Chapter 4

Chapter 4
Costing Systems:
Process Costing
Process Costing System
• Objective 1
Describe the process costing system, identify
the reasons for its use, and discuss its role in
the management process.
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Product Costing Systems
• Provide unit cost information
• Supply cost data to support management
decisions
• Furnish ending values for inventory
accounts
– Materials Inventory
– Work in Process Inventory
– Finished Goods Inventory

Process Costing Systems
• Used by companies that produce large amounts
of similar products or liquid products
• Used by companies that have long, continuous
production runs of identical products
Because products are alike, they should

cost the same to produce.
A process costing system accumulates costs and assigns

them to products as they are produced during a period.

Plan
• Managers use information about past and
projected product costing to determine:
– What a product should cost
– If the product cost is reasonable
– Target number of units to be sold

Perform
• Actual unit costs are computed.
• Managers use timely cost and volume
information and actual unit costs to support
their ethical decision making to add value to
all their stakeholders.

Evaluate
• Analyze variances
Compare in actual and
actual and targeted costs.
targeted • Recommend
total unit changes.
costs.

Communicate
Actual units produced and
costs incurred are used to
Managers value:
prepare – Inventory on the
financial balance sheet
statements. – Cost of goods sold on
the income statement

Stop & Review
A. During which stage in the management
process would a product’s selling price be
determined?
A. During the planning stage, managers
determine reasonable selling prices for
products, forecast future costs, and create
budgets.

Stop & Review (cont’d)
A. What types of businesses use process
costing?
A. Companies that make large amounts of
similar products or liquid products or that
have long, continuous production runs of
identical products
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Patterns of Product Flows
and Cost Flow Methods
• Objective 2
Relate the patterns of product flows to the
cost flow methods in a process costing
environment.

Patterns of
Product Flows and Cost Flows
Products flow in a first-in, first-out (FIFO)
fashion through several processes,
departments, or work cells.
Steps describing the production flow

during the manufacture of computer chips:
1. Producing the silicon wafer
2. Fabricating the chips
3. Final testing, assembly, and packaging of
the chips
and Cost Flows (cont’d)
Costs are accumulated as the product passes
through each manufacturing process,
department, or work cell and passed on to the
next manufacturing process, department, or
work cell.

and Cost Flows (cont’d)
When using process costing, the steps in
processing can be combined in hundreds
of different ways.
– Two basic production flows
1. The completed product from one department
becomes the direct materials for the next
department.
2. Two separate products are each developed in
their own department and then joined with a
third direct material in another department.

Product Flows in a Process Costing
System for Computer Chip Making

Process Cost Report
Assigns costs that have accumulated

during the period to units that have
transferred out of the department
and are still work in process
Used to assign costs using the

FIFO costing method

FIFO Costing Method
• Cost flow follows the logical physical flow
of production.
– Costs assigned to first materials processed are
the first costs transferred out when the
materials flow to the next process, department,
or work cell.

Average Costing Method
• Assigns an average cost to all products made
during an accounting period
• Uses averages and does not attempt to match
cost flow with the physical flow of production

Stop & Review
A. How does cost flow relate to physical flow
when using a FIFO costing system?
A. The cost flow follows the logical physical
flow of production. The costs assigned to the
first materials processed are the first costs
transferred out when the materials flow to the
next process, department, or work cell.

Cost Flows Through the
Work in Process Inventory Accounts
• Objective 3
Explain the role of the Work in Process
Inventory accounts in a process costing
system.

Cost Flows Through the
Work in Process Inventory Accounts
Work in Process
Inventory accounts are
the focal point of process
costing.
As products flow through the Work in Process

Inventory accounts for each process, department,
or work cell, the costs associated with them flow
to the Work in Process Inventory account of that
process, department, or work cell.

Recording the Transfer of Costs
Entries
Work in Process Inventory—Next Dept. XX
Work in Process Inventory—This Dept. XX
Finished Goods Inventory XX
Work in Process Inventory XX

Cost Flows Through the Work in
Process Inventory Accounts
Mixing
Department
Cookie dough
is prepared
Costs of cookie
dough
accumulate
• Cookie dough is prepared in the Mixing Department, where the costs of direct
materials, direct labor, and overhead incurred accumulate.

Process Inventory Accounts (cont’d)
Mixing Baking
Department Department
Cookie dough Cookies

is prepared are baked
Costs of cookie
Costs of cookie dough
dough +
accumulate Baking costs
accumulate
• Cookie dough is transferred to the Baking Department.

• The costs accumulated in the Mixing Department Work in Process Inventory
account are transferred to the Baking Department Work in Process Inventory
account.
• Costs incurred to bake the cookies are accumulated in the Baking Department
Work in Process Inventory account.
Mixing Baking Packaging
Department Department Department
Cookie dough Cookies Cookies

is prepared are baked are packaged
Costs of cookie Costs of cookie

Costs of cookie dough dough & baking
dough + +
accumulate Baking costs Packaging costs
accumulate accumulate
• The baked cookies are transferred to the Packaging Department.

• The costs accumulated in the Baking Department Work in Process Inventory
account are transferred to the Packaging Department Work in Process
Inventory account.
• Costs incurred to package the cookies are accumulated in the Packaging
Department Work in Process Inventory account.
Mixing Baking Packaging
Department Department Department
Cookies
Cookie dough Cookies Cookies are moved to
is prepared are baked are packaged finished goods
storeroom
Costs of cookie Costs of cookie Total costs of

Costs of cookie dough dough & baking cookies are
dough + + transferred to
accumulate Baking costs Packaging costs Finished Goods
accumulate accumulate Inventory
• The packaged cookies are transferred to the finished goods storeroom.

• The costs accumulated in the Packaging Department Work in Process
Inventory account are transferred to the Finished Goods Inventory account.
• When the cookies are sold, their costs will be transferred to the Cost of
Goods Sold account.

Stop & Review
A. Which accounts are the focal point of a
process costing system?
A. As products flow through the Work in
Process Inventory accounts for each process,
department, or work cell, the costs
associated with them flow to the Work in
Process Inventory account of that process,
department, or work cell.

Computing Equivalent
Production
• Objective 4
Define equivalent production, and compute
equivalent units.

Equivalent Production
A measure that applies a percentage-of-
completion factor to partially completed units to
calculate the equivalent number of whole units
produced in an accounting period
• Also called equivalent units
• Computed for each type of input:
– Direct materials
– Direct labor
– Overhead

Computation of
Equivalent Production
Sum of:
1. Total units started and completed during the period
2. Amount representing the work done on partially completed
products
(In both the beginning and ending work in process
inventories)
Equivalent production must be computed separately for

each type of input because of differences in the ways the
costs are incurred.

Computation of Equivalent Units
Equivalent production must be computed
separately for each type of input because of
differences in the ways the costs are incurred.
Direct
materials
usually Combine
added direct labor
to Equivalent Production
and
production overhead
at beginning (conversion
of process. costs).

Computing Equivalent Production
Soda Products Company makes bottled soft drinks. The company started Week 2 with
one half-completed drink in process. During Week 2, it started and completed three
drinks, and at the end of Week 2, it had one drink that was three-quarters completed.
Equivalent units in regard to conversion costs = .5 (1 x 50%)
One soft drink was started Direct materials were all The soft drink was 50 percent
during Week 1 and was 50 added during Week 1, so there completed during Week 1, so
percent completed (and still in were no equivalent units in the other 50 percent of
production) when Week 2 regard to direct materials costs conversion costs were
started. during Week 2. incurred during Week 2.

Computing Equivalent Production (cont’d)
The company started Week 2 with one half-completed drink in process. During
Week 2, it started and completed three drinks, and at the end of Week 2, it had one
drink that was three-quarters completed.
Three soft drinks were Because materials are Equivalent units in regard
started and completed added at the beginning of to direct materials costs = 3
during Week 2. production, all direct (3 x 100%).
materials for these drinks
were added during Week 2.
Three soft drinks were The soft drinks were started Equivalent units in regard
started and completed and completed during to conversion costs = 3 (3 x
during Week 2. Week 2, so 100 percent of 100%).
conversion costs were
incurred during Week 2.
One soft drink was started Direct materials were all added Equivalent units in regard
during Week 2 and was 75 during Week 2, so direct to direct materials costs = 1
percent completed (and still in materials costs were 100 (1 x 100%).
production) when Week 2 percent in regard to direct
ended. materials costs during Week 2.
One soft drink was started Because 75 percent of this soft Equivalent units in regard to
during Week 2 and was 75 drink was completed during conversion costs = .75 (1 x
percent completed (and still in Week 2, 75 percent of 75%).
production) when Week 2 conversion costs were incurred
ended. during Week 2.
Total equivalent units 4 4.25

Stop & Review
Q. What is equivalent production?
A. A measure that applies a percentage-of-
completion factor to partially completed units
to calculate the equivalent number of whole
units produced in an accounting period

Stop & Apply
A. If 100 items in beginning inventory were 100
percent complete in regard to direct materials
costs and 35 percent complete in regard to
conversion costs, what is the number of
equivalent units in regard to conversion costs if
they were completed during the current period?
A. 100 x 65% = 65. Since 35 percent of conversion
costs were incurred during the previous period, 65
percent must have been incurred during the
current period.

Preparing a Process Cost Report
Using the FIFO Costing Method
• Objective 5
Prepare a process cost report using the
FIFO costing method.

Process Cost Report
A report that managers use to track and
analyze costs for a process, department, or
work cell in a process costing system

Using the FIFO Costing Method
Five steps:
1. Account for the physical flow of products.
2. Compute equivalent production.
3. Accumulate and analyze all costs charged to the Work
in Process Inventory accounts of each production
process, department, or work cell.
4. Compute the cost per equivalent unit for direct materials
and conversion costs.
5. Assign costs to products transferred out of the area and
to those remaining behind in ending work in process
inventory.

Accounting for Units
For the accounting period ending February, Soda Products Company had beginning
work in process inventory consisting of 6,200 units, 60 percent complete. These
units were completed and 57,500 more were started into production. Of the 57,500
started, 52,500 were completed. The other 5,000 remained in ending work in
process inventory and were 45 percent complete.
Step 1 - Account for physical units
These 63,700 units are the actual physical units that the
manager is responsible for during the period.

Accounting for Equivalent Units
Step 2 - Account for equivalent units
Units accounted for in Step 2 must equal

the units accounted for in Step 1.

Beginning Inventory
For the accounting period ending February, Soda Products Company had
beginning work in process inventory consisting of 6,200 units, 60 percent
complete. These units were completed and 57,500 more were started into
production. Of the 57,500 started, 52,500 were completed. The other 5,000
remained in ending work in process inventory and were 45 percent complete.
0 0%
Because all materials are added at the

beginning of the production process, the units
in beginning inventory were already 100
percent complete in regard to direct materials.

Beginning Inventory (cont’d)
0 0% 2,480 40%
They were 60 percent complete in regard to

conversion costs; therefore, the remaining 40
percent of conversion costs were incurred during
the current month (6,200 x 40% = 2,480).

Units Started and Completed During the Period
0 0% 2,480 40%
52,500 100% 52,500 100%
All direct materials costs and conversion

costs for the 52,500 units started and
completed were incurred during this period.

Ending Inventory
0 0% 2,480 40%
52,500 100% 52,500 100%

All materials were added to the
5,000 100% units in ending inventory when
the units went into production
during the month.

Ending Inventory (cont’d)
0 0% 2,480 40%
52,500 100% 52,500 100%
5,000 100% 2,250 45%
These units were 45 percent complete in regard to

conversion costs by the end of the period (5,000
x 45%).
Totals
0 0% 2,480 40%
52,500 100% 52,500 100%
5,000 100% 2,250 45%

57,500 57,230
Total equivalent units for direct materials costs and
conversion costs will be used in Step 4.
Accounting for Costs
During the accounting period ending February, Soda Products Company had costs from
beginning inventory of $20,150 for direct materials and $21,390 for conversion costs.
Current period costs include $189,750 for direct materials costs and $320,488 for
conversion costs.
Step 3 - Account for costs
Only the Total Costs Current costs for direct materials costs and
column is totaled. conversion costs will be used in Step 4.

Accounting for Costs (cont’d)
For the accounting period ending February, Soda Products Company’s equivalent
units of production totaled 57,500 for direct materials costs and 57,230 for
conversion costs. Current period costs totaled $189,750 for direct materials and
$320,488 for conversion costs.
Step 4 – Compute cost per equivalent unit
Costs attached to beginning inventory are not included in these

computations because the FIFO costing method uses separate costing
analyses for each accounting period.
Assigning Costs
Step 5 – Assign costs to cost of goods manufactured and
ending inventory
• Use information from Steps 2 through 4 to assign costs:
– Step 2
• Equivalent units for direct materials costs
• Equivalent units for conversion costs
– Step 3
• Total costs of beginning inventory
• The total costs assigned to units completed and transferred out and
to ending inventory in Step 5 must equal the total costs in Step 3.
– Step 4
• Cost per equivalent unit for direct materials costs
• Cost per equivalent unit for conversion costs

Cost of Goods Manufactured
and Transferred Out
ending inventory
This amount is calculated in Step 3 in the Total

Costs column for beginning inventory.

and Transferred Out (cont’d)
ending inventory
Current costs to complete 13,888 = $0 + (2,480 x $5.60)
The 2,480 equivalent units were The $5.60 cost per

calculated in Step 2 in the Equivalent equivalent unit for
Units/Conversion Costs column for conversion costs was
beginning inventory. calculated in Step 4.

Units Started and Completed This Period
ending inventory

Units started and completed
this period 467,250 = (52,500 x $3.30) + (52,500 x $5.60)
The 52,500 equivalent units were The $3.30 and $5.60 costs per
calculated in Step 2 in the Equivalent equivalent unit for direct materials
Units/Direct Materials Costs and costs and conversion costs,
Conversion Costs columns for units respectively, were calculated in
started and completed during the period. Step 4.

and Transferred Out
ending inventory

this period 467,250 = (52,500 x $3.30) + (52,500 x $5.60)
Cost of goods manufactured $522,678

Ending Inventory
ending inventory

this period 467,250 = (52,500 x $3.30) + (52,500 x $5.60)
Ending inventory 29,100 = (5,000 x $3.30) + (2,250 x $5.60)
The 5,000 and 2,250 equivalent units were The $3.30 and $5.60 costs per equivalent
calculated in Step 2 in the Equivalent unit for direct materials costs and
Units/Direct Materials Costs and Conversion conversion costs, respectively, were
Costs columns, respectively, for ending calculated in Step 4.
inventory.
Total Costs
ending inventory

this period 467,250 = (52,500 x $3.30) + (52,500 x $5.60)
Total costs $551,778
Remember that the total If differences occur due to rounding in Step 4, adjust the
costs in Steps 3 and 5 must total costs transferred out for any rounding difference so
always be the same. that the total costs in Steps 3 and 5 are equal.

Recap of Work in Process Account
Work in Process Inventory Account: Cost Recap
Beg. Bal. $41,540 $522,678 (cost of goods

manufactured and
Direct Materials 189,750 transferred out)
Conversion Costs 320,488
End. Bal. $29,100
Work in Process Inventory Account: Unit Recap
Beg. Bal. 6,200 58,700 (FIFO units

transferred out from the
Direct Materials 6,200 in beginning
and Conversion inventory plus 52,500
Costs 57,500 started and completed)
End. Bal. 5,000

Process Costing for
Two or More Production Departments
• A Work in Process Inventory account for
each department is required.
• Costs are accumulated in each department
and transferred to the next department as the
product flows from one department to the
next.

Stop & Review
A. How is the cost per equivalent unit
computed?
A. For either direct materials costs or
conversion costs, divide the current period
costs by the number of equivalent units.

Using the Average Costing Method
• Objective 6
Prepare a process cost report using the
average costing method.

FIFO Method Versus
Average Costing Method
Cost flows follow the logical
FIFO
physical flow of production.
Method
Average Cost flows do not follow the logical

physical flow of production.
Costing • Costs in beginning inventory are averaged
Method with current period costs.
Both methods include the same five steps, but the

procedures for completing the steps are different.

For the accounting period ending February, Soda Products Company had beginning work
in process inventory consisting of 6,200 units, 60 percent complete. These units were
completed and 57,500 more were started into production. Of the 57,500 started, 52,500
were completed. The other 5,000 remained in ending work in process inventory and were
45 percent complete.
Step 1 - Account for physical units
This step is identical for both the average

costing and FIFO costing methods.

Units Completed and Transferred Out
58,700 100% 58,700 100%
Both direct materials costs and

conversion costs of the units completed
in February are treated as if they were
Recall that FIFO disregards incurred in the current period.
previous period costs of units
started in the last period.

Ending Inventory
58,700 100% 58,700 100%
5,000 100%
All materials were added to the units in

ending inventory when the units went
into production during the month.

58,700 100% 58,700 100%
5,000 100% 2,250 45%
These units were 45 percent complete

with regard to conversion costs by the
end of the period (5,000 x 45%).

58,700 100% 58,700 100%
5,000 100% 2,250 45%

63,700 60,950
Total equivalent units for direct materials costs

and conversion costs will be used in Step 4.
Accounting for Costs
During the accounting period ending February, Soda Products Company had costs from
beginning inventory of $20,150 for direct materials and $21,390 for conversion costs.
Current period costs include $189,750 for direct materials costs and $320,488 for
conversion costs.
Step 3 - Account for costs
Total costs for direct materials costs and

conversion costs will be used in Step 4.

For the accounting period ending February, Soda Products Company’s equivalent units
of production totaled 57,500 for direct materials costs and 57,230 for conversion costs.
Current period costs totaled $189,750 for direct materials and $320,488 for conversion
costs.
*Rounded to nearest cent (any rounding differences are

assigned to the units transferred out in Step 5).

For the accounting period ending February, Soda Products Company’s equivalent units
of production totaled 57,500 for direct materials costs and 57,230 for conversion costs.
Current period costs totaled $189,750 for direct materials and $320,488 for conversion
costs.
Notice that average costing method divides total cost by total equivalent units,
whereas the FIFO costing method divides current costs by current equivalent units.

Assigning Costs
ending inventory
• Use information from Steps 2 through 4 to assign costs:
– Step 2
• Equivalent units for direct materials costs
• Equivalent units for conversion costs
– Step 3
• Total costs of direct materials
• Total costs of conversion
– Step 4
• Cost per equivalent unit for direct materials costs
• Cost per equivalent unit for conversion costs

Assigning Costs
ending inventory
To better understand the treatment of rounding differences, we will
begin with total costs and then assign costs to ending inventory and
cost of goods manufactured.
Direct Materials Conversion
Costs Costs
Cost of goods manufactured and
transferred out
Ending inventory
Remember that total costs in If differences occur due to rounding in Step

Steps 3 and 5 must always be 4, the total cost transferred out is adjusted
the same. for any rounding difference.
Ending Inventory
Step 5 – Assign costs to ending inventory

Costs Costs
transferred out

The 5,000 and 2,250 equivalent units were calculated

in Step 2 in the Direct Materials Costs and
Conversion Costs columns for ending inventory.

Step 5 – Assign costs to ending inventory

The $3.30 and $5.61 costs per equivalent unit for direct
materials costs and conversion costs were calculated in
Step 4, and these amounts were rounded.

and Transferred Out
Step 5 – Assign costs to cost of goods manufactured

Costs Costs
transferred out $523,017 = (58,700 x $3.30) + (58,700 x $5.61)

(58,700 x $3.30) + (58,700 x $5.61) = $523,017


Costs Costs

But, $523,017 + $29,123 does not equal $551,778.
$523,017 + $29,123 is equal to $552,140, which

is $362 more than the total costs of $551,778.


Costs Costs

This difference is caused by rounding in Step 4, so the

amount of cost of goods manufactured and transferred
out must be adjusted.
Cost of goods manufactured and transferred out is

adjusted to $522,655 ($523,017 − $362 = $522,655).

Recap of Work in Process Account
Work in Process Inventory Account: Cost Recap
Beg. Bal. $41,540 $522,655 (cost of goods

manufactured and
Direct Materials 189,750 transferred out)
Conversion Costs 320,488
End. Bal. $29,123
Work in Process Inventory Account: Unit Recap
Beg. Bal. 6,200 58,700 units of goods

transferred out
Direct Materials
and Conversion
Costs 57,500
End. Bal. 5,000

Stop & Review
A. How do the FIFO costing and average costing
methods differ when accounting for equivalent
units?
A. FIFO costing method
Materials costs and conversion costs that were incurred in
the previous period for units in beginning inventory are not
included in the current period.
Average costing method
Both materials costs and conversion costs for units in
beginning inventory are treated as if they were incurred in
the current period.

Using Information About Product
Cost to Evaluate Performance
• Objective 7
Evaluate operating performance using
information about product cost.

How Do Managers Use
Product Costing Information?
To evaluate:
• Cost trends of a product or product line
• Units produced per time period
• Materials usage per unit produced
• Labor cost per unit produced
• Special needs of customers
• Cost-effectiveness of changing to a more advanced
production process

Cost Trends
• Identify areas of rising costs and find areas
in which cost-effectiveness has improved.
• Evaluate operating efficiency.

Trends in Usage
Managers track direct materials
usage and labor cost per unit.
Optimal resource
usage can be
determined.

Trends in Sales
Tracking size, cost, and type of
products ordered by customers
Helps managers anticipate customers’

needs and improve customer relations

Stop & Review
Q. Why would managers want to analyze cost trends
of a product?
A. Cost trends developed over a period of time help
managers identify areas of rising costs or areas in
which cost-effectiveness has improved. The factors
causing the changes can then be identified for
purposes of improving cost-effectiveness.

Chapter Review
1. Describe the process costing system,
identify the reasons for its use, and discuss
its role in the management process.
2. Relate the patterns of product flows to the
cost flow methods in a process costing
environment.
3. Explain the role of the Work in Process
Inventory accounts in a process costing
system.

Chapter Review (cont’d)
• Define equivalent production and
compute equivalent units.
• Prepare a process cost report using the
FIFO costing method.
• Prepare a process cost report using the
average costing method.
• Evaluate operating performance using
information about product cost.

Chapter 4

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Chapter 4

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Because products are alike, they should

A process costing system accumulates costs and assigns

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Steps describing the production flow

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Assigns costs that have accumulated

Used to assign costs using the

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As products flow through the Work in Process

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Cookie dough Cookies

• Cookie dough is transferred to the Baking Department.

Cookie dough Cookies Cookies

Costs of cookie Costs of cookie

• The baked cookies are transferred to the Packaging Department.

Costs of cookie Costs of cookie Total costs of

• The packaged cookies are transferred to the finished goods storeroom.

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Equivalent production must be computed separately for

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Equivalent units in regard to conversion costs = .5 (1 x 50%)

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Total equivalent units 4 4.25

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Units accounted for in Step 2 must equal

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Because all materials are added at the

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They were 60 percent complete in regard to

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52,500 100% 52,500 100%

All direct materials costs and conversion

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52,500 100% 52,500 100%

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