Process Costing

CHAPTER 20 OVERVIEW – PROCESS COSTING In Chapter 20, process costing is introduced and described under the first-in, first-out (FIFO) method. The weighted average method is presented in the chapters appendix. A process manufacturer makes products that are indistinguishable from each other using a continuous production process. Process manufacturers use process costing to record product costs for each department or process. Process costing is similar to job order costing in that each method records and summarizes product costs; classifies product costs as direct materials, direct labor, and factory overhead; allocates factory overhead costs to products; uses a perpetual inventory system for materials, work in process, and finished goods; and provides useful product cost information for decision making. In process costing, the cost of units transferred out of each department must be determined along with the cost of any partially completed units remaining in the department. These costs are summarized in a cost of production report. This report is prepared in four steps: (1) determine the units to be assigned costs, (2) compute equivalent units of production, (3) determine the cost per equivalent unit, and (4) allocate costs to units transferred out and partially completed units. Journal transactions are discussed as these product transfers need to be journalized. Additionally, Chapter 20 demonstrates how managers can analyze the cost of production report by tracking changes in the direct materials and conversion cost per equivalent unit between periods. By investigating the causes of increases or problems using the cost of production report, managers can make decisions regarding efficiency and improvement. I. Process Operations- is mass production of similar products in a continuous flow of sequential processes. Use a standardized process to make large volumes of similar products. A. Organization of Process Operations 1. Each process is identified as a separate production department, workstation 2. Series of repetitive processes or steps. 3. Each applies direct labor, overhead and often direct materials to move the product toward completion. 4. Final process or department in the series finishes the goods and makes them ready for sale. B. Comparing Process and Job Order Costing Systems 1. Both use materials, labor and overhead and aim to compute cost per unit of product. 2. Cost object: a. Job order costing: job or job lot. b. Process costing: process or department 3. Cost per unit: a. Job order costing: measures cost per unit after completion of a job b. Process costing: measures costs at the end of the period 4. Internal reporting: a. Job order costing: job cost sheets and cost of goods manufactured b. Process costing: production cost report 5. Work in process inventory: a. Job order costing: one Work in Process Inventory account b. Process costing: one Work in Process Inventory account per process Process Costing Demonstration this section uses the weighted-average method to demonstrate the four-step process costing system. The weighted-average method combines units and costs across two periods in computing equivalent units and cost per equivalent unit. A. Step 1: Determine Physical Flow of Units 1. A physical unit flow reconciliation proves that: 1) beginning units in process plus those started in the period equals the 2) ending units in process plus those completed and transferred out in the period. 2. The following totals should agree: a. Units in beginning work in process + units started during the period = the number of units to account for. b. Units completed and transferred out during the period + units in ending work in process inventory = the units accounted for. c. The units to account for and the units accounted for must be equal. B. Step 2: Compute Equivalent Units of Production (EUP) number of whole units that could have been started and completed given the costs incurred in the period. 1. Must convert the physical units worked on to equivalent units based on the amount of each input (direct materials, direct labor, and overhead) that has been used. 2. Equivalent Units-Direct Materialsadd together the results of a two-step calculation: a. Units completed and transferred out during the period times 100% (since the units have all required materials). b. Units in ending inventory times % of materials added during the period. 3. Equivalent UnitsConversion Costsadd together the results of a two-step calculation: a. Units completed and transferred out during the period times 100% (since the units have all required labor and overhead). b. Units in ending inventory times the percent of labor and overhead added during the period. C. Step 3: Compute Cost per Equivalent Unit uses equivalent units of production from step 2 along with cost data, to compute cost per equivalent unit. 1. Cost per Equivalent Unit for Direct MaterialsThe materials costs in beginning work in process inventory plus the direct materials costs added during the period are divided by the equivalent units of production (EUP) for direct materials (from step 2) to get the cost per equivalent unit for direct materials for the period. 2. Cost per Equivalent Unit for Conversion CostsThe conversion costs in the beginning work in process inventory plus the conversion costs added during the period are divided by the equivalent units of production (EUP) for conversion costs (from step 2) to get the cost per equivalent unit for conversion costs for the period. D. Step 4: Assign and Reconcile Costs uses EUP from step 2 and cost per EUP from step 2 to assign costs to the units completed and transferred out and to the units in ending work in process. 1. The following totals should agree: a. Cost of beginning work in process inventory plus cost incurrent during the period equal total costs to account for. b. Cost of units completed and transferred out plus cost of ending work in process inventory equal total costs accounted for. 2. Reconciliation management verifies that total costs assigned to units completed and transferred out plus the cost of units in ending work in process equal the costs incurred by production. E. Using Process Cost Information 1. Control costs departments equivalent cost per unit can be compared to prior months and if changed a lot, corrective action can be taken. 2. Evaluate performance top management can evaluate department managers based on their control of costs. Costs per equivalent unit are often compared to budgeted amounts. 3. Evaluate process improvements organizations strive to improve processes. The success of process improvements can be evaluated by examining how costs per equivalent unit change after process improvements. 4. Prepare financial statements cost of goods sold and ending inventory amounts computed from process cost data are reported on the income statement and balance sheet, respectively. F. Production Cost Report 1. Primary managerial accounting report. Also called a production report. 2. A separate report is prepared for each process or production department. 3. Four sections: a. Physical flow of units: Reconciles beginning units in process and those started in a period with ending units in process and those completed and transferred out. b. Equivalent units of production for direct materials and for conversion. c. Cost per equivalent unit of production for direct materials and for conversion. d. Assignment of total costs among units worked on in the period. IV. Accounting for Process Costing A. Accounting for Production Costs 1. Materials, labor and overhead costs flow through the manufacturing processes as shown in exhibit 16.12. There are separate Work in Process Inventory accounts for each department. When the goods are ready for sale, their costs are transferred to Finished Goods Inventory. When goods are sold, their costs are transferred to Cost of Goods Sold. B. Materials Costs 1. Raw materials purchased on credit are recorded by debiting Raw Materials Inventory and crediting Accounts Payable. 2. Direct materials used in production are recorded by debiting each departments Work in Process Inventory account and crediting Raw Materials Inventory. 3. Indirect materials used are recorded with a debit to Factory Overhead and a credit to Raw Materials Inventory. C. Labor Costs 1. Direct labor costs used in production are recorded by debiting each departments Work in Process Inventory account and crediting Factory Payroll Payable. 2. Indirect labor costs are recorded by debiting Factory Overhead and crediting Factory Payroll Payable D. Factory Overhead 1. Overhead costs other than indirect materials and indirect labor are recorded by debiting Factory Overhead and crediting the related accounts. 2. Applying Overhead to Work in Process use predetermined overhead rates to apply overhead. Rates are estimated at the beginning of a period and used to apply overhead during the period. 3. Applied using activity bases such as direct labor or machine hours. 4. Predetermined rate times actual cost driver quantity. 5. Journal entry to apply factory overhead costs to each department includes a debit to the departments Work in Process Inventory and a credit to Factory Overhead. CHAPTER 20 OVERVIEW – PROCESS COSTING In Chapter 20, process costing is introduced and described under the first-in, first-out (FIFO) method. The weighted average method is presented in the chapters appendix. A process manufacturer makes products that are indistinguishable from each other using a continuous production process. Process manufacturers use process costing to record product costs for each department or process. Process costing is similar to job order costing in that each method records and summarizes product costs; classifies product costs as direct materials, direct labor, and factory overhead; allocates factory overhead costs to products; uses a perpetual inventory system for materials, work in process, and finished goods; and provides useful product cost information for decision making. In process costing, the cost of units transferred out of each department must be determined along with the cost of any partially completed units remaining in the department. These costs are summarized in a cost of production report. This report is prepared in four steps: (1) determine the units to be assigned costs, (2) compute equivalent units of production, (3) determine the cost per equivalent unit, and (4) allocate costs to units transferred out and partially completed units. Journal transactions are discussed as these product transfers need to be journalized. Additionally, Chapter 20 demonstrates how managers can analyze the cost of production report by tracking changes in the direct materials and conversion cost per equivalent unit between periods. By investigating the causes of increases or problems using the cost of production report, managers can make decisions regarding efficiency and improvement. I. Process Operations- is mass production of similar products in a continuous flow of sequential processes. Use a standardized process to make large volumes of similar products. A. Organization of Process Operations 1. Each process is identified as a separate production department, workstation 2. Series of repetitive processes or steps. 3. Each applies direct labor, overhead and often direct materials to move the product toward completion. 4. Final process or department in the series finishes the goods and makes them ready for sale. B. Comparing Process and Job Order Costing Systems 1. Both use materials, labor and overhead and aim to compute cost per unit of product. 2. Cost object: a. Job order costing: job or job lot. b. Process costing: process or department 3. Cost per unit: a. Job order costing: measures cost per unit after completion of a job b. Process costing: measures costs at the end of the period 4. Internal reporting: a. Job order costing: job cost sheets and cost of goods manufactured b. Process costing: production cost report 5. Work in process inventory: a. Job order costing: one Work in Process Inventory account b. Process costing: one Work in Process Inventory account per process Process Costing Demonstration this section uses the weighted-average method to demonstrate the four-step process costing system. The weighted-average method combines units and costs across two periods in computing equivalent units and cost per equivalent unit. A. Step 1: Determine Physical Flow of Units 1. A physical unit flow reconciliation proves that: 1) beginning units in process plus those started in the period equals the 2) ending units in process plus those completed and transferred out in the period. 2. The following totals should agree: a. Units in beginning work in process + units started during the period = the number of units to account for. b. Units completed and transferred out during the period + units in ending work in process inventory = the units accounted for. c. The units to account for and the units accounted for must be equal. B. Step 2: Compute Equivalent Units of Production (EUP) number of whole units that could have been started and completed given the costs incurred in the period. 1. Must convert the physical units worked on to equivalent units based on the amount of each input (direct materials, direct labor, and overhead) that has been used. 2. Equivalent Units-Direct Materialsadd together the results of a two-step calculation: a. Units completed and transferred out during the period times 100% (since the units have all required materials). b. Units in ending inventory times % of materials added during the period. 3. Equivalent UnitsConversion Costsadd together the results of a two-step calculation: a. Units completed and transferred out during the period times 100% (since the units have all required labor and overhead). b. Units in ending inventory times the percent of labor and overhead added during the period. C. Step 3: Compute Cost per Equivalent Unit uses equivalent units of production from step 2 along with cost data, to compute cost per equivalent unit. 1. Cost per Equivalent Unit for Direct MaterialsThe materials costs in beginning work in process inventory plus the direct materials costs added during the period are divided by the equivalent units of production (EUP) for direct materials (from step 2) to get the cost per equivalent unit for direct materials for the period. 2. Cost per Equivalent Unit for Conversion CostsThe conversion costs in the beginning work in process inventory plus the conversion costs added during the period are divided by the equivalent units of production (EUP) for conversion costs (from step 2) to get the cost per equivalent unit for conversion costs for the period. D. Step 4: Assign and Reconcile Costs uses EUP from step 2 and cost per EUP from step 2 to assign costs to the units completed and transferred out and to the units in ending work in process. 1. The following totals should agree: a. Cost of beginning work in process inventory plus cost incurrent during the period equal total costs to account for. b. Cost of units completed and transferred out plus cost of ending work in process inventory equal total costs accounted for. 2. Reconciliation management verifies that total costs assigned to units completed and transferred out plus the cost of units in ending work in process equal the costs incurred by production. E. Using Process Cost Information 1. Control costs departments equivalent cost per unit can be compared to prior months and if changed a lot, corrective action can be taken. 2. Evaluate performance top management can evaluate department managers based on their control of costs. Costs per equivalent unit are often compared to budgeted amounts. 3. Evaluate process improvements organizations strive to improve processes. The success of process improvements can be evaluated by examining how costs per equivalent unit change after process improvements. 4. Prepare financial statements cost of goods sold and ending inventory amounts computed from process cost data are reported on the income statement and balance sheet, respectively. F. Production Cost Report 1. Primary managerial accounting report. Also called a production report. 2. A separate report is prepared for each process or production department. 3. Four sections: a. Physical flow of units: Reconciles beginning units in process and those started in a period with ending units in process and those completed and transferred out. b. Equivalent units of production for direct materials and for conversion. c. Cost per equivalent unit of production for direct materials and for conversion. d. Assignment of total costs among units worked on in the period. IV. Accounting for Process Costing A. Accounting for Production Costs 1. Materials, labor and overhead costs flow through the manufacturing processes as shown in exhibit 16.12. There are separate Work in Process Inventory accounts for each department. When the goods are ready for sale, their costs are transferred to Finished Goods Inventory. When goods are sold, their costs are transferred to Cost of Goods Sold. B. Materials Costs 1. Raw materials purchased on credit are recorded by debiting Raw Materials Inventory and crediting Accounts Payable. 2. Direct materials used in production are recorded by debiting each departments Work in Process Inventory account and crediting Raw Materials Inventory. 3. Indirect materials used are recorded with a debit to Factory Overhead and a credit to Raw Materials Inventory. C. Labor Costs 1. Direct labor costs used in production are recorded by debiting each departments Work in Process Inventory account and crediting Factory Payroll Payable. 2. Indirect labor costs are recorded by debiting Factory Overhead and crediting Factory Payroll Payable D. Factory Overhead 1. Overhead costs other than indirect materials and indirect labor are recorded by debiting Factory Overhead and crediting the related accounts. 2. Applying Overhead to Work in Process use predetermined overhead rates to apply overhead. Rates are estimated at the beginning of a period and used to apply overhead during the period. 3. Applied using activity bases such as direct labor or machine hours. 4. Predetermined rate times actual cost driver quantity. 5. Journal entry to apply factory overhead costs to each department includes a debit to the departments Work in Process Inventory and a credit to Factory Overhead.