Chapter 17

Process costing

 Process Costing

Process costing is a product costing system that

accumulates costs according to process or departments
and assigns them to a large number of nearly identical
products.
Firms employ a standardized production process to
manufacture homogeneous and indistinguishable products
Firms having homogenous products that pass through a series
of similar processes or departments, use process costing.

Example : Production of Coca-Cola.

 Process costing is used in many industries, such as

chemicals, oil refining, textiles, paints, flour , canneries,
rubber , steel, glass, food processing, mining, automobile
production lines, drugs, paper, cement, leather, goods etc.
It is also be used by service organization with
homogeneous services and repetitive processes such as,
check clearing processing in RBI, or mail sorting in Post
Offices.

The departmental production cost report is a key

document in tracking production quantity and cost
information.
Unit product cost is calculated by dividing process costs in
each department by the number of equivalent units
produced during the period.

So.Process-Costing is.
Process-costing is a system where the unit cost of a
product or service is obtained by assigning total costs
to many identical or similar units
Each unit receives the same or similar amounts of
direct

materials

costs,

direct

labor

costs,

and

manufacturing overhead
Unit costs are computed by dividing total costs
incurred by the number of units of output from the
production process

Comparison of Job-Order Costing and

Process Costing
Process
Process
Costing
Costing

Job-order
Costing

Used for production of small,

identical, low cost items.

Mass produced in automated

continuous production process.
Costs cannot be directly traced to
each unit of product.

Process costing is used in

repetitive production
environments, where large
numbers of identical or
very similar products are
manufactured in a
continuous flow.

4-5

Comparison of Job-Order Costing and

Process Costing
Process
Process
Costing
Costing

Job-order
Costing

Typical process cost applications:

Petrochemical refinery
Paint manufacturer
Paper mill
Industries using process costing include paper, petroleum, chemicals, textiles, food
processing, lumber, and electronics.

4-6

Comparison of Job-Order Costing and Process Costing

In many ways, job-order costing and process costing are similar. Both product-costing
systems have the same ultimate purposeassignment of production costs to units of
output. Moreover, the flow of costs through the manufacturing accounts is the same in
the two systems.

Job-order costing

Process costing

Costs accumulated by the

job.

Costs accumulated by
department or process.

Work in process has a jobcost sheet for each job.

Work in process has a

production report for each
batch of products.

Many unique, high cost

jobs.
Jobs built to customer
order.

A few identical, low cost

products.
Units continuously
produced for inventory in
automated process.
4-7

Job-Costing and Process Costing:

Opposite Ends of a Continuum

Job-Costing Systems

Process-Costing
Systems

Distinct, identifiable
units of a product

Masses of identical

or service

or similar units of a
product or service

Examples:
Custom-made

Examples:

machines,

Food,

Houses

Chemical processing

Differences Between Job-Order and Process Costing

In job-order costing, costs are accumulated by job order and recorded on job-cost
records. The cost of each unit in a particular job order is found by dividing the total
cost of the job order by the number of units in the job.

The work-in-process
account consists of
individual jobs in a
job-order cost system.

Direct Material

Direct Labor

Manufacturing
Overhead

Jobs

Finished
Goods

Cost of
Goods
Sold
4-9

Differences Between Job-Order and Process Costing

In process costing, costs are accumulated by department, rather than by job order or
batch. The cost per unit is found by averaging the total costs incurred over the units
produced.

The work-in-process
account consists of
individual products in a
process cost system.

Direct Material
Direct Labor
& Overhead
(Conversion)

Products

When direct labor is a relatively small amount

compared to material and overhead, it is often
combined with overhead.

Finished
Goods

Cost of
Goods
Sold
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Process-Costing Assumptions
Direct Materials are added at the beginning
of the production process, or at the start of

work in a subsequent department down the

assembly line

Conversion Costs are added equally along

the production process

Process Cost Flows

How to Prepare journal entries to record the flow of costs in a process-costing system
with sequential production departments
Work-in-Process
Inventory
Direct material
Direct labor
Applied manufacturing
overhead

One Production Department

Finished Goods
Inventory

Cost of goods completed

and transferred to
finished goods

Cost of Goods Sold

Cost of goods sold
during current
period

In a single production department situation, direct-material, direct-labor, and manufacturingoverhead costs are added to a Work-in-Process Inventory account. As goods are finished, costs
are transferred to Finished-Goods Inventory. During the period when goods are sold, the
product costs are transferred to Cost of Goods Sold.

4-12

Process Cost Flows

Two Sequential Production Departments
Work-in-Process Inventory
Work-in-Process Inventory
Production Department A
Production Department B
Cost of goods completed
Direct material
Direct labor
in department A and
Cost of goods completed
Applied manufacturing
transferred to
and transferred to
overhead
department B
finished goods
Direct material
Direct labor
Applied manufacturing
overhead

Finished Goods Inventory

Cost of Goods Sold

Cost of goods sold

during current period

In the two-department case, when goods are finished in the first production department,
costs accumulated in the Work-in-Process Inventory account for production department A
are transferred to the Work-in-Process Inventory account for production department B.
4-13

Equivalent Units: A Key Concept

Costs are accumulated for a period of time for products
in work-in-process inventory.
Products in work-in-process inventory at the beginning
and end of the period are only partially complete.
Equivalent units is a concept expressing these
partially completed products as a smaller number of
fully completed products.
The term equivalent units is used in process costing to
refer to the amount of manufacturing activity that has
been applied to a batch of physical units.
4-14

Equivalent Units
A derived amount of output units that:
Takes the quantity of each input in units
completed and in unfinished units of work in
process and
converts the quantity of input into the
amount of completed output units that could
be produced with that quantity of input

Are calculated separately for each input (direct

materials and conversion cost)

Equivalent Units Example

Two one-half completed products are
equivalent to one completed product.

That is ..if two units are 50 percent complete, that is equivalent to 1 unit
that is 100 percent complete.

So, 10,000 units 70 percent complete

are equivalent to 7,000 complete units.

4-16

Equivalent Units Question 1

For the current period, Jones started 15,000 units
and completed 10,000 units, leaving 5,000 units in
process 30 percent complete. How many
equivalent units of production did Jones have for
the period?
a. 10,000
b. 11,500
c. 13,500
d. 15,000
4-17

Equivalent Units Question 1

For the current period, Jones started 15,000 units
and completed 10,000 units, leaving 5,000 units in
process 30 percent complete. How many
equivalent units of production did Jones have for
the period?
a. 10,000
10,000 units + (5,000 units .30)
b. 11,500
= 11,500 equivalent units
c. 13,500
d. 15,000
The 5,000 units that are 30 percent complete are equivalent to 1,500 units. Add that to
the 10,000 units that are 100 percent complete for a total of 11,500 equivalent units.
4-18

Equivalent Units Question 2

If Jones incurred $27,600 in
production costs for the 11,500 equivalent
units. What was Joness cost per equivalent
unit for the period?
a. $1.84
b. $2.40
c.
$2.76
d. $2.90
4-19

Equivalent Units Question 2

If Jones incurred $27,600 in
production costs for the 11,500 equivalent
units. What was Joness cost per equivalent
unit for the period?
a. $1.84
$27,600 11,500 equivalent units
b. $2.40
= $2.40 per equivalent unit
c.
$2.76
d. $2.90
The production costs are divided by the number of equivalent units to arrive at the
cost per equivalent unit.
4-20

Calculating and Using Equivalent Units of Production

To calculate the direct materials and conversion costs

per equivalent unit for the period:
Materials
cost per
equivalent
unit
Conversion
cost per
equivalent
unit

Materials cost for the period

Materials equivalent units for the
period

Conversion cost for the period

Conversion equivalent units for the
period

Direct material is usually placed into production at beginning of the production process. In
contrast, direct labor and manufacturing overhead, called conversion costs, usually are
incurred uniformly throughout the process. When an accounting period ends, the partially
completed goods that remain in process generally are at different stages of completion with
respect to material and conversion activity. The most important feature of process costing is
that the costs of direct material and conversion are assigned to equivalent units rather than to
4-21
physical units.

Departmental Production Report

Analysis of

Calculation

physical flow
of units.

of equivalent
units.

Production
Report

Computation

Analysis of

of unit costs.

total costs.
4-22

 The key document in a typical process-costing system is

the departmental production report, prepared for each
production department at the end of every accounting
period.
The departmental production report summarizes the
flow of production quantities through the department,
and it shows the amount of production cost transferred
out of the departments Work-in-Process Inventory
account during the period.
There are four steps used in preparing a departmental
production report:
1. Analysis of physical flow of units.
2. Calculation of equivalent units.
3. Computation of unit costs.
4. Analysis of total costs.

Equivalent Units of Production

Weighted-Average Method
The method of process costing that we will focus on ..is called the weightedaverage method. This method is almost always used in practice by
companies using process costing. There is another process-costing method
called the first-in, first-out, or FIFO, method

The weighted-average method . . .

Makes no distinction between work done in the
prior period and work done in the current period.
Blends together units and costs from the prior
period and the current period.
The FIFO method is a more
complex method and is
rarely used in practice.
4-24

Weighted-Average
Process-Costing Method
Calculates cost per equivalent unit of all
work done to date (regardless of the

accounting period in which it was done)

Assigns this cost to equivalent units

completed

&

transferred

out

of

the

process, and to incomplete units in still

in-process

Weighted-Average
Process-Costing Method

Weighted-average costs is the total of all costs

in the Work-in-Process Account divided by the

total equivalent units of work done to date

The beginning balance of the Work-in-Process

account (work done in a prior period) is
blended in with current period costs

Result of the Process

Two critical figures arise out of the cost

allocation process:
The
amount
of
the
Journal
Entry
transferring the allocated cost of units
completed and sent from Work-in-Process
Inventory to Finished Goods Inventory
The ending balance of the Work-in-Process
Inventory account that will appear on the
Balance Sheet

First-in, First-Out
Process-Costing Method

Assigns the cost of the previous accounting periods

equivalent units in beginning work-in-process inventory
to the first units completed and transferred out of the

process

Assigns the cost of equivalent units worked on during

the current period first to complete beginning inventory,

next to stat and complete new units, and lastly to units

in ending work-in-process inventory

The beginning balance of the Work-in-Process account

(work done in a prior period) is kept separate from

current period costs

Result of the Process (as before)

Two critical figures arise out of the cost allocation

process:
The amount of the Journal Entry transferring the
allocated cost of units completed and sent from
Work-in-Process Inventory to Finished Goods
Inventory
The ending balance of the Work-in-Process
Inventory account that will appear on the Balance
Sheet

Production Report Example

MVP Sports Equipment Company makes baseball gloves in two
departments, Cutting and Stitching.
MVP uses the weighted-average cost procedure.
Material is added at the beginning of the Cutting Department,
and conversion is incurred uniformly throughout the process.
Using the following information for the month of March, lets
prepare a production report for the Cutting Department.
The MVP Sports Equipment Company manufactures baseball gloves. Two production
departments are used in sequence: the Cutting Department and the Stitching
Department.
In the Cutting Department, direct material is placed into production at the beginning
of the process. Direct-labor and manufacturing overhead costs are incurred uniformly
throughout the process.
The predetermined overhead rate used in the Cutting Department is 125 percent of
direct-labor cost.

4-30

Production Report Example

Work in process, March 1: 20,000 units
Materials:
100% complete.
Conversion:
10% complete.

Cost
$ 50,000
7,200

Units started into production in March:

Units completed and transferred out in March:

30,000 units
40,000 units

Work in process, March 31:

Materials
100% complete.
Conversion
50% complete.

10,000 units

Costs incurred during March

Materials cost
Conversion costs:
Direct labor
Applied manufacturing overhead
Total conversion costs
Total costs to account for

90,000

$ 86,000
107,500
193,500
$ 340,700
4-31

 The previous slide presents a summary of the

activity and costs in the Cutting Department
during March.
The direct-material and conversion costs for the
March 1 work in process consist of costs that
were incurred during February.
These costs were assigned to the units remaining
in process at the end of February.
Materials costs of $90,000 and conversion costs
of 193,500 were added during the month of
March.
The beginning work in process and the costs
added during March are the total costs to be
accounted for.

Production Report Example

Analysis of Physical Flow of Units
Physical
Units
Work in process, March 1
Units started during March
Total units to account for

20,000
30,000
50,000

Units completed and transferred out during March

Work in process, March 31
Total units accounted for

40,000
10,000
50,000

The first step is to prepare a table summarizing the physical flow of production units
during March.
4-33

Production Report Example

The second step is to calculate the equivalent units of direct material and conversion activity. The table of equivalent units,
displayed on this slide, is based on the table of physical flows prepared in step 1. The Cutting Department completed their
work on 40,000 physical units. Thus, they represent 40,000 equivalent units for both direct material and conversion. The
10,000 units in the Cutting Departments ending work-in-process inventory are 50 percent complete with respect to
conversion. Therefore, the ending work-in-process inventory represents 5,000 equivalent units of conversion activity
(10,000 physical units x 50% complete).

Calculation of Equivalent Units

Physical
Units

Conversion
Percentage
Complete

Work in process, March 1

Units started during March
Total units to account for

20,000
30,000
50,000

10%

Units completed and transferred

Work in process, March 31
Total units accounted for
Total equivalent units

40,000
10,000
50,000

100%
50%

Equivalent Units
Direct
Material Conversion

50% of 10,000 units

40,000
10,000

40,000
5,000

50,000

45,000

Beginning inventory % is not used in weighted-average method.

4-34

Production Report Example

With respect to direct material, the 10,000 units in the Cutting Departments ending workin-process inventory are 100 percent complete. Therefore, the ending work-in-process
inventory represents 10,000 equivalent units of direct material.

Calculation of Equivalent Units

Physical
Units

Conversion
Percentage
Complete

Work in process, March 1

Units started during March
Total units to account for

20,000
30,000
50,000

10%

Units completed and transferred

Work in process, March 31
Total units accounted for
Total equivalent units

40,000
10,000
50,000

100%
50%

Equivalent Units
Direct
Material Conversion

100% of 10,000 units, all

material added at beginning
40,000
10,000

40,000
5,000

50,000

45,000

4-35

Production Report Example

The third step in the process-costing procedure is calculating the cost per equivalent unit for both direct
material and conversion activity. The cost per equivalent unit for direct material is computed by dividing the
total direct-material cost, including the cost of the beginning work in process and the cost incurred during
March, by the total equivalent units (from step 2). The same procedure is used for conversion costs.

Computation of unit costs

Direct
Material
Work in Process, March 1
Costs incurred during March
Total costs to account for

$ 50,000
90,000
$ 140,000

Equivalent units
Cost per equivalent unit

50,000
$
2.80

$140,000 50,000 equivalent units

Conversion
$

7,200
193,500
$ 200,700
$

45,000
4.46

Total
$ 57,200
283,500
$ 340,700
$

7.26

$2.80 + $4.46

$200,700 45,000 equivalent units

4-36

Production Report Example

The final step is to determine the total cost to be transferred out of the Cutting Departments
Work-in-Process Inventory account and into the Stitching Departments Work-in-Process
Inventory account. The cost per equivalent unit, $7.26, was calculated in step 3. The number of
units transferred is multiplied by the cost per equivalent unit.

Analysis of total costs

Cost of goods completed and transferred during March
40,000 units x $7.26 per equivalent unit
Costs remaining in work-in-process on March 31
Direct Material:
10,000 equivalent units x $2.80 per equivalent unit
Convserion:
5,000 equivalent units x $4.46 per equivalent unit
Total cost of March 31 work-in-process
Total costs accounted for

$ 290,400

$ 28,000
22,300
50,300
$ 340,700

The direct material equivalent units is multiplied by the direct materials cost per equivalent
unit. The conversion equivalent units is multiplied by the conversion cost per equivalent
unit. These two amounts are added together.
4-37

Production Report Example

The sum of these costs is added to the cost of goods completed and transferred. Now all
costs on the production report have been accounted for. These calculations are used as the
basis for the journal entries to transfer the cost of goods completed and transferred out to
the Stitching Department

Analysis of total costs

Cost of goods completed and transferred during March
40,000 units x $7.26 per equivalent unit
Costs remaining in work-in-process on March 31
Direct Material:
10,000 equivalent units x $2.80 per equivalent unit

$ 290,400

$ 28,000

Convserion:
5,000 equivalent units x $4.46 per equivalent unit
Total cost of March 31 work-in-process
Total costs accounted for

All costs
accounted for

22,300
50,300
$ 340,700

4-38

 We have now completed all four steps necessary

to prepare a production report.
The report in the next slide simply combines the
tables prepared till now.
The report provides a convenient summary of all
of the process-costing calculations made under
the weighted-average method.
This method is called the weighted-average
method because the cost per equivalent unit, for
both direct material and conversion activity, is
computed as a weighted average of the costs
incurred during two different accounting
periods.

MVP SPORTS EQUIPMENT COMPANY

Production Report: Cutting Department
Percentage of
Completion
Equivalent Units
Physical with Respect to
Direct
Units
Conversion
Material
Conversion
Work in process, March 1
Units started during March
Total units to account for

20,000
30,000
50,000

10%

Units completed and transferred

Work in process, March 31
Total units accounted for
Total equivalent units

40,000
10,000
50,000

100%
50%

Direct
Material
Work in Process, March 1
Costs incurred during March
Total costs to account for

$ 50,000
90,000
$ 140,000

Equivalent units
Cost per equivalent unit

50,000
2.80

40,000
10,000

40,000
5,000

50,000

45,000

Conversion
$

7,200
193,500
$ 200,700

45,000
4.46

Cost of goods completed and transferred during March

40,000 units x $7.26 per equivalent unit
Costs remaining in work-in-process on March 31
Direct Material:
10,000 equivalent units x $2.80 per equivalent unit
Conversion:
5,000 equivalent units x $4.46 per equivalent unit
Total cost of March 31 work-in-process
Total costs accounted for

Total
$ 57,200
283,500
$ 340,700

7.26

$ 290,400

28,000

22,300
50,300
$ 340,700

4-40

Departmental Production Report

Analysis of
physical flow
of units.

In our illustration, production requires

two sequential production
operations: cutting and stitching.

Calculation
of equivalent
units.

The cost of goods completed and

transferred out of the Cutting
Department must remain assigned to
the partially completed product units
as they undergo further processing in
the Stitching Department.

Although the process-costing procedures for the

second department are similar to those illustrated for
the first, there is one additional complication.

Computation
of unit costs.

Analysis of
total costs.

Process-costing procedures for

subsequent production departments are
covered in Cost Accounting texts
4-41