CHAPTER FIVE

PROCESS COSTING SYSTEM

Process costing systems are used to apply costs to similar products that are mass produced in a
continuous fashion, such as the production of ice cream, steel or soft drinks. In comparison, costs
in a job order cost system are assigned to a specific job, such as the construction of a customized
home, the making of a motion picture, or the manufacturing of a specialized machine. Job order
cost and process cost systems are similar in that:
a) Both use the same three manufacturing cost elements of direct materials, direct labor, and
manufacturing overhead;
b) Both accumulate costs of raw materials by debiting Raw Materials Inventory, factory labor
by debiting Factory Labor, and manufacturing overhead costs by debiting Manufacturing
Overhead; and
c) Both flow costs to the same accounts of Work in Process, Finished Goods Inventory, and
Cost of Goods Sold.

The major differences between a job order cost system and a process cost system are as follows:
Feature Job Order Cost System Process Cost System
Work in process accounts One for each job One for each process
Documents used Job cost sheets Production cost reports
Determination of total Each job Each period
manufacturing costs
Unit-cost computations Cost of each job ÷ Units Total manufacturing costs ÷
produced for the job Units produced during the period

Process Cost Flow

Let’s assume that we have a manufacturing company with two processes, processing (or
machining) and assembly. In the Machining Department, the raw materials are shaped, honed,
and drilled. In the Assembly Department, the parts are assembled and packaged. Materials, labor,
and manufacturing overhead can be added in both the Machining and Assembly Departments.
When the Machining Department finishes its work, the partially completed units are transferred
to the Assembly Department. In the Assembly Department, the goods are finished and are then
transferred to the finished goods inventory. Upon sale, the goods are removed from the finished
goods inventory.

Manufacturing Work in Process Work in Process Finished Goods Cost of Goods

Costs Machining Department Assembly Department Inventory Sold
Raw Materials Assigned Costs Cost of Cost of
Factory Labor To transferred completed goods
Manufacturing out to work sold
Overhead

As the flow of costs indicates, the company can add materials, labor, and manufacturing
overhead in both the Machining and Assembly Departments. When it finishes its work, the
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Machining Department transfers the partially completed units to the Assembly Department. The
Assembly Department finishes the goods and then transfers them to the finished goods inventory.
Upon sale, the Company removes the goods from the finished goods inventory. Within each
department, a similar set of activities is performed on each unit processed.

Flow of Costs in Process Cost System- Assignment of Manufacturing Costs

All raw materials issued for production are a materials cost to the producing department.
Materials requisitions slips may be used in a process cost system, but fewer requisitions are
generally required than in a job order cost system, because the materials are used for processes
rather than for specific jobs. The entry to record the materials used is:

Work in Process--Machining........................................ XX
Work in Process--Assembly......................................... XX
Raw Materials Inventory.................................. XX

Time tickets may be used in determining the cost of labor assignable to the production
departments. The labor cost chargeable to a process can be obtained from the payroll register or
departmental payroll summaries. All labor costs incurred within a producing department are a
cost of processing the raw materials. The entry to assign the labor costs is:

Work in Process--Machining........................................ XX
Work in Process--Assembly......................................... XX
Factory Labor..................................................... XX

The basis for allocating the overhead costs to the production departments in an objective and
equitable manner is the activity that "drives" or causes the costs. A primary driver of overhead
costs in continuous manufacturing operations is machine time used, not direct labor. Thus,
machine hours are widely used in allocating manufacturing overhead costs. The entry to allocate
overhead is:

Work in Process--Machining........................................XX
Work in Process--Assembly.........................................XX
Manufacturing Overhead..................................... XX

At the end of the period, the following transfer entries are needed:
Work in Process--Assembly........................................XX
Work in Process--Machining..................................XX

Finished Goods Inventory............................................XX

Work in Process--Assembly................................... XX

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Cost of Goods Sold...................................................... XX
Finished Goods Inventory....................................... XX

Illustration 5.1
A drug Company manufactures drugs through two processes: blending and bottling. In June, raw
materials used were blending $18,000 and bottling $4,000. Factory labor costs were blending
$12,000 and bottling $5,000. Manufacturing overhead costs were blending $6,000 and bottling
$2,500. The company transfers units completed at a cost of $19,000 in the Blending Department
to the Bottling Department. The Bottling Department transfers units completed at a cost of
$11,000 to Finished Goods. Journalize the assignment of these costs to the two processes and the
transfer of units as appropriate.
Solution:
The entries are:
Work in Process—Blending 18,000
Work in Process—Bottling 4,000
Raw Materials Inventory 22,000
(To record materials used)

Work in Process—Blending 12,000

Work in Process—Bottling 5,000
Factory Labor 17,000
(To assign factory labor to production)

Work in Process—Blending 6,000

Work in Process—Bottling 2,500
Manufacturing Overhead 8,500
(To assign overhead to production)

Work in Process—Bottling 19,000

Work in Process—Blending 19,000
(To record transfer of units to the Bottling
Department)

Finished Goods Inventory 11,000

Work in Process—Bottling 11,000
(To record transfer of units to finished goods)

Equivalent Units (EU)

A major step in process cost accounting is the calculation of equivalent units. Equivalent units of
production measure the work done during the period, expressed in fully completed units. This
concept is used to determine the cost per unit of completed product. The formula to compute
equivalent units of production is given below under weighted average method.
Equivalent Units of = Units Completed and + Equivalent Units of Ending Work in
Production Transferred Out Process

Weighted-Average Method

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It is a process costing method that blends (bring /combine) together units and costs from both the
current and prior periods. It considers the degree of completion (weighting) of the units
completed and transferred out and the ending work in process. There is another method called
the First in, First out method (or FIFO); discussed below.

Production Cost Report

A production cost report is the key document used by management to understand the activities in
a department because it shows the production quantity and cost data related to that department.
In order to be ready to complete a production cost report, the company must perform the
following four Production Cost Report steps:
1. Compute the physical unit flow.
2. Compute the equivalent units of production.
3. Compute unit production costs.
4. Prepare a cost reconciliation schedule.

The computation of physical units involves:

a) Adding the units started (or transferred) into production during the period to the units in
process at the beginning of the period to determine the total units to be accounted for; and
b) Accounting for these units by determining the output for the period - which consists of units
transferred out during the period plus the units in process at the end of the period. These units
added together equal the total units accounted for.

Note: Total units to account for and Total units accounted for must ALWAYS BE EQUAL! (We
are talking about physical units.)

In computing unit costs, production costs are expressed in terms of equivalent units of
production. When equivalent units are different for materials and conversion costs, the formulas
for computing unit costs are as follows:

Unit Materials Cost = Total Materials Cost ÷ Equivalent Units of Materials

Unit Conversion Cost = Total Conversion Costs ÷ Equivalent Units of Conversion Costs
Total Manufacturing Cost per Unit = Unit Materials Cost + Unit Conversion Cost

The cost reconciliation schedule shows that the total costs accounted for equal the total costs to
be accounted for as follows:

Costs to be accounted for

Transferred out …………………………………………………$XX
Work in process, End
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 Materials …………………………. $XX
Conversion costs …………………..XX XX
Total costs ……………………………………………………..$XXX
Process costing system is usually illustrated under three cases:
1) Process costing with no beginning or ending work in process inventory
 All units are started and fully completed by the end of the accounting period. This simplify
the assumption that how materials and conversion costs applied to units of products.
2) Process costing with no beginning work in process inventory, but with ending work in
process inventory
 Some units are started during the accounting period are not completed at the end of the
period.
3) Process costing with both beginning and ending work in process inventories
 This case describes the effect of weighted average and first-in-first-out (FIFO) cost flow
assumptions on cost of units completed and cost of work in process inventory.

Illustration 5.2
To illustrate the computation of equivalent units using the weighted-average method, assume that
materials are entered at the beginning of the process and the following information is provided
for the Processing Department of the Silva Company:

Units in WIP, Beginning: Materials 100% complete; Conversion 80% complete = 2,500 units
Units in WIP, Ending: Materials 100% complete; Conversion 60% complete … = 1,000 units
Units started into Production …………………………………………………….. = 4,500 units
Units transferred out ……………………………………………………………… = 6,000 units

Assume the Processing Department of the Silva Company has the following additional cost
information:
Work in process, Beginning:
Direct materials: 100% complete = $ 24,000
Conversion costs: 80% complete = 19,620
Cost of work in process, Beginning = $ 43,620
Costs incurred during production:
Direct materials = $200,000
Conversion costs = 150,000
Costs incurred = $350,000

The two equivalent unit computations are as follows:

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 (Step 2)
(Step 1) Equivalent Units
Quantities (Flow of production) Physical Units Direct Material Conversion
Units to be accounted for:
Work in process, Beg. 2,500
Started into production 4,500
Total units 7,000
Units accounted for:
Transferred out 6,000 6,000 6,000
Work in process, End. 1,000 1,000 600*
Total units 7,000 7,000 6,600
*(1,000x 60%)

The Silva Company's Processing Department Production Cost Report at the end of the period is
as follows:

(Step 3) Unit Cost Total Costs Direct Material Conversion Costs

Cost during the period (a) $393,620 $224,000 $169,620
Equivalent Units (b) 7,000 6,600
Unit cost (a) ÷ (b) $57.7 $32 $25.7
Costs to be accounted for:
Work in process, Beg. $43,620
Started into production 350,000
Total costs $393,620
(Step 4) Cost Reconciliation Schedule
Costs accounted for:
Transferred out (6,000*$57.7) $346,200
Work in process, End.
Materials (1,000*$32) 32,000
Conversion costs (600*$25.7) 15,420
Total costs $393,620
Production cost reports provide a basis for evaluating the productivity of a department. In
addition, managers can use the cost data to assess whether unit costs and total costs are
reasonable. By comparing the quantity and cost data with predetermined goals, top management
can also judge whether current performance is meeting planned objectives.

FIFO Method
The FIFO method of process costing differs from the weighted-average method in two ways:
(1) The computation of equivalent units, and
(2) The way in which costs of beginning inventory are treated.
The FIFO method is generally considered more accurate than the weighted-average method, but
it is more complex. The complexity is not a problem for computers, but the FIFO method is a
little more difficult to understand and to learn than the weighted-average method.

Equivalent Units—FIFO Method

The computation of equivalent units under the FIFO method differs from the computation under
the weighted-average method in two ways:
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 First, the “units transferred out” is divided into two parts. One part consists of the units from
the beginning inventory that were completed and transferred out, and the other part consists
of the units that were both started and completed during the current period.
 Second, full consideration is given to the amount of work expended during the current period
on units in the beginning work in process inventory as well as on units in the ending
inventory.

Thus, under the FIFO method, both beginning and ending inventories are converted to equivalent
units basis. For the beginning inventory, the equivalent units represent the work done to
complete the units; for the ending inventory, the equivalent units represent the work done to
bring the units to a stage of partial completion at the end of the period (the same as with the
weighted-average method).

Operations Costing
Companies often use a combination of a process cost and a job order cost system, called operations
costing. An operation costing is similar to process costing in that standardized methods are used to
manufacture the product. At the same time, the product may have some customized, individual features
that require the use of a job order cost system.

Discussion Questions, Exercises and Problems

5-1. Under what conditions would it be appropriate to use a process costing system?
5-2. In what ways are job-order and process costing similar?
5-3. Why is cost accumulation simpler in a process costing system than it is in a job-
order costing system?
5-4. How many Work in Process accounts are maintained in a company that uses
process costing?
5-5. Assume that a company has two processing departments—Mixing followed by
Firing. Prepare a journal entry to show a transfer of work in process from the Mixing
Department to the Firing Department.
5-6. Assume that a company has two processing departments—Mixing followed by
Firing. Explain what costs might be added to the Firing Department’s Work in
Process account during a period.
5-7. What is meant by the term equivalent units of production when the weighted-
average method is used?
5-8. Arada Jewelry plc produces thousands of medallions made of bronze, silver, and
gold. The medallions are identical except for the materials used in their manufacture.
What costing system would you advise the company to use?

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Ex 5-1ABC Corporation produces bricks in two processing departments—Molding and
Firing. Information relating to the company’s operations in March follows:

a) Raw materials were issued for use in production: Molding Department, $28,000; and
Firing Department, $5,000.
b) Direct labor costs were incurred: Molding Department, $18,000; and Firing
Department, $5,000.
c) Manufacturing overhead was applied: Molding Department, $24,000; and Firing
Department, $37,000.
d) Unfired, molded bricks were transferred from the Molding Department to the Firing
Department. According to the company’s process costing system, the cost of the
unfired, molded bricks was $67,000.
e) Finished bricks were transferred from the Firing Department to the finished goods
warehouse. According to the company’s process costing system, the cost of the
finished bricks was $108,000.
f) Finished bricks were sold to customers. According to the company’s process costing
system, the cost of the finished bricks sold was $106,000.
Required: Prepare journal entries to record items (a) through (f) above.

Ex 5-2The PVC Company manufactures a high-quality plastic pipe that goes through
three processing stages prior to completion. Information on work in the first
department, Cooking, is given below for May:
Production data:
Units in process, May 1: materials 100% complete; conversion 90%
complete . . . . . . . . . .. . . . . .. 70,000
Units started into production during
May . . ... . . . . . . . . . . . . . . . ... . . . . . . . . . . . . . .. . . . . . . . . . 350,000
Units completed and transferred to the next department . . . . . . . . ... . . . . . . . . . . . . . . .
. . . . .. . . . . ?
Units in process, May 31: materials 75% complete; conversion 25%
complete . . . . . . . . . . .. . . . . . 40,000
Cost data:
Work in process inventory, May 1:
Materials cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$86,000
Conversion cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $36,000
Cost added during May:
Materials cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $447,000

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Conversion cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $198,000
The company uses the weighted-average method.
Required:
a. Compute the equivalent units of production.
b. Compute the costs per equivalent unit for the month.
c. Determine the cost of ending work in process inventory and of the units transferred out
to the next department.
d. Prepare a cost reconciliation report for the month.