Financial Analysis

Rift Valley University/ Department of Accounting/ Lecture note
CHAPTER THREE
Costing methods
Introduction
The cost accounting system uses the perpetual inventory system, and achieves greater accuracy
in the determination of product costs than is possible with the general accounting system. There
are two extremes of cost accounting systems for manufacturing operations – job order cost
system, and process cost system.
A process costing is used in situations where the company produces many units of a single
product for long periods at a time. In this system, the cost object is masses of identical or
similar units of a product or service.
A job-order costing is used in situations where many different products are produced each
period.
Similarities between job-Order Costing and Process Costing

1. The same basic purposes exist in both systems, which are to assign material, labor, and
overhead cost to products and to provide a mechanism for computing unit costs.
2. Both systems maintain and use the same basic manufacturing accounts, including MO,
Raw Materials, Work in Process, and Finished Goods.
3. The flow of costs through the manufacturing accounts is basically the same in both
systems.
Differences between Job-Order Costing and Process Costing

1) Job-Order Costing 2) Process Costing
1. Many different jobs are worked on during 1. A single product is produced either on a
each period, with each job having continuous basis for long periods of time.
different production requirements. All units of product are identical.
2. Costs are accumulated by identical job. 2. Costs are accumulated by department.
3. The job cost sheet is the key document 3. The department production report is the
controlling the accumulation of costs by a key document showing the accumulation
job. and disposition of costs by a department.
4. Unit costs are computed by job on the job 4. Unit costs are computed by department on
cost sheet. the department production report.
Cost Systems and Cost Accumulation Procedures

3.2 Job Order Costing System
A job order cost system provides a separate record of the cost of each particular quantity of
product that passes through the factory. The system accumulates costs for a particular batch
of production, commonly referred as a Job. A job has a definite starting and completion
time as would, for example, the production of 10 pieces of windows, or 50 coffee tables.
RVU, Department of Accounting Page 1

 In job order costing system, costs are accumulated by job. For each job, the firm
maintains a separate job cost sheet, which is a record on which manufacturing costs of
the job are accumulated.
Work and cost flow in job order costing cycle

The physical flow of production is the sequence of operating activity that begins with the
decision to order direct materials and ends with finished product being sold to customers. The
intervening steps may vary from firm to firm. The following may show the steps of the physical
flow of production.
a) Purchase Requisition – For commonly used direct materials, organizations have a

reorder level, which is the minimum amount of stock that can be on hand at any given
time before another purchase is made to meet the lead time demand. The reason for
maintaining such a minimum stock level is to hedge against the risk of stock shortages
due to reasons like unexpected heavy usage, delays, and other reason that results in stock
out situations. When the stock level reaches such a point, the storeroom clerk fills a
purchase requisition, a form requesting the purchase of the needed material. After the
form is duly filled, it will be sent to the purchasing department.
A sample of purchase requisition form looks like the one as follows:
ALDER Furniture Factory
Date January 5, 2004 Requisition no. 121
Purchase requisition form
Prepared by: Tola G.
Quantity Description Date needed
1,000 board ft Lumber (eucalyptus) January 15, 2004
5 gallons Glue January 15, 2004
50 boxes Nails January 15, 2004
 No journal entry is required when a purchase requisition is prepared.

b) Purchase Order – the purchasing department following purchase requisitions from the
storeroom clerk will prepare a purchase order. A purchase order is a document that
authorizes the supplier to ship the specified merchandise ordered. A typical purchase
order may contain the following:
A sample purchase order looks the following:
Purchase order form
Date January 6, 2004 Purchase No. 496
Vendor
Gentle lumber processing
Arat Kilo, Close to AAU, Science faculty
F.O.B point Ship Via Terms Delivery date Requisition no.
Factory site Tana Transport 2/10, n/30 Jan. 15, 121
PLC 2004

Item no. Quantity Description Unit price Total
1. 1,000 board ft. Lumber 10 10,000.00
 No journal entry is required when a purchase order is filled.
c) Receiving Report – when the ordered materials are received, the receiving department
prepares a receiving report, which lists the description, and quantities of goods received.
A copy of the document will be sent to the storeroom clerk along with the materials. The
receiving report, together with the invoice of the supplier forms the basis for recording the
purchase of the materials. The purchase of the lumber in the above example, for instance,
would be as follows:
Dr. Cr.
January 15, 2004 Direct material 10,000.00
Cash/ Account payable 10,000.00
A sample receiving report is shown below.
Receiving report form
Received from: Receiving report No. R 1345
Gentle lumber processing Arat Kilo
Close to AAU, Science faculty
Freight: Purchase order No. 496
Pd X Collect
Date received: February 15, 2004 Received by: Abera G.
Quantity Description Weight
Gross Net
1,000 board ft. Lumber (eucalyptus)
d) Production Order – a manufacturer can produce in response to a customer order or just

for stock. Whatsoever, when the decision to produce is made, productions order will be
prepared and approved by the manager in charge.
A sample production order is presented here below.
Production Order
Date: January 19, 2004 Job No. 365
Manufactured for: Stock
Date needed: March 20, 2004
Quantity Model number Description
150 F. 4152 Coffee table
Authorized by: Dereje Demissie
 No journal entries are required on the company’s books when the production
order is issued.

e) Material Requisition – to commence production, evidently the production department
needs direct materials. The materials required for production are requested through a
document called material requisition form. The material requisition form should contain
specific description of the direct and indirect materials required for production.
A sample material requisition form is shown below:

Material requisition No. 906 Date: January 28, 2004
Job No. to be charged: 365
Quantity Description Unit cost Total cost Classification
1,000 board ft. Lumber 10 Br. 10,000.00 Direct
1 box Nail 22 22 Indirect
1 Gallon Glue 30 30 Indirect
Total 10,052.00
Direct materials -------10,000.00
Authorized signature Indirect materials ----------52.00
At the time the materials are issued from the storeroom, the following entry is made:
Jan. 28, 2003 Work in process 10,000.00
Manufacturing overhead 52.00
Raw materials 10,052.00
 Direct materials that are sent for manufacturing process are no more direct materials
since they are soon to be processed to become finished goods Thus, the cost is charged
to work in process account.
Job Cost Sheet

 Right after the materials are received from store, a job cost sheet will be prepared. The job
cost sheet is used to accumulate the manufacturing costs incurred in producing that
particular job.
 The key source document in a job costing system is a job cost record, also called a job cost
sheet, a document that records and accumulates all the costs assigned to a specific job. The
job cost record is started as soon as work begins in a particular job.
 After being notified that the production order had been issued, the Accounting Department
prepares a job cost sheet. A job cost sheet is a form prepared for each separate job that
records the materials, labor, and overhead costs charged to the job.
 In addition to serving as a means for chagrining costs to jobs, the job cost sheet also serves
as a key part of a firm’s accounting records. The job cost sheet form a subsidiary ledger to
the Work in Process account. A separate cost sheet is maintained for each job. Thus, the
value of work in process at any time can be found by adding the different job cost sheet.
The following is a sample job cost sheet:
Job Cost sheet
Job No. 365 Date started: Jan. 29, 2004
Date completed: March 20, 2004
Item F 4152 – coffee tables
For stock
Direct material Direct labor Manufacturing overhead
Date Req.No. Amount Date Hours Amount Date DLH Rate Amount

Jan. 28,2004 906 10,000
Cost summary
Cost item Amount
Total direct material
Total direct labor
Total manufacturing overhead applied
Shipping summary
Date Number of units shipped Cost balance
Job time ticket – the second cost category of manufacturing firms is the direct labor
employed. A job time ticket is used to record how much time is spent on a particular job. When
a particular job is started, the employee fills the time the job is started on the job time ticket,
and he punch out the card and fills the time he stopped when he left the job. Suppose analysis
of the job time ticket showed direct labor of 9,600.00 and indirect labor of 4,800.00.
The journal entry to record the cost of direct and indirect labor looks like the following:
Jan. 28, 2004 Work in process 9,600.00
Manufacturing overhead 4,800.00
Wages payable 14,400.00
A sample of job time ticket is shown below
Job time ticket
Employee’s Name: Date: March 5
Department: Sanding Time started: 8:30 am
Time completed: 11:30
Operation: Sanding Job no. 365
Hours Rate of pay Direct labor Comment
3 hrs. 8 24
Idle time may exist because of machine breakdown, or when there is material shortage or time
lost while the employee shifts from one job to another. The cost of idle time should be absorbed
by all units produced in the year instead of cost of a specified product. Thus, cost of idle time is
debited to overhead.
Manufacturing overhead – costs other than direct material and direct labor that are necessary
to transform the raw materials into finished goods is called manufacturing overhead.
 Such Manufacturing costs are common costs – costs shared by more than one cost object-
that should be apportioned among the cost objects sharing the cost.
 However, the total overhead costs cannot be known exactly until the end of the year. Thus,
organizations should wait up to the end of the year if they are to charge the actual amount.
 Yet, many jobs are completed but the job cost sheet remains open waiting for the actual
overhead cost. Thus, interim financial statements are impossible which in turn affect
managerial decision purposes.
 A predetermined overhead rate is determined to allocate such costs to individual jobs, which
is found by dividing estimated overhead cost to the estimated amount of allocation base.
 The allocation base is assumed to be a cost driver of manufacturing overhead costs.
 In other words, there has to be a cause and effect relationship between the allocation base
and manufacturing overhead costs. For instance, a labor intensive firm should use a labor

oriented base, and a machine base should use a machine oriented base since most these
overhead costs may respond to a change to the allocation base.
o Costs include factory rent, electricity, and depreciation on machinery. Most of these costs
are common to more than one batch of job and hence cannot be directly traced to a specific
job.
o Thus, such costs must be assigned to the different cost objects in some way. However,
assigning MOH to units of product is a difficult task; because of three reasons:
 MOH is an indirect cost, it is difficult to trace to a particular job.
 MOH consists of many different items ranging from the grease used in machines to the
annual salary of production manager.
 MOH costs tend to remain relatively constant due to the presence of fixed costs.
Therefore, the only way to assign overhead costs to products is to use an allocation process.
This allocation overhead cost is accomplished by selecting an allocation base that is common to
all of the company’s products and services.
An allocation base is a measure such as direct labor hours (DLH) or machine hours (MH) that
is used to assign overhead costs to products and services. The allocation base is used to
compute the predetermined overhead rate:
Predetermined Overhead Rate (POR) = Estimated total manufacturing overhead cost
Estimated total units in the allocation base
 The predetermined overhead rate is based on estimated rather than an actual figure. This
is because the predetermined overhead rate is computed before the period begins and is
used to apply overhead cost to jobs throughout the period. The process of assigning
overhead cost to jobs is called overhead application.
Overhead applied to a particular job = Predetermined * Amount of the allocation
Overhead Rate (POR) base incurred by the job
o A predetermined overhead rate is calculated using the projected overhead cost and some
activity base that has a cause and effect relationship with manufacturing overhead costs.
o For instance, assume that the projected overhead cost for the upcoming year is Birr
80,000.00, and the direct labor hour is estimated to be 4,000 hrs, the predetermined
overhead rate can thus be calculated as follows:
Predetermined Overhead Rate (POR) = Estimated overhead cost

Estimated activity base (direct labor hr)
POR = Br. 80,000 = 20 per direct labor hour.

4,000
If we assume that the direct labor hours spent on the job are 90 hrs, the manufacturing over
head applied will therefore be 90 X 20 =Br.1,800.
The entry to record the manufacturing overhead applied is as follows:
March 18, 2004 Work in process 1,800.00
Manufacturing overhead applied 1,800.00
 The manufacturing overhead applied is a contra account to the actual manufacturing cost.

 Although actual costs are not assigned, they should be recorded as incurred. Suppose that
factory rent, utilities, and other manufacturing costs totaled Birr 22,000.00.
The following entry is required to record the actual manufacturing cost.
March 20, 2004 Manufacturing over head 22,000.00
Various accounts 22,000.00
Finished Goods Inventory Ledger card – when work in process is completed and transferred
to the finished good inventory warehouse, the following journal entry is required:
March 20, 2004 Finished goods 21,400.00
Work in process 21,400.00
Cost of Goods sold – two records are maintained when sale is made under the perpetual
inventory system: one for sales and the other for cost of goods sold. Assume that half of the
coffee tables produced are sold for birr 180 each on with a 40% down payment. The entry to
record the sales looks the following:
April 10, 2004 Cash 5,400.00
Account receivable 8,100.00
Sales 13,500.00
 The total units produced are 150 as shown in the production order. Half of that amount
is 75, and 75 units at 180 is equal to 13,500.00. When we come to the cost of goods
sold, the total cost of goods produced is Birr 21,400.00. Thus, the unit cost of each
coffee table is Birr 142.67. The cost of the 75 units that are sold is Birr 10,700.00.
The following entry is necessary to record the cost of goods sold.
April 10, 2004 Cost of goods sold 10,700.00
Finished goods 10,700.00
 In general, a firm’s cost accounting system parallels its flow of operation. The nine
steps followed in the previous illustration are summarized below in a concise manner.
1. Procurement – raw materials and supplies needed for manufacturing are ordered,
received, and stored.
2. Production – raw materials are transferred from storeroom to factory. Labor, tools,
machines, power, and other costs are applied to transform the raw material into finished
product.
3. Warehousing – finished goods are moved from the factory to the ware house to be
held until they are sold.
4. Selling – customers are found. Merchandises are shipped from the warehouse, and
customer accounts are charged.

The following diagram shows the above points:
Procurement Production Warehousing Selling
Raw materials Work in process Finished good CGS
In Out In Out In Out In
Direct labor
Out
MOH
Out
As shown in the table cost flow parallels with the physical flow of production.
Actual Costing versus Normal costing

The use of an applied overhead instead of an actual overhead has the advantage of timeliness,
and hence relevance for timely decision making. However, the amount may not be as accurate
as the actual overhead cost. But the actual cost is known only at the end of the period, and thus
product costing is impossible before the year ends. Actual costing thus makes product costing
untimely, and this in turn affect decisions like product pricing, and controlling operations.
Therefore, most firms use an applied overhead cost than actual cost for indirect manufacturing
costs.
 Normal costing is a costing system where the actual direct material and direct labor
are added to the work in process inventory at the actual amount, and overhead costs are
applied to the work in process inventory using a predetermined overhead rate. The term
normal comes from the idea that the rate is normalized over a long period of time.
 Actual costing is a costing system where direct material and direct labor costs are
traced to the job at their actual amounts, and overhead costs are allocated using actual
overhead. Since manufacturing overhead costs cannot be directly traced to each job in
an economically feasible way, still the amount charged to each job is simply an
allocated amount. The difference is simply the use of an actual overhead than an
estimated overhead.
The table below shows summary of actual and normal costing
Cost Assignment Actual costing Normal costing
Direct material Tracing Actual Actual

Direct labor Tracing Actual Actual
Manufacturing overhead Allocation Actual over head Estimated overhead
rate X actual cost rate X actual amount
driver used of cost driver
Disposition of over and under applied overhead
Under normal costing, the actual amount of manufacturing overhead costs at the end of the
period rarely matches with the applied manufacturing overhead costs during that same period.
Often the applied amount may either be less or more than the actual amount.
 If the amount of manufacturing overhead is less than the actual amount, the difference
is said underapplied overhead or under absorbed overhead. When the reverse is true,
the difference is said overapplied overhead or over absorbed overhead.
 Under and overapplied overhead at the end of one fiscal year should not be carried to
the upcoming periods; rather they should be disposed off in the year the difference
occurs. The disposition of under and over applied overhead costs can take one of the
following two ways.
 Closed out to Cost of Goods Sold.
 Allocated between Work in Process, Finished Goods, and Cost of Goods Sold
in proportion to the overhead applied during the current period in the ending
balances of these accounts.
Closed out to Cost of Goods Sold
Cost of Goods Sold xxx
Manufacturing Overhead xxx
(If the actual cost  overhead applied = Underapplied)
Manufacturing Overhead xxx
 (If the actual cost  overhead applied = Overapplied
 Suppose that the manufacturing overhead – control has a debit balance of Birr
607,500, and the manufacturing costs applied is Birr 540,000. The under applied
manufacturing overhead cost can thus be disposed to cost of goods sold in the
following manner:
Debit Credit
Cost of goods sold 67,500.00
Manufacturing overhead -control 607,500.00
OR
Debit Credit
 The applied manufacturing overhead is a contra account to manufacturing overhead

control, and thus, the normal balance for the applied manufacturing overhead is credit.
 At the end of the period both must be closed. The applied manufacturing overhead is
debited and the manufacturing overhead is credited, and any difference is closed to cost
of goods sold.

Allocated Between Accounts (Proration Approach)

Under and over applied overhead costs can also be disposed off by prorating to work in
process, finished good inventory and cost of goods sold. Assume the following information is
pertaining to Awash Manufacturing Company:
End of year balance Manufacturing overhead
before proration allocated component of year-
end-balances (before proration)
Work in process 11,400.00 3,907.00
Finished good 18,600.00 7,814.00
Cost of goods sold 427,500.00 183,629.00
Total 457,500.00 195,350.00
Further, assume that the manufacturing overhead control account shows a debit balance of Birr
192,650.00, which shows an overapplied balance of Birr 2,700.00. The over applied amount of
manufacturing overhead will be prorated to work in process, finished good, and cost of goods
sold.
o The proration base may be on the basis of the manufacturing overhead applied to the
three accounts, or on the respective balance of the three accounts. Prorating on the basis
of the manufacturing overhead applied is theoretical sound than using the year-end
balance. The table below shows the proration process:
Account Account Manufacturing Proration of the over Account
balance overhead applied allocated overhead balance after
(%) proration
Work in process 11,400.00 3,907.00 = 2% 2% X 2,700.00 = 67.50 11,332.50
Finished good 18,600.00 7,814.00 = 4% 4% X 2,700.00 = 108 18,492.00
Cost of goods sold 427,500.00 183,629.00=94% 94% X 2,700 = 2,524.50 424,975.50
Total 457,500.00 195,350.00 2,700.00 454,800.00
The following journal entry is required to show the proration of the over allocated overhead.
Debit Credit
Work in process 67.50
Finished good 108.00
Debit Credit
 The over allocated amount is prorated and the balance of work in process, finished
good, and cost of goods sold is reduced. The amount is reduced because the costs of the

three accounts initially charged higher than the actual, and thus the balance must be
reduced.
 The over allocated amount can be prorated on the basis of the year-end balance of the
respective accounts as well. The following table shows the proration of the over
allocated cost on the basis of the year-end balance of the three accounts.
Account Account Proration of the over allocated Account balance
balance overhead after proration
Work in process 11,400.00 11,400/457,500.00 = 2.5% 11,332.50
2.5% X 2,700.00 = 67.50
Finished good 18,600.00 18,600.00/457,500.00 = 4% 18,492.00
4% X 2,700.00 = 108
Cost of goods sold 427,500.00 427,500.00/457,500.00 = 93.5% 424,975.50
93.5% X 2,700.00 = 2,524.50
Total 457,500.00 2,700.00 454,800.00
The journal entry is the same except that the amount is different. The journal entry looks the
following:
Debit Credit
Debit Credit
Manufacturing overhead 2700.00
3.2. PROCESS COSTING SYSTEM

A process costing is most commonly used in industries that produce essentially homogeneous
(i.e. uniform) products on a continuous basis. Process costing system accumulate costs by
department for a period of time, just as a job order costing system accumulate costs by job, and
the total cost then will be assigned to the units produced during that period.
 In manufacturing process costing setting, each unit is assumed to receive the same amount
of direct materials cost, direct manufacturing labor costs, and indirect manufacturing costs.
Units are computed by dividing total costs by the number of units.
The Flow of Costs in Process Costing System with Sequential Production Departments
1. As direct materials and direct labor are used in production department A, these costs are
added to the Work-in Process inventory account for Department A. Overhead is applied
using predetermined overhead rate. The POR is determined in the same way in job order
and process costing.
Work-in Process: Production Department A xxx

Raw Materials xxx
Wage Payable xxx
Manufacturing overhead applied xxx
2. When production department A completes its work on some units of product, these units
of product are transferred to production department B. The costs assigned to these goods
are transferred from the Work-in Process Inventory account for department A to work-in
Process inventory account in department B, the costs assigned to those partially
completed products are called transferred-in costs1.
Work-in Process: Production Department B xxx
Work-in Process: Production Department A xxx
3. Direct material and direct labor are used in production department B, and manufacturing
overhead is applied using POR.
Raw Materials xxx
Wages Payable xxx
Manufacturing overhead applied xxx
4. Goods are completed in production department B and transferred to the finished goods
warehouse.
Finished-Goods xxx
5. Goods are sold

Finished-Goods xxxx
Cost Accumulation Methods in Process Costing System

o When a firm produces identical lots of goods repetitively, maintaining a separate job
cost sheet would be unnecessarily expensive. The aggregate cost and the unit cost can
be computed without a job cost sheet, thus saving the costs associated with producing
such records.
o Costs accumulate by department over a certain period and the unit cost can be found by
dividing the total cost to the units produced during that period. Process costing system
fit among others to, paint manufacturers, oil refineries, sugar refineries, and salt
producers.
o In process costing system, manufacturing costs, direct material, direct labor, and
manufacturing overhead costs are accumulated in the same way as job order costing
system. However, the costs are accumulated by department over some period of time
than by individual jobs.
o The time period over which the cost is to be accumulated depends on the information
needs of the company. It can be a week, two weeks, but no longer than a month most
1
Transferred-in costs are assigned to partially completed products that are transferred into one production
department from a prior department.

often. Cost accumulation is much simpler for a process costing system than for a job
order cost system.
Illustrating Process Costing

Assumptions: ABC Manufacturing Company manufactures thousands of Products A.
These components are assembled in the Assembly Department, upon completion the units
are completely transferred to the Testing Department. The process-costing system for
Product A has a single direct cost category (direct materials) and a single indirect-cost
category (conversion costs). Direct materials are added at the beginning of the process in
Assembly. Conversion costs are added evenly during Assembly.
Prime Cost = Direct Material Cost + Direct Labor Cost
Conversion Cost = Direct Labor Cost + Manufacturing Overhead Cost
Case 1: Process costing with zero beginning and zero ending work in process inventory
that is all units are started and fully completed by the end of the accounting period.
Data for the Assembly Department for January 2001
Physical Units for January 2001
Work in Process, beginning inventory (January 1) 0 units
Started during January 400 units
Completed and transferred out during January 400 units
Work in Process, ending inventory (January 31) 0 units
Total Costs for January 2001
Direct materials costs added during January Br.32, 000
Conversion costs added during January 24,000
Total Assembly Department costs added during January 56,000
Solution:
Direct Material costs per unit (32,000/400) Br. 80
Conversion costs per unit (24000/400) 60
Assembly Department costs per unit Br 140
Case 2: Process Costing with zero beginning but some ending work in process inventory
Data for the Assembly Department for February 2001
Physical Units for February 2001
Work in Process, beginning inventory (February 1) 0 units
Started during February 400 units
Completed and transferred out during February 175 units
Work in Process, ending inventory (February 28) 225 units
Total Costs for February 2001
Direct materials costs added during February Br.32, 000
Conversion costs added during February 18,600
Total Assembly Department costs added during February Br. 50,600
In addition, the Assembly Department estimates that the partially assembled units are on
averages 60% complete as to conversion costs.

How should the co. calculate the cost of fully assembled units in February 2001 and the cost of
partially assembled units still in process at the end of February 2001?
Steps:
 Summarize the flow of physical units of output.
 Compute output in terms of equivalent units.
 Compute equivalent unit costs.
 Summarize total costs to account for.
 Assign total costs to unit’s completed and to units in ending work in process.
Equivalent Units: A key Concept

 Material, labor and overhead costs are incurred at different rates in production process.
Direct material usually placed in production at one or more discreet points in the
process. In contrast, direct labor and manufacturing overhead, called conversion costs,
and usually are incurred continuously throughout the process.
 When an accounting period ends, the partially completed goods that remain in process
generally are at different stages of completion with respect to material and conversion
activity.
Example: Suppose there are 1,000 physical units in process at the end of an accounting period.
Each of the physical units is 75% complete with respect to conversion. How much conversion
activity has been applied to these partially completed units?
Conversion activity occurs uniformly throughout the production process. Therefore, the amount
of conversion activity required to do 75% of the conversion on 1,000 units is equivalent to the
amount of the conversion on 750 units. The number is computed as follows:
1,000 partially completed physical units in process * 75% complete with respect to Conversion
= 750
The term equivalent units is used in process costing to refer to the amount of manufacturing
activity that has been applied to a batch of physical units. The 1,000 physical units in process
represent 750 equivalent units of conversion activity.
The term equivalent unit is also used to measure the amount of direct materials represented by
the partially completed goods. Since direct materials are incorporated at the beginning of the
production process, the 1,000 physical units represent 1000 equivalent units of direct material
(1,000 physical units * 100% complete with respect to direct materials).
Solution:
Physical units and Equivalent units (Step 1&2)
Equivalent units is a derived amount of output units that takes the quantity of each input
(factor of production) in units completed or in work in process, and converts it into the amount
of completed output units that could be made with that quantity of input.
Equivalent Units(Step 2)

Flow of Production Physical Direct Conversion
Units Materials Costs
(Step 1) (DM) (CC)
Work in process, beginning 0
Started during current period 400
To account for 400
Completed and transferred out during current period 175 175 175
Work in process, ending 225
DM =(225*100%=225); CC=(225*60%=135) 225 135
Accounted for 400
Work done in current period 400 310
Calculation of Product Costs (Steps 3, 4, and 5)

Total Direct Conversion
Production Materials Costs(CC)
Costs (DM)
(Step 3) Costs added during February divided by 50,600 Br.32,000 Br.18,600
equivalent units of work done in current period 400 310
Cost per equivalent unit Br. 80 Br. 60
(Step 4) Total costs to account for Br. 50,600
(Step 5) Assignment of costs:
Completed & transferred out (175 units) Br. 24,500 (175*80) (175*60)
Work in process, ending (225 units)
Direct Materials 18,000 225*80
Conversion costs 8,100 135*60
Total work in process, ending 26,100
Total costs accounted for Br.50,600
Journal Entries
Work in Process- Assembly 32,000
Account Payable Control 32,000
(To record direct materials purchased and used in production)
Various accounts 18,600
(To record Assembly department conversion costs)
Work in Process- Testing 24,500
(To record cost of goods completed and transferred from Assembly to
Testing Department)
Case 3: Process costing with some beginning and some ending work in process inventory.
Data for the Assembly Department for March 2001
Physical Units for March 2001
Work in Process, beginning inventory (March 1) 225 units
Direct Materials (100% complete)

Conversion costs (60% complete)
Started during March 275 units
Completed and transferred out during March 400 units
Work in Process, ending inventory (March 31) 100 units
Direct Materials (100% complete)
Conversion costs (50% complete)
Total Costs for March 2001
Work in process, beginning inventory
Direct materials (225 equivalent units * Br. 80/unit) Br. 18,000
Conversion costs (135 equivalent units * Br.60/unit) 8,100 Br. 26,100
Direct materials costs added during March 19,800
Conversion costs added during March 16,380
Total costs to account for Br.62, 280
To assign cost of each of these categories, however, we need to choose an inventory cost-
flow method we first described the 5 steps approach for the weighted average method and
then for the first-in first-out method.
1. Weighted-Average process costing method

 This method calculates the equivalent unit cost of the work done to date (regardless
of the period in which it was done) and assigns this cost to equivalent units
completed and transferred out of the process and to equivalent units in ending work
in process inventory.
 The weighted average cost is the total of all costs entering in the work in process
account (regardless of whether it is from the beginning work in process or from
work started during the period) divided by total equivalent units of work done to
date.
Physical units and Equivalent units (Step 1and 2)
Units Materials Costs(CC)
(Step 1) (DM)
To account for 500
Completed and transferred out during current period 400
Work in process, ending 100 400 400
DM=(100*100%=100); CC=(100*50%=50) 100 50
Accounted for 500
Production Materials(DM) Costs(CC)
Costs
(Step 3) Work in process, beginning Br.26,100 Br.18,000 Br.8,100

Costs added during the current period 36,180 19,800 16,380
Costs incurred to date divided by Br. 37,800/ Br. 24,480/
Equivalent units of work done to date 500 450
Cost per equivalent unit of work done Br.75.60 Br.54.40
(Step 4) Total costs to account for Br.62,280
(Step 5) Assignment of Costs
Completed and transferred out (400 units) Br.52,000 (400*75.60) (400*54.40)
Direct Materials 7,560 100*75.60
Conversion costs 2,720 50*54.40
Total work in process, ending Br.10,280
Total costs accounted for Br. 62,280
Journal Entries:
Account Payable Control 19,800
(To record direct materials purchased and used in production)
Various accounts 16,380
(To record Assembly department conversion costs)
Testing Department)
2. First-in, First-out Method

 The FIFO process costing method assigns the cost of the previous period’s equivalent units
in beginning work-in process inventory to the first units completed and transferred out of
the process, and assigns the cost of equivalent units worked on during the current period
first to complete beginning inventory, then to start and complete new units in ending work
in process inventory.
 This method assigns that the earliest equivalent units in the work in process-Assembly
account are completed first.
 A distinct feature of the FIFO process-costing method is that work done on beginning
inventory before the current period is kept separate from work done in the current period.
 Costs incurred in the current period and units produced in the current period are used to
calculate costs per equivalent unit of work done in the current period.
 In contrast equivalent unit and cost per equivalent unit calculations in the weighted average
method merge the units and costs in beginning inventory with units and costs of work done
in the current period.

Physical units and Equivalent units (Step 1 and 2)
Units Materials Costs
(Step 1) (DM) (CC)
To account for 500
Completed and transferred out during current period
From beginning work in process 225
DM(225*(100%-100%=0); 0
CC(225*(100%-60%=90) 90
Started and Completed 175
DM(175*100%=175), CC(175*100%=175) 175 175
Work in process, ending 100
DM(100*100%=100);CC(100*50%=50) 100 50
Accounted for 500

Production Materials costs(CC)
Costs (DM)
(Step 3) Work in process, beginning Br.26,100
Costs added current period divided by 36,180 19,800/ 16,380/
Equivalent units of work done in current period 275 315
Costs per equivalent unit of work done in the
current period Br. 72 Br. 52
(Step 4) Total costs to account for Br.62,280
(Step 5) Assignment of Costs:
Completed and transferred out (400 units) Br. 26,100 (400*75.60) (400*54.40)
Work in process, beginning (225 units):
Direct Materials added in current period 0 (0*72)
Conversion costs added in current period 4,680 (90*52)
Total from beginning inventory Br. 30,780
Started and completed (175 units) 21,700 (175*72) (175*52)
Total costs of units completed & transferred Br. 52,480
Direct Materials 7,200 100*72
Conversion costs 2,600 50*52
Total work in process, ending Br. 9,800
Total costs accounted for Br. 62,280
Journal Entries:
Testing Department)

Important points to note:
 The first physical units assumed to be completed and transferred out during the period are
the 225 units from the beginning work-in process inventory.
 Of the 275 physical units started, 175 are assumed to be completed. 400 physical units
were completed during March, the FIFO method assumes that the first 225 of these units
must have been started and completed during March.
 Ending work-in process inventory consists of 100 physical units-the 275 physical units
started minus the 175 of these physical units completed.
 Note that the physical units “to account for” equal the physical units “accounted for” (500
units)
 The equivalent unit calculated for each cost category focus on the equivalent units of work
done in the current period only. Under the FIFO method, the work done in the current
period is assumed to first complete the 225 units in beginning work in process. The
equivalent unit’s works done in March on the beginning work-in process inventory are
computed by multiplying the 225 physical units by the percentage of work remaining to be
done to complete these units: 0% for direct materials, and 40% for conversion costs.

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Rift Valley University/ Department of Accounting/ Lecture note

Similarities between job-Order Costing and Process Costing

Differences between Job-Order Costing and Process Costing

Cost Systems and Cost Accumulation Procedures

RVU, Department of Accounting Page 1

Work and cost flow in job order costing cycle

a) Purchase Requisition – For commonly used direct materials, organizations have a

5 gallons Glue January 15, 2004

50 boxes Nails January 15, 2004

 No journal entry is required when a purchase requisition is prepared.

RVU, Department of Accounting Page 2

 No journal entry is required when a purchase order is filled.

d) Production Order – a manufacturer can produce in response to a customer order or just

Authorized by: Dereje Demissie

RVU, Department of Accounting Page 3

A sample material requisition form is shown below:

Job Cost Sheet

RVU, Department of Accounting Page 4

RVU, Department of Accounting Page 5

Predetermined Overhead Rate (POR) = Estimated overhead cost

POR = Br. 80,000 = 20 per direct labor hour.

RVU, Department of Accounting Page 6

RVU, Department of Accounting Page 7

The following diagram shows the above points:

Procurement Production Warehousing Selling

Raw materials Work in process Finished good CGS

In Out In Out In Out In

Actual Costing versus Normal costing

RVU, Department of Accounting Page 8

 The applied manufacturing overhead is a contra account to manufacturing overhead

RVU, Department of Accounting Page 9

Allocated Between Accounts (Proration Approach)

RVU, Department of Accounting Page 10

3.2. PROCESS COSTING SYSTEM

RVU, Department of Accounting Page 11

5. Goods are sold

Cost Accumulation Methods in Process Costing System

RVU, Department of Accounting Page 12

Illustrating Process Costing

RVU, Department of Accounting Page 13

Equivalent Units: A key Concept

RVU, Department of Accounting Page 14

Calculation of Product Costs (Steps 3, 4, and 5)

RVU, Department of Accounting Page 15

1. Weighted-Average process costing method

RVU, Department of Accounting Page 16

2. First-in, First-out Method

RVU, Department of Accounting Page 17

Calculation of Product Costs (Steps 3, 4, and 5)

RVU, Department of Accounting Page 18

RVU, Department of Accounting Page 19

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