2009 Foster School of Business Cost Accounting L.DuCharme 1

Process Costing

Chapter 17

2009 Foster School of Business Cost Accounting L.DuCharme 2

Quote for today

• When I was a boy of fourteen, my father was so ignorant I could hardly stand to have the old man around. But when I got to be twenty-one I was astonished at how much the old man had learned in seven years.

--Mark Twain

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Overview—Process Costing

• When to use

• Accounting issue

• Equivalent Units (EUs)

• Mechanics of process costing– w/o TI costs– with TI costs

• Accounting for Spoilage (chapter 18)

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When is it appropriate to useprocess costing?

• Or what companies use process costing?

• Which companies would not use process costing?

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Illustrating Process Costing

Direct Materials, Direct LaborIndirect Manufacturing Costs

DepartmentA

DepartmentB

Finished Goods Cost of Goods Sold

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What is the BIG accounting issue?

The task is to divide the total costs in WIP between ending WIP and inventory completed and transferred out (CTO).

This is no big deal until you consider that E.WIP is partially completed and CTO by definition is 100% complete (for each step of production)! What do we do?

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Equivalent Units

• 15 half-time (50%) professors is equivalent to 7.5 full-time professors. Often for people we refer to FTEs.

• 100 teddy bears that are (on average) 45% complete are equivalent to 45 completed bears = 45 equivalent units.

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EU—when to use

• Not all organizations that use process costing have to calculate EUs!

• You only have to calculate/use EUs when ending WIP inventories are material.– No (or little) ending WIP—what companies?– Material ending WIP—what companies?

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Assumed flow of costs

• Process costing is combined with the assumed flow of costs:– Standard cost– Weighted average (we will focus on this)– FIFO (least used)

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Three Equations/steps

• At the core of calculations are 3 equations:– Physical unit calculations (in units)—

• B.WIP + units started this period = CTO + E.WIP

– EU calculations (in EU)—• B.WIP + work done this period = CTO + E.WIP

– Costs (in $)—• B.WIP + period’s costs = CTO + E.WIP

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Timing of added costs

• Whenever a factor of production is added at a different time (beginning, middle, end, etc.) in production, a separate EU computation is required (for that factor)!

• For example if DM is added at a different time than CC, each has to have a separate EU calculation (see example in class)

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Transferred –In Costs

CTO from one department is TI to the next department.

TI does not equal direct materials.

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The BIG Picture

The goal is to assign costs to CTO units. In order to do this you need costs per unit.

(1) When costs change from period to period, you have to make a cost-flow assumption.

(2) When incomplete units are present in E.WIP, you have to adjust via EU calculations.

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Process Costing Examples

(1) Without TI costs

(2) With TI costs

My format****

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Process Costing--WA method

P.U. $DM $CC

WIP, Apr.1 300 $7,500 $2,125

Started in Apr.

(or work done)

2,200

CTO Apr.

WIP, Apr.30 500

Cost added in Apr. $70,000 $42,500

Apr. 1, % complete 100% 40%

Apr. 30, % complete 100% 25%

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WA-- solution

P.U. $DM EU-DM $CC EU-cc

WIP, Apr.1 300 $7,500 300 $2,125 120

Started in Apr.

(or work done)

2,200

CTO Apr. 2,000 2,000 2,000

WIP, Apr.30 500 500 125

Cost added in Apr. $70,000 $42,500

Total Cost $77,500 $44,625

WA $/EU $31 / EU $21 /EU

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WA--solution

DM CC Total

CTO(2,000 EU)

2,000 eu * $31/eu

$62,0002,000 eu * $21/eu

$42,000$104,000

E.WIP(500 : 125 EU)

500 eu * $31/eu

$15,500125 eu * $21/eu

$2,625$18,125

Total = $77,500 $44,625 $122,125

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Today’s Quote

• “I have no use for bodyguards, but I have very specific use for two highly trained certified public accountants.”

--Elvis Presley

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WA with TI costs--example

• Finishing department (assume that):– TI costs are added at the beginning– DM are added at the end– CC are added evenly throughout

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Data for problem

P.U. TI $ TI-eu DM $ DM-eu CC $ CC-eu

B.WIP 500 $17,750 100% $0 0% $7,250 60%

Started(or work done)

2,000

CTO 2,100

E.WIP 400 100% 0% 30%

Costs

Added

$104,000 $23,100 $38,400

Total $ $121,750 $23,100 $45,650

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WA with TI costs--solution

P.U. TI $ DM $ CC $

B.WIP 500 $17,750 $0 $7,250

Started(or work done)

2,000

CTO 2,100

E.WIP 400

Total $ $121,750 $23,100 $45,650

WA $/EU

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WA with TI costs--solution

TI DM CC Total

WA: $/EU $48.700 $11.000 $20.563

CTO2,100 eu

$102,270 $23,100 $43,182 $168,552

E.WIP400 : 0 : 120

$19,480 $0 $2,468 $21,948

Total $190,500

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Chapter 18

This chapter focuses on accounting for Spoilage (flip side of product quality).

You are responsible for the first 3 pages of the chapter and what is covered in class.

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Terminology

• Spoilage– Unacceptable product discarded or sold for disposal

value (e.g., “Seconds”).

• Reworked units– Unacceptable product that is reworked and sold as good

product.

• Scrap—material left over with min. or zero sales value.

• Waste—can be toxic and very costly to dispose of.

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Goal of most operations

• Reduction of S/R/S/W– Consistent with increased quality

– R&D and design play key roles in reducing S/R/S/W.

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“Types” of spoilage

• Normal spoilage– Expected spoilage with efficient operations.(“normal spoilage rates” = units of normal spoilage / total good units)

• Abnormal spoilage– Unexpected (greater than expected) spoilage

under efficient operations. Considered avoidable & controllable. Some companies treat all spoilage as abnormal!

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Why do we care?

• Because we account for the two types differently!!

• Abnormal spoilage is expensed in the period it is discovered.

• Normal spoilage is added to job cost, or under process costing added equally to all units passing the inspection point.

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Accounting for Spoilage

Job Costing Process Costing

Abnormal

Spoilage

Expense Expense

Normal Spoil. :

Due to this job

Add to job cost N/A

Common to all Add to cost of all via MOH

Add equally to all units passing inspection point

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End of Chapter 17 & 18