Chapter 04 - Process Costing and Hybrid Product-Costing Systems

CHAPTER 4

PROCESS COSTING AND HYBRID PRODUCT-COSTING

SYSTEMS

Learning Objectives

1. List and explain the similarities and important differences between

job-order and process costing.

2. Prepare journal entries to record the flow of costs in a process-costing

system with sequential production departments.

3. Prepare a table of equivalent units under weighted-average process

costing.

4. Compute the cost per equivalent unit under the weighted-average

method of process costing.

5. Analyze the total production costs for a department under the

weighted-average method of process costing.

6. Prepare a departmental production report under weighted-average

process costing.

7. Describe how an operation costing system accumulates and assigns

the costs of direct-material and conversion activity in a batch
manufacturing process.

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Chapter 04 - Process Costing and Hybrid Product-Costing Systems

Chapter Overview

I. Comparison of Job-Order Costing and Process Costing

A. Purpose of product-costing systems
B. Differences in manufacturing environments
C. Differences in cost accumulation
D. Similarities in cost flows

II. Equivalent Units in Process-Costing Systems

A. Stage of completion of the work-in-process ending inventory
B. Equivalent-unit calculations
1. Conversion cost
2. Direct materials

III. Illustration of Reporting in a Process-Cost System

A. The departmental production report
B. Weighted-average method
C. Steps in preparing the departmental production report
1. Analysis of physical flow of units
2. Calculation of equivalent units
3. Computation of equivalent-unit costs
4. Analysis of total costs

IV. Other Issues in Process Costing

A. Actual versus normal costing
B. Using a cost driver other than direct labor

V. A Hybrid Product-Costing System: Operation Costing for Batch

Manufacturing

Key Lecture Concepts

1. COMPARISON OF JOB-ORDER COSTING AND PROCESS COSTING

Both systems have similar objectives: accumulate total product

costs and assign those costs to each unit manufactured.

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Chapter 04 - Process Costing and Hybrid Product-Costing Systems

A company that uses a job-costing system produces goods by order or

in distinct batches, and the products tend to differ significantly
from each other.

With a process-costing system, a company works in a

repetitive production environment, manufacturing a large
number of like units in a continuous flow. Industries that use
process costing include those involved with paper, petroleum,
lumber, and chemicals.

Cost accumulation: Costs in a job-order system are accumulated

by job; in a process-costing system, the costs are accumulated
by department or process.

Flow of costs: The flow of costs through general ledger accounts

is similar in both systems: through Work in Process, to Finished
Goods, to Cost of Goods Sold. In a sequential production
operation, each department establishes its own Work-in-Process
account.

2. EQUIVALENT UNITS

Equivalent units is a key concept in process costing. The term

refers to the amount of manufacturing activity that has been
applied to a batch of physical units after adjusting for the stage
of completion.

If a batch of goods has been completed, the number of

physical units and equivalent units will be the same.

Units in the ending Work-in-Process Inventory are only

partially completed and may be in different stages of
production. For example, 100% of the materials may be
present in the product, but only 50% of the conversion
work (labor and overhead) may have been performed.

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Chapter 04 - Process Costing and Hybrid Product-Costing Systems

Conversion costs are usually added continuously throughout the

process in text problems. Thus, if 100 units are 60% of the way
through the process, the company is said to have performed 60
equivalent units of work during the period.

Teaching Tip: In the preceding example, emphasize to students that

none of the units are completed. The firm is said to have done the
work equivalent to manufacturing 60 finished units.

Direct materials, in contrast, are usually added at discrete points

in text problems. When considering materials, determine at
what point the ending in-process units are and evaluate whether
or not the materials have been added.

If added, the units are 100% complete with respect to

materials; if not, the units are 0% complete.

When computing the cost of a unit, we base the related

calculations on equivalent units, not physical units. This
procedure puts fully-completed units on the same measurement
scale as partially-completed units, thus avoiding the addition
(combination) of "apples and oranges."

Next, the direct material cost and conversion cost is divided by

the proper number of equivalent units. The cost to be used is a
combination of current costs plus those costs in the beginning
work-in-process inventory.

Teaching Tip: Students should be reminded that if they divide cost by

total physical units, they would show a cost per unit that understates
the true cost to make a finished product.

3. PRODUCTION REPORTS

Departmental production reports are completed to disclose

equivalent units and unit costs, along with the cost of completed
production and the cost of the ending work-in-process inventory.

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Chapter 04 - Process Costing and Hybrid Product-Costing Systems

The text focuses on the weighted-average method of process

costing because of the method's popularity in practice.

Under this approach, all units completed during a period

are assumed to be started and completed during that
period.

Another feature: Equivalent units are calculated without

distinguishing as to whether the manufacturing activity
occurred in current period or the preceding period.

Production reports have several sections, which are prepared as

follows:

Step 1: Analyze the physical flow of units.

Step 2: Calculate the equivalent units for direct materials

and conversion.

Step 3: Calculate the cost per equivalent unit.

Step 4: Analyze the total costs to determine the cost of

completed production and the cost of ending work-in-
process inventory. Step 4 is accomplished by multiplying
equivalent units (step 2) by the equivalent-unit costs (step
3).

4. OTHER ISSUES IN PROCESS COSTING

Actual versus normal costing: Either actual or applied overhead

(i.e., actual costing or normal costing) may be used with process
costing. The use of applied overhead smooths per-unit cost
fluctuations attributable to changes in production levels, as was
the case in job-costing systems.

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Chapter 04 - Process Costing and Hybrid Product-Costing Systems

Cost drivers: As in job costing, cost drivers should be chosen to

provide an equitable allocation of overhead to products. If a
driver other than labor is used, overhead and direct labor should
be separated on the production report and not combined into
one overall conversion-cost figure.

5. HYBRID PRODUCT-COSTING SYSTEMS

Some processes have elements of both the job-cost environment

and the process-cost environment, and companies turn to a third
(hybrid) system known as operation costing.

One example involves the manufacture of fruit juice, with

similar conversion processes but different direct materials
(e.g., artificial sweetener versus sugar).

Direct materials would be tracked by job, but the

other cost elements would be more efficiently
tracked by process.

Conversion costs are applied to products by using a

predetermined application rate.

Teaching Overview

Process costing can be introduced by first comparing it to job costing and

discussing the similar objective of each: efficient accumulation of costs and
assignment of costs to individual products. While reviewing the job-cost
area, I ask students why it isn't possible to determine per-unit product cost
with the following calculation:

Per-unit cost = Total production cost Total number of units

Students quickly respond that the units are different in size, shape, and
other features. I then ask if in process costing where, by definition, the units
are like units, whether the preceding formula would be applicable. After
some puzzled looks, someone will usually point out that although the units
are alike, not all units are 100% complete on the last day of the period. In a
sense, therefore, the units are not all alike. The formula

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Chapter 04 - Process Costing and Hybrid Product-Costing Systems

must be modified.

We then discuss the concept of equivalent units. This involves the

conversion of physical units at various stages of completion into units
expressed as "equivalently complete." It may be helpful to draw an analogy
of students who take varying numbers of credit hours being converted into
FTEs (full-time equivalent students) for college-funding purposes, an
example with which the class can probably relate.

Once the concept of equivalent units has been mastered, production reports
progress smoothly. Some time should be spent putting the report into a
business context: what it measures, how it tracks unit costs, how one
department's report links to that of the next department, and how one
month's report links to that of the next month.

A word of caution: it is very easy when teaching process costing to get

bogged down in detail and for the students to become totally confused (and
turned-off). I merely skim the surface of this highly procedural topic and let
a junior-level cost management course do the rest. Quite frankly, if one gets
carried away teaching process costing at the introductory level, there is not
much else that an instructor can add in a more-advanced offering.

I recommend Problem 4-25 as a good lecture demonstration problem.

Links to the Text

Homework Grid

Learnin Completi Special

Item No. g on Feature
Objectiv Time s*
es (min.)
Exercises:
4-15 1, 3 10
4-16 1 20 W
4-17 1, 3 15
4-18 1, 3 15
4-19 1, 3 30
4-20 1, 3, 4 15
4-21 1, 3, 4 15
4-22 5 25
4-23 5 25
4-24 7 45

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Chapter 04 - Process Costing and Hybrid Product-Costing Systems

Problems:

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Chapter 04 - Process Costing and Hybrid Product-Costing Systems

4-25 3, 4, 5 45
4-26 3, 4, 5 45

Learnin Completi Special

Item No. g on Feature
Objectiv Time s*
es (min.)
4-27 4, 5, 6 50
4-28 2, 3, 4, 5 40
4-29 3, 4, 5 40
4-30 2, 3, 4, 5 35
4-31 3, 4, 5 50
4-32 3, 4, 5 30 C
4-33 4, 5, 6 30
4-34 3, 4, 5 50 I
4-35 2, 3, 4, 45
5, 6
4-36 7 35
4-37 7 40
4-38 7 45 I
Cases:
4-39 3, 4, 5, 6 45 E, C
* C = Business communication E = Ethics G = Group work I = International
W = Web-based application

Links to the Ancillaries

Video Programs

McGraw-Hill has produced various videos that are relevant to the instruction
of managerial/cost accounting. Information about these videos (including a
description of those applicable to this chapter) appears in Appendix A.

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