Chapter 3: Product Costing Systems

Two costing systems are commonly used in manufacturing and in many service
companies; these two systems are known as process costing and job-order costing.
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 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 1. A single product is produced either on a
during 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 4. Unit costs are computed by department
job cost sheet. on the department production report.

JOB ORDER COSTING SYSTEM

Cost Accounting System
 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 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.
 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.

Cost & Management Accounting I/ Lecture note on Chapter III 1

Job order costing for manufacturing firms:
An interrelationship exists between the physical flow of production, and the cost
accounting cycle. The flow of costs parallels the flow of work in the production settings.

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, but they share a common thread. The
following may show the steps of the physical flow of production.

1. 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:
Quantity Description Date needed
1,000.00 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.
2. 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:

Cost & Management Accounting I/ Lecture note on Chapter III 2

 ALDER Furniture Factory
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 Requisition
date no.
Factory site Tana Transport 2/10, n/30 Jan. 15, 121
PLC 2003
Item no. Quantity Description Unit price Total
1. 1,000 board ft. Lumber 20 20,000.00
(eucalyptus)
 No journal entry is required when a purchase order is
filled.
3. 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, 2003 Direct material 20,000.00
Account payable 20,000.00

A sample receiving report is shown below.

ALDER Furniture Factory
Receiving report form
Received from: Receiving report No. R
Gentle lumber processing Arat Kilo 1345
Close to AAU, Science faculty
Freight: Purchase order No. 496
Pd Collect
X
Date received: February 15, 2003 Received by: Abera G.

Quantity Description Weight

Gross Net
1,000 board ft. Lumber (eucalyptus)

4. 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.

ALDER Furniture Factory

Cost & Management Accounting I/ Lecture note on Chapter III 3

Production Order
Date: January 19, 2003 Job No. 365
Manufactured for: Stock
Date needed: March 20, 2003
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.

5. 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, 2003
Job No. to be charged: 365
Quantity Description Unit cost Total cost Classification
500 board ft. Lumber 20 10,000.00 Direct
1 box Nail 22 22 Indirect
1 Gallon Glue 30 30 Indirect
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

o 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.

Cost & Management Accounting I/ Lecture note on Chapter III 4

  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, 2003
Date completed: March 20, 2003
Item 4152 – coffee tables
For stock
Direct material Direct labor Manufacturing overhead
Date Req. Amount Date Hours Amount Date DLH Rate Amount
No.
Jan. 28 906 10,000
2003
Cost summary
Cost item Amount
Total direct material
Total direct labor
Total manufacturing overhead applied
Shipping summary
Date Number of units shipped Cost balance

6. 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, 2003 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

Cost & Management Accounting I/ Lecture note on Chapter III 5

 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.
7. Manufacturing overhead – costs other than direct material and direct labor that
are necessary to transform the raw materials into finished goods are 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:
1. MOH is an indirect cost, it is difficult to trace to a particular job.
2. MOH consists of many different items ranging from the grease used in machines to
the annual salary of production manager.
3. 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.

Cost & Management Accounting I/ Lecture note on Chapter III 6

  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 = 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 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. 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 cost = Estimated overhead cost
Estimated activity base (direct labor hr.)
POR = 80,000 = 20 per direct labor hour.
4,000
If we assume that the direct labor hours spent on the job are 90, the manufacturing over
head applied will therefore be 90 X 20 =1800. The entry to record the manufacturing
overhead applied is as follows:

March 18, 2003 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, 2003 Manufacturing over head 22,000.00
Various accounts 22,000.00

8. Finished good 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, 2003 Finished goods 21,400.00

Work in process 21,400.00

Cost & Management Accounting I/ Lecture note on Chapter III 7

 9. 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, Cash 5,400.00
2003 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, Cost of goods sold 10,700.00

2003 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

Cost & Management Accounting I/ Lecture note on Chapter III 8

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
rate X actual cost overhead rate X

Cost & Management Accounting I/ Lecture note on Chapter III 9

 driver used actual amount
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

Cost of Goods Sold 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 applied 540,000.00
Manufacturing overhead -control 607,500.00
OR
Debit Credit
Cost of goods sold 67,500.00
Manufacturing overhead 67,500

 The applied manufacturing overhead is a contra account to manufacturing

overhead control, and thus, the normal balance for the applied manufacturing
overhead is credit.

Cost & Management Accounting I/ Lecture note on Chapter III 10

  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 allocated

before proration 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 Account

balance overhead applied over allocated balance after
(%) overhead proration
Work in process 11,400.00 3,907.00 = 2% 2% X 2,700.00 11,346.00
54
Finished good 18,600.00 7,814.00 = 4% 4% X 2,700.00 18,492.00
108
Cost of goods sold 427,500.00 183,629.00=94% 94% X 2,700 424,962.00
2,538.00
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
Manufacturing overhead applied 195,350.00
Work in process 54.00
Finished good 108.00
Cost of goods sold 2,538.00

Cost & Management Accounting I/ Lecture note on Chapter III 11

 Manufacturing overhead -control 192,650.00

Debit Credit
Manufacturing overhead 2700.00
Work in process 54.00
Finished good 108.00
Cost of goods sold 2,538.00

 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 overhead balance after
proration
Work in process 11,400.00 11,400/457,500.00 = 2.5% 11,332.50
2.5% X 2,700.00 = 67.5
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 = 2,524.5
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
Manufacturing overhead applied 195,350.00
Work in process 67.50
Finished good 108.00
Cost of goods sold 2,524.50
Manufacturing overhead -control 192,650.00

Debit Credit
Manufacturing overhead 2700.00
Work in process 67.50
Finished good 108.00

Cost & Management Accounting I/ Lecture note on Chapter III 12

 Cost of goods sold 2,524.50

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.
 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 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 PDR 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

Cost & Management Accounting I/ Lecture note on Chapter III 13

 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 PDR.
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
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
1
Transferred-in costs are assigned to partially completed products that are transferred into one production
department from a prior department.

Cost & Management Accounting I/ Lecture note on Chapter III 14

 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 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 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 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.

Cost & Management Accounting I/ Lecture note on Chapter III 15

  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
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% 225 135
Accounted for 400
Work done in current period 400 310

Cost & Management Accounting I/ Lecture note on Chapter III 16

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*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 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
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 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)

Cost & Management Accounting I/ Lecture note on Chapter III 17

 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

 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
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

Cost & Management Accounting I/ Lecture note on Chapter III 18

 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.
 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

Cost & Management Accounting I/ Lecture note on Chapter III 19

 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
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
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)

Cost & Management Accounting I/ Lecture note on Chapter III 20

  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.

Cost & Management Accounting I/ Lecture note on Chapter III 21