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Process Costing

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Chapter Eleven Process Costing Identify the types of firms or operations for which a process costing system is most suitable Explain and calculate equivalent units ... – PowerPoint PPT presentation

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Title: Process Costing


1
Process Costing
Chapter Eleven
2
Learning Objectives
  • Identify the types of firms or operations for
    which a process costing system is most suitable
  • Explain and calculate equivalent units produced
  • Describe the five steps in process costing
  • Demonstrate the weighted-average method of
    process costing
  • Demonstrate the FIFO method of process costing

3
Learning Objectives (continued)
  • Apply process costing to a firm with multiple
    departments
  • Prepare journal entries to record the flow of
    costs in a process cost system
  • Explain how process cost systems are implemented
    and enhanced in practice
  • Account for spoilage in process costing

4
Process Costing
  • Process costing a product costing system that
    accumulates costs according to processes or
    departments
  • Accumulated costs are spread over output of the
    period
  • Used when outputs are standardized/ homogeneous
  • Examples chemicals, oil refining, textiles,
    paints, flour, canneries, rubber, steel, glass,
    cement, and sporting goods

5
Production Cost Report
  • Prepared each period (e.g., each month) for each
    department
  • Each department has its own WIP Inventory account
  • The production cost report summarizes
  • The number of physical and equivalent units
  • Costs incurred during the period
  • Cost per equivalent unit for each cost element
    (e.g., DL, DM, factory overhead)
  • Costs assigned to units completed and to units in
    ending WIP inventory

6
Production Cost Report (continued)
  • Equivalent units
  • A measure of output for the period
  • Example 2 units 50 complete 1 unit fully
    complete
  • An expression of partially completed units in
    terms of fully completed units
  • Cost/equivalent unit costs in each department
    for the period by the number of equivalent
    units produced during the period
  • Definition of numerator and denominator depends
    on whether FIFO or weighted-average method is used

7
Some Cost Issues
  • Because of the relatively small DL content in
    many process industries, factory overhead and DL
    costs are often combined into a separate cost
    element and called conversion costs
  • Many firms incur conversion costs uniformly
    throughout the production process
  • DM costs can be added at discrete points of
    manufacturing or continuously over production (in
    the latter case, DM for equivalent-unit purposes
    will be calculated using the same proportion as
    conversion costs)

8
Flow of Costs in Process Costing
9
Completing the Production Cost Report 5 Steps
  • Account for the physical units
  • Calculate equivalent units for each
    manufacturing cost element (FIFO or
    weighted-average method)
  • Determine total costs for each manufacturing
    cost element (FIFO or weighted-average method)
  • Compute cost per equivalent unit for each
    manufacturing cost element
  • Assign total manufacturing costs to units
    completed and ending WIP Inventory

10
Weighted-Average vs. FIFO?
  • The weighted average method includes all costs
    (i.e., beginning WIP inventory current period
    manufacturing costs) in calculating cost per
    equivalent unit for each cost element the unit
    cost
  • Thus, prior period and current period costs are
    averaged
  • The FIFO method includes in calculating the unit
    cost only costs incurred and work effort
    performed during the current period
  • Thus, FIFO costs represent the current periods
    cost per equivalent unit for each manufacturing
    cost element

11
Process Costing Example
HSU Toy Company has two production departments,
molding and finishing. Molding places direct
materials into production at the beginning of the
process. Direct labor and factory overhead costs
are incurred gradually throughout the process
with different proportions. The molding
departments units of production and costs for
the month of June are provided.
12
Process Costing Example (continued)
13
Step 1 Account for Physical Product Flow
14
Step 2 Calculate Equivalent Units for Each Cost
Element
15
Step 3 Determine Total Cost for Each Cost Element
Total Costs for Each Manufacturing Cost Element
Numerator in cost per equivalent unit
calculation (and is different for FIFO vs.
Weighted-Average method)
16
Step 4 Calculate Cost per Equivalent Unit for
Each Cost Element
17
Step 5 Cost Assignment
18
FIFO Example Step 1
19
Step 2, Alternative 1 Calculate FIFO Equivalent
Units
20
Step 2, Alternative 2 Calculate FIFO Equivalent
Units
21
Step 3 Calculate FIFO (i.e., Current Period)
Costs
22
Step 4 Calculate FIFO Costs per Equivalent Unit
23
Step 5, Part 1 Assign Costs to Units Completed
from Beginning WIP Inventory
24
Step 5, Part 2 Assign Costs to Units Started
Completed and Account for Total Costs
25
Weighted-Average vs. FIFO
Weighted-Average FIFO
Handling of partially completed beginning WIP No separate treatment Separates the units in the beginning WIP (and their costs) from the units started and completed during the period
Ease of calculation and appropriateness Easier best in situations where WIP is small and prices/costs are stable More difficult best in situations where prices/costs fluctuate better for control purposes
26
Process Costing with Multiple Departments
  • As a product passes from one department to
    another, the accumulated cost passes from
    department to department
  • Transferred-in costs, or prior department costs,
    are costs of work performed in earlier
    departments that are transferred into the present
    department
  • These costs are treated like an additional cost
    element

27
Implementation and Enhancement of Process Costing
  • Sometimes process-based manufacturers have very
    different products going through different
    processes, making process costing by itself
    inadequate
  • Activity-based costing (ABC) is an important
    enhancement to process costing when product and
    process variety arises
  • Process costing also lacks the ability to
    identify the most profitable product mix--to
    remedy this shortcoming we might use
  • The contribution methods (Chapter 9)
  • The theory of constraints (Chapter 10)

28
Spoilage in Process Costing
  • There are two options to account for normal
    spoilage
  • Count the number of spoiled units, prepare a
    separate equivalent unit computation with the
    cost per unit of the spoiled goods, and then
    allocate the cost of spoilage to the good units
    produced
  • Omit the spoiled units in computing the
    equivalent units of production the spoilage cost
    is thus included as part of total manufacturing
    costs

29
Chapter Summary
  • Process costing is a product costing system that
    accumulates costs according to processes or
    departments and assigns them to a large number of
    nearly identical products
  • The typical firm that uses process costing
    employs a standardized production process (often
    mass production) to manufacture homogeneous
    products
  • Process costing is used in industries such as
    chemicals, oil refining, textiles, paints, flour,
    canneries, rubber, steel, glass, cement, and
    sporting goods

30
Chapter Summary (continued)
  • Each period, each department prepares a
    production cost report
  • Five steps in preparing a production cost report
  • Analyze the physical flow of units
  • Calculate equivalent units for each manufacturing
    cost element (FIFO or Weighted-average method)
  • Determine total costs for each manufacturing cost
    element (FIFO or Weighted-average method)
  • Compute cost per equivalent unit for each
    manufacturing cost element
  • Allocate total manufacturing costs for the period
    to units completed and to ending WIP

31
Chapter Summary (continued)
  • The weighted average method includes all costs
    in calculating unit costs, including both costs
    incurred during the period and those in the
    beginning WIP inventory (i.e., those costs
    brought forward from last period into the current
    period)
  • Thus, prior period and current period costs are
    averaged

32
Chapter Summary (continued)
  • The FIFO method includes in calculating
    equivalent unit cost only costs incurred and work
    effort performed during the current period thus,
    the FIFO costs can be considered current period
    manufacturing costs per equivalent unit for each
    cost element
  • For cost assignment purposes, the cost of units
    from the beginning WIP inventory will include a
    combination of last periods costs the current
    periods (FIFO) cost to complete the units
  • Units that are both started and completed during
    the period are assigned the current period costs
    per equivalent unit
  • Ending inventory is assigned the current (FIFO)
    periods costs

33
Chapter Summary (continued)
  • Transferred-in costs, or prior department costs,
    are costs of work performed in an earlier
    department that are transferred into the present
    department
  • These costs are treated like an additional cost
    element
  • Activity-based costing (ABC), the contribution
    methods, and the theory of constraints are
    important enhancements to a process costing
    system
  • There are two options when accounting for
    spoilage
  • Calculate the cost per spoiled unit and allocate
    it to the good units
  • Omit the spoiled units from the computation
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