3-1 Chapter 3 Process Costing Learning Objectives After studying this chapter, you should be able...

3-1

Chapter 3Process Costing

Learning Objectives

After studying this chapter, 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 four steps necessary to prepare a production cost report.

[7] Prepare a production cost report.

3-2

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

Illustration 3-1

LO 1 Understand who uses process cost systems.

Uses of Process Cost Systems

Nature of Process Cost SystemsNature of Process Cost Systems

3-3

Illustration 3-2


Process and Job Cost Comparison


3-4

Service companies that provide specific, nonroutine services

will probably benefit from using a job order cost system.

Those that perform routine, repetitive services will probably

be better off with a process cost system.


Process Costing for Service Companies


3-5LO 2 Explain the similarities and differences between

job order cost and process cost systems.

Similarities and Differences Between Job Order Cost and Process Cost Systems

Job Order Cost

Costs assigned to each job.

Products have unique characteristics.

Process Cost

Costs assigned to each department.

Products are uniform or relatively homogeneous and produced in a large volume.


3-6

Illustration 3-3

LO 2 Explain the similarities and differences between job order cost and process cost systems.


Illustration 3-3Job order cost and process cost flow

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Indicate whether the following statements are true or false.

1. A law firm is likely to use process costing for major

lawsuits.

2. A manufacturer of paintballs is likely to use process

costing.

3. Both job order and process costing determine product

costs at the end of a period of time, rather than when a

product is completed.

4. Process costing does not keep track of manufacturing

overhead.

False

True

False

LO 2

False

3-8

Process Cost Flow

LO 3 Explain the flow of costs in a process cost system.

Illustration 3-5

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.


3-9

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

LO 4 Make the journal entries to assign manufacturing costs in a process cost system.


Assigning Manufacturing Costs

3-10

Two important key terms and one assumptionTwo important key terms and one assumption

Conversion cost: Conversion cost: the costs that represents activities that turn a raw the costs that represents activities that turn a raw material into finished products. material into finished products. Labor costs and manufacturing Labor costs and manufacturing overhead overhead combined will be conversion cost. combined will be conversion cost.

Assumption: Assumption: MaterialsMaterials are entered at the beginning of the process, are entered at the beginning of the process, labor and manufacturing overhead labor and manufacturing overhead are added gradually throughout are added gradually throughout the process.the process.

Equivalent Units (of production): Equivalent Units (of production): a measure of how hard we worked a measure of how hard we worked expressed in completed (finished) units. expressed in completed (finished) units.

Use the weighted average method (not FIFO method). Use the weighted average method (not FIFO method).

3-11

Equivalent Units (EU)-Why do we need this number? Equivalent Units (EU)-Why do we need this number? You are a company that makes Youphone. You tell your boss proudly You are a company that makes Youphone. You tell your boss proudly afterafter one one

month’s work: month’s work:

Finished goods: 1,200 unitsFinished goods: 1,200 units

Unfinished goods: 800 units—only 70% completeUnfinished goods: 800 units—only 70% complete

Your boss: Your boss: just tell me how many units of goods have you just tell me how many units of goods have you finished finished this this month? I want a number for the month? I want a number for the finishedfinished goods!!! goods!!!

Equivalent (finished) Units = 1,200 + 800* 70% = 1,760 unitsEquivalent (finished) Units = 1,200 + 800* 70% = 1,760 units

1,200 (finished units) + 800 (partially-70% completed units) ~ 1,760 EU1,200 (finished units) + 800 (partially-70% completed units) ~ 1,760 EU

(Note that the (Note that the Percentage of completionPercentage of completion is the key here). is the key here).

Why is this number important? (Total costs /total units finished = cost/unit) Why is this number important? (Total costs /total units finished = cost/unit)

3-12

Why is the EU number important?: Why is the EU number important?: Total cost Total cost incurred during the production process: incurred during the production process:

1) total material cost + total Conversion cost (labor +overhead) = 1) total material cost + total Conversion cost (labor +overhead) = totaltotal

76,000 100,000 = $176,00076,000 100,000 = $176,000

2) Total units /total EU = 1,7602) Total units /total EU = 1,760

so, unit cost = $ /unitso, unit cost = $ /unit

Two important things Two important things to remember when calculating EU: to remember when calculating EU:

1) the beginning balance of unfinished work (or beginning WIP inventory) does 1) the beginning balance of unfinished work (or beginning WIP inventory) does NOTNOT matter (All the boss cares about is: matter (All the boss cares about is: at the end of at the end of the month/year, how much work the month/year, how much work you have done? And what is EQ for the work you did?)you have done? And what is EQ for the work you did?)

2) 2) Percentage of completionPercentage of completion (%) is the key here. (%) is the key here.

3-13

Illustration: The output of Kori Company’s Packaging

Department during the period consists of 10,000 units

completed and transferred out, and 5,000 units in ending

work in process which are 70% completed.

Calculate the equivalent units of production.

LO 5 Compute equivalents units.

Completed units 10,000

Work in process equivalent units (5,000 x 70%) 3,500

13,500

Equivalent UnitsEquivalent Units

Weighted Average Method

3-14

Illustration: Kellogg Company has produced Eggo® Waffles

since 1970. Three departments produce these waffles: Mixing,

Baking, and Freezing/Packaging. The Mixing Department

combines dry ingredients, including flour, salt, and baking

powder, with liquid ingredients, including eggs and vegetable

oil, to make waffle batter.

Illustration 3-9 provides information related to the Mixing

Department at the end of June.


Refinements on the Weighted-Average Method

Equivalent Units—a more difficult exampleEquivalent Units—a more difficult example

3-15

Illustration: Information related to the Mixing Department at

the end of June.Illustration 3-9

Notice that the Percentage of Completion is different for materials and conversion costs. Remember the assumption?


Refinements on the Weighted-Average Method

3-16

Conversion costs are labor costs plus overhead costs.

Beginning work in process is not part of the equivalent-

units-of-production formula.


Illustration 3-10


3-17

The Mixing Department’s output during the period consists of

20,000 units completed and transferred out, and 5,000 units in

ending work in process 60% complete as to materials and

conversions costs. Beginning inventory is 1,000 units, 40%

complete as to materials and conversion costs. The equivalent

units of production are:

a. 22,600 b. 23,000

c. 24,000 d. 25,000

Review Question



3-18

The fabricating department has the following production and

cost data for the current month.


Beginning Units EndingWork in Process Transferred Out Work in Process

–0– 15,000 10,000

Materials are entered at the beginning of the process. The

ending work in process units are 30% complete as to conversion

costs. Compute the equivalent units of production for (a)

materials and (b) conversion costs.

3-19 LO 5 Compute equivalents units.

Compute the equivalent units of production for (a) materials and (b) conversion costs.

Units transferred out 15,000

Ending work in process units 10,000

25,000




–0– 15,000 10,000

3-20 LO 5 Compute equivalents units.

Compute the equivalent units of production for (a) materials and (b) conversion costs.

Units transferred out 15,000

Equivalent unit in ending WIP (10,000 x 30%) 3,000

18,000




–0– 15,000 10,000

3-21

A production cost report is the

Key document used to understand activities.

Prepared for each department and shows Production

Quantity and Cost data.

Four steps in preparation:

Step 1: Compute physical unit flow

Step 2: Compute equivalent units of production

Step 3: Compute unit production costs

Step 4: Prepare a cost reconciliation schedule

LO 6 Explain the four steps necessary to prepare a production cost report.

Production Cost ReportProduction Cost Report

3-22

Illustration 3-12Flow of costs in makingEggo® Waffles



3-23

Illustration 3-13 Unit and cost data—Mixing Department

LO 6


3-24

Physical units - actual units to be accounted for

during a period, regardless of work performed.

Total units to be accounted for - units started (or

transferred) into production during the period + units

in production at beginning of period.

Total units accounted for - units transferred out

during period + units in process at end of period.

Compute the Physical Unit Flow (Step 1)



3-25 LO 6 Explain the four steps necessary to prepare a production cost report.

Illustration 3-14


Compute the Physical Unit Flow (Step 1)

3-26

Mixing Department

Department adds materials at beginning of process and

Incurs conversion costs uniformly during the process.Illustration 3-15



Compute Equivalent Units of Production (Step 2)

3-27

Costs expressed in terms of equivalent units of

production.

When equivalent units of production are different for

materials and for conversion costs, three unit costs are

computed:

1. Materials

2. Conversion

3. Total Manufacturing


Compute Unit Production Costs (Step 3)


3-28 LO 6

Compute total materials cost related to Eggo® Waffles:

Work in process, June 1

Direct materials costs $ 50,000

Cost added to production during June

Direct material cost 400,000

Total material costs $450,000

Illustration 3-17

Illustration 3-16



3-29 LO 6

Compute total conversion costs related to Eggo® Waffles:

Work in process, June 1

Conversion costs $ 35,000

Costs added to production during June

Conversion costs 170,000

Total conversion costs $205,000

Illustration 3-19



Illustration 3-18

3-30

Compute total manufacturing costs per unit: Illustration 3-20


Compute Unit Production Costs (Step 3)Illustration 3-19


3-31

Kellogg charged total costs of $655,000 to the Mixing Department in June, calculated as follows.

Costs to be accounted for

Work in process, June 1 $ 85,000

Started into production 570,000

Total costs $655,000

Illustration 3-21



Prepare a Cost Reconciliation Schedule (Step 4)

3-32

Illustration 3-22



3-33

Prepare the Production Cost Report

LO 7

Production Cost ReportProduction Cost ReportIllustration 3-23

3-34

Largo Company has unit costs of $10 for materials and $30 for

conversion costs. If there are 2,500 units in ending work in

process, 40% complete as to conversion costs and fully

complete as to materials cost, the total cost assignable to the

ending work in process inventory is:

a. $45,000.

b. $55,000.

c. $75,000.

d. $100,000.

Review Question

LO 7 Prepare a production cost report.


3-35

In March, Rodayo Manufacturing had the following unit production

costs: materials $6 and conversion costs $9. On March 1, it had zero

work in process. During March, Rodayo transferred out 12,000 units.

As of March 31, 800 units that were 25% complete as to conversion

costs and 100% complete as to materials were in ending work in

process. Assign the costs to the units transferred out and in process.

Costs transferred out $180,000

Work in process, March 31

Materials (800 x $6) $4,800

Conversion costs (200 x $9) 1,800

Total costs $186,600


3-36

A process cost system requires fewer material requisition

slips than a job order cost system.

► Materials are used for processes and not specific jobs.

► Requisitions are for larger quantities of materials.

► Journal entry to record materials used:

Material Costs


Other Exercises: Some Journal Entries in Process Cost Other Exercises: Some Journal Entries in Process Cost

SystemsSystems

3-37

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:



Factory Labor Costs

3-38

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:

Manufacturing Overhead Costs



3-39

Monthly Entry to transfer goods to next department:

LO 4

Entry to transfer completed goods to Finished Goods:

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


Transfers

3-40

Blue Diamond Company manufactures ZEBO through two

processes: blending and bottling. In June, raw materials used

were Blending $18,000 and Bottling $4,000. Factory labor costs

were Blending $12,000 and Bottling $5,000. Manufacturing

overhead costs were Blending $6,000 and Bottling $2,500. The

company transfers units completed at a cost of $19,000 in the

Blending Department to the Bottling Department. The Bottling

Department transfers units completed at a cost of $11,000 to

Finished Goods. Journalize the assignment of these costs to

the two processes and the transfer of units as appropriate.


3-41

Journalize the assignment of these costs to the two processes.

To Record Materials Used:

Work in Process—Blending 18,000

Work in Process—Bottling 4,000

Raw Materials Inventory 22,000

To Assign Factory Labor to Production:



Factory Labor17,000

LO 4

3-42

To Assign Overhead to Production:



Manufacturing Overhead 8,500


Journalize the assignment of these costs to the two processes.

3-43

Journalize the transfer of units as appropriate.

To Record Transfer of Units to the Bottling Department:



To Record Transfer of Units to Finished Goods:

Finished Goods Inventory 11,000



3-44

Companies often use a combination of a process cost

and a job order cost system.

Called operations costing, this hybrid system is similar

to process costing in its assumption that standardized

methods are used to manufacture the product.

At the same time, the product may have some

customized, individual features that require the use of

a job order cost system.

Costing Systems – Final Comments



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