AMali

DEPARTMENT OF BUSINESS STUDIES

PROCESS COSTING
PROCESS COSTING

Many companies use mass-production techniques to produce identical or similar units of a

product or service:
Apple (smartphones), Coca-Cola (soft drinks), ExxonMobil (gasoline), JP Morgan Chase
(processing of checks), and Novartis (pharmaceuticals).
Managerial accountants at companies like these use process costing because it helps them
(1) determine how many units of the product the firm has on hand at the end of an accounting
reporting period,
(2) evaluate the units’ stages of completion, and
(3) assign costs to units produced and in inventory
PROCESS COSTING VS JOB COSTING

• Before examining process costing in more detail, briefly look at the distinction between
process costing and job costing.
PROCESS COSTING VS JOB COSTING

• In process-costing system, the unit cost of a product or service is obtained by assigning

total costs to many identical or similar units of output.
• In other words, unit costs are calculated by dividing total costs incurred by the number
of units of output from the production process.
• In a manufacturing process-costing setting, each unit receives the same or similar
amounts of direct material costs, direct manufacturing labor costs, and indirect
manufacturing costs (manufacturing overhead).
PROCESS COSTING VS JOB COSTING

• The main difference between process costing and job costing is the extent of averaging
used to compute the unit costs of products or services.
• In a job-costing system, individual jobs use different quantities of resources, so 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
rather than processed as individual jobs, process costing is used to calculate an average
production cost for all units produced.
PROCESS COSTING VS JOB COSTING
PROCESS COSTING –COST FLOW

Consider how product costs flow through a process costing system:

PROCESS COSTING –COST FLOW

A job order costing system, the costs of each job are accumulated on a job cost sheet.
The total of all the job cost sheet equals the total Work in Process Inventory account
balance.
In process costing, by contrast the costs are accumulated by department.
For example, Lae Biscuit’s Work in Process Inventory Account may consists of mixing,
baking and packaging have three subaccounts.
So the direct raw material can be added in each of three sections.
PROCESS COSTING

• Process-costing systems separate costs into cost categories according to when costs are
introduced into the process.
• Only two cost classifications—direct materials and conversion costs—are necessary to
assign costs to products.
• Conversion costs are all manufacturing costs other than direct material costs, including
manufacturing labor, energy, plant depreciation, and so on.
_Why only two?
Because all direct materials are added to the process at one time and all conversion costs
generally are added to the process evenly through time. Sometimes the situation is different.
PROCESS COSTING

Process costing can be illustrated using three cases of increasing complexity;

1. Case 1—Process costing with zero beginning and zero ending work-in-process
inventory.
2. Case 2—Process costing with zero beginning work-in-process inventory and some
ending work-in-process inventory.
3. Case 3—Process costing with both some beginning and some ending work-in-process
inventory.
COST ACCUMULATION AND REPORTING

• Case 1: When there is no Work in Process Inventory at the end of a period, cost
accumulation and reporting is extremely easy under process costing.
• The product costs are simply added up and divided evenly among the products produced.
• Case 2 & 3—Process costing with zero beginning work-in-process inventory and some ending
work-in-process inventory. When work is in the process at the end of a period, however, cost
accumulation and reporting become more complicated.
• The cost incurred to get the in-process units to present state need to remain in the Work in
Process Inventory account, while the costs incurred to produce the completed goods need to
be transferred to the Finished Goods Inventory account.
COST ACCUMULATION AND REPORTING

• Consider Lae Biscuit Ltd, the producer of Snax biscuits. The Biscuit production can be
very complicated. Here consider four stages of production, preparation, baking, cooling
and finishing.
• So there is a way to assign costs to the completed units and to the partially completed
goods that remain in the Work in Process Inventory.
PROCESS COSTING RECAP

• The objective of process costing is the same as job order costing: to develop a product
unit cost to use in decision making and inventory valuation.
• At this point, process costing may seem more complicated to you than job order costing.
• True, there are some additional steps in calculating the unit product cost.
• But if you follow these steps, you will be able to work through the complexities without
becoming overwhelmed.
PROCESS COSTING- STEP 1

• Calculate the physical unit flow:Add the number of units started into production during the
period to the number of units in beginning inventory.
• The total is the number of units you must account for.
• Then subtract the number of units that were completed and transferred out of the
department.
• The remaining units constitute the ending work in process inventory.
• Reconcile the physical unit flow using the following equation.
Beginning WIP units + Units started = Units transferred out + Ending
WIP Units
PROCESS COSTING- STEP 2

Calculate the equivalent units of production. The units of product in the ending Work in Process
must be converted to equivalent units of production.
This calculation must be done separately for the direct materials and conversion costs, since the
units may not be at the same stage of completion in the two cost categories.
To determine the number of equivalent units produced, multiply the percentage of completion
for each cost category by the number of physical units in the ending Work in Process Inventory.
Add these results to the number of units transferred out of the department during the period
to obtain the total equivalent units of production for the period.
PROCESS COSTING- STEP 3

• Calculate the equivalent unit costs of production: Add the cost of direct materials
placed into production during the period to the direct materials cost in the beginning Work in
Process Inventory.
• Divide this total by the equivalent units of production for direct materials. This is the direct
materials equivalent unit cost.
• Next, add the direct labor and manufacturing overhead costs incurred during the month to
the direct labor and manufacturing overhead costs in beginning Work in Process Inventory.
• Divide this total cost by the equivalent units of production for conversion costs to obtain the
conversion equivalent unit cost.
PROCESS COSTING- STEP 4

• Allocate the equivalent unit costs of production: Using the amounts calculated in
Steps 2 and 3, multiply the number of equivalent units in the ending Work in Process
Inventory by the cost per equivalent unit to determine the ending dollar balance in the
Work in Process Inventory account.
• Then multiply the number of units transferred out of the department during the period
by the cost per equivalent unit to determine the total cost transferred out of the
department during the period.
• Remember to do separate calculations for direct materials and conversion costs.
PROCESS COSTING- STEP 5

• Reconcile the costs of production: To be sure that you have accounted for all production
costs, use the following equation:

Beginning WIP balance + Costs added = Costs transferred out + Ending

WIP balance.
PROCESS COSTING- STEP 6

• Repeat Steps 1-5 for each department: Equivalent units and costs must be
calculated separately for each department in the production process.
• Since these calculations include costs transferred in from other departments, they must
be performed in the same order as the production process, so that the required
information will be available.
TOPIC FOCUS: PRACTICE EXERCISE

Smash-It Company mass- produces tennis balls in two departments: Shaping and Covering.
In the Shaping department, long sheets of rubber are put through a machine that cuts the
required pieces and then cements them together. From the Shaping Department, the balls
go to the Covering Department. During April the following information was recorded for
the Shaping Departments:
TOPIC FOCUS: PRACTICE EXERCISE

Units Costs

Materials Conversion
s
Work in Process

Beginning inventory, April 15, 000 $2, 110 $2, 625

Added to production 250, 000 34, 815 $52, 395

Completed and transferred out 260, 000 ? ?

Ending inventory, April 30 5, 000 ? ?

TOPIC FOCUS: PRACTICE EXERCISE

Ending inventory was 75% complete with respect to materials and 40% complete with respect to conversion.
1. What is the total cost to be accounted for – that is, what total cost needs to be assigned to the units
completed and transferred out of the Shaping Department and to those remaining in the ending Work in
Process Inventory?
2. Compute the equivalent units for materials
3. Compute the equivalent units for conversions
4. Determine the cost per equivalent units for both materials and conversion.
5. Determine the cost that should be assigned to the completed units transferred to the Covering
Department.
6. Determine the cost that should be assigned to the Shaping Department’s ending Work in Process Inventory.