ch05

Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton

Slides prepared by Kim Langfield-Smith
Chapter 5
Process costing and
operation costing

2
Product costing systems
Job costing and process costing are two
extremes of the continuum of conventional
product costing systems
Job costing systems accumulate the costs
of each job
Process costing systems accumulate the
cost of each process, then average these
costs across all units produced
Many businesses use a combination of job
and process costinghybrid costing
3
Process costing
Used by businesses that mass-produce one
product or a small range of almost identical
products
Involves a number of processes that are
performed repetitively
Used by oil refineries, food processors,
manufactures of tobacco, chemicals and paper
Also used by producers of repetitive services
routine processing of cheques in banks and
delivery of standard letters in Australia Post
continued
4
Process costing
Two main steps
Estimate the cost of the production process
Calculate the average cost per unit by dividing
the cost of the process by the number of units
produced
Process costing can be used in situations
where there is no opening or closing WIP
inventory (see Chapter 4)
More complex process costing takes place
where there is WIP inventory
5
Process costing with WIP
WIP inventory
Product is not complete at the beginning or end
of the month
Production costs will relate to
Units started in the previous period and
completed in current period (beginning WIP)
Units started and completed in the period
Units that are incomplete at the end of the
period (ending WIP)
continued
6
Partially-completed goods at the beginning
or end of the period change the way we
allocate production costs
Equivalent units
The amount of production inputs that have been
applied to the physical units in production
Physical units are all units currently in
production whether complete or incomplete
WIP inventory needs to be converted to
equivalent units

continued
7
Labour and overhead are incurred at
different stages of the production process
Units in ending WIP are generally at
different stages of completion in respect to
material and labour
8
Calculation of equivalent
units for ending WIP
If WIP is 50% complete for 10,000 litres on
hand at the end of the month:
100% complete for direct materials, which are
added at the start of the process 10,000
equivalent units of material
50% complete for conversion costs, assuming
that conversion costs occur uniformly across the
production process 5,000 equivalent units of
conversion cost
Equivalent units are used to calculated unit
costs when there is WIP

9
The effect of beginning
and ending WIP
Four steps in process costing
1. Analyse the physical flow of units
2. Calculate the equivalent units
3. Calculate the unit costs
4. Analyse the total costs
Product are costed using either
Weighted average method
First in first out (FIFO) method

10
Process costing using the
weighted average method
Step one: analyse the physical flow of units

Physical units
in beginning
WIP
Physical
units
started
Physical units
completed and
transferred out
Physical units
in ending WIP
=
-
+
continued
11
Step two: calculate the equivalent units
The equivalent units in beginning WIP are not
identified separately, a key feature of weighted
average cost method

Equivalent units
completed and
transferred out
Equivalent units
in ending WIP
Total equivalent
units
+
=
continued
12
Step three: calculate the unit costs
The cost per equivalent unit for direct material
is the total direct material (conversion costs)
costs divided by the total equivalent units
Under the weighted average method the cost
per equivalent unit is based on the total costs
incurred, including the cost of beginning WIP
Step four: analyse the costs

13
14
15
16
FIFO method
It is assumed that the oldest inventory is
completed before new production
commences
Step one: analyse the physical flow of units
Identical to the weighted average method
Step two: calculate the equivalent units
Under FIFO, equivalent units in opening WIP
are subtracted from total equivalent units to
give new units of production
continued
17
18
FIFO method
Step three: calculate the unit costs
Cost per equivalent unit is calculated for direct
material (or conversion cost) by dividing the
direct material cost incurred during the current
month only by the new equivalent units added
during the current month only.
Step four: analyse total costs
Assumes that the units in beginning inventory
are completed and transferred out first
Cost of the beginning WIP are not mixed with
those incurred during current month
19
20
21
22
Comparison of weighted
average vs. FIFO
Key difference is the treatment of the
beginning WIP
Under weighted average costs, cost of
beginning WIP and equivalent units of work
done on it are included in the calculation of the
cost per equivalent unit
Under FIFO, cost per equivalent unit is based
only on costs incurred in the current month
Weighted average is more commonly used
Simpler and WIP inventory may be negligible
23
Process costing and spoilage
Spoilage cost: the cost of defective product
and wasted resources that cannot be
recovered by rework or recycling
When spoilage occurred there are three forms
of output
Units completed and transferred out
Spoiled units, and
Unfinished units remaining in WIP
Spoiled units are costed using cost per
equivalent unit along with other two outputs
continued
24
Process costing and spoilage
Spoilage is accounted for depending on
whether it is normal or abnormal
Normal spoilage: inherent in the production
process and occurs even under efficient
operating conditions
Included as part of the cost of good units
completed
Abnormal spoilage: should not occur under
efficient operating conditions
Cost of abnormal spoilage are expensed
25
Operation costing
Some businesses have repetitive production
processes, but produce a narrow range of
products that differ in some significant
aspects
In batch manufacturing processes,
individual product lines are produced in
large batches and require specific
combinations of direct materials and a
specific sequence of production processes
continued
26
27
Operation costing
Hybrid costing has features of both job
costing and process costing
Operation costing is used to estimate
product costs in a batch manufacturing
environment
Direct costs are assigned to individual batches
a job costing approach
Conversion costs are accumulated by
departmenta process costing approach
28
Other issues in process
costing
Standard costs are more likely to be used
that actual costs
Process costing and operation costs are
consistent with concepts of responsibility
accounting
Processes or operations are usually performance
in different departments, and
Departmental managers may be held
responsible for the departments costs and
output produced
continued
29
costing
A pre-determined overhead rate may be
used in process costing and a pre-
determined conversion cost rate in
operation costing
Production units are usually used as the
cost driver in process costing and operation
costing
Inputs may be used as cost drivers in operation
costing
continued
30
costing
The percentage of completion is difficult to
determine and is often only a rough
estimate
In service firms, some routine repetitive or
similar services can be costing using
process or operation costing

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Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An

Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton

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