Process Costing

After studying this Process costing, you should be able to:

[1] Understand who uses process cost systems.
[2] Explain the similarities and differences between job
order cost and process cost systems.
[3 Explain the flow of costs in a process cost system.
[4] Make the journal entries to assign manufacturing
costs in a process cost system.
[5] Compute equivalent units.
[6] Explain the five steps necessary to prepare a
production cost report.
[7] Prepare a production cost report.
 Process Costing
• Unlike, Job-costing system that is – For Distinct,
identifiable units of a product or service (for example,
custom-made machines and houses); the
• Process-costing system is– For Masses of identical or
similar units of a product or service (for example:
food or chemical processing). Unit cost of a product
or service is obtained by assigning total costs to many
identical or similar units of output. Each unit receives
the same or similar amounts of direct material costs,
direct manufacturing labor costs, and indirect
manufacturing costs (manufacturing overhead).
• process costing is used to calculate an average
production cost for all units produced.
 Nature of Process Cost Systems

Uses of Process Cost Systems:

 Use to apply costs to similar products that are mass-
produced in a continuous fashion
 Examples include the production of Cereal, Paint,
Manufacturing Steel, Oil Refining and Soft Drinks
 Process Cost Flow

 Tyler Company manufactures roller blade and skateboard wheels

that it sells to manufactures and retail outlets. Manufacturing
consists of two processes: machining and assembly. The
Machining Department shapes, hones, and drills the raw materials.
The Assembly Department assembles and packages the parts.
 Assigning Manufacturing Costs

 Accumulation of materials, labor, and overhead costs is

same as in job order costing.
► Debit Raw Materials Inventory for purchases of raw
materials.
► Debit Factory Labor for factory labor incurred.
► Debit Manufacturing Overhead for overhead cost incurred.
 Assignment of the three manufacturing cost elements to Work
in Process in a process cost system is different from a job
order cost system. Journal entry to record materials used:
 Factory Labor Costs

 Time tickets may be used in both systems.

 All labor costs incurred within a production department are a
cost of processing.
 The journal entry to record factory labor costs:
 Manufacturing Overhead Costs
 Objective of assigning overhead is to allocate overhead to
production departments on objective and equitable basis.
 Use the activity that “drives” or causes the costs.
 Machine time used - primary driver.
 Journal entry to allocate overhead
 …cont’d
 Transfers
Monthly Entry to transfer goods to next department:

Entry to transfer completed goods to Finished Goods:

Entry to record Cost of Goods sold at the time of sale:

 Example

• Blue Diamond Company manufactures ZEBO through two

processes: blending and bottling. In June, raw materials
used were Blending Br.18,000 and Bottling Br.4,000.
Factory labor costs were Blending Br.12,000 and Bottling
Br.5,000. Manufacturing overhead costs were
Blending(combination) Br.6,000 and Bottling Br.2,500.
The company transfers units completed at a cost of
Br.19,000 in the Blending Department to the Bottling
Department. The Bottling Department transfers units
completed at a cost of Br.11,000 to Finished Goods.
• Required Journalize the assignment of these costs to
the two processes and the transfer of units as
appropriate
 ………cont’d

 Journal entry to record (materials used, Overhead Assigned and

Factory Labor Assigned) :
Work in Process - blending ----- Br.18,000
Work in Process- bottling ----- Br.4,000
Raw materials ----- Br.22,000
(To Record Raw Material Used)
Work in Process - blending ----- Br.12,000
Work in Process - bottling----- Br.5,000
Factory Labor----- Br.17,000
(To Assign Factory Labor to Production)
Work in Process - blending ----- Br.6,000
Work in Process - bottling ----- Br.2,500
Manufacturing Overhead ---- Br.8,500
(To Assign Manufacturing Overhead to Production)
 ………cont’d

 Transfers
 Monthly Entry to transfer goods to next department:
Work in Process - blending ----- Br.19,000
Work in Process - bottling Department----- Br.19,000
 Entry to transfer completed goods to Finished Goods:
Finished Goods Inventory ---- Br.11,000
Work in Process - bottling ---- Br.11,000
 Entry to record Cost of Goods sold at the time of sale:
Cost of Goods Sold ---- Br.11,000
Finished Goods Inventory ---- Br.11,000
 Equivalent Units of Production

Equivalent units are the product of the number

of partially completed units and the percentage
completion of those units.

 We need to calculate equivalent units because a

department usually has some partially completed units
in its beginning and ending inventory. These partially
completed units complicate the determination of a
department’s output for a given period and the unit cost
that should be assigned to that output.
 Equivalent Units – The Basic Idea
Two half completed products are equivalent to one
complete product.

+ = 1

So,
So, 10,000
10,000 units
units 70%
70% complete
complete
are
are equivalent
equivalent to
to 7,000
7,000 complete
complete units.
units.
 Quick Check 
For the current period, Jones started 15,000
units and completed 10,000 units, leaving
5,000 units in process 30 percent complete.
How many equivalent units of production
did Jones have for the period? {(5,000* 30%)
+10,000 = 11,500}
a. 10,000
b. 11,500
c. 13,500
d. 15,000
 Calculating Equivalent Units
 Equivalent units can be calculated in two ways:
The Weighted-Average Method
1. Makes no distinction between work done in prior or
current periods.
2. Blends (mix) together units and costs from prior and
current periods.
3. Determines equivalent units of production for a
department by adding together the number of units
transferred out plus the equivalent units in ending
Work in Process Inventory.
 Equivalent Units of Production; The First-In, First-Out
Method
 The FIFO method (generally considered more accurate than the weighted-
average method) differs from the weighted-average method in two ways:

The computation of equivalent units . The way in which the costs of beginning
inventory are treated.

Equivalent units are computed on a first-in, first-out basis.

FIFO usually corresponds to the actual physical flow of goods.

Assumes that the beginning work in process is completed before new work is started.

Under FIFO, equivalent units are the sum of work performed to:

 Finish the units of beginning work in process inventory.

 Complete the units started into production during the period (referred to as units
started and completed).

 Start, but only partially complete, the units in ending work in process
inventory.
 Treatment of Direct Labor
xx

Direct
Materials
Conversion
Direct labor and
manufacturing
Dollar Amount

Direct
Labor overhead may be
combined into one
Direct Manufacturing
Overhead
classification of
Labor product cost called
conversion costs.
Type of Product Cost
 Production Cost Report
Key document used to understand activities.
Prepared for each department and shows:
 Production quantity.
 Cost data.

Five steps in preparation:

Step 1: Compute physical unit flow.
Step 2: Compute equivalent units of production.
Step 3: Compute unit production costs.
Step 4: Costs to account for
Step 5: Prepare a cost reconciliation schedule.
Case 1: Process Costing with No Beginning or Ending Work In Process
On January 1, 2008, there were no beginnings WIP of computers in the assembly
department. During January 2008, SNAP computers started and completed assembly of
computers and transferred out to finishing department 400 units. Additional information
for assembly department is given below:
Physical unit for January, 2008:
• WIP beginning------------- 0 unit
• Started during January ------- 400 unit
• Completed and transferred --- 400 unit
• WIP ending ------------------ 0 unit
• Total cost for January, 2008:
• DM cost added during January -- Br.640,000
• Conversion cost added -------------- 480,000
Total assembly department cost -Br.1,120,000
Required : a} Determine the average cost for the month
b} Record journal entries related to production report
When 400 units transferred into finishing dept record journal entries
Case 2: Process costing with Zero Beginning but Some Ending
WIP inventory
Data for the assembly department for the month of
February 2008 are:
 Physical unit for February 2008:
 WIP beginning (February 1) ------------------ 0 unit
 Units Started during February --------------- 400 unit
 Completed and transferred out ------------- 175 unit
 WIP ending ( February 29) ---------------- 225 unit
Direct material (100% complete)
Conversion cost (60% complete)
 Total cost for February:
DM cost added during February ------------Br.640,000
CC cost added during February -------------- 372,000
 Total assembly department cost------------Br.1,012,000
 Solution

(Step 1)
Flow of production Physical flow
Work in process beginning 0
(Step 2)
Units started in current period 400 Equivalent Units
Units to account for 400 Direct Materials Conversion Costs
Units completed and transferred out 175 175 175
Work in process ending 225 225 135
Units accounted for 400
Work done in current period only
(Equivalent units) 400 310
(Step 3): Cost Summary
Costs added during February Br. 1,012,000 Br 640,000 Br 372,000
Divide by equivalent units ÷ 400 ÷ 310
Cost per equivalent units Br. 1,600 Br. 1,200
(Step 4):
Total cost to account for Br. 1,012,000
(Step 5) Assignment of cost:
To completed and transferred units (175 units) Br. 490,000 Br. 1,600×175 + Br. 1,200×175
To work in process ending (225 units) 522,000 Br. 1,600×225 + Br. 1,200×135
Total cost accounted for Br. 1,012,000
 Case 3: some beginning WIP & some ending WIP
Illustration 3: At the beginning of March, 2008, SNAP computers had 225 units of partially
assembled computers in the assembly department. It started production of another 275 units in

March, 2008; data for assembly department for the month of March are:
Physical units for March 2008.
WIP beginning------------------------------------ 225 unit
Direct material (100% complete)
Conversion cost (60% complete)
Started during March ---------------------------- 275 unit
Completed and transferred out -------------------- 400 unit
WIP ending ----------------------------------------- 100 units
• Direct material (100% complete)
• Conversion cost (50% complete)
Total cost for March:
WIP beginning:
DM ------------------------- Br.360, 000
CC-------------------------- 162,000 - Br.522, 000
DM added during March ---------------------------- 396,000
CC added during March ------------------------------ 327,600
 Weighted average method
(Step 1)
Flow of production Physical flow
Work in process beginning 225
(Step 2)
Units started in current period 275 Equivalent Units
Units to account for 500 Direct materials Conversion costs
Units completed and transferred out 400 400 400
Work in process ending 100 100 50
Units accounted for 500
Work done to date (Equivalent units) 500 450
(Step 3) ; Cost summary
Work in process beginning Br. 522, 000 Br. 360, 000 Br. 162,000
Costs added during February 723,600 396,000 327,600
Total cost incurred to date Br. 756,000 Br. 489,600
Divide by equivalent units ÷ 500 ÷ 450
Cost per equivalent units Br 1,512 Br 1,088
(Step 4)Total cost to account for Br. 1,245,600
(Step 5) Assignment of cost:
To completed and transferred units (400 units) Br. 1,040,000 Br. 1,512×400 + Br. 1,088×400
To work in process ending (100units) 205,600 Br. 1,512×100 + Br. 1,088×50
 Solution
Flow of production (Step 1) Physical flow
Work in process beginning 225
(Step 2)
Units started in current period 275 Equivalent Units
Units to account for 500 Direct Materials Conversion Costs
Units completed and transferred out:
From beginning work in process 225 0 90
Started and completed 175 175 175
Work in process ending 100 100 50
Units accounted for 500
Work done in current period only 275 315
(Step 3): Cost summary
Work in process beginning Br. 522, 000 Incurred Last Month
Costs added during March 723,600 Br. 396,000 Br. 327,600
Divide by equivalent units ÷ 275 ÷ 315
Cost per equivalent units Br. 1,440 Br. 1,040
(Step 4) Total cost to account for Br. 1,245,600
(Step 5) Assignment of cost:
To completed units (400 units)
Work In process beginning (225 units) Br. 522, 000 -------------------------------------
Cost added to beginning WIP in the current month 93600 0×Br. 1,440 + 90×Br. 1,040
Total from beginning Inventory Br. 615,600
Started and completed 434000 175×Br. 1,440 + 175×Br. 1,040
Total cost of units completed Br. 1,049,600
To work in process ending (100units) 196,000 Br. 1,440×100 + Br. 1,040×50
 Transfer in cost

Physical units
WIP beginning ----------------------------- 240 units
Transferred in Cost (100% complete)
Direct material (0% complete)
Conversion cost (62.5% complete)
Transferred in during April -------------- 400 unit
Completed during April ------------------------- 440 unit
WIP ending ---------------------------------------200 units
Transferred in Cost (100% complete)
Direct material (0% complete)
Conversion cost (80% complete
Cost for finishing department in April:
WIP beginning
Transferred In cost --------------------------Br.672, 000
Direct materials ---------------------------------- 0
Conversion cost ---------------------------- 360,000
Transferred in during April:
Under WA method -------------------------------Br.1, 040,000
Under FIFO method ----------------------------- 1, 049,600
Direct material cost added during April --------- -- -- 13,200
Conversion cost during April ----------------------- --- 48,600
 Weighted Solution

(Step 1)
Flow of production Physical flow
(Step 2)
Work in process beginning 240
Equivalent Units

Units started in current period 400

Units to account for 640 Transferred in cost Direct material Conversion costs

Units completed and transferred out: 440 440 440 440

Work in process ending 200 200 0 160
Units accounted for 640 - - -
Work done in current period only 640 440 600
(Step 3): Cost summary
Work in process beginning Br. 1,032,000 Br. 672,000 0 Br. 360,000
Costs added during March 1,101,800 1, 040,000 13,200 48,600
Total cost Br. 1,712,000 Br. 13,200 408,600
Divide by equivalent units ÷ 640 ÷ 440 ÷ 600
Cost per equivalent units Br. 2,675 Br. 30 Br. 681
(Step 4)
Total cost to account for Br.2,133,800
(Step 5) Assignment of cost:
To completed units (440 units) Br.1,489,840 (440×2,675) + (440×30) + (440×681)
 FIFO METHOD
(Step 1)
Flow of production Physical flow
(Step 2)
Work in process beginning 240
Equivalent Units

Units started in current period 400

Units to account for 640 Transferred in cost Direct material Conversion costs
Units completed
From WIP Beginning 240 0 240 90
Started and completed 200 200 200 200
WIP Ending 200 200 0 160
Units accounted for 640 - - -
Work done in current period only 400 440 450
(Step 3): Cost summary
Work in process beginning Br. 1,032,000 Incurred last month
Costs added during March 1,111,400 Br. 1, 049,600 Br. 13,200 48,600
Divide by equivalent units ÷ 400 ÷ 440 ÷ 450
Cost per equivalent units Br. 2,624 Br. 30 Br. 108
(Step 4) Total cost to account for 2,143,400
(Step 5) Assignment of cost:
To completed units (440 units)
From WIP Beginning (240 units) Br.1,032,000
Cost added to WIP Beginning 16,920 (0×2,624) + (240×30) + (90×108)
Total from beginning Inventory Br. 1,048,920
Started and completed 552,400 (200×2,624)+(200×30)+ (200×108)
Total cost of units completed Br. 1,601,320
To WIP ending (200 units) 542,080 (200×2,624) + (0×30) + (160×108)
 Treatment of Spoilage, Rework and Scrap

Treatment of Rework
Rework : is units of production that do not meet the
specifications required by customers but that are
subsequently repaired and sold as good finished units.
Rework is units of production that are inspected,
determined to be unacceptable, repaired, and sold as
acceptable finished goods.
Process costing: accounts for abnormal rework in the
same way as job costing. Accounting for normal rework
follows the accounting described for normal
rework common to all jobs (units) because masses of
identical or similar units are being
manufactured.
 Treatment of Scrap

Scrap is residual material that results from manufacturing a

product; it has low total sales
value compared with the total sales value of the product. No
distinction is made between
normal and abnormal scrap because no cost is assigned to scrap.
Scrap can sometimes be sold for relatively small amounts. In that
sense, scrap is similar to byproducts.
There are two aspects of accounting for scrap:
1. Planning and control, including physical tracking
2. Inventory costing, including when and how scrap affects
operating income.
Accounting for scrap under process costing is similar to
accounting under job costing when
scrap is common to all jobs.
 Treatment of Spoilage

Spoilage is units of production—whether fully or

partially completed—that do not meet the specifications
required by customers for good units and that are
discarded or sold at reduced prices.
NB: An advantage of Job order costing is, it helps to
distinguish profitable jobs from unprofitable jobs; it helps
to identify defective work and spoilage with a department
or person than Process costing. The Two Types of
spoilage costs are: normal and abnormal spoilage.
Normal spoilage :the cost of normal spoilage is included
in the cost of the good units completed. Due to its certain
level of spoilage is almost unavoidable.
 Treatment of Spoilage cont…

Abnormal Spoilage
Unlike normal spoilage costs, abnormal spoilage costs are
not included as a part of the cost of
good units produced.
Abnormal spoilage is spoilage that is not inherent in a
particular production process and
would not arise under efficient operating conditions.
Overview of Operation-Costing Systems
An operation-costing system is a hybrid-costing system
applied to batches of similar, but
not identical, products.
Each batch of products is often a variation of a single
design, and it proceeds through a sequence of operations.