completed and
transferred out to the next department during the period and the equivalent units in the ending
work in process inventory in the department.
Equivalent Units transferred to Equivalent units
units of the next department in ending work in
production or to finished goods process inventory
The treatment of beginning inventory under the weighted-average method since work performed
in prior periods is included in the equivalent units. Point out that this is called the weighted-
average method because it averages together beginning inventory and the work that was
performed in the current period. Costs and units are treated consistently. Both the equivalent
units and the costs that go into the unit cost calculations under the weighted-average method
include amounts already in beginning inventory.
D. Production Report. The purpose of a production report is to summarize all of the activity
that takes place in a department's work in process account for a period. A production report
consists of three parts:
• A quantity schedule and a computation of equivalent units.
• A computation of costs per equivalent unit.
• A reconciliation of all cost flows into and out of the department during the period.
1. Quantity Schedule and Equivalent Units. The first step in preparing a production report
is to prepare a quantity schedule, which shows the physical flow of units through the
department. This schedule allows managers to see at glance how many units moved
through the department during the period. Using the quantity schedule, the equivalent units
can be easily computed.
2. Costs per Equivalent Unit. The second step in preparing a production report is to
calculate the costs per equivalent unit. The cost per equivalent unit is computed for a
particular cost category (i.e., materials, labor, overhead, or conversion) by dividing its total
cost by its total equivalent units. Note that under the weighted-average method the costs
include both the costs already in beginning inventory as well as the costs added by the
department during the current period.
3. Cost Reconciliation. The third step in preparing a production report is to prepare a cost
reconciliation. The purpose of a cost reconciliation is to show how the costs from
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beginning work in process inventory and costs that have been added during the period are
accounted for.
a. Costs come into the department from units in beginning inventory, from material, labor,
and overhead costs that are added during the period, and from any units that might have
been transferred in from a prior department.
b. A department's costs are accounted for by showing the costs that are transferred out to
the next department (or to finished goods) and by specifying the costs that remain in the
ending work in process inventory.
F. Operation Costing. The costing systems discussed in Topic and 5 represent the two ends
of a continuum. On one end is job-order costing and on the other is process costing. Between
the two extremes, there are many “hybrid” systems. Operation costing is an example of such a
hybrid system. It is used in situations where products have some common as well as individual
characteristics. TVs, for example, have some common characteristics in that all models must be
assembled and tested following the same basic steps. However, each model has different
components with different costs. The costs of the components (materials) would be charged to a
batch of a particular model individually, as in job-order costing, but the conversion costs may be
assigned using process costing.
EXAMPLE 1:
This is the data for May operation of the Shaping and Milling of Double Diamond Skis to
illustrate the production report.
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EXAMPLE 2:
Production Report
Quantity
Schedule
Units to be accounted for:
Work in process, May 1 10,000
Started into production 190,000
Total units to be accounted for 200,000
Equivalent Units
Units accounted for: Materials Conversion
Transferred to next department 180,000 180,000 180,000
Work in process, May 31 20,000 20,000 5,000*
Total units to be accounted for 200,000 200,000 185,000
G. FIFO Method. The FIFO method segregates the units and costs in the beginning inventory
from the units and costs of the current period. WILL NOT BE COVERED IN LECTURE.
EXERCISE
Muizzudin Bhd is company producing a type of product called Comele. The production of the
product has to go through two departments, namely, the Mixing Department and the Bottling
Department. The following is the information obtained from the Mixing Department for
October 2019:
Answer:
Quantity
Schedule
Units to be accounted for:
Work in process, October 1 40,000
Started into production 80,000
Total units to be accounted for 120,000
Equivalent Units
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Units accounted for: Materials Conversion
Transferred to next department 100,000 100,000 100,000
Work in process, October 31 20,000 5,000 5,000
Total units to be accounted for 120,000 105,000 105,000
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