SYSTEMS DESIGN: PROCESS COSTING

SYSTEM ; COST ALLOCATION

 Outline
1. Concept
2. Cost Allocation: Weighted Average Method
3. Cost Allocation: First-in, First Out (FIFO) Method
4. Process Costing in Multiple Departments
5. Journal Entries
6. Cost Allocation of Support Departments
7. Joint Products and By-Products
 The Concept of Process Costing
◈Used in continuous and mass productions of…
◈Homogenous products
◈Examples: socks production, canned goods production,
flour production
◈No need to maintain separate records for each job
◈Cost object: Unit of product
 The Concept of Process Costing
Dept. 1 Dept. 2 Finished Goods

M How do we
TO allocate costs
TO
L TO to transferred
out units and
WIP,
OH
End ending work-
M
in-process?
L
WIP.
end
OH
 Methods of Cost Allocation
1. Weighted Average Method – the cost of beginning work-in-process
is mingled with current production costs.
2. First-in, first-out method – the cost of the beginning work-in-
process is kept separated from the current production costs.
 Weighted-Average Method
We will use Illustrative Problem 7.2. Please read and analyze
it before proceeding.

Let us familiarize ourselves with the .

 Weighted-Average Method
Step 1: Fill-up the total units to account for section. Write the % of completion.
◈ This is the total units of product that was processed through in a department in a
given period.
◈ Composed of beginning work-in process and units started.
WIP, beginning 100,000
Units started 400,000
Total units to account for 500,000
 Weighted-Average Method
Step 2: Fill up the costs to account for section.
 Weighted-Average Method
Step 3: Fill up the units as accounted for section and put their respective % of
completion.
◈ This section is a sort of explanation on the whereabouts of the units that passed
through a department.
◈ Composition:
▪ Units transferred out
▪ Units lost and/or spoiled (if applicable)
▪ WIP, end
 Weighted-Average Method
Step 4: Fill up the equivalent units of production (EUP) section.
◈ What is EUP?
A computation tool that converts the efforts expended on units processed into whole units.
Demonstration 1: What is the EUP of 2 units that are 50% complete?

50% x 2 = 1
Two units which are 50% complete = One unit which is 100% complete
 Weighted-Average Method
Demonstration 2: What is the EUP of 4 units which are 75% complete?

75% x 4 = 3
4 units that are 75% complete = 3 units that are 100% complete
 Weighted-Average Method
◈ Under the weighted average method, units transferred out will always have 100% EUP.
◈ For the WIP, end, we must multiply the units of the inventory to the percentage of
completion . WIP, end has 60,000 units which is 100% complete in materials, 50%
complete in labor, and 60% complete in overhead. Thus, the respective EUPs are:
Materials 60,000 x 100% = 60,000
Labor 60,000 x 50% = 30,000
Overhead 60,000 x 60% = 36,000
 Weighted-Average Method
Step 5: Compute for the costs per EUP for each cost element.
Cost per EUP = Total cost to account for / Total EUP
Materials = P540,000 / 500,000 units = P1.08 per unit
Labor = P235,000 / 470,000 units = P0.50 per unit
Overhead = P452,200 / 476,000 = P0.95 per unit
 Weighted-Average Method
Step 6: Allocate the factory costs to WIP, end, spoiled units and units transferred out. This will be
done on a per cost element basis.
Cost per EUP x EUP
Cost element Transferred out WIP, end
Materials 440,000 x P1.08 = P475,200 60,000 x P1.08 = P64,800
Labor 440,000 x P0.47 = P206,800 30,000 x P0.47 = P15,000
Overhead 440,000 x P0.95 = P418,000 36,000 x P0.95 = P34,200
Weighted Average Method – Journal Entries
 Weighted Average Method – Journal Entries
Some reminders about the :
✔The total physical units of the units to account for and the
units as accounted for sections must always be equal.
✔The total factory costs of the costs to account for and the
costs as accounted for sections must always be equal.
Proceed to next part
 First-in, First Out (FIFO) Method
◈ The cost of the beginning WIP is not included in computing EUP and Cost per EUP.
◈ Only the current period cost is used.

We will use the same data we used for weighted average.

 First-in, First Out (FIFO) Method
◈ The steps used in weighted average method will still be followed.
◈ The difference lies in:
❑ EUP for units transferred out
❑ Cost per EUP
◈Steps 1 to 2 will be the same as in weighted average method.
 First-in, First Out (FIFO) Method
Step 3: Fill up the units as accounted for section.
◈ The units transferred out will be classified into two:
o Beginning WIP transferred out this period
o Units started and finished this period
 First-in, First Out (FIFO) Method
We introduced a new set of columns for Step 3 which we call % effort this period. This represent
the effort expended for the units being accounted for this period.
◈ For Beginning WIP (BWIP), the percentages were obtained by deducting the reported BWIP %
of completion from 100%. The answers will be the % effort this period for each cost element.
o Materials = 100% - 100% = 0%
✔ Since materials were added at the beginning of the process, no materials were added to
BWIP this period. Materials for BWIP were added in the previous period.
o Labor = 100% - 30% = 70%
✔ Since BWIP is reported as 30% complete as of June 1, only 70% of the labor costs were
incurred this period.
o Overhead = 100% - 40% = 60%
✔ Since BWIP is reported as 40% complete as of June 1, only 60% of the overhead costs
were incurred this period.
 First-in, First Out (FIFO) Method
◈ For the units started and transferred out this period, the EUP will
always be 100% since all efforts for this units were expended this
period.
◈ The percentages computed will be used in computing EUP (Step 4).
 First-in, First Out (FIFO) Method
Step 4: Fill up the equivalent units of production (EUP) section.
◈ The units transferred out will be classified into two like in the
previous step.
◈ Their EUPs will be computed as:
% effort this period (from Step 3) x Physical units
◈ This computation will result to EUPs for effort this period only.
 First-in, First Out (FIFO) Method
Related computation for the EUP follows:
Cost element BWIP transferred out Units started and transferred EWIP
Materials 0% x 100,000 = 0 100% x 340,000 = 340,000 100% x 60,000 = 60,000
Labor 70% x 100,000 = 70,000 100% x 340,000 = 340,000 50% x 60,000 = 30,000
Overhead 60% x 100,000 = 60,000 100% x 340,000 = 340,000 60% x 60,000 =36,000
 First-in, First Out (FIFO) Method
Step 5: Compute for the costs per EUP for each cost element.
◈ Only the costs added this period (current cost) will be used.
Materials = P440,000 / 400,000 EUP = P1.10 per EUP
Labor = P224,400 / 440,000 EUP = P0.51 per EUP
Overhead = P436,000 / 436,000 EUP = P1.00 per EUP
 First-in, First Out (FIFO) Method
Step 6: Allocate the factory costs to EWIP, spoiled units and units transferred out. This will be
done on a per cost element basis.
◈ There will be separate lines for the costs of BWIP and the costs incurred to finish it.
◈ The formula Cost per EUP x EUP will be applied to obtain:
o Cost to finish the BWIP
o Cost of units started and transferred out
o Cost of EWIP
◈ The procedure to be followed is similar to that of the weighted-average method.
 First-in, First Out (FIFO) Method
The journal entries for this production run appear below:
Proceed to next part
 Cost Allocation in Subsequent Departments
◈ The procedure followed is the same as discussed in the two methods.
◈ An additional cost column for the costs of units received from the
previous department is created.
◈ These costs are referred to as Transferred-in Costs.
We will continue the problem we used in the previous slides with the
additional data (not in the book) appearing on the next slide:
Cost Allocation in Subsequent Departments
The finishing department adds packaging materials when the process is 90% complete.
Conversion costs are incurred evenly throughout the process.
Pertinent data about the department's activities follow:

Work in process, June 1

Number of units 70,000
Transferred in costs ₱ 183,400.00
Materials, 0% complete ₱ -
Conversion costs, 75% complete ₱ 630,000.00

Costs added this period:

Units received from previous department 440,000
Transferred in costs ₱ 1,113,200.00
Direct materials ₱ 349,500.00
Conversion costs ₱ 6,000,000.00

Work-in-process, June 30
Number of units 22,000
Transferred in costs ₱ 57,420.00
Materials, 0% complete ₱ -
Conversion costs, 75% complete ₱ 198,000.00
 Cost Allocation in Subsequent Departments
Step 1: Fill-up the total units to account for section. Write the
% of completion.
◈The transferred in cost of the BWIP is always 100%
complete.
◈This is because these units will not reach the finishing
department if it is not 100% complete in processing of the
molding (previous) department.
 Cost Allocation in Subsequent Departments
Step 2: Fill up the costs to account for section. (No special procedure involved.)
Step 3: Fill up the units as accounted for section and put their respective % of completion.
◈ The number of units transferred out was not mentioned.
◈ This could be computed by subtracting from the total units to account for the number of units in
the ending inventory.
510,000 – 22,000 = 488,000
◈ The transferred in costs % of completion for both transferred out units and EWIP is always
100% following the logic used for BWIP.
◈ It should be noted that both BWIP and EWIP are 0% complete as to materials since materials
are added when the process is 90% complete. Both have not yet reached this point.
 Cost Allocation in Subsequent Departments
Step 4: Fill up the equivalent units of production (EUP) section. (No
special procedure.)
Step 5: Compute for the cost per EUP. (No special procedure.)
Step 6: Allocate the factory costs to EWIP, spoiled units and units
transferred out. This will be done on a per cost element basis. (No
special procedure.)
Journal Entries; Subsequent Departments
Work-in-process - Finishing 1,113,200.00
Work-in Process Molding 1,113,200.00

Work-in-process - Finishing 6,349,500.00

Direct Materials Inventory 349,500.00
Various Accounts (L & OH) 6,000,000.00

Finished Goods 8,003,329.78

Work-in-process - Finishing 8,003,329.78
 Cost Allocation in Subsequent Departments
Now let us assume that the company uses FIFO.
◈ Steps 1 to 2 will result to the same outcome.
◈ Step 3: Fill up the units as accounted for section and put their respective %
effort this period.
o The BWIP has 0% effort this period for transferred-in cost because it was
received by the finishing department in the previous period.
o It has 100% for materials since these were added when the units were 90%
complete. This point was reached this period.
 Cost Allocation in Subsequent Departments
Step 4: Fill up the equivalent units of production (EUP) section. (No
special procedure.)
Step 5: Compute for the cost per EUP. (No special procedure.)
◈ Reminder: Current costs only
◈ Step 6: Allocate the factory costs to EWIP, spoiled units and units
transferred out. This will be done on a per cost element basis. (No
special procedure.)
Journal Entries; Subsequent Departments
FIFO entries
Work-in-process - Finishing 1,109,900.00
Work-in Process Molding 1,109,900.00

Work-in-process - Finishing 6,349,500.00

Direct Materials Inventory 349,500.00
Various Accounts (L & OH) 6,000,000.00

Finished Goods 7,998,278.45

Work-in-process - Finishing 7,998,278.45
Proceed to next part
 Cost Allocation of Support Departments
◈ This is done as part of the evaluation of personnel and department performance.
◈ This is done based on the concept that many departments depend and benefit
from the cost of support departments.
◈ The activities of these dependent departments act as “cost drivers” of support
department costs.
◈ The support departments do not lose responsibility in controlling their costs
even though dependent departments may also be held responsible for the costs
of support departments.
 Cost Allocation of Support Departments
We will use the illustrative case on page 236A. Please read and
analyze it before proceeding.

There are three methods of allocation to be discussed:

1. Direct method
2. Step Method (Sequential Method)
3. Algebraic method
 Cost Allocation of Support Departments
The following will be the bases of allocation:
Materials Handling – cost of materials requisitioned
Repairs & Maintenance – labor hours of service used
Building & Grounds – square footage
 Cost Allocation of Support Departments
Direct method – involves directly allocating the support department costs to the producing
(dependent) departments. The allocation of the cost of support departments is shown below:
Cost Allocation of Support Departments
 Cost Allocation of Support Departments
The total departmental costs of the producing departments after allocation follow:
 Cost Allocation of Support Departments
✔Advantage: This is the simplest method to use.
o Disadvantage: It does not recognize the interdependence of
the departments.
 Cost Allocation of Support Departments
Step Method
◈Involves allocating the support department costs to the
other departments (support and producing).
◈Once a cost of a support department is already allocated, no
amount of support department cost is allocated back to it.
◈Follows an order of priority in allocation
 Cost Allocation of Support Departments
For our illustrative problem, we will assume that the order of allocation is:
1. Materials Handling costs will be allocated to Repairs & Maintenance, Building
& Grounds, Assembly, and Treating.
2. Repairs & Maintenance costs will be allocated to Building & Grounds,
Assembly, and Treating.
3. Building & Grounds costs will be allocated to Assembly and Treating.
Cost Allocation of Support Departments
Cost Allocation of Support Departments
Cost Allocation of Support Departments
 Cost Allocation of Support Departments
✔Advantage: Partially recognizes the interdependence
between departments
o Disadvantage: Do not totally recognize the interdependence
between departments
 Cost Allocation of Support Departments
Algebraic method
◈ Involves the development of equations based on the interdependence of the departments with
each other
◈ An improvement from the step method because costs are allocated back to all departments even
if its cost is already allocated.
◈ The usage of all departments by the service of the other departments must be expressed in
percentage.
◈ Based on these percentages, equations will be developed for the support departments.
 Cost Allocation of Support Departments

The following equations developed from the table above will be solved
simultaneously:
M = 43,500 + 0.16B
R = 36,250 + 0.2299M + 0.10B
B= 35,350 + 0.1954M + 0.5952R
 Cost Allocation of Support Departments
M = 43,500 + 0.16B
R = 36,250 + 0.2299M + 0.10B
B= 35,350 + 0.1954M + 0.5952R
We will solve this equation using substitution. We substitute the equation for M to the equations of
R and B. Thus,
R = 36,250 + 0.2299 (43,500 + 0.16B) + 0.10B
R = 46,250.65 + 0.1368B
B = 35,350 + 0.1945 (43,500 + 0.16B) + 0.5952R
0.9689B = 43,810.75 + 0.5952R
 Cost Allocation of Support Departments
Next we substitute the developed equation R = 46,250.65 + 0.1368B to the other developed
equation 0.9689B = 43,810.75 + 0.5952R. Thus:
0.9689B = 43,810.75 + 0.5952 (46,250.65 + 0.1368B)
B = 80,382
We substitute this B value to the original M equation as shown here:
M = 43,500 + 0.16 (80,382) = 56,361
Lastly , we substitute the B value to the developed R equation*:
R = 46,250.65 + 0.1368 (80,382) = 57,246
*Substitution could also be made to the original R equation.
 Cost Allocation of Support Departments
We now have the three values that will be simultaneously allocated as shown below:

(Rounding errors are present)

The totals for the assembly and finishing departments will be used in developing the overhead
application rate if normal costing is used.
 Cost Allocation of Support Departments
Algebraic method is
✔ Most accurate of the three methods
o Tedious if done manually
Proceed to next part
 Joint Products and By-products
◈ Joint products – are products from the same production with common set of inputs (joint
process) with substantial sales value.
Example: A common process in a bakery that produces different type of breads
◈ By-products – are products with relatively small sales value compared to joint products.
Example: A bakery may produce trimmings of bread which are deformed. These can be
sold at a lower price.
◈ Split-off point – the point in a joint process where individual products can be identified
separately.
◈ Scrap – residue of a production process that has little or no value.
Ex: Wood trimmings in a furniture shop
 Joint Products and By-products
◈ Waste – has no recovery value and must be disposed.
◈ Spoiled units – cannot be reworked economically
◈ Defective units – can be reworked economically

✔ The next slides will deal on accounting for joint products and by-products.
 Accounting for Joint Products
Accounting issue: How do we allocate common costs (joint costs) to joint products?
◈ There are three bases that can be used:
1. Physical measure
2. Sales value
3. Net realizable value

The three methods basically follows the same steps. We will discuss each in the following slides.
 Accounting for Joint Products
(1) Physical measure method is used when:
✔ The selling price of the products are not available.
✔ The selling price of the products are volatile.
✔ Much processing occurs before the products become saleable
Assume that a joint process of logs costing P1,800,000 produced 1,400 units of clipboard and
1,960 units of lumber. The joint cost is allocated as follows:
Clipboard [1,400 / (1,400 + 1,960)] x P1,800,000 = P750,000
Lumber [1,960/ (1,400 + 1,960)] x P1,800,000 = P1,050,000
 Accounting for Joint Products
(2) Sales value method can be used only when the products are saleable at the split-off point.
This is the most widely used method.
Assume that a P16,000 joint process produced 2,000 lbs. of fillet that can be sold at P2.20/lb. and
8,000 lbs. of canned tuna that can be sold at P1.65/lb. The joint cost is allocated as follows:
 Accounting for Joint Products
(3) Net realizable value method (NRV)
◈ Used when not all joint products are saleable at split-off point
◈ NRV = Final selling price – separable costs
◈ Separable costs – additional processing and selling costs
Assume that a P16,000 joint process produced 2,000 lbs. of fillet and 8,000 lbs. of canned tuna.
The fillets needs additional processing and selling cost of P0.03 and P0.05 per pound respectively
before they can be sold for P2.20 per pound. The canned tuna will require P0.02 and P0.04 per
pound of additional processing and selling costs before they could be sold for P1.70 per pound.
The joint cost is allocated on the next slide:
Accounting for Joint Products
Proceed to next part
 Accounting for By-products
There are two methods:
1. The NRV is deducted from the cost of the main product
2. The NRV is treated as other income

Let us assume the following data:

JKL X
Sales value ₱ 2,000,000.00 ₱ 11,000.00
Processing cost up to split-off point ₱ 800,000.00
Additional processing cost ₱ 3,000.00

The two methods of presenting by-products in the income statement follows.

Accounting for By-products
Sales revenue 2,000,000.00 2,000,000.00
Other income - 8,000.00
Total revenue 2,000,000.00 2,008,000.00

Cost of sales 800,000.00 800,000.00

By-product 8,000.00 -
Adjusted cost of sales 792,000.00 800,000.00

Gross margin 1,208,000.00 1,208,000.00

 Accounting for By-products
Under the two methods, the following entries will be recorded :

By-product cost 3,000.00

Various accounts (L & OH) 3,000.00

Cash or Accounts Receivable 11,000.00

By-product revenue 11,000.00

Under the 1st method, an additional entry is made:

By-product revenue 11,000.00
By-product cost 3,000.00
Work-in-process 8,000.00