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Product Costing

The primary objective of a product costing


system is to assign production costs to
products and services for the purpose of
internal and external financial reporting.

Firms that produce homogeneous outputs in


batch or continuous production processes do
not need an elaborate costing system.
Firms that produce heterogeneous and custom
outputs need a costing system that can track
product costs to the product or customer level.

Product Costing
Cost identification
Cost measurement
Product cost assignment

Methods of Product Costing


Before products can be costed, a
determination must be made about:
1. the cost accumulation
system (job order or process
costing) and
2. the valuation method to be
used (actual, normal, or
standard costing).
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Methods of Product Costing


Cost Accumulation System defines
cost object
method of assigning costs to production

Valuation Method specifies


how product costs will be measured

Six Possibilities
V
A
L
U
A
T
I
O
N

COST ACCUMULATION
SYSTEM
M
E
T
H
O
D

Job Order

Process

Actual
Normal
Standard

Actual
Normal
Standard

Valuation Methods
Actual
Actual direct material
Actual direct labor
Actual overhead

Standard

Normal
Actual direct material
Actual direct labor
Predetermined overhead

Standard direct
material
Standard direct labor
Standard overhead
The
Difference

Valuation Methods
An actual cost system is a valuation
method that uses actual direct
material, direct labor, and overhead
costs in determining the cost of
Work in Process Inventory.

Service businesses that have few


customers and/or low volume may use
an actual cost system.
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Valuation Methods
A normal cost system is a valuation
method that uses actual direct
material, actual direct labor, and
applied overhead (estimated using
predetermined overhead rates) in
determining the cost of Work in
Process Inventory.
(This chapter assumes the use of
normal costing.)
10

Valuation Methods
In a standard cost system,
standards (predetermined
benchmarks) are developed for
direct material and direct labor
quantities and/or costs and
overhead is applied to production
using a predetermined rate that is
considered the standard.
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Valuation Methods
A standard cost system allows
companies to quickly recognize
variances from expected production
costs and to correct problems from
excess usage and/or costs, a capability
not found in actual cost systems and
provided only for overhead in normal
cost systems.

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Types
Types of
of Product-Costing
Product-Costing Systems
Systems
Process
Costing

Job-Order
Costing

Used for production of large,


unique, high-cost items.
Built to order rather than
mass
produced.
Many costs can be directly
traced

13

Types
Types of
of Product-Costing
Product-Costing Systems
Systems
Process
Costing

Job-Order
Costing

Job-shop operations
Products manufactured in
very
low volumes or one at a
time.
Batch-production operations
Multiple products in

14

Types
Types of
of Product-Costing
Product-Costing Systems
Systems
Process
Costing

Job-Order
Costing

Typical job-order cost


applications:
Special-order printing
Building construction
Also used in service industry
Hospitals
Law firms

15

Types
Types of
of Product-Costing
Product-Costing Systems
Systems
Process
Costing

Job-Order
Costing

The word job is synonymous


with client, engagement,
project, or contract.

16

Types
Types of
of Product-Costing
Product-Costing Systems
Systems
Process
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

17

Types
Types of
of Product-Costing
Product-Costing Systems
Systems
Process
Costing

Job-Order
Costing

Typical process cost


applications:
Petrochemical refinery
Paint manufacturer
Paper mill
18

More Examples of Businesses Using


Process Costing
Chemicals
Chemicals
Oil
Oil refining
refining
Textiles
Textiles
Flour
Flour
Canneries
Canneries
Rubber
Rubber
Steel
Steel
Food
Food
processing
processing

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Dollar Amount

Characteristics of Process Costing


Direct
Materials

Direct
Labor

Direct labor costs


are usually small
Factory
in comparison to
Overhead
other product
costs in process
cost systems.

Type of Product Cost

20

Dollar Amount

Characteristics of Process Costing


Direct
Direct labor costs
Materials
Conversion are usually small
in comparison to
other product
costs in process
cost systems.

Type of Product Cost


So, direct labor and factory overhead are often
combined into one product cost called conversion.
21

Characteristics of Process Costing


Process
Process costing
costing accumulates
accumulates costs
costs
by
by process
process or
or department
department and
and
then
then assigns
assigns them
them to
to aa large
large
number
number of
of nearly
nearly identical
identical products.
products.

Continuous
Continuous
mass
mass production
production

Unit cost =

Similar
Similar
processes
processes

Homogeneous
Homogeneous
products
products

Process costs
Equivalent units produced

22

Illustration 3-3

23

Basic Operational and Cost


Concepts

Comparison of
Cost Accumulation
Methods

24

Hybrid Costing
Hybrid
Hybridcosting
costingemploys
employssome
someaspects
aspects
of
both
job-order
and
process
costing.
of both job-order and process costing.

Job-order
Process
Costing
Costing

Hybrid Costing
(Products produced in batches)

Material Costs Charged


to batches as in
job-order costing.

Labour and overhead


costs assigned to
batches as in process
costing.

Types of Physical Production Flows


Sequential product flow each product is
processed in the same series of steps.
Parallel product flow certain portions of
the work are done simultaneously and then
brought together in a final process or
processes for completion and transfer to
finished goods.
Selective product flow the product moves
to different departments within the plant,
depending on what final product is to be
produced.
26

Sequential Product Flow

27

Parallel Product Flow

28

Selective Process Flow

29

Comparing Job Costing and


Process Costing
Same objective:
objective: determine
determine
Same
the cost
cost of
of products
products
the

Same
Same Inventory
Inventory accounts:
accounts: raw
raw materials,
materials,
work
work in
in process,
process, and
and finished
finished goods
goods

Same
Same overhead
overhead assignment
assignment method:
method:
predetermined
predetermined rate
rate times
times actual
actual activity
activity
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Equivalent Units
Samenow
objective:
determine
We must
deal with
the concept
the
cost of products
of
equivalent
units.

Equivalent
unitsaccounts:
is a concept
expressing
Same
Inventory
raw
materials,
partially
units
asfinished
a smaller
number
workcomplete
in process,
and
goods
of fully complete units.
Cost
per
Same
overhead
assignmentcosts
method:
Manufacturing
for a
equivale =
predetermined
rate times
actual activity
period
nt
Equivalent units for the
unit
period

31

Equivalent Units
Two one-half filled cups are
equivalent to one full cup.

So, 10,000 units 70 percent


complete
are equivalent to 7,000 complete
units.

32

Equivalent Units
During
During its
its first
first month
month of
of business,
business, you
you
started
started 15,000
15,000 units
units and
and completed
completed
10,000
10,000 units,
units, leaving
leaving 5,000
5,000 units
units in
in
process
process 30
30 percent
percent complete.
complete. How
How
many
many equivalent
equivalent units
units of
of production
production
did
did you
you have
have for
for the
the month?
month?
a.
a. 10,000
10,000
b.
b. 11,500
11,500
c.
c. 13,500
13,500
d.
d. 15,000
15,000
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Equivalent Units
During
During its
its first
first month
month of
of business,
business, you
you
started
started 15,000
15,000 units
units and
and completed
completed
10,000
10,000 units,
units, leaving
leaving 5,000
5,000 units
units in
in
process
process 30
30 percent
percent complete.
complete. How
How
many
many equivalent
equivalent units
units of
of production
production
did
did you
you have
have for
for the
the month?
month?
a.
a. 10,000
10,000 10,000 units + (5,000 units
.30)
b.
b. 11,500
11,500 = 11,500 equivalent units
c.
c. 13,500
13,500
d.
d. 15,000
15,000
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Cost per Equivalent Units


Now
Now assume
assume that
that you
you incurred
incurred
P27,600
P27,600
in
in production
production costs
costs for
for the
the 11,500
11,500
equivalent
equivalent units.
units. What
What was
was your
your cost
cost
per
per equivalent
equivalent unit
unit for
for the
the period?
period?
a.
a. P1.84
P1.84
b.
b. P2.40
P2.40
c.
c. P2.76
P2.76
d.
d. P2.90
P2.90
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Cost per Equivalent Units


Now
Now assume
assume that
that you
you incurred
incurred
P27,600
P27,600
in
in production
production costs
costs for
for the
the 11,500
11,500
equivalent
equivalent units.
units. What
What was
was your
your cost
cost
per
per equivalent
equivalent unit
unit for
for the
the period?
period?
P27,600 11,500
a.
P1.84
a.
P1.84
equivalent units
b.
b. P2.40
P2.40
= P2.40 per equivalent
c.
c. P2.76
P2.76
unit
d.
d. P2.90
P2.90
36

Process Costing
Direct material
added at the beginning, during,
and/or at the end of process
Direct labor
added throughout the process
Overhead
added throughout the process
based on direct labor or other
multiple cost drivers
37

Journal Entries

38

Journal Entries

39

Journal Entries

40

Journal Entries

41

Journal Entries

42

Calculating Equivalent Units


Equivalent
Equivalent units
units can
can be
be calculated
calculated two
two
ways:
ways:

The
The Weighted-Average
Weighted-Average Method
Method

The
The First-In,
First-In, First-Out
First-Out Method
Method

43

Compute the equivalent units


of production using the
Weighted Average Method

44

Equivalent Units of Production


Weighted-Average Method
The weighted-average method . . .
Makes no distinction between work done in prior
or current periods.
Blends together units and costs from prior and
current periods.
Determines equivalent units of production for a
department by adding together the number of
units transferred out plus the equivalent units in
ending work in process inventory.
45

Weighted-Average Example
Double Diamond Skis reported the following
activity in Shaping and Milling Department for
the month of May:

46

Weighted-Average Example
The first step in calculating the equivalent units is to
identify the units completed and transferred out of
the Department in May (4,800 units)

47

Weighted-Average Example
The second step is to identify the equivalent units of
production in ending work in process with respect
to materials for the month (160 units) and add this
to the 4,800 units from step one.

48

Weighted-Average Example
The third step is to identify the equivalent units of
production in ending work in process with respect to
conversion for the month (100 units) and add this to
the 4,800 units from step one.

49

Weighted-Average Example
Equivalent
Equivalent units
units of
of production
production always
always equals:
equals:
Units
Units completed
completed and
and transferred
transferred
++ Equivalent
Equivalent units
units remaining
remaining in
in work
work in
in process
process

50

Weighted-Average Example
Materials
Materials
Beginning
Work in Process
200 Units
55% Complete

5,000 Units Started

4,600 Units Started


and Completed

4,800 Units Completed


160 Equivalent Units
4,960 Equivalent units
of production

Ending
Work in Process
400 Units
40% Complete

400 40%
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Weighted-Average Example
Conversion
Conversion
Beginning
Work in Process
200 Units
30% Complete

5,000 Units Started

4,600 Units Started


and Completed

4,800 Units Completed


100 Equivalent Units
4,900 Equivalent units
of production

Ending
Work in Process
400 Units
25% Complete

400 25%
52

Weighted-Average Example
Alternative presentation:

Materials Conversion
Beginning WIP inventory
200
200
Started and completed
4,600
4,600
Ending WIP inventory
160
100
Equivalent units
4,960
4,900

53

Compute the equivalent units


of production using the
First-in, First-out Method

54

Equivalent Units FIFO Method


Lets revisit the Double Diamond Skis example.
Assume the following activity is reported in Shaping
and Milling Department for May:

55

Equivalent Units FIFO Method


Step 1:
1 Determine equivalent units needed to
complete beginning inventory.

56

Equivalent Units FIFO Method


Step 2:
2 Determine units started and completed during
the period.

57

Equivalent Units FIFO Method


Step 3:
3 Add the equivalent units in ending working in
process inventory.

58

FIFO Example
Materials
Materials
Beginning
Work in Process
200 Units
55% Complete

200 45%

5,000 Units Started

4,600 Units Started


and Completed

90 Equivalent Units
4,600 Units Completed
160 Equivalent Units
4,850 Equivalent units
of production

Ending
Work in Process
400 Units
40% Complete

400 40%

59

FIFO Example
Conversion
Conversion
Beginning
Work in Process
200 Units
30% Complete

200 70%

5,000 Units Started

4,600 Units Started


and Completed

140 Equivalent Units


4,600 Units Completed
100 Equivalent Units
4,840 Equivalent units
of production

Ending
Work in Process
400 Units
25% Complete

400 25%

60

Equivalent Units: Weighted Average vs.


FIFO
As shown below, the equivalent units in beginning inventory are
subtracted from the equivalent units of production per the weightedaverage method to obtain the equivalent units of production under the
FIFO method.

61

A Comparison of Costing
Methods
In a lean production environment, FIFO and
weighted-average methods yield similar unit
costs.
When considering cost control, FIFO is
superior to weighted-average because it
does not mix costs of the current period with
costs of the prior period.

Solve:
17-16
17-17
17-18
(#1)
17-19
17-21
17-30

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