Systems Design: Process Costing: Chapter Four

Systems Design:
Process Costing
Chapter Four
McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

4-2
Similarities Between Job-Order and Process
Costing
• Both systems assign material, labor and

overhead costs to products and they provide a
mechanism for computing unit product cost.
• Both systems use the same manufacturing
accounts, including Manufacturing Overhead,
Raw Materials, Work in Process, and Finished
Goods.
• The flow of costs through the manufacturing
accounts is basically the same in both systems.

4-3
Differences Between Job-Order and Process
Costing
• Process costing is used when a single product is

produced on a continuing basis or for a long period of
time. Job-order costing is used when many different
jobs are worked on each period.
• Process costing systems accumulate costs by
department. Job-order costing systems accumulated
costs by individual jobs.
• Process costing systems compute unit costs by
department. Job-order costing systems compute unit
costs by job on the job cost sheet.

4-4
Quick Check 
Process costing is used for products that are:

a. Different and produced continuously.
b. Similar and produced continuously.
c. Individual units produced to customer
specifications.
d. Purchased from vendors.

4-5
Quick Check 
Process costing is used for products that are:

a. Different and produced continuously.
b. Similar and produced continuously.
c. Individual units produced to customer
specifications.
d. Purchased from vendors.

4-6
Processing Departments
Any unit in an organization where materials, labor

or overhead are added to the product.
The activities performed in a processing
department are performed uniformly on all
units of production. Furthermore, the output of
a processing department must be
homogeneous.

4-7
Learning Objective 1
Record the flow of

materials, labor, and
overhead through a
process cost system.

4-8
Comparing Job-Order
and Process Costing
Direct
Materials
Direct Labor Work in Finished

Proces Goods
s
Manufacturing Cost of
Overhead Goods
Sold
4-9
Comparing Job-Order
and Process Costing
Costs are traced and

applied to individual
Direct jobs in a job-order
Materials cost system.
Direct Labor Finished

Jobs Goods
Overhead Goods
Sold
4-10
Comparing Job-Order
and Process Costing
Costs are traced and

applied to departments
Direct in a process cost
Materials system.
Direct Labor Processing Finished

Department Goods
Overhead Goods
Sold
4-11
T-Account and Journal Entry Views of Cost Flows
For purposes of this example,

assume there are two
processing departments –
Departments A and B.
We will use T-accounts and
journal entries.

4-12
Process Cost Flows
(in T-account form)
Work in Process
Raw Materials Department A
•Direct •Direct
Materials Materials
Work in Process
Department B
•Direct
Materials

4-13
Process Cost Flows
(in journal entry form)
GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Work in Process - Department A XXXXX
Work in Process - Department B XXXXX
Raw Materials XXXXX
To record the use of direct material.

4-14
Process Cost Flows
(in T-account form)
Work in Process
Department A
Wages Payable
•Direct
•Direct Materials
Labor •Direct
Labor
Work in Process
Department B
•Direct
Materials
•Direct
Labor

4-15
Process Costing

Post.
W ork in Process - De pa rtme nt A XXXXX
W ork in Process - De pa rtme nt B XXXXX
Salarie s and W ages Payable XXXXX
To record direct labor costs.

4-16
Process Cost Flows
(in T-account form)
Work in Process
Department A
Manufacturing •Direct
Overhead Materials
•Direct
•Actual •Overhead Labor
Overhead Applied to •Applied
Work in Overhead
Process
Work in Process
Department B
•Direct
Materials
•Direct
Labor
•Applied
Overhead
4-17
Process Costing
(In journal entry form)

Post.
Manufa cturing Overhead XXXXX
To apply overhead to departments.

4-18
Process Cost Flows
(in T-account form)
Work in Process Work in Process

Department A Department B
•Direct Transferred •Direct
Materials to Dept. B Materials
•Direct •Direct
Labor Labor
•Applied •Applied
Overhead Overhead
•Transferred
from Dept. A

4-19
Process Costing

Post.
To record the transfer of goods from
Department A to Department B.

4-20
Process Cost Flows
(in T-account form)
Work in Process
Department B Finished Goods
•Direct •Cost of •Cost of
Materials Goods Goods
•Direct Manufactured Manufactured
Labor
•Applied
Overhead
•Transferred
from Dept. A

4-21
Process Costing

Post.
Finished Goods XXXXX
W ork in Process - Department B XXXXX
To record the completion of goods
and their transfer from Department B
to finished goods inventory.

4-22
Process Cost Flows
Work in Process
Department B Finished Goods
•Direct •Cost of •Cost of •Cost of
Materials Goods Goods Goods
•Direct Manufactured Manufactured Sold
Labor
•Applied
Overhead
•Transferred
from Dept. A Cost of Goods Sold
•Cost of
Goods
Sold

4-23
Process Costing

Post.
Accounts Receivable XXXXX
Sales XXXXX
To record sales on account.
Cost of Goods Sold XXXXX

Finished Goods XXXXX
To record cost of goods sold.

4-24
Equivalent Units of Production
Equivalent units are the product of the number of

partially completed units and the percentage
completion of those units.
We need to calculate equivalent units because a

department usually has some partially completed units
in its beginning and ending inventory.
4-25
Equivalent Units – The Basic Idea
Two half completed products are

equivalent to one completed product.
= 1
So, 10,000 units 70% complete

are equivalent to 7,000 complete units.
4-26
Quick Check 
For the current period, Jones started 15,000

units and completed 10,000 units, leaving
5,000 units in process 30 percent complete.
How many equivalent units of production did
Jones have for the period?
a. 10,000
b. 11,500
c. 13,500
d. 15,000
4-27
Quick Check 
For the current period, Jones started 15,000

units and completed 10,000 units, leaving
5,000 units in process 30 percent complete.
How many equivalent units of production did
Jones have for the period?
a. 10,000
10,000 units + (5,000 units × 0.30)
b. 11,500 = 11,500 equivalent units
c. 13,500
d. 15,000
4-28
Calculating Equivalent Units
Equivalent units can be calculated two

ways:
The First-In, First-Out Method – FIFO is
covered in the appendix to this chapter.
The Weighted-Average Method – This

method will be covered in the main portion of the
chapter.

4-29
Compute the equivalent

units of production using
the weighted-average
method.

4-30
Equivalent Units of Production
Weighted-Average Method
The weighted-average method . . .

• Makes no distinction between work done in prior
or current periods.
• Blends together units and costs from prior and
current periods.
• Determines equivalent units of production for a
department by adding together the number of
units transferred out plus the equivalent units in
ending work in process inventory.

4-31
Treatment of Direct Labor
Direct
Materials Direct labor costs
may be small
in comparison to
Dollar Amount
Conversion other product

costs in process
Direct cost systems.
Labor
Type of Product Cost

4-32
Treatment of Direct Labor
Direct
Materials Direct labor costs
Conversion
may be small
in comparison to
Dollar Amount
other product
costs in process
cost systems.
Type of Product Cost

Direct labor and manufacturing overhead may be
combined into one product cost called conversion.
4-33
Weighted-Average Example
Double Diamond Skis reported the following activity in

Shaping and Milling Department for the month of May:
Percent Completed
Shaping and Milling Department Units Materials Conversion
Beginning work in process 200 55% 30%
Units started into production in May 5,000
Units completed during May and 4,800 100% 100%

transferred to the next department
Ending work in process 400 40% 25%

4-34
The first step in calculating the equivalent units is

to identify the units completed and transferred
out of the Department in May (4,800 units)
Materials Conversion
Units completed and transferred
to the next department 4,800 4,800

4-35
The second step is to identify the equivalent units of

production in ending work in process with respect to
materials for the month (160 units) and add this to the
4,800 units from step one.
Work in process, June 30:
400 units × 40% 160
Equivalent units of Production in

during the month of May 4,960

4-36
The third step is to identify the equivalent units of

production in ending work in process with respect to
conversion for the month (100 units) and add this to the
4,800 units from step one.
400 units × 40% 160
400 units × 25% 100
during the month of May 4,960 4,900

4-37
Equivalent units of production always equals:

+ Equivalent units remaining in work in process
400 units × 40% 160
400 units × 25% 100
during the month of May 4,960 4,900

4-38
Materials 5,000 Units Started
Beginning Ending
Work in Process 4,800 Units Started Work in Process
200 Units and Completed 400 Units
55% Complete 40% Complete
4,800 Units Completed

160 Equivalent Units 400 × 40%
4,960 Equivalent units
of production
4-39
Conversion 5,000 Units Started
Beginning Ending
4,800 Units Completed

400 × 25%
100 Equivalent Units
of production
4-40
Compute the cost per

equivalent unit using the
weighted-average method.

4-41
Compute and Apply Costs
Beginning work in process: 200 units
Materials: 55% complete $ 9,600

Conversion: 30% complete 5,575
Production started during May 5,000 units

Production completed during May 4,800 units
Costs added to production in May

Materials cost $ 368,600
Conversion cost 350,900
Ending work in process 400 units

Materials: 40% complete
Conversion: 25% complete

4-42
The formula for computing the cost per

equivalent unit is :
Cost of beginning
Cost per
work in process + Cost added during
equivalent =
inventory the period
unit
Equivalent units of production

4-43
Here is a schedule with the cost and equivalent

unit information.
Total
Cost Materials Conversion
Cost to be accounted for:
Work in process, May 1 $ 15,175 $ 9,600 $ 5,575
Costs added in the Shipping
and Milling Department 719,500 368,600 350,900
Total cost $ 734,675 $ 378,200 $ 356,475
Equivalent units 4,960 4,900

Cost per equivalent unit

4-44
Here is a schedule with the cost and equivalent

unit information.
Total
Cost to be accounted for:
Work in process, May 1 $ 15,175 $ 9,600 $ 5,575
Costs added in the Shipping
and Milling Department 719,500 368,600 350,900
Total cost $ 734,675 $ 378,200 $ 356,475

Cost per equivalent unit $ 76.25 $ 72.75
Total cost per equivalent unit = $76.25 + $72.75 = $149.00
$356,475 ÷ 4,900
$378,200 unitsunits
÷ 4,960 = $72.75
= $76.25
4-45
Assign costs to units using

the weighted-average
method.

4-46
Applying Costs
Shaping and Milling Department

Cost of Ending Work in Process Inventory and the Units Transferred Out
Materials Conversion Total
Ending work in process inventory:
Equivalent units of production 160 100
Cost of ending work in process inventory $ 12,200 $ 7,275 $ 19,475
Units completed and transferred out:

Units transferred to the next department 4,800 4,800
Cost of units transferred out $ 366,000 $ 349,200 $ 715,200

4-47
Applying Costs



4-48
Applying Costs



4-49
Computing the Cost of Units Transferred Out



4-50



4-51



4-52
Reconciling Costs

Cost Reconciliation
Costs to be accounted for:
Cost of beginning work in process inventory $ 15,175
Costs added to production during the period 719,500
Total cost to be accounted for $ 734,675
Cost accounted for as follows:

Cost of ending work in process inventory $ 19,475
Cost of units transferred out 715,200
Total cost accounted for $ 734,675

4-53
Reconciling Costs

Cost Reconciliation


4-54
Operation Costing
Operation costing is a hybrid of job-order and

process costing because it possesses
attributes of both approaches
Operation costing is
commonly used when
batches of many
different products pass
through the same
processing department.

FIFO Method
Appendix 4A

4-56
FIFO vs. Weighted-Average Method
The FIFO method (generally considered more

accurate that the weighted-average method)
differs from the weighted-average method in
two ways:
1. The computation of equivalent units.

2. The way in which the costs of beginning
inventory are treated in the cost
reconciliation report.

4-57
Compute the equivalent

units of production using
the FIFO method.

4-58
Equivalent Units – FIFO Method
Let’s revisit the Double Diamond Skis example.

Assume the following activity is reported in
Shaping and Milling Department for May:
Percent Completed
Shaping and Milling Department Units Materials Conversion
Beginning work in process 200 55% 30%
Units started into production in May 5,000
Units completed during May and 4,800 100% 100%

transferred to the next department
Ending work in process 400 40% 25%

4-59
Step 1: Determine equivalent units needed to complete

beginning inventory.
To complete beginning work in process:
Materials: 200 units × (100% - 55%) 90
Conversion: 200 units × (100% - 30%) 140
Units started and completed during May 4,600 4,600
Ending work in process
Materials: 400 units × 40% complete 160
Conversion: 400 units × 25% complete 100
Equivalent units of production 4,850 4,840

4-60
Step 2: Determine units started and completed during

the period.
Materials: 200 units × (100% - 55%) 90

4-61
Step 3: Add the equivalent units in ending work in

process inventory.
Materials: 200 units × (100% - 55%) 90

4-62
FIFO Example
Materials 5,000 Units Started
Beginning Ending
200 × 45%
90 Equivalent Units
4,600 Units Completed 400 × 40%
of production
4-63
FIFO Example
Conversion 5,000 Units Started
Beginning Ending
200 × 70%
4,600 Units Completed 400 × 25%
of production
4-64
Equivalent Units: Weighted Average vs. FIFO
As shown below, the equivalent units in beginning inventory are

subtracted from the equivalent units of production per the weighted-
average method to obtain the equivalent units of production under
the FIFO method.
Equivalent units - weighted average method 4,960 4,900
Less equivalent units in beginning inventory:
200 units × 55% 110
200 units × 30% 60
Equivalent units - FIFO method 4,850 4,840

4-65
Compute the cost per

equivalent unit using the
FIFO method.

4-66
Cost per Equivalent Unit - FIFO
Let’s revisit the Double Diamond Skis Shaping and Milling

Department for the Month of May to prepare our production report.
Beginning work in process: 200 units
Materials: 55% complete $ 9,600
Conversion: 30% complete 5,575
$15, 175
Production started during May 5,000 units

Production completed during May 4,800 units
Costs added to production in May

Materials cost $ 368,600
Conversion cost 350,900
Ending work in process: 400 units
Materials: 40% complete
Conversion: 25% complete

4-67
The formula for computing the cost per

equivalent unit under FIFO method is as follows:
Cost per Cost added during the period

equivalent =
unit Equivalent units of production

4-68
Total
Costs added in the Shaping
and Milling Department $ 719,500 $ 368,600 $ 350,900
Total cost per equivalent unit = $76.00 + $72.50 = $148.50

4-69
Assign costs to units using

the FIFO method.

4-70
Applying Costs - FIFO
Step 1: Record the equivalent units of production in ending work

in process inventory.

Cost of Ending Work in Porcess Inventory and the Units Transferred Out


4-71
Step 2: Record the cost per equivalent unit.



4-72
Step 3: Compute the cost of ending work in process inventory.



4-73
Cost of Units Transferred Out
Step 1: Record the cost in beginning work in process inventory.

Units transferred out:
Cost in beginning work in process (WIP) $ 9,600 $ 5,575 $ 15,175
Cost to complete beginning WIP:
Equivalent units to complete 90 140
Cost to complete beginning WIP $ 6,840 $ 10,150 $ 16,990
Cost of units started and completed in May
Units started and completed in May 4,600 4,600
Cost of units started and completed in May $ 349,600 $ 333,500 $ 683,100
Cost of units transferred out $ 715,265

4-74
Step 2: Compute the cost to complete the units in beginning

work in process inventory.

4-75
Step 3: Compute the cost of units started and completed this

period.

4-76
Step 4: Compute the total cost of units transferred out.


4-77
Reconciling Costs

Cost Reconciliation


4-78
Reconciling Costs

Cost Reconciliation


4-79
A Comparison of Costing Methods
In a lean production environment, FIFO and

weighted-average methods yield similar
unit costs.
When considering cost control, FIFO is superior

to weighted-average because it does not mix
costs of the current period with costs of the
prior period.

Service Department
Allocations
Appendix 4B

4-81
Operating Departments
An operating department carries out

the central purpose of the organization
The An
Accounting Assembly
Department Department
at your at General
University. Motors.

4-82
Service Departments
A service department does not directly

engage in operating activities.
The The Human

Accounting Resources
at Macys at Walgreens.

4-83
Interdepartmental Services
Service Operating
Costs of the service
department become
overhead costs to
the operating
department

4-84
Allocation Approaches
Direct

Method

Step-Down
Method
Reciprocal 
Method
4-85
Reciprocal Services
Service Service
Department 1 Department 2
When service
departments provide
services to each
other we call them
reciprocal services.

4-86
Allocate service
department costs to
operating departments
using the direct method.

4-87
Direct Method
Service Operating
Interactions Department Department
between service (Cafeteria) (Machining)
departments are
ignored and all
costs are
allocated directly
to operating Service Operating
departments. Department Department
(Custodial) (Assembly)

4-88
Direct Method
Service Department Allocation Base

Cafeteria Number of employees
Custodial Square feet occupied

4-89
Direct Method
How much of the Cafeteria and Custodial costs

should be allocated to each operating department
using the direct method of cost allocation?

4-90
Direct Method
20
$360,000 × = $144,000
20 + 30
Allocation base: Number of employees

4-91
Direct Method
30
$360,000 × = $216,000
20 + 30

4-92
Direct Method
25,000
$90,000 × = $30,000
25,000 + 50,000
Allocation base: Square feet occupied

4-93
Direct Method
50,000
$90,000 × = $60,000
25,000 + 50,000

4-94
To allocate service
department costs to
operating departments
using the step-down
method.

4-95
Step Method
Service Operating
Once a service (Cafeteria) (Machining)
department’s costs
are allocated,
other service
department costs
are not allocated
back to it.
Service Operating

4-96
Step Method
There are three key points to understand

regarding the step method:
 In both the direct and step methods, any amount of
the allocation base attributable to the service
department whose cost is being allocated is always
ignored.
 Any amount of the allocation base that is
attributable to a service department whose cost has
already been allocated is ignored.
 Each service department assigns its own costs to
operating departments plus the costs that have
been allocated to it from other service departments.
4-97
Step Method
We will use the same data used

in the direct method example.
Service Department Allocation Base

Cafeteria Number of employees
Custodial Square feet occupied

4-98
Step Method
Allocate Cafeteria costs first since

it provides more service than Custodial.

4-99
Step Method
10
$360,000 × = $60,000
10 + 20 + 30

4-100
Step Method
20
$360,000 × = $120,000
10 + 20 + 30

4-101
Step Method
30
$360,000 × = $180,000
10 + 20 + 30

4-102
Step Method
New total = $90,000 original Custodial cost

plus $60,000 allocated from the Cafeteria.

4-103
Step Method
25,000
$150,000 × = $50,000
25,000 + 50,000

4-104
Step Method
50,000
$150,000 × = $100,000
25,000 + 50,000

4-105
Reciprocal Method
Service Operating
Interdepartmental (Cafeteria) (Machining)
services are given
full recognition
rather than partial
recognition as with
the step method. Service Operating
Because of its mathematical complexity,

the reciprocal method is rarely used.
4-106
Quick Check Data
for Direct and Step Methods
The direct method of allocation is used.

Allocation bases:
Business school administration costs (ADMIN):
Number of employees
Business Administration computer services
(BACS): Number of personal computers
4-107
Quick Check 
How much cost will be allocated from

Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000

4-108
Quick Check 
How much cost will be allocated from

Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000
20
$180,000 × = $36,000
20 + 80
4-109
Quick Check 
How much total cost will be allocated from

ADMIN and BACS combined to the
Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500

4-110
Quick Check 

a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500
18
$90,000 × = $13,500
18 + 102
4-111
Quick Check Data
The step method of allocation is used.

Allocation bases:
Business school administration costs (ADMIN):
Number of employees
Business administration computer services
(BACS): Number of personal computers
4-112
Quick Check 

a. $35,250
b. $49,072
c. $18,000
d. $26,333

4-113
Quick Check 

a. $35,250
b. $49,072
c. $18,000
d. $26,333

4-114
End of Chapter 4

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Systems Design:

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

• Both systems assign material, labor and

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

• Process costing is used when a single product is

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Process costing is used for products that are:

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Process costing is used for products that are:

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Any unit in an organization where materials, labor

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Record the flow of

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Direct Labor Work in Finished

Costs are traced and

Direct Labor Finished

Costs are traced and

Direct Labor Processing Finished

T-Account and Journal Entry Views of Cost Flows

For purposes of this example,

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

GENERAL JOURNAL Page 4

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GENERAL JOURNAL Page 4

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GENERAL JOURNAL Page 4

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Work in Process Work in Process

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GENERAL JOURNAL Page 4

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GENERAL JOURNAL Page 4

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GENERAL JOURNAL Page 4

Cost of Goods Sold XXXXX

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Equivalent Units of Production

Equivalent units are the product of the number of

We need to calculate equivalent units because a

Equivalent Units – The Basic Idea

Two half completed products are

So, 10,000 units 70% complete

For the current period, Jones started 15,000

For the current period, Jones started 15,000

Calculating Equivalent Units

Equivalent units can be calculated two

The Weighted-Average Method – This

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Compute the equivalent

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The weighted-average method . . .

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Treatment of Direct Labor