Chapter System Design—Process Costing Learning Objectives LO1 LO2 LO3 LO4 LO5 LO6 LO7 LO8 LO9 Record the flow of materials, labor, and overhead through a process costing system Compute the equivalent units of production using the weighted-average method Prepare a quantity schedule using the weighted-average method Compute the costs per equivalent unit using the weighted-average method Prepare a cost reconciliation using the weighted-average method (Appendix 4A) Compute the equivalent units of production using the FIFO method (Appendix 4A) Prepare a quantity schedule using the FIFO method (Appendix 4A) Compute the costs per equivalent unit using the FIFO method (Appendix 4A) Prepare a cost reconciliation using the FIFO method New in this Edition • Additional simple exercises have been created Chapter Overview A Job-Order Costing vs Process Costing Process costing is used in industries that produce homogenous products such as bricks, flour, and cement on a continuous basis Similarities between job-order and process costing Job-order and process costing systems share some characteristics: a Both systems have the same basic purpose—to assign material, labor, and overhead cost to products b Both systems use the same basic manufacturing accounts: Manufacturing Overhead, Raw Materials, Work In Process, and Finished Goods c The flow of costs through the manufacturing accounts is basically the same Differences between job-order and process costing The differences between job-order and process costing occur because the flow of units in a process costing system is more or less continuous and the units are essentially indistinguishable from one another Under process costing: a A single homogenous product is produced on a continuous basis over a long period of time This differs from job-order costing in which many different products may be produced in a single period 207 b Costs in process costing are accumulated by department, rather than by individual job c The department production report is the key document in process costing, showing the accumulation and disposition of cost In job-order costing, the job-cost sheet is the key document B Overview of Process Costing (Exercises 4-1 and 4-10.) Manufacturing costs are accumulated in processing departments in a process costing system A processing department is any location in the organization where work is performed on a product and where materials, labor, and overhead costs are added to the product Processing departments should also have two other features First, the activity performed in the processing department should be essentially the same for all units that pass through the department Second, the output of the department should be homogeneous In process costing, the average cost of processing units for a period is assigned to each unit passing through the department Two process costing methods are illustrated in the text—the weighted-average method and the FIFO method While the FIFO method provides more current cost data for decision-making and performance evaluation purposes, it is more difficult for students to grasp For that reason, the FIFO method is covered in an appendix C Equivalent Units of Product (Exercises 4-2, 4-11, 4-13, and 4-17.) In order to calculate the average cost per unit, the total number of units must be determined Partially completed units pose a difficulty that is overcome using the concept of equivalent units Equivalent units are the equivalent, in terms of completed units, of partially completed units The formula for computing equivalent units is: Number of Equivalent = partially completed × Percentage units completion units Equivalent units are the number of complete, whole units one could obtain from the materials and effort contained in partially completed units Under the weighted-average method, the equivalent units for a particular cost category (e.g., materials or conversion cost) is computed by adding together the number of units completed and transferred out to the next department during the period and the equivalent units in the ending work in process inventory in the department Equivalent Units transferred to Equivalent units units of = the next department + in ending work in production or to finished goods process inventory D Production Report The purpose of a production report is to summarize all of the activity that takes place in a department's work in process account for a period A production report consists of three parts: • A quantity schedule and a computation of equivalent units • A computation of costs per equivalent unit • A reconciliation of all cost flows into and out of the department during the period 208 E Production Report: Weighted-Average Method (Exercise 4-13 followed by Exercise 4-14.) Emphasize that the weighted-average method does not attempt to separate units in the beginning inventory from units started during the current period Costs and units from beginning inventory are blended together with costs and units from the current period Quantity Schedule and Equivalent Units (Exercises 4-2, 4-4, and 4-11.) The first step in preparing a production report is to prepare a quantity schedule, which shows the physical flow of units through the department This schedule allows managers to see at glance how many units moved through the department during the period Using the quantity schedule, the equivalent units can be easily computed Costs per Equivalent Unit (Exercises 4-6 and 4-13.) The second step in preparing a production report is to calculate the costs per equivalent unit The cost per equivalent unit is computed for a particular cost category (i.e., materials, labor, overhead, or conversion) by dividing its total cost by its total equivalent units Note that under the weighted-average method the costs include both the costs already in beginning inventory as well as the costs added by the department during the current period Cost Reconciliation (Exercise 4-7.) The third step in preparing a production report is to prepare a cost reconciliation The purpose of a cost reconciliation is to show how the costs from beginning work in process inventory and costs that have been added during the period are accounted for a Costs come into the department from units in beginning inventory, from material, labor, and overhead costs that are added during the period, and from any units that might have been transferred in from a prior department b A department's costs are accounted for by showing the costs that are transferred out to the next department (or to finished goods) and by specifying the costs that remain in the ending work in process inventory F Operation Costing The costing systems discussed in Chapters and represent the two ends of a continuum On one end is job-order costing and on the other is process costing Between the two extremes, there are many “hybrid” systems Operation costing is an example of such a hybrid system It is used in situations where products have some common as well as individual characteristics TVs, for example, have some common characteristics in that all models must be assembled and tested following the same basic steps However, each model has different components with different costs The costs of the components (materials) would be charged to a batch of a particular model individually, as in job-order costing, but the conversion costs may be assigned using process costing G FIFO Method (Appendix 4A) (Exercise 4-15 followed by Exercise 4-16.) The FIFO method segregates the units and costs in the beginning inventory from the units and costs of the current period Quantity Schedule (Exercises 4-5 and 4-12.) The quantity schedule prepared under the FIFO method is identical to that prepared under the weighted-average method, except that the “units transferred out” are separated into those units that came from beginning inventory and those units that were started and completed this period 209 Equivalent Units (Exercises 4-3 and 4-12.) The FIFO method differs from the weightedaverage method for computation of equivalent units in two ways a First, under the FIFO method the “units transferred out” figure is split between units completed from the beginning inventory and units started and completed during the current period b Second, the equivalent units refers to just the equivalent units for the work performed during the current period The equivalent units under the FIFO method consist of three amounts: the work needed to complete the units in the beginning inventory; the work expended on the units started and completed during the current period; and the work expended on partially completed units in the ending inventory c This method is called the FIFO method because it assumes that the units in beginning inventory are completed and transferred out before any new units are started The costs of beginning inventory are segregated from costs added during the period d The only difference in the equivalent unit calculations between the two methods is that the equivalent units in beginning inventory are included in the weighted-average method Under the weighted-average method the costs already in beginning inventory will be added to the costs incurred during the period to arrive at unit costs To be consistent we must add the equivalent units already in beginning inventory to the equivalent units for the work performed during the current period Costs per Equivalent Unit (Exercise 4-8.) In computing costs per equivalent unit, costs associated with the beginning work in process inventory are ignored It is assumed that the units in beginning inventory are completed and transferred to the next department before any new units are worked on Providing that more units are transferred out than were in beginning inventory, all of the costs associated with beginning inventory will be transferred to the next department Cost Reconciliation (Exercises 4-9 and 4-16.) As with the weighted-average method, the purpose of a cost reconciliation is to show how the costs have been charged to a department during a period and to show how these costs are accounted for a The “Costs to be accounted for” section of the report is the same as for the weightedaverage method b The “Cost accounted for” section differs from the weighted-average method in that four layers of cost are involved These layers are (1) the cost in the beginning inventory, (2) the cost required to complete the units in the beginning inventory, (3) the cost of units started and completed during the current period, and (4) the cost of the ending work in process inventory H Evaluation of Weighted-Average and FIFO (Appendix 4A) The weighted-average method is simpler to learn and apply than the FIFO method, but the FIFO method is generally considered to be superior for cost control The reason is that the FIFO method helps to isolate current performance by segregating current costs from prior period costs The weighted-average method mixes the costs of the current period with the costs of prior periods 210 Assignment Materials Assignment Exercise 4-1 Exercise 4-2 Exercise 4-3 Exercise 4-4 Exercise 4-5 Exercise 4-6 Exercise 4-7 Exercise 4-8 Exercise 4-9 Exercise 4-10 Exercise 4-11 Exercise 4-12 Exercise 4-13 Exercise 4-14 Exercise 4-15 Exercise 4-16 Exercise 4-17 Exercise 4-18 Problem 4-19 Problem 4-20 Problem 4-21 Problem 4-22 Problem 4-23 Problem 4-24 Problem 4-25 Problem 4-26 Problem 4-27 Problem 4-28 Case 4-29 Case 4-30 Case 4-31 Topic Process costing journal entries Computation of equivalent units—WAC (Appendix 4A) Computation of equivalent units—FIFO Preparation of quantity schedule—WAC (Appendix 4A) Preparation of quantity schedule—FIFO Cost per equivalent unit—WAC Cost reconciliation—WAC (Appendix 4A) Cost per equivalent unit—FIFO (Appendix 4A) Cost reconciliation—FIFO Process costing journal entries Quantity schedule and equivalent units—WAC (Appendix 4A) Quantity schedule and equivalent units—FIFO Equivalent units and cost per equivalent unit—WAC Cost reconciliation—WAC [assign after Exercise 4-13] (Appendix 4A) Quantity schedule; equivalent units; cost per equivalent unit—FIFO (Appendix 4A) Cost reconciliation—FIFO [assign after Exercise 4-15] Quantity schedule; equivalent units, and cost per equivalent unit—WAC (Appendix 4A) Quantity schedule; equivalent units, and cost per equivalent unit—FIFO Step-by-step production report—WAC (Appendix 4A) Step-by-step production report—FIFO Production report—WAC (Appendix 4A) Production report—FIFO Analysis of Work in Process T-account—WAC (Appendix 4A) Analysis of Work in Process T-account—FIFO Interpreting a production report—WAC Comprehensive process costing problem—WAC Equivalent units; costing of inventories; journal entries—WAC Comprehensive process costing problem—WAC Ethics and the manager; understanding the impact of percentage completion on profit—WAC Production report of second department—WAC (Appendix 4A) Production report of second department—FIFO Level of Difficulty Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Suggested Time 20 10 10 15 15 15 20 10 45 10 15 15 20 15 Basic 20 Basic 20 Basic 20 Basic Basic Basic Basic Basic Medium Medium Medium Difficult Difficult Difficult 20 45 45 45 45 45 45 30 90 60 90 Difficult Difficult Difficult 90 45 60 Essential Problems: Problem 4-19, Problem 4-21 Supplementary Problems: Problem 4-23, Problem 4-25, Problem 4-26, Problem 4-27, Problem 4-28, Case 4-29, Case 4-30 Appendix 4A Essential Problems: Problem 4-20, Problem 4-22 Appendix 4A Supplementary Problems: Problem 4-24, Case 4-31 Linked problems and exercises: Exercise 4-14 should be assigned in conjunction with Exercise 4-13 Exercise 4-16 should be assigned in conjunction with Exercise 4-15 211 212 Chapter Lecture Notes Helpful Hint: Before beginning the lecture, show students the fourth segment from the first tape of the McGraw-Hill/Irwin Managerial/Cost Accounting video library This segment introduces students to many of the concepts discussed in chapter The lecture notes reinforce the concepts introduced in the video Chapter theme: Managers need to assign costs to products to facilitate external financial reporting and internal decision making This chapter illustrates an absorption costing approach to calculating product costs known as process costing I Comparison of job-order and process costing A Similarities between job-order and process costing i Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product costs ii Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods iii The flow of costs through the manufacturing accounts is basically the same in both systems 213 214 B Differences between job-order and process costing i Process costing is used when a single product is produced on a continuing basis or for a long period of time Job-order costing is used when many different jobs are worked each period ii Process costing systems accumulate costs by department Job-order costing systems accumulate costs by individual jobs iii Process costing systems use department production reports to accumulate costs Job-order costing systems use job cost sheets to accumulate costs iv Process costing systems compute unit costs by department Job-order costing systems compute unit costs by job 4-5 Quick Check − process vs job-order costing “In Business Insights” Some companies use a hybrid approach to calculating product costs that combines elements of process and job-order costing For example: “A Hybrid Approach” (page 147) • Some hospital pharmacies may use process costing to develop the cost of formulating the base solution for parenterals (that is, drugs delivered by injection or through the blood stream) • Job-order costing can be used to accumulate the additional costs incurred to create specific parenteral solutions 215 216 TM 4-3 SEQUENTIAL PROCESSING DEPARTMENTS (Exhibit 4-2) © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-4 T-ACCOUNT MODEL OF PROCESS COSTING FLOWS (Exhibit 4-3) © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-5 OVERVIEW OF PROCESS COSTING A In process costing, costs are accumulated in processing departments B A separate departmental production report is compiled for each processing department This report provides the details of how costs are assigned to units that pass through the department C Costs to be accounted for in each processing department consist of: 1) Costs of the beginning work in process inventory in the department 2) Costs added during the period a Costs of units transferred in from a preceding department b Costs added in the department itself Materials + Labor + Overhead Conversion Costs D Costs are accounted for by assigning them to: 1) Ending work in process inventory in the department 2) Units transferred out to the next department (or to finished goods) © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-6 OVERVIEW OF PROCESS COSTING (continued) E In process costing, each unit is assigned the average cost of units processed through the department F Two things must be known to compute the average cost per unit in a department: 1) The total cost 2) The total number of units processed G Partially completed units are converted to equivalent (whole) units For example, 200 units in ending inventory are 25% complete with respect to conversion costs Equivalent = Number of partially × Percentage units completed units completion = 200 × 50% = 50 EUs H The two common methods of computing average costs per unit are the weighted-average method and the FIFO method The FIFO method is discussed in Appendix 4A © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-7 WEIGHTED-AVERAGE METHOD • The weighted-average method averages together the beginning work in process inventories with the units started during the current period • For each category of cost in each processing department the following calculations are made: Costs to be Costs of Costs added accounted = beginning WIP + during the for inventory current period Equivalent Units Equivalent units units of = transferred + of ending WIP production out inventory Units transferred out of the department are 100% complete with respect to the work done in the department Cost per = Costs to be accounted for EU Equivalent units of production Costs of units = Units × Cost transferred out transferred out per EU Costs of units in = Equivalent units of × Cost ending WIP inventory ending WIP inventory per EU © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-8 WEIGHTED-AVERAGE METHOD (cont’d) EXAMPLE: Halsey Company makes small sailboats During the most recent month, the following activity was recorded in the Hull Fabrication Department for conversion costs Work in process, beginning (80% complete) Units started into production Units transferred out Work in process, ending (30% complete) Conversion Costs: Work in process, beginning Conversion costs incurred during the month 15,000 180,000 175,000 20,000 units units units units $24,000 $338,000 Costs to be Costs of Costs added accounted = beginning WIP + during the for inventory current period = $24,0000 + $338,000 = $362,000 Equivalent Units Equivalent units units of = transferred + of ending WIP production out inventory =175,000 + (20,000 × 30%) = 181,000 Cost per EU = = Costs to be accounted for Equivalent units of production $362,000 = $2 per EU 181,000 EU Costs of units = Units × Cost transferred out transferred out per EU = 175,000 × $2 = $350,000 Costs of units in = Equivalent units of × Cost ending WIP inventory ending WIP inventory per EU = (20,000 × 30%) × $2 = $12,000 © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-9 PRODUCTION REPORT The production report summarizes all of the activity and cost flows in a department The production report has three separate, but highly interrelated, parts: A quantity schedule with equivalent units Computation of costs per equivalent unit A reconciliation of all cost flows into and out of the department during the period EXAMPLE: The following data are for the first processing department at Midwest Refining, a company that reclaims petroleum products from used motor oil Work in process, beginning: Units in process Percentage completion Cost of beginning inventory Units started into production Costs added in the department during the current period Units completed and transferred Work in process, ending: Units in process Percentage completion Units Materials Conversion 60% $4,300 50% $7,600 $74,100 $140,400 80% 25% 10,000 190,000 180,000 20,000 © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-10 QUANTITY SCHEDULE AND EQUIVALENT UNITS: WEIGHTED-AVERAGE METHOD • The quantity schedule accounts for the physical flow of units through a department for a period • The equivalent units are also shown for the units transferred out of the department and for ending work in process inventory Units to be accounted for: Work in process, beginning Started into production Total units to be accounted for Units accounted for as follows: Units transferred out Work in process, ending* Total units accounted for Quantity Schedule 10,000 190,000 200,000 180,000 20,000 200,000 Equivalent Units (EU) Materials Conversion 180,000 16,000 196,000 180,000 5,000 185,000 * Materials: 20,000 units × 80% complete = 16,000 EUs; Conversion: 20,000 units × 25% complete = 5,000 EUs Note: The quantity schedule is based on the following equation: Units in beginning work in process + Units started into production = Units transferred out + Units in ending work in process © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-11 COMPUTATION OF COSTS PER EQUIVALENT UNIT: WEIGHTED-AVERAGE METHOD Cost to be accounted for: Work in process, beginning Costs added Total cost to be accounted for (a) Equivalent units (b) Cost per EU (a) ÷ (b) Total Cost Materials Conversion $ 11,900 214,500 $ 4,300 74,100 $226,400 $78,400 196,000 $0.40 Whole Unit $ 7,600 140,400 $148,000 185,000 + $0.80 = $1.20 COST RECONCILIATION: WEIGHTED-AVERAGE METHOD Cost accounted for as follows: Transferred out: 180,000 units @ $1.20 each Work in process, ending: Materials @ $0.40 per EU Conversion @ $0.80 per EU Total work in process, ending Total cost accounted for Total Cost Equivalent Units (EU) Materials Conversion $216,000 180,000 6,400 4,000 10,400 $226,400 16,000 © The McGraw-Hill Companies, Inc., 2006 All rights reserved 180,000 5,000 TM 4-12 FIFO METHOD (Appendix) • The FIFO method separates the costs of beginning inventory from the costs incurred during the current period (The weightedaverage method combines them.) • FIFO assumes the beginning inventory is completed before any new units are started QUANTITY SCHEDULE AND EQUIVALENT UNITS: FIFO METHOD Units to be accounted for: Work in process, beginning Started into production Total units to be accounted for Units accounted for as follows: Transferred out: From beginning inventory* Started and completed† Work in process, ending Total units accounted for Quantity Schedule 10,000 190,000 200,000 10,000 170,000 20,000 200,000 Equivalent Units (EU) Materials Conversion 4,000 170,000 16,000 190,000 5,000 170,000 5,000 180,000 * Materials: 10,000 × (100% – 60%) = 4,000 EUs Conversion: 10,000 × (100% – 50%) = 5,000 EUs † 19,000 units started – 20,000 units in ending WIP = 170,000 units © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-13 COMPARISON OF EQUIVALENT UNITS Weighted-Average Method 190,000 Units Started Beginning Work in Process: 10,000 Units 60% Complete Started and Completed: 170,000 Units Units transferred to next department: Work in process, ending: 20,000 units x 80% Equivalent units of production Ending Work in Process: 20,000 Units 80% Complete 180,000 16,000 196,000 FIFO Method 190,000 Units Started Beginning Work in Process: 10,000 Units 60% Complete Started and Completed: 170,000 Units Work in process, beginning: 10,000 units x (100% - 60%) Units started and completed: Work in process, ending: 20,000 units x 80% Equivalent units of production Ending Work in Process: 20,000 Units 80% Complete 4,000 170,000 16,000 190,000 © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-14 COMPUTATION OF COSTS PER EQUIVALENT UNIT: FIFO METHOD Cost to be accounted for: Work in process, beginning Cost added in the department (a) Total cost to be accounted for Equivalent units (b) Cost per EU (a) ÷ (b) Total Cost Materials Conversion Whole Unit $ 11,900 214,500 $ 74,100 $226,400 190,000 $0.39 $140,400 180,000 + $0.78 = $1.17 Note: Unlike the weighted-average method, under the FIFO method only the costs added by the department during the current month are included when computing the costs per EU The costs of beginning inventory are not included in the cost per EU under the FIFO method © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 4-15 COST RECONCILIATION: FIFO METHOD Cost accounted for as follows: Transferred out: From beginning inventory: Cost in beginning inventory Cost to complete these units: Materials @ $0.39 per EU Conversion @ $0.78 per EU Total cost from beginning inventory Units started and completed 170,000 units @ $1.17 each Total Cost Equivalent Units Materials Conversion $ 11,900 1,560 3,900 4,000 5,000 17,360 198,900 170,000 Total cost transferred 216,260 Work in process, ending: Materials @ $0.39 per EU Conversion @ $0.78 per EU Total work in process, ending 6,240 3,900 10,140 Total cost accounted for $226,400 16,000 © The McGraw-Hill Companies, Inc., 2006 All rights reserved 170,000 5,000 TM 4-16 A COMPARISON OF PRODUCTION REPORT CONTENT (Exhibit 4A-4) © The McGraw-Hill Companies, Inc., 2006 All rights reserved © The McGraw-Hill Companies, Inc., 2006 All rights reserved [...]... − calculating equivalent units iii Equivalent units can be calculated two ways 28 1 The FIFO method is covered in the appendix 2 The weighted-average method is included within the main portion of the chapter and it is covered next B The weighted-average method of calculating equivalent units and the cost per equivalent unit i Characteristics of the weighted-average method: 29 1 This method makes no