Chapter 3: Process Costing

 A process costing is most commonly used in industries that produce essentially

homogeneous (i.e., uniform) products on a continuous basis.
 Firms producing distinct and unique products use job order costing where as firms
producing similar or identical units use process-costing system.
 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.
Similarities between job-Order 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 and Process Costing

Job-Order Costing Process Costing

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

 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 principal difference between process costing and job costing is the extent of
averaging used to compute unit costs of products or services. In job-costing
system, individual jobs use different quantities of production resources. Thus, it
would be incorrect to cost each job at the same average production cost.
 In contrast, when identical or similar units of products or services are mass
produced, and not processed as individual jobs, process costing averages
production costs over all units produced.
 The difference between job order and process costing system is, thus, the
extent of the averaging used to compute unit cost. In job order costing
each job differs in terms of material used, labor incurred, and
manufacturing overhead. Hence, it is impossible to assign the same cost
for different jobs. On the contrary, identical units produced in mass took

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 equal amount of direct material, direct labor, and manufacturing
overhead. Thus, the unit cost can be found by dividing total cost by the
number of units produced.

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.
Work-in Process: Production Department B xxx
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
Work-in Process: Production Department B xxx
5. Goods are sold
Cost of Goods Sold xxx
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
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Transferred-in costs are assigned to partially completed products that are transferred into one production
department from a prior department.

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 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 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.

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 2021

Physical Units for January 2021
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 2021
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 140

Case 2: Process Costing with zero beginning but some ending work in
process inventory

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 Data for the Assembly Department for February 2021
Physical Units for February 2021
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 2021
Direct materials costs added during February Br.32,000
Conversion costs added during February 18,600
Total Assembly Department costs added during February 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 2021 and
the cost of partially assembled units still in process at the end of February 2021?
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 1000 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 1000 units is
equivalent to the amount of the conversion on 750 units. The number is computed as
follows:
1000 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 1000
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

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the beginning of the production process, the 1000 physical units represent 1000
equivalent units of direct material (1000 physical units * 100% complete with respect to
direct materials).

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
Flow of Production Physical Direct Conversion
Units Materials costs
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
225*100%; 225*60% 225 225
Accounted for 400
Work done in current period 400 310

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

Total Direct Conversion
Productio Materials Costs
n Costs
(Step 3) Costs added during February divided by 50,600 Br.32,000/ Br.18,000/
equivalent units of work done incurrent 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*800) (175*60)
Work in process, ending (225 units)
Direct Materials 18,000 225*80
Conversion costs 8,100 135*60
Total work in process 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)
Work in Process- Assembly 18,600

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 Various accounts 18,600
(To record Assembly department conversion costs)
Work in Process- Testing 24,500
Work in Process- Assembly 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 2021
Physical Units for March 2021
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 2021
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

 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 1&2)

Equivalent Units
Flow of Production Physical Direct Conversion
Units Materials costs
Work in process, beginning 225
Started during current period 275
To account for 500
Completed and transferred out during current
period 400 400 400
Work in process, ending 100

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100*100%; 100*50% 100 50
Accounted for 500
Work done in current period 500 450

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

Total Direct Conversion
Production Materials costs
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) 52,000 (400*75.60) (400*54.40)
Work in process, ending (100 units)
Direct Materials 7,560 100*75.60
Conversion costs 2,720 50*54.40
Total work in process 10,280
Total costs accounted for Br. 62,280

Journal Entries
Work in Process- Assembly 19,800
Account Payable Control 19,800
(To record direct materials purchased and used in production)
Work in Process- Assembly 16,380
Various accounts 16,380
(To record Assembly department conversion costs)
Work in Process- Testing 52,000
Work in Process- Assembly 52,000
(To record cost of goods completed and transferred from Assembly to
Testing Department)

 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.

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  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&2)

Equivalent Units
Flow of Production Physical Direct Conversion
Units Materials costs
Work in process, beginning 225
Started during current period 275
To account for 500
Completed and transferred out during current
period
From beginning work in process 225
225*(100%-100%); 225*(100%-60%) 0 90
Started and Completed 175
175*100%, 175*100% 175 175
Work in process, ending 100
100*100%; 100*50% 500 100 50
Accounted for
Work done in current period 275 315

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

Total Direct Conversion
Production Materials costs
Costs
(Step 3) Work in process, beginning Br.26,100
Costs added current period 36,180 19,800/ 16,380/
Divided by equivalent units of work 275 315
done in current period
Costs per equivalent unit of work done in the Br. 72 Br. 52
current period
(Step 4) Total costs to account for Br.62,280
(Step 5) Assignment of Costs (400*75.60) (400*54.40)
Completed and transferred out (400 units)
Work in process, beginning (225 units) Br. 26,100
Direct Materials added in current period 0 0*72
Conversion costs added in current period 4,680 90*52
Total from beginning inventory 30,780
Started and completed (175 units) 21,700 175*72 175*52

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Total costs of units completed & transferred 52,480
Work in process, ending (100 units)
Direct Materials 7,200 100*72
Conversion costs 2,600 50*52
Total work in process, ending 9,800
Total costs accounted for Br. 62,280

Work in Process- Testing 52,480

Work in Process- Assembly 52,480
(To record cost of goods completed and transferred from Assembly to
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 bigining wirk-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.